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Reed J. Taylor, A Single Person v. Aia Services Corporation

September 7, 2011

REED J. TAYLOR, A SINGLE PERSON, PLAINTIFF/COUNTERDEFENDANT/APPELLANT/ CROSS-RESPONDENT,
v.
AIA SERVICES CORPORATION, AN IDAHO CORPORATION; AIA INSURANCE, INC., AN IDAHO CORPORATION; R. JOHN TAYLOR AND CONNIE TAYLOR, INDIVIDUALLY, AND THE COMMUNITY PROPERTY COMPRISED THEREOF; BRYAN FREEMAN, A SINGLE PERSON; JOLEE DUCLOS, A SINGLE PERSON; AND JAMES BECK AND CORRINE BECK, DEFENDANTS/COUNTERCLAIMANTS/ RESPONDENTS/CROSS-APPELLANTS, AND CROP USA INSURANCE AGENCY, INC., AN IDAHO CORPORATION, DEFENDANT-RESPONDENT, AND 401(K) PROFIT SHARING PLAN FOR THE AIA SERVICES CORPORATION, INTERVENOR/CROSS-APPELLANT.



Appeal from the District Court of the Second Judicial District, State of Idaho, Nez Perce County. Hon. Jeff M. Brudie, District Judge.

The opinion of the court was delivered by: Burdick, Chief Justice

2011 Opinion No. 97

Stephen W. Kenyon, Clerk

District court decision granting partial summary judgment and dismissing causes of action, affirmed.

On July 12, 1995, AIA Services Corporation (AIA Services) entered into a Stock Redemption Agreement with Appellant Reed Taylor to purchase all of his shares (613,494 shares) in AIA Services for a $1.5 million down payment promissory note, a $6 million promissory note and other consideration. Reed Taylor is the founder of AIA Insurance, Inc. (AIA Insurance), which is a wholly-owned subsidiary of AIA Services, and at the time he negotiated the Stock Redemption Agreement, Reed Taylor was the majority shareholder of AIA Services. AIA Services failed to pay a $1.5 million note issued to Reed Taylor under the Stock Redemption Agreement when it became due on October 20, 1995. Reed Taylor and AIA Services agreed to modify the Stock Redemption Agreement and entered into the Stock Redemption Restructure Agreement, but thereafter, AIA Services failed to make certain payments that had become due under the new terms. On January 29, 2007, Reed Taylor filed suit against AIA Services, AIA Insurance and John Taylor, seeking to recover the amounts owed on the two promissory notes.

On June 17, 2009, the district court granted partial summary judgment in favor of Respondents and dismissed six of Reed Taylor's causes of action upon finding the Stock Redemption Agreement to be illegal and unenforceable under the 1995 version of I.C. § 30-1-6, which restricts a corporation to use only earned surplus and, under certain circumstances, capital surplus when redeeming its shares. Reed Taylor appeals, arguing that the Stock Redemption Agreement complies with I.C. § 30-1-6 and that even if the Stock Redemption Agreement fails to comply with I.C. § 30-1-6, it is still enforceable under numerous theories. Reed Taylor also argues that the district court committed multiple errors in its proceedings. Respondents cross appeal, arguing that all causes of action in Reed Taylor's Complaint should be dismissed. We affirm.

I. FACTUAL AND PROCEDURAL BACKGROUND

Reed Taylor is the founder of AIA Insurance, an insurance agency based in Lewiston, Idaho, which sells insurance products to farmers and members of various agricultural growers associations. Reed Taylor was the majority shareholder of AIA Services, a holding company which has wholly-owned AIA Insurance at all times relevant to this lawsuit. In 1995, he held 63 percent of approximately 973,000 outstanding shares of AIA Services common stock and served as the Chairman of the Board of Directors and the Chief Executive Officer of AIA Services.

AIA Services noticed a meeting of shareholders to be held on March 7, 1995, to consider various transactions, including exercising an option to purchase 500,000 of Reed Taylor's 613,494 shares of AIA Services common stock for $7.5 million. At the March 7, 1995 special meeting of shareholders, AIA Services shareholders approved the purchase of Reed Taylor's shares as well as other transactions. The shareholders were not provided information as to the source of funds from which Reed Taylor's shares would be purchased. The plan to redeem Reed Taylor's shares was not consummated because AIA Services failed to raise the necessary funds through the private placement of Series B Preferred Stock and Series C Preferred Stock and Warrants, which the board approved by resolution on January 12, 1995.

