Aggrieved minority shareholder or opportunist? Sometimes the answer turns on contract interpretation, as it did in a recent lawsuit between the owner of a genetics testing company called Xitenel, Inc. and a would-be 10% shareholder who sued for his alleged share of profits after the company was sold to a third party.
The court’s decision issued last month, authored by Nassau County Commercial Division Justice Ira B. Warshawsky, finds that the plaintiff’s brief period of employment with the company, against a backdrop of informal discussions, email exchanges and an unsigned offer letter, never coalesced into an enforceable agreement giving the plaintiff his desired 10% interest. Bombard v. Xitenel, Inc., 2011 NY Slip Op 31387(U) (Sup Ct Nassau County May 24, 2011).
There’s nothing novel about litigation of this kind. Frequently the issue arises as a threshold contest over the standing of the petitioner to seek judicial dissolution based on shareholder oppression or deadlock. In other instances, such as in Bombard and in another case I wrote about last year called Kun v. Fulop, the plaintiff sues for a judicial declaration of his or her ownership interest and entitlement to associated economic and shareholder voting rights.
Plaintiff Allan Bombard and defendant Leonard Kellner were long-time acquaintances when Bombard, a physician, assisted Kellner, a non-physician, in establishing Xitenel as a licensed genetics testing laboratory company. In 2008, after Kellner thought he had lined up $10 million private equity financing, Kellner recruited Bombard for CEO of Xitenel at an annual salary of $450,000. Bombard simultaneously was being recruited by another lab.
In August 2008, when Bombard still was actively considering joining the other lab, Kellner sent an email to Bombard trying to convince him that he’d be better off joining Xitenel, in which Kellner wrote, "I got [the private equity investor] to cover your nut . . . plus I am giving you 10% of [Xitenel] in writing." The email’s final sentence stated, "Before you do something #%&*@!, maybe we both should fly down to Houston when you get back before you give them an answer." Bombard’s email reply agreed to the proposed meeting without indicating an acceptance of any offer.
The following month Bombard and Kellner had an airport meeting at which Bombard allegedly accepted the CEO job. Bombard submitted his written resignation to his employer at the time, and sent Kellner an email so informing him.
After Bombard began his services as CEO in October 2008, he prepared and emailed to Kellner an employment offer letter for himself with a three-year term and a 10% stake in Xitenel. Kellner never signed the letter.
Then the Madoff scandal broke in December 2008, one of whose victims was the private investor lined up by Kellner. The investor backed out leaving Xitenel with insufficient funds to pay Bombard’s salary. Bombard resigned in January 2009 to join another laboratory, promising in an email sent to Kellner to continue assisting "in a non-salaried, ownership role."
Kellner continued to operate Xitenel without Bombard’s help, until he sold the company in March 2010 for about $5.5 million. In June 2010, Bombard filed a complaint against Xitenel and Kellner for breach of contract and breach of fiduciary duty, claiming that he was entitled to statutory notice of the sale transaction and a portion of the proceeds as 10% shareholder.
Xitenel and Kellner moved for summary judgment of dismissal, arguing that Bombard lacked an enforceable agreement giving him a 10% stock interest. (Read here and here Bombard’s and Xitenel’s legal memoranda.) Justice Warshawsky’s 10-page opinion, which includes a helpful tutorial on the law of contract formation, summarizes his acceptance of the defendants’ argument as follows:
The court finds that Kellner’s promise, if any, to grant Bombard a 10% interest in Xitenel did not create a legally binding and enforceable contract because the alleged exchange or agreement lacks two essential elements of any contract, mutual assent to be bound and definiteness.
Mutual assent to be bound is lacking, Justice Warshawsky explains, because Kellner’s email messages relied upon by Bombard "are statements made during the course of preliminary negotiations," and Bombard’s own reply messages are "evidence that Kellner’s statements with regard to a 10% interest in Xitenel did not invite an immediate acceptance such as to conclude a bargain." Kellner’s email reference to giving Bombard a 10% interest in Xitenel "in writing," Justice Warshawsky further notes, shows that Kellner did not intend to be bound until a formal contract was executed.
Justice Warshawsky also finds that Bombard’s conduct after the airport meeting, at which he allegedly accepted the terms of his employment, undermines Bombard’s claims. First, Bombard "attempted to iron out [the] details for his acquisition of a 10% interest in Xitenel by the formal employment agreements he drafted," which Kellner never signed. Second, Bombard’s departure from Xitenel after only three months,
despite having contemplated agreeing to a three-year term of employment, according to his draft employment letter, bolsters the conclusion that Bombard and Kellner never settled on the final details and terms of their agreement by which Bombard was to be CEO for some period of time and in exchange acquire a 10% interest in Xitenel. Bombard’s unsigned employment letter is therefore prima facie evidence that Bombard’s and Kellner’s alleged bargain was never sealed, and that any oral discussions regarding Bombard’s 10% stake in Xitenel constitute non-binding statements in the course of preliminary negotiations which also fail for indefiniteness or lack of material terms.
Justice Warshawsky’s discussion of indefiniteness analogizes a sale or exchange of corporate shares to a real estate conveyance — as opposed to a UCC-governed merchant transaction in which the statute has certain "gap-fillers" to supply missing terms — in which "stability is the hallmark of the law controlling such transactions" and "therefore indefiniteness will not do." The definiteness requirement, also reflected in the Business Corporation Law’s requirement that the corporation maintain a stock ledger, is not vitiated by the repeal some years ago of the statute of frauds for stock conveyances formerly codified in Section 8-319 of the UCC.
The alleged agreement in Bombard lacks the requisite definiteness, Justice Warshawsky finds, because "[i]t is not at all clear what would be the sum and substance of Bombard’s and Kellner’s alleged bargain according to Bombard, or that this sum and substance can be ascertained." For example,
there is no evidence that any terms were agreed to regarding Bombard’s voting rights, ability to transfer his shares, or any methods for valuing Bombard’s shares in the event of liquidation. And, again, Bombard cannot escape the fact that a definite term of employment for his services as CEO was discussed as part of his bargain with Kellner.
Nor did Bombard’s performance as CEO for three months constitute "an acceptance of any definite offer . . . and it did not seal Bombard’s and Kellner’s alleged bargain, given the evidence that a definite term of employment had been considered and no agreement reached." Justice Warshawsky adds:
Thus, if Bombard had in fact stayed on as CEO of Xitenel for three years, he would have a much stronger, if not conclusive case, that he had acquired a 10% ownership in Xitenel. Because he left after only three months, however, his leaving is conclusive proof that he did not complete or render the performance that Kellner had requested, and thus Bombard cannot benefit from Kellner’s promise.
The icing on the cake, so to speak, is Justice Warshawsky’s observation that Bombard "never believed that he was a 10% owner of Xitenel" as evidenced, inter alia, by his failure to report his 10% ownership to the IRS, "even though it would have been in his financial interest to do so." (I assume this means Xitenel made an S corporation election and that, were he a shareholder, Bombard would have been issued K-1s showing deductible losses.)
Bombard illustrates anew the dangers of entering a new business relationship without first obtaining formal agreement. In this case, it appears that the longstanding friendship and presumed trust between the parties, whilst under pressure of pending financing and Bombard’s simultaneous negotiations for a position with a competing laboratory, contributed to a half-baked understanding of terms even as Bombard took over the company’s helm.