Year In Review: 2005 Case Law Developments In Georgia Corporate And Business Organization Law - Part One

This article will report on case law developments in corporate and business organization law reflected in decisions handed down by the Supreme Court of Georgia and the Georgia Court of Appeals during 2005.

Last year was characterized by a surprising level and range of appellate activity in business organization litigation. The Georgia appellate courts rendered decisions during 2005 involving a variety of forms of business organizations – business and nonprofit corporations, statutory close corporations, professional corporations, limited liability companies and general partnerships. Their decisions addressed a wide range of issues, such as piercing the corporate veil; dissolution; shareholder oppression; standing, settlement and special committee investigation and dismissal of derivative actions; fiduciary duties in the purchase and sale of businesses, oral contracts for the formation of partnerships and for the sale of an interest in a corporation; business opportunities and their renunciation; and the enforceability of buy-sell agreements. Many of these decisions apply well-settled principles in typical settings, but others break new ground. We think it would be helpful to survey the 2005 business organization case law generally, novel and settled issues alike, because it helps give practitioners a reading on where matters currently stand. To summarize these developments briefly:

Business Corporations. The Georgia Supreme Court in Baillie Lumber Co. v. Thompson, 279 Ga. 288, 612 S.E.2d 296 (2005), held that a corporation in bankruptcy or its bankruptcy representative can pierce the corporation’s own veil and hold a shareholder liable for all its debts. In Infrasource, Inc. v. Hahn Yelena Corporation, 272 Ga. App. 703, 613 S.E.2d 144 (2005), the Georgia Court of Appeals held that parties negotiating the sale of a business did not enter into a confidential relationship giving rise to fiduciary duties and requiring disclosure. Bienert v. Dickerson, A05A2004, 2005 WL 3244288 (Ga. App., Dec. 2, 2005), finds on its facts that a fiduciary duty was owed by a business broker to her client. In Thompson v. Scientific Atlanta, Inc., 275 Ga. App. 680, 621 S.E.2d 796 (2005), the Court of Appeals affirmed a trial court’s dismissal of a corporate derivative action based on an extensive report of a special litigation committee of the Board of Directors, appearing in the process to adopt the position of the Delaware courts that discovery on the committee’s investigation and decision is a matter of the trial court’s discretion, not a matter of right. Leventhal v. Post Properties, Inc., No. A05A1155, 2005 WL 3149258 (Ga. App., Nov. 23, 2005), restricted standing to object to a derivative action settlement only to those shareholders who owned shares at the time the acts giving rise to the action occurred. In Massih v. Mulling, 271 Ga. App. 685, 610 S.E.2d 657 (2005), the Court held an oral agreement for an officer to receive a percentage ownership interest in a corporation too indefinite to enforce because it did not contain all material terms, e.g., a specific delivery date. In Ranier Holdings, Inc. v. Tatum, 275 Ga. App. 878, 622 S.E.2d 86 (2005), the Court held that a pro se answer filed by a corporation, while improper, is a curable defect.

Statutory Close Corporations. In Gallagher v. McKinnon, 273 Ga. App. 727, 615 S.E.2d 746 (2005), the Court of Appeals held that an ousted majority shareholder of a statutory close corporation need not demonstrate justifiable reliance in order to obtain relief under O.C.G.A. § 14-2-940 for shareholder oppression.

Professional Corporations. The Court of Appeals in Albany Bone & Joint Clinic, P.C. v. Hajek, 272 Ga. App. 464, 612 S.E.2d 509 (2005), decided that a provision in a professional corporation’s bylaws requiring a member departing for other employment to sell his shares at book value was not an invalid restrictive covenant in restraint of trade.