AIA Services sent a letter to its shareholders announcing that it could not proceed with the previously approved plan and announced a new plan for reorganization, which included redeeming all of Reed Taylor's AIA Services common stock for $7.5 million and other consideration, including airplanes and debt forgiveness. The letter sought shareholder approval to cancel the previously authorized Series B Preferred Stock and to amend the Articles of Incorporation to increase the number of authorized shares of Series C Preferred Stock from 150,000 to 500,000 shares. The letter informed the shareholders that the sale of the additional Series C Preferred Stock would be used to retire certain Series A Preferred Stock, to retire bank debt and/or to fund the balance of the redemption price due to Reed Taylor. The letter was accompanied by a Confidential Private Placement Memorandum, dated June 1, 1995 ("PPM"), offering up to 500,000 shares of Series C Preferred Stock for $10 per share. The PPM explained: "Assuming the Company sells the maximum number of Shares offered hereby, the net proceeds from this private placement are expected to be sufficient . . . . If the Company sells only the minimum number of shares, additional financing will be required to complete the proposed reorganization."

On July 12, 1995, AIA Services issued an Amended Notice of Special Meeting of AIA Services Shareholders to occur on July 18, 1995, accompanied by a Disclosure Statement. The notice states that certain transactions contemplated as part of the new reorganization plan require shareholder approval. Neither the notice nor the accompanying disclosure mentions the redemption of Reed Taylor's common stock. At the July 18 meeting, the shareholders were not asked to approve, and did not approve, the redemption of Reed Taylor's common stock. However, on that day, AIA Services' Board of Directors authorized the redemption of Reed Taylor's common stock for $7.5 million and other consideration. The resolution provides that "the amount of the down payment for Mr. Taylor's Common Stock which [AIA Services] may be able to afford will depend on the amount of proceeds from commercial loans and from the sale of additional Series C Preferred Stock and attendant warrants."

AIA Services and Reed Taylor entered into a Stock Redemption Agreement effective July 22, 1995, to redeem all of Reed Taylor's common stock for $7.5 million and other consideration. AIA Services originally agreed to pay $1.5 million at the closing of the Stock Redemption Agreement; however, the parties entered into an Addendum whereby AIA Services would issue a $1.5 million down payment note payable 90 days after closing (the "$1.5M Note"). Pursuant to the Stock Redemption Agreement, Reed Taylor was given debt forgiveness, transfer of title to airplanes and other payments aggregating over $2 million. The balance of the $7.5 million redemption price was to be paid pursuant to a promissory note dated August 1, 1995, in the principal amount of $6 million (the "$6M Note"). The $6M Note provided for monthly interest payments and for all principal and accrued interest to be paid on August 1, 2005. As collateral for the Stock Redemption Agreement, the parties entered into a security agreement that granted Reed Taylor a secured interest in most of AIA Services' assets.

AIA Services was not able to pay the $1.5M Note when it became due on October 20, 1995, and Reed Taylor notified AIA Services that it was in default by three letters from April through June, 1996. On July 1, 1996, Reed Taylor and AIA Services executed the Stock Redemption Restructure Agreement, which called for the $1.5M Note to be paid on October 31, 1996, and the $6M Note to be paid in full on July 1, 2005, with interest payments for ten years. AIA Services again failed to pay the $1.5M Note when it became due, and AIA Services fell behind in making interest payments on the $6M Note.

On January 29, 2007, Reed Taylor filed the Complaint in this lawsuit seeking to obtain the money owed under the Stock Redemption Agreement and the Stock Redemption Restructure Agreement (collectively hereinafter the "Stock Redemption Agreement"). The defendants (hereinafter "Respondents") include AIA Services, AIA Insurance and John Taylor (Reed Taylor's brother and business partner), who were named in the original complaint, as well as other managers and directors of AIA Services, who were added in later amended complaints. The 401(k) Profit Sharing Plan for AIA Services Corporation (the Plan) intervened to assert the illegality of the Stock Redemption Agreement.

In April, 2008, Respondents filed a motion for partial summary judgment concerning the legality of the Stock Redemption Agreement, arguing that when the agreement was entered into, it violated the then-existing I.C. § 30-1-6, which authorizes corporations to redeem their shares but places restrictions on the source of funds used to redeem shares. The district court granted partial summary judgment in favor of Respondents in its Opinion and Order dated June 17, 2009. The district court found that the Stock Redemption Agreement violated I.C. § 30-1-6 because AIA Services did not have any earned surplus when it entered into the agreement and was not authorized by its articles of incorporation or by majority shareholder vote to use capital surplus to pay for Reed Taylor's shares. The district court then declared the Stock Redemption Agreement illegal and unenforceable and concluded that it must leave the parties where it finds them.

The district court denied Reed Taylor's motion for reconsideration in its Opinion and Order dated August 13, 2009. The district court issued a Judgment dismissing six of the eleven causes of action in Reed Taylor's Fifth Amended Complaint. Reed Taylor appealed to this Court. On September 01, 2010, we granted Respondents' motion to dismiss certain extraneous issues raised on appeal by Reed Taylor which were beyond the scope of the I.R.C.P. 54(b) certified partial judgment.

II. STANDARD OF REVIEW

This Court set forth the standard of review for an appeal from an order on summary judgment in Jones v. HealthSouth Treasure Valley Hospital:

When reviewing an order for summary judgment, this Court applies the same standard of review as was used by the trial court in ruling on the motion for summary judgment. See Cristo Viene Pentecostal Church v. Paz, 144 Idaho 304, 307, 160 P.3d 743, 746 (2007). Summary judgment is proper "if the pleadings, depositions, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." I.R.C.P. 56(c). "If there is no genuine issue of material fact, only a question of law remains, over which this Court exercises free review." Cristo, 144 Idaho at 307, 160 P.3d at 746 (quoting Infanger v. City of Salmon, 137 Idaho 45, 47, 44 P.3d 1100, 1102 (2002)).

"It is axiomatic that upon a motion for summary judgment the non-moving party may not rely upon its pleadings, but must come forward with evidence by way of affidavit or otherwise which contradicts the evidence submitted by the moving party, and which establishes the existence of a material issue of disputed fact." Zehm v. Associated Logging Contractors, Inc., 116 Idaho 349, 350, 775 P.2d 1191, 1192 (1988). This Court liberally construes all disputed facts in favor of the nonmoving party, and all reasonable inferences drawn from the record will be drawn in favor of the nonmoving party. Cristo, 144 Idaho at 307, 160 P.3d at 746. If reasonable persons could reach differing conclusions or draw conflicting inferences from the evidence presented, then summary judgment is improper. McPheters v. Maile, 138 Idaho 391, 394, 64 P.3d 317, 320 (2003).

147 Idaho 109, 112, 206 P.3d 473, 476 (2009).

"The burden of showing the trial court abused its discretion rests with the appellant." Walker v. Boozer, 140 Idaho 451, 456, 95 P.3d 69, 74 (2004). In reviewing a trial court's abuse of discretion, this Court considers: (1) whether the court correctly perceived the issue as discretionary; (2) whether the court acted within the outer boundaries of its discretion and consistently with applicable legal standards; and (3) whether it reached its decision by an exercise of reason. Stewart v. Stewart, 143 Idaho 673, 678, 152 P.3d 544, 549 (2007).

This Court will not consider an issue which is not supported by argument and authority in the opening brief. Liponis v. Bach, 149 Idaho 372, 374, 234 P.3d 696, 698 (2010). "The argument shall contain the contentions of the appellant with respect to the issues presented on appeal, the reasons therefor, with citations to authorities, statues and parts of the transcript and the record relied upon." I.A.R. 35(a)(6).

"This Court will not reverse the trial court if an alleged error is harmless. . . . [I]f an error did not affect a party's substantial rights or the error did not affect the result of the trial, the error is harmless and not grounds for reversal." Myers v. Workmen's Auto Ins. Co., 140 Idaho 495, 504, 95 P.3d 977, 986 (2004). See I.R.C.P. 61 ("The court at every stage of the proceeding must disregard any error or defect in the proceeding which does not affect the substantial rights of the parties.").

III. ANALYSIS

The district court granted partial summary judgment in favor of Respondents upon determining that the Stock Redemption Agreement violated I.C. § 30-1-6 and was, therefore, illegal. Idaho Code § 30-1-6 (1995)*fn1 provides, in relevant part:

Right of corporation to acquire and dispose of its own shares. A corporation shall have the right to purchase . . . its own shares, but purchases of its own shares . . . shall be made only to the extent of unreserved and unrestricted earned surplus available therefor, and, if the articles of incorporation so permit or with the affirmative vote of the holders of a majority of all shares entitled to vote thereon, to the extent of unreserved and unrestricted capital surplus available therefor.

Thus, pursuant to I.C. § 30-1-6, a corporation is generally authorized to use earned surplus to redeem shares; whereas, the use of capital surplus to redeem shares requires authorization either in the articles of incorporation or by majority shareholder vote.

On appeal, Reed Taylor argues: (1) AIA Services had sufficient earned surplus to enter into the Stock Redemption Agreement; (2) AIA Services was authorized by shareholder vote to redeem the shares out of capital surplus; (3) I.C. § 30-1-6 does not apply, because AIA Services redeemed Reed Taylor's shares on credit; (4) Respondents and the Plan are barred from asserting illegality, because they are not intended beneficiaries of I.C. 30-1-6; and (5) even if the Stock Redemption Agreement is illegal, it is nevertheless enforceable under multiple exceptions to illegality. Reed Taylor also raises other issues, all of which are addressed in turn. On cross appeal, Respondents argue that the district court erred in dismissing only six of Reed Taylor's causes of action and ask this Court to dismiss the remaining five causes of action.

A. The Stock Redemption Agreement violates I.C. § 30-1-6.

1. AIA Services had no earned surplus when it entered into the Stock Redemption Agreement.

Pursuant to the Stock Redemption Agreement, AIA Services agreed to pay Reed Taylor $7.5 million and give other consideration. In the Opinion and Order dated June 17, 2009, the district court found:

Without exception, each of the accountants, including Plaintiff's expert, found AIA had no earned surplus in the years 1995 and 1996, but instead had an earned deficit. During oral arguments, counsel for Plaintiff conceded that the earned surplus numbers for AIA in 1995 and 1996 were in the negative and that no amount of accounting adjustment of numbers would turn the earned surplus sufficient to cover the $7.5 million debt incurred to Reed Taylor.

According to Reed Taylor, while he admits to acknowledging that AIA Services' balance sheets suggest that it had insufficient earned surplus, a corporation's balance sheet is not the conclusive indicator of earned surplus. Reed Taylor argues that the district court erred when it failed to consider the fair market value of AIA Services and asserts that the following evidence shows that AIA Services had sufficient earned surplus to redeem his shares: (1) appraisals from 1995 and 1996 that value a minority interest in AIA Services at $2 million and $4 million respectively; (2) a 1994 appraisal valuing the whole company at over $19 million; (3) Reed Taylor's valuation of the commissions and contractual relationships held by AIA Services at over $24 million in 1995; and (4) AIA Services' projection of substantial earnings upon redeeming Reed Taylor's shares and redirecting the company.

Reed Taylor relies primarily on Klang v. Smith's Food & Drug Centers, Inc., 702 A.2d 150, 152 (Del. 1997), where the Delaware Supreme Court explained that "[b]alance sheets are not . . . conclusive indicators of surplus or a lack thereof." However, at issue in Klang was whether a corporation had sufficient "surplus" to redeem shares without violating a statutory prohibition against the impairment of capital. Id. at 153. In the case at hand, "earned surplus" is at issue, which Idaho Code distinguished from "surplus."

"Surplus" is defined in Idaho as "the excess of the net assets of a corporation over its stated capital." I.C. § 30-1-2(k). "Earned surplus" is defined as follows:

"Earned surplus" means the portion of the surplus of a corporation equal to the balance of its net profits, income, gains and losses from the date of incorporation, or from the latest date when a deficit was eliminated by an application of its capital surplus or stated capital or otherwise, after deducting subsequent distributions to shareholders and transfers to stated capital and capital surplus to the extent such distributions and transfers are made out of earned surplus. Earned surplus shall include also any portion of surplus allocated to earned surplus in mergers, consolidations, or acquisitions of all or substantially all of the outstanding shares or of the property and assets of another corporation, domestic or foreign.

I.C. § 30-1-2(l) (emphasis added). "Capital surplus" is defined as "the entire surplus of a corporation other than its earned surplus." I.C. § 30-1-2(m).

American Law Reports explains:

[G]enerally for the protection of its creditors, the right of a corporation to purchase its own stock has been limited in various ways, such as a prohibition against such purchase when it would impair the capital of the corporation or while it is insolvent or when the transaction will render it insolvent.

Apparently to make it easier to determine whether a corporation, at a particular point in time, may legally purchase its own shares, some states have required, by statute, that corporations may purchase their shares of stock only out of some fund in excess of capital, expressly limited by some statutes to earned surplus and more broadly defined by others to include surplus in general. In other words, a corporation cannot use its capital to purchase its stock. The terms "surplus" and "surplus profits" usually include various types of surplus which generally represent the excess of the aggregate value of assets over and above the aggregate value of liabilities. It has, however, been pointed out that whether a corporation has a surplus should be determined by examining the actual value, not the book value, of the corporation. On the other hand, "earned surplus" has a narrower scope and has been construed to include only actual earnings or profits.

61 A.L.R.3d 1049 ch. I § 2 (2009) (emphasis added).

First, Reed Taylor provides no argument or explanation as to how any of the four pieces of evidence he set forth constitute earned surplus as then defined by I.C. § 30-1-2(k): profits, income or gains. Even if they do go toward earned surplus, Reed Taylor provides no argument or explanation as to whether they create a sufficient amount of earned surplus such that the agreement satisfies I.C. § 30-1-6. In his brief, Reed Taylor merely asserts that earned surplus is not limited to balance sheets and sets forth the four pieces of evidence.

Second, none of these four pieces of evidence upon which Reed Taylor relies constitute earned surplus. As to AIA Services' projections of future earnings and to Reed Taylor's valuation of AIA Services' commissions and contractual obligations, these are anticipated earnings, not actual earnings, and are not earned surplus. See Mindenburg v. Carmel Film Prods., 282 P.2d 1024, 1030 (Cal. Ct. App. 1955) ("The law is settled to the effect that paper profits, or anticipated earnings, or accrued items of debit or credit are not to be taken into consideration in computing earned surplus, either for purpose of dividends or as a basis for corporate purchase of its own shares of stock."). As to the other two pieces of evidence Reed Taylor puts forth, which are the appraisals of the company and the appraisals of minority shareholder interests, even assuming that they show some kind of increase in value (which Reed Taylor does not explain in his brief), such increases would not be earned surplus. See Berks Broadcasting Co. v. Craumer, 52 A.2d 571, 573 (Pa. 1947) (earned surplus does not include an unrealized appreciation in the value of fixed assets but must be founded on actual earnings or profits).

Therefore, we affirm the district court's finding that AIA Services had insufficient earned surplus at the time it entered into the Stock Redemption Agreement.

2. AIA Services was not authorized to use capital surplus to fund the Stock Redemption Agreement.

Respondents and the Plan argue, and the district court held, that in order to authorize the use of capital surplus by shareholder vote, the shareholder vote must explicitly authorize the use of capital surplus and that the shareholder votes approving the Stock Redemption Agreement and the Resolutions failed to satisfy I.C. ยง 30-1-6 because they did not specifically designate the source of funds for the payment of the promissory notes. Reed Taylor argues that AIA Services' shareholders impliedly authorized the use of capital surplus by voting in favor of the Stock Redemption Agreement. More specifically, according to Reed Taylor, the AIA Services shareholder votes approving the Stock Redemption Agreement and the Resolutions impliedly authorized the use of capital surplus, because: (1) the February 9, 1995 Notice of Special Meeting of Shareholders to approve the Stock Redemption Agreement sought approval for "[a]ll corporate actions necessary to . . . reorganize the Company"; (2) the March 7, 1995 shareholder vote in favor of the Stock Redemption Agreement approved "[a]ll other corporate actions necessary" and was not conditioned on AIA Services first selling a certain ...


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