Pennsylvania Appellate Court Upholds Appointment of Custodial Receiver after Finding a Shareholder Was Oppressed

Posted in Shareholder Oppression

In Adler v. Tauberg, 881 A.2d 1267 (Pa. Super. 2005), a Pennsylvania Appellate Court upheld an Order of the Court of Common Pleas of Allegheny County appointing Lawrence N. Adler, M.D., (“Adler”), a fifty percent shareholder, director and president of a closely-held Pennsylvania corporation, as custodian to manage the business affairs of the corporation after finding that the defendants oppressed him.

At trial, Adler sought appointment of a custodian on the basis of the defendant’s alleged illegal, oppressive and fraudulent conduct, causing the assets of the closely-held Pennsylvania Corporation to be misapplied and wasted. During the course of the trial, Adler further alleged the defendants wrongly attempted to issue stock and change the rules of governance of the corporation to Adler’s detriment. In granting Adler’s motion for appointment of a custodian, the trial court concluded, inter alia, appellants "had unjustly exercised authority and power over [Adler] with respect to the corporate affairs of [the closely held Pennsylvania Corporation]." Id. at 1267-1268.

In their appeal, the Defendants argued the trial court record did not support the need for the appointment of a custodian, given that the evidence presented was insufficient to sustain a finding they had acted illegally, oppressively or fraudulently within the meaning of the statute. Id. at 1268 (citing 15 Pa.C.S.A. § 1767).

During the course of the trial, the Court heard testimony and came to the following factual conclusions:

  1. The three other directors were attempting to issue stock and change the rules of governance for the corporation to the detriment of the corporation and Adler, who was a director and president of the corporation.
  2. Beginning in October of 2002, the Defendants began to request that Adler retire from the practice and his position as president.
  3. The Defendants initially demanded that Adler’s salary be reduced by one-third, then demanded that his contractually guaranteed salary be revoked and his compensation be tied to his production.
  4. The other members of corporation attempted to divert patients from the care and treatment of Adler.
  5. On November 5, 2003, the other shareholder [appellants] attempted to issue corporate shares to Dr. Tauberg. When the corporation’s counsel advised that a previous written agreement restricting the transfer of corporate shares may have precluded the issuance of these shares, the vote was tabled. On November 18, 2003, defendants Dr. Chandra and Dr. Madhavan (each owning 25% of the shares), voted to increase the number of board members from 3 to 4 and fill the new board seat with Dr. Tauberg. The Defendants then voted to make themselves officers and pay each of them an additional $ 50,000 for serving as officers. This had the effect of reducing Adler’s compensation by $ 37,500.
  6. The Defendants then fired the corporations’ long-time legal counsel and replaced him with their attorney.
  7. The Defendants approved a resolution that paid their attorney’s fees with corporate funds.
  8. The Defendants effectively removed Adler’s power to write checks on the corporation’s bank accounts. The Defendants wrote corporate checks for items with which Adler did not agree.

As a result of considering the evidence, the Trial Court concluded that the ongoing disagreements between the parties negatively affected the functioning of the corporation and could have endangered patient care. Id.

In deciding the appeal, the Superior Court of Pennsylvania Appellate Court held that under 15 Pa.C.S. § 1767, a trial court may appoint a custodian for a corporation upon application of a shareholder when: "[i]n the case of a closely held corporation, the directors or those in control of the corporation have acted illegally, oppressively or fraudulently toward one or more holders or owners of 5 percent or more of the outstanding shares of any class of the corporation in their capacities as shareholders, directors, officers or employees." Id. (quoting 15 Pa.C.S. § 1767(a)(2)).

The Adler Court then held that “Oppressive conduct in the context of a close corporation ‘often takes the form of freezing-out a minority shareholder by removing him from his various offices or by substantially diminishing his power or compensation,’ although no further description is given.” Id. (citing, 15 Pa.C.S. § 1767).

The Superior Court found that there was not a lot of law in Pennsylvania defining oppressive conduct. Rather, the Adler Court recognized that there are three different definitions of “oppressive” conduct utilized by Courts throughout the country. They are:

  1. Oppression as ‘burdensome, harsh and wrongful conduct, a visible departure from the standards of fair dealing and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely;
  2. Oppression is linked to the term directly to breach of the fiduciary duty of good faith and fair dealing majority shareholders owe minority shareholders, a duty that many courts recognize as enhanced in a close corporation setting; and
  3. A third view ties oppression to frustration of the reasonable expectations of the shareholders.

The Adler Court found that Pennsylvania employs the “reasonable expectations of the shareholders” test. That would be the same test used by New York and New Jersey Courts. In finding the same, the Superior Court upheld the trial court’s findings that Adler was oppressed. As such, it affirmed the trial court’s appointment of a custodian to manage the day-to-day affairs of the corporation.

The Adler v. Tauberg decision is important for three reasons. First, the Court found that a 50% owner was found to be an oppressed minority shareholder despite the fact that he controlled half of the company. The Court recognized that although Adler held half of the stock he was being controlled by the other two shareholders who collectively owned the remaining 50% of the corporation’s shares. Second, a custodial receiver may be appointed pursuant to Pennsylvania law if oppression or deadlock is found. Third, the Superior Court used the “reasonable expectations of the shareholder” test when determining shareholder oppression.