Nonprofit Corporations. In Shorter College v. Baptist Convention of Georgia, 279 Ga. 466, 614 S.E.2d 37 (2005), the Supreme Court struck down a purported corporate dissolution under the Georgia Nonprofit Corporations Code as an impermissible "sham" attempt to evade membership representation restrictions in the corporation’s bylaws. The Court of Appeals in Waverly Hall Baptist Church, Inc. v. Branham, No. A05A0893, 2005 WL 3046523 (Ga. App., Nov. 15, 2005), addressed the court’s jurisdiction in church governance matters, attempting to determine when the courts may enforce rights and obligations under corporate bylaws and the Nonprofit Code, without infringing on religious doctrine or practices.

Limited Liability Companies. In Stoker v. Bellemeade, 272 Ga. App. 817, 615 S.E.2d 1 (2005), the Court held that a member of a closely-held LLC could bring a breach of fiduciary duty claim directly, rather than derivatively, without the need to show special individualized injury. In that case and in Alimenta (US) Inc. v. Oil Seed S, LLC, ___ Ga. App. ___, 622 S.E.2d 363, 2005 WL 2323345 (Ga. App., Sept. 23, 2005), the Court also rejected breach of fiduciary duty claims by enforcing contractual provisions in the LLCs’ operating agreements permitting members to pursue opportunities in competition with the LLC.

Partnerships. In the partnership area, the Supreme Court in Accolades Apartments, L.P. v. Fulton County, 279 Ga. 257, 612 S.E.2d 284 (2005), held that a publicly-filed statement of partnership is conclusive evidence that a partnership rather than a joint venture exists. In two other decisions, Antoskow & Assoc., LLC. v. Gregory, No. A05A1626, 2005 WL 3416300 (Ga. App., Dec. 14, 2005), and Wnuk v. Doyle, No. A06A0023, 2005 WL 3149139 (Ga. App., Nov. 23, 2005), the Court of Appeals addressed the requirement of consideration in the formation of a partnership.

1. Supreme Court of Georgia Holds That a Corporation in Bankruptcy Can Pierce Its Own Veil – Baillie Lumber Co. v. Thompson

In Baillie Lumber Co. v. Thompson, 279 Ga. 288, 612 S.E.2d 296 (2005), the Georgia Supreme Court, answering a certified question from the Eleventh Circuit Court of Appeals, expanded the potential liability of shareholders of bankrupt Georgia corporations by allowing corporations to "pierce their own corporate veil" and seek to impose liability for their entire debt on controlling shareholders. The Supreme Court further held that such claims belong exclusively to the debtor-corporation or its representatives when it is in bankruptcy and cannot be pursued independently by individual creditors.

In the underlying proceedings, Piedmont Hardwood Flooring, LLC ("Piedmont") filed for Chapter 11 bankruptcy reorganization. Piedmont’s bankruptcy representative sued Piedmont’s former manager and sole shareholder Bert F. Thompson ("Thompson") in bankruptcy court to set aside fraudulent conveyances, based on Thompson’s alleged misappropriation of corporate assets. Outside of the bankruptcy proceeding, Baillie Lumber Co. ("Baillie"), a Piedmont creditor, brought suit against Thompson seeking to "pierce the corporate veil" and hold Thompson individually liable for Piedmont’s debt to Baillie. Thompson applied to the bankruptcy court for an injunction against Baillie’s suit, arguing that the veil-piercing claim belonged to the bankruptcy estate and that Baillie’s state court lawsuit violated the Bankruptcy Code’s automatic stay. Baillie argued in response that a Georgia corporation cannot pierce its own veil. The Supreme Court, hearing the issue at the Eleventh Circuit’s request,¹ ruled that a bankrupt corporation could indeed pierce its own corporate veil and that the claim must be pursued exclusively by the bankrupt corporation or its bankruptcy representative for the benefit of all creditors.

The doctrine of piercing the corporate veil allows a court, where the corporate form has been abused, to disregard the separate existence of a corporation and to hold the person who controls the company personally liable to creditors, finding the corporation to be the mere "alter ego" of the shareholder. While these cases often involve individuals who improperly use the corporation to conduct their personal affairs, the corporate veil between parent and subsidiary corporations can also be pierced.

In rejecting the argument that a corporation lacked standing to bring an alter ego claim, the Georgia Supreme Court noted that veil-piercing claims have evolved over time beyond suits brought by individual third party creditors. Alter ego claims may be asserted where necessary to "remedy injustices which arise where a party has . . . [abused the] corporate entity in order to defeat justice, perpetrate fraud or evade contractual or tort responsibility." Id. at *3. The Court concluded that a corporation could pierce its own corporate veil under limited circumstances where necessary to avoid an injustice. Bankruptcy is one such appropriate circumstance. Id. Indeed, the Supreme Court hinted that the applicability of its holding may be limited to bankruptcy, since alter ego claims are equitable in nature and can only be used where no other legal theories are available to provide complete relief.

The Supreme Court further ruled that the claim constituted "property of the [bankruptcy] estate,"² observing that the Bankruptcy Code generally prohibits creditors from exercising control over property of the bankruptcy estate.³ Baillie thus could not pursue an alter ego claim against Thompson for its own benefit. The Supreme Court agreed with the bankruptcy court that, in bankruptcy, the greatest equity would be achieved by allowing only the debtor corporation to pursue any alter ego suit against its principal.

Importantly, the Court also held, with no discussion, that, where a principal is found at fault in an alter ego suit brought by the debtor corporation, the "measure of damages" should be the imposition of liability for the entire debt of the corporation.⁴

The full ramifications of this new development remain to be seen. It may increase the frequency and risk of alter ego suits in bankruptcy liquidation cases. Bankruptcy trustees and creditors’ committees have access to corporate records and information regarding company finances and observance or abuse of the corporate form, not typically available to creditors attempting to collect their individual claims. Georgia bankruptcy trustees can be expected to consider adding an alter ego claim and a veil-piercing remedy whenever they find evidence of fraudulent transfers and self-dealing.

Bankruptcy trustees are also motivated by the desire to see company debts satisfied and to reach beyond inadequate resources of the estate. This decision certainly increases the exposure of a controlling shareholder by allowing liability for all of the company debts to be imposed, not merely the debt owed to a single creditor or the defendant’s liability for specific transfers or proximately caused losses. Bankruptcy therefore now poses a significantly greater risk for controlling shareholders of Georgia corporations where corporate formalities and finances have not been properly respected, and bankruptcy is more likely to be avoided or resisted by those who are aware of the risk.

2. No Confidential Relationship or Duty of Disclosure Between Parties in Failed Arms-Length

Sale Transaction – Infrasource, Inc. v. Hahn Yelena Corporation In Infrasource, Inc. v. Hahn Yelena Corporation, 272 Ga. App. 703, 613 S.E.2d 144 (2005), the Court of Appeals of Georgia reversed the trial court’s denial of a motion for directed verdict and a judgment entered on a jury verdict in a suit by a corporate acquisition target against the proposed acquirer for fraudulent concealment, holding that there was no evidence of a confidential relationship between parties negotiating a sale of a business on which the target company could base a duty to disclose and a fraudulent concealment claim.

The plaintiff in the trial court entered negotiations with the defendant in early 1999 for the sale of the plaintiff to the defendant. There was no dispute that the parties failed to reach an agreement; the plaintiff admitted that "there were some items left for them to do." After some time, the defendant renewed talks with a previous acquisition target. The defendant informed the plaintiff of this development but did not identify the company. In the meantime, the plaintiff had begun to work with a sister company of the defendant on a project, even though no contract was ever signed with this sister company. The plaintiff eventually walked off of that job. The plaintiff sued, claiming in part that the defendant’s failure to reveal the identity of its other acquisition target was fraudulent. The jury ruled in the plaintiff’s favor.

On appeal, the Court found that the defendant had no obligation under the law to disclose the identity of its other acquisition target, given that the parties were no more than parties to an arm’s-length transaction that was never consummated. The Court noted that under Georgia law, unless there is an existing duty of disclosure, fraud claims cannot be based on a failure to disclose and that, in the absence of a confidential relationship, there is no duty of disclosure between parties engaged in arm’s-length business negotiations. The Court reiterated its past holdings that "an arm’s length relationship by its nature excludes a confidential relationship" and that parties negotiating the sale of a business are presumed to be dealing at arm’s length. The fact that one party reposes trust and confidence in another does not suffice to create a confidential relationship. The Court found that the evidence showed the parties to be sophisticated and represented by counsel and that the plaintiff negotiated for provisions in the agreement that would allow it to maintain its independence in the relationship. In fact, the Court noted that the plaintiff believed that its desire for independence contributed to the breakdown of the relationship, a position that the Court found to be "wholly inconsistent with the existence of a confidential relationship." Finally, the Court rejected plaintiff’s argument that its relationship with the defendant’s sister corporation was evidence of a "common business objective," finding that the evidence supported nothing more than the finding of a failed attempt to negotiate such a relationship.

In the same case, the Court found that the plaintiff failed justifiably to rely on the claimed fraudulent concealment, because it failed to investigate further when placed on notice of the existence of another acquisition target. Further, it found that there was no evidence that the defendant made promises to the plaintiff with no intent to perform, stating that the re-appearance of the second acquisition target was an unforeseen change in circumstances.

Bienert v. Dickerson, 2005 WL 3244288 (Ga. App. Dec. 2, 2005) is not technically a business organization case, but is included because it addressed, among other things, whether a fiduciary duty was owed by a business broker to her client. It provides a different perspective on fiduciary duties in the purchase and sale of businesses from that in the Infrasource, Inc. v. Hahn Yelena Corporation case discussed above.

In Bienert, a business owner wanted to sell her insurance personnel business, the assets of which included two condominiums. The owner orally hired a business broker to assist with the sale. The broker found a potential buyer and worked for months on the sale. As the closing approached, there was disagreement over the amount of commission that the owner was to pay the broker. The broker filed a lien on the business assets and in order to execute the lien, she made a false statement that she was a party to the sales agreement. Though the broker removed the lien, it delayed the closing and forced the owner to expend money to resolve the matter. The sale eventually closed, with the buyer paying the owner $1.8 million for her business and its assets.

The broker sued to recover her alleged commission. The owner counterclaimed for breach of fiduciary duty for the broker’s filing of the false lien and sought punitive damages. The jury awarded the owner over $81,000 on her breach of fiduciary duty claim. The broker appealed; the Court of Appeals affirmed on the fiduciary duty claim.

The principal issue presented by the appeal relevant to this survey was whether the broker, in fact, owed a fiduciary duty to the business owner. At trial, the broker admitted that as the owner’s broker, "in the facts of this particular case," she owed a fiduciary duty of allegiance to put the owner’s interests above her own. The broker also testified that as a business broker she engaged in a "long-term, in-depth relationship" with the owner so as to "understand the workings of [the owner’s] business."

The broker argued on appeal, however, that by statute no fiduciary duty existed, citing O.C.G.A. § 10-6A-4(a), which states that "[a] broker shall not be deemed to have a fiduciary relationship with any party or fiduciary obligations to any party." O.C.G.A. § 10-6A-3(2), defines "broker" to mean "any individual or entity issued a broker's real estate license by the Georgia Real Estate Commission." The Court found no difficulty in holding that the term "broker," for purposes of O.C.G.A. § 10-6A-4(a), does not include business brokers, but applies only to real estate brokers.

The Court instead applied the general standards for the creation and existence of a confidential relationship under O.C.G.A. § 23-2-58.⁵ The Court stated that "Representing Dickerson’s interests, Bienert played an intimate role in the negotiations and was not a mere middleman," and held that those facts supported a finding of a confidential or fiduciary relationship.

The clear import of this decision is that a business broker may have fiduciary duties, depending on the relationship created and the role the broker plays. The decision also demonstrates the importance of brokers’ defining their relationship and responsibilities in situations where both a traditional business enterprise and real estate transactions are at issue.

In Thompson v. Scientific Atlanta, Inc., 275 Ga. App. 680, 621 S.E.2d 796 (2005), the Court of Appeals addressed the special statutory procedure, authorized under O.C.G.A. § 14-2-744, for dismissal of a derivative action if a majority of independent directors, a special committee or a panel of independent persons makes "a determination in good faith after conducting a reasonable investigation upon which its conclusions are based that the maintenance of the derivative suit is not in the best interests of the corporation."

The shareholder plaintiff submitted a derivative demand to the Scientific Atlanta, Inc. ("SA") Board of Directors, claiming that insider selling followed by an announcement of declining orders and a drop in the company’s stock resulted from breaches of fiduciary duty by the Board. The company began by requesting additional information from Thompson, who did not respond. The Board next appointed a special litigation committee ("SLC") consisting of non-selling independent directors to investigate and respond to the demand. Thompson filed suit before the SLC concluded its work. The Court described the SLC process:

Pursuant to this report, the Board of Directors adopted the SLC's recommendations and a motion to dismiss Thompson's lawsuit was filed on March 18, 2004.

The plaintiff failed to respond to the motion and failed to initiate discovery, but appeared at a hearing on the motion and made a belated oral request for discovery. In ruling on the plaintiff’s appeal of the dismissal of the complaint, the Court of Appeals first noted that the standard of review was abuse of discretion. The Court found that the Committee’s 900-page report "reflected a detailed and documented investigation." The Court ultimately held that the plaintiff had waived his right to respond.

Addressing the request for discovery, the Court cited Delaware decisions to the effect that discovery into the independence, good faith of the committee and the reasonableness of the investigation is "not by right, but by order of the Court, with the type and extent of discovery left totally to the discretion of the Court." The Court of Appeals found that Thompson had failed to show any abuse of discretion in the trial court’s denial of his request for discovery.

This case unfortunately also documents the very considerable effort spent and the tremendous expense undoubtedly incurred in responding to a derivative demand when, whether because of delay or a simple loss of interest, the shareholder fails to pursue or effectively abandons the claims asserted.

Leventhal v. Post Properties, Inc., No. A05A1155 2005 WL 3149258 (Ga. App. Nov. 23, 2005) reaffirms the rules that (a) in order to participate in any way in a shareholder derivative action, even if only to object to a settlement, a shareholder must have held shares at the time the acts giving rise to the action occurred, and (b) because any claims in a derivative action belong to the company, a shareholder cannot pursue objections to a derivative settlement on a pro se basis since corporate interests can only be represented in court through a licensed attorney.

In Leventhal, with knowledge of a pending derivative lawsuit, the plaintiff Ronald Leventhal purchased shares of Post Properties, Inc. ("Post") stock. He later filed an objection to a proposed settlement agreement in the derivative action and filed his own separate pro se action against Post and many of its directors. Leventhal subsequently filed a second objection to the derivative action settlement and moved to intervene in order to protect his own suit. The trial court overruled Leventhal’s objections to the settlement and denied his motion to intervene. Leventhal appealed.

Although the opinion is not entirely clear, the Court of Appeals appears to have affirmed both rulings relying on the rule, under O.C.G.A. § 14-2-741, that a shareholder who did not own shares in the corporation at the time the actions giving rise to the derivative action occurred has no standing to participate in the action. Leventhal asserted that despite not being a shareholder at the time the events arose, he was entitled to intervene under O.C.G.A. § 9-11-24(a)(2). The appellate court affirmed the trial court’s finding that Leventhal did not satisfy the requirements for intervention, because he failed to prove that (1) his interests related to the property or transaction that was the subject matter of the action, (2) an impairment of his interest may result from the disposition of the action, and (3) there was inadequate representation of his interest by already existing parties and counsel.

O.C.G.A. § 14-2-741(1), which the parties to the consolidated derivative action cited as the ultimate reason that Leventhal was barred from intervening and objecting, states that "[a] shareholder may not commence or maintain a derivative proceeding unless the shareholder was a shareholder of the corporation at the time of the act or omission complained of or become a shareholder through transfer by operation of law from one who was a shareholder at that time." The Court concluded that O.C.G.A. § 9-11-24(a)(2) does not change the requirements of Section 14-2-741(1) and in fact, the first prong of Section 9-11-24(a)(2), an interest in the subject matter of the action, in this context, requires fulfillment of Section 14-2-741(1). Because Leventhal was not a shareholder at the time of the events at issue in the derivative case, he lacked an interest that would support intervention.

Another problem for Leventhal was that he was seeking to represent the interests of the corporation through his settlement objection and motion to intervene on a pro se basis. The court affirmed the long standing rule, exemplified in the Ranier decision discussed below, that corporations must be represented by legal counsel and held, as a matter of first impression in Georgia, that this rule also applies to derivative actions and their settlements.

Leventhal’s petition for certiorari is currently pending in the Georgia Supreme Court.

In Massih v. Mulling, 271 Ga. App. 685, 610 S.E.2d 657 (2005), the Court of Appeals held that an oral agreement to acquire a percentage ownership interest in a corporation that did not contain all material terms, e.g., a specific delivery date, was too indefinite to enforce. Id. at 659.⁶ The plaintiff claimed she had an agreement with her employer to form a company together, to serve as its president and "own" twenty percent (20%) of the company. The new company was formed and the plaintiff became president. Shortly thereafter, she resigned. She then sued her employer for breach of contract because he did not transfer her 20% ownership interest to her upon her departure.

The Court resolved the claims based on the basic principle of contract law that "[a] contract cannot be enforced if its terms are incomplete, vague, indefinite or uncertain. In addition, the party asserting the existence of a contract has the burden of proving its existence and its terms." Id. (citations omitted). With little further analysis or discussion, the Court found that the oral agreement at issue was too indefinite to enforce.

This case reiterates that in order to create an enforceable shareholder agreement in Georgia, an agreement, whether oral or written, must contain all material terms. At the same time, the decision shows how readily oral promises on which a promisee acts, can lead to enforceable agreements.

Business entities can only act through representatives – officers, directors, employees and agents – and hence cannot appear in legal proceedings pro se. An answer filed by an officer on behalf of a corporation is therefore improper, unless the officer is admitted to practice law. In Ranier Holdings, Inc. v. Tatum, 275 Ga. App. 878, 622 S.E.2d 86 (2005), an officer timely filed an answer on behalf of the corporate defendant. The plaintiff moved to strike the answer. In response, a lawyer appeared and filed a second answer for the corporation. The second answer was filed four months after the filing of the original answer. The trial court struck the corporation’s answer and entered a default judgment against it. Citing Peachtree Plastics v. Verhine, 242 Ga. App. 21, 528 S.E.2d 837 (2000), the Court of Appeals reversed, stating:

This principle should be equally applicable to other business organizations that would similarly be prohibited from litigating on a pro se basis.

In Gallagher v. McKinnon, 273 Ga. App. 727, 615 S.E.2d 746 (2005), the Court of Appeals of Georgia addressed the special anti-oppression provisions of the Georgia Business Corporation Code for statutory close corporations. The Court held that neither fraud by the defendant nor justifiable reliance on the part of a shareholder are necessary requirements for the shareholder protections of O.C.G.A. § 14-2-940. A shareholder may obtain court relief under the statute, including an order setting aside the defendant’s issuance of stock to himself, based on the defendant’s oppressive conduct alone, despite the absence of findings of fraud or justifiable reliance. The Court also found a breach of fiduciary duty in the defendant’s failure to comply with the requirements of O.C.G.A. § 14-2-641(c) that the board of directors determine whether the consideration to be received in exchange for the issuance of stock is adequate.

The parties to the suit had been equal principal shareholders (48% apiece) and the sole directors of Peliton, Inc., a corporation that apparently had made the election for treatment as a statutory close corporation.⁷ The plaintiff offered evidence showing that the defendant schemed to take control of the corporation. The scheme involved fabricating a sexual harassment claim against the plaintiff by another employee in order to coerce the plaintiff into agreeing to an issuance of additional stock to the defendant, a transaction that would give the defendant a controlling interest in the corporation. The jury found that the defendant lied in telling the plaintiff that sexual harassment allegations had been made against him; however, it found that the plaintiff did not justifiably rely on these false representations. Nonetheless, the jury found that the plaintiff agreed to the issuance of new shares under duress and coercion, and the trial court entered judgment against the defendant setting aside the issuance of new shares.

On appeal, the Court of Appeals turned to the language of O.C.G.A. § 14-2-940(a)(1), which states in relevant part that a finding of "illegal, oppressive, fraudulent, or unfairly prejudicial conduct" is sufficient to trigger the statute’s protections. Furthermore, O.C.G.A. § 14-2-941, which lists the types of relief available to a plaintiff bringing a claim under § 14-2-940, explicitly states that relief is available if the court finds that "one or more" of the grounds for relief described in § 14-2-940(a) are present. Because the jury affirmatively found the defendant’s conduct to be illegal, oppressive and unfairly prejudicial, the Court held that the motion for directed verdict was properly denied.

In a companion appeal, the Court affirmed the trial court’s grant of summary judgment in favor of the plaintiff rescinding the issuance of the new shares. The Court found that no consideration had been given for the issuance of new stock. It also found the stock had been issued in breach of the defendant’s fiduciary duty under O.C.G.A. § 14-2-621(c) to the corporation and its shareholders to determine that the shares were issued for adequate consideration:

In Albany Bone & Joint Clinic, P.C. v. Hajek, 272 Ga. App. 464, 612 S.E.2d 509 (2005), the Court of Appeals of Georgia held that a provision in a professional corporation’s bylaws requiring that a member departing for other employment be paid book value for his shares was not an invalid restrictive covenant in restraint of trade.

The Albany Bone & Joint Clinic, P.C. ("Clinic"), a professional corporation of doctors, was incorporated in Georgia in 1999. In 2003, one shareholder, Dr. Hajek, left the Clinic to take another position and sought compensation for his shares. The parties disagreed over the method of valuation and the doctor filed a declaratory action to determine the value of his shares. The Clinic’s bylaws provided that shares of departing members would be redeemed at book value, while upon death, permanent disability or retirement, shares of members could be determined by agreement or arbitration, a potentially higher value. The doctor asserted, and the trial court agreed, that the book value redemption imposed on the doctor who ended his employment with the Clinic and took up a position in a competing practice was, in essence, a penalty and thus operated as an illegal restrictive covenant.

The Court of Appeals reversed the trial court’s ruling and held that the bylaws were valid and therefore governed. The Court began by reviewing the types of restrictive covenants recognized in Georgia, noting that they generally impose restrictions on future business activities and arise most frequently in employment contexts. The Court distinguished the bylaw provision before it from restrictive covenants, finding that the bylaw was not an employment contract, but rather an agreement governing stockholders and their shares that conformed to Georgia’s requirement that only an active member may hold shares in a professional corporation. Further, the provision did not limit the doctor’s future business activities but merely specified the compensation to be received by departing shareholders. Finally, the Court rejected the lower court’s characterization of the provision as a penalty, noting that it did not single out those who left the Corporation to seek out new employment for disparate treatment, but rather applied to members whose departure from the corporation was caused by bankruptcy, loss of license and other reasons as well. Thus, the Court enforced the bylaws and found the doctor was only owed the book value of his shares.

In Shorter College v. Baptist Convention of Georgia, 279 Ga. 466, 614 S.E.2d 37 (2005), the Supreme Court of Georgia rejected an attempted dissolution of a nonprofit corporation found to have been effectuated to avoid requirements in the organization’s bylaws, because it resulted in the transfer of assets to a new corporation, not the winding up of the dissolved corporation’s business. In the process, the Court held that the dissolution of a nonprofit corporation is subject to the same fundamental principles applicable to the dissolution of for-profit corporations.⁸

Shorter College’s bylaws gave the Baptist Convention of the State of Georgia ("GBC") sole authority to name the College’s Board of Trustees. GBC was a "member" of the nonprofit corporation. In 2001, this arrangement threatened the College’s accreditation, and a dispute arose between the College and GBC, after which the College rejected two trustees named by the Convention and named its own replacements. The disputes continued and the old Board approved a plan that purported to dissolve the College and then transfer the corporation’s name and all its assets for no consideration to another entity, the Shorter College Foundation, which would carry on the College’s operations. When the College and Foundation sought to recover certain funds from GBC, it responded by seeking to enjoin the dissolution.

In a 4-3 decision, the Supreme Court found that the attempted transaction was not an actual dissolution. Unlike a true dissolution, which would have ended the school’s existence, the intent of the plan was to preserve assets and continue the College, while altering the governing authority. The Court held that, "Such a ‘reorganization’ fails to qualify as a valid ‘dissolution’ of a for-profit corporation because the end result is not the extinction of any former business, but the mere transfer of the same business to another entity which thereafter will continue its operation."

In so holding, the Court found that there was no meaningful distinction between the provisions of the Georgia Nonprofit Corporation Code governing dissolution of nonprofit corporations and the counterpart provisions of the Georgia Business Corporation Code. The Court noted that the legislature intended the Georgia Nonprofit Corporation Code to conform generally to the GBCC and that the specific sections governing dissolution were nearly identical between the two Codes.

In so ruling, the Court rejected arguments based on differences between the Business and Nonprofit Codes in the eligible recipients for distribution of a dissolved corporation’s assets. The Court found that the statutory language governed and evidenced a legislative intent to apply the same standards.

In the process, the Court noted that the end result of the Board’s actions in transferring the College’s assets intact might well be possible under the dissolution provisions of the Business Corporation Code, but in this respect, the differences between for-profit and nonprofit procedures worked against the College. O.C.G.A. § 14-3-1403(b) requires and permits assets received and held for charitable purposes to be transferred to nonprofit organizations "engaged in activities substantially similar to those of the dissolving corporation." The Court conceded that under § 14-3-1403(b), Shorter College’s assets could have been conveyed intact to another educational institution. However, the Court held, that "unlike for-profit corporations," the Nonprofit Code does not permit a dissolving nonprofit corporation "to perpetuate its business by means of a transfer of all assets to another corporation which will then continue to carry on the identical pre-dissolution activity." 279 Ga. at 472, 614 S.E.2d at 41 (emphasis in original).⁹

The Court further held that the fact that the former Board called the transaction a dissolution rather than a merger was not controlling, nor was the fact that the former Board’s actions were motivated by a good faith concern and effort to preserve the College’s accreditation. The Court found that the transfer of assets to the Foundation was simply "an unauthorized effort on the part of the Board to reorganize the College so as to operate the school as before, but with a new set of trustees," not a bona fide dissolution followed by a statutorily permitted transfer of assets to a similar nonprofit institution, as the College and Foundation argued. Notably, the Court found that the College’s trustees complied with their required standard of care under O.C.G.A. § 14-3-830(1)(A), but "the underlying good faith of the trustees cannot substitute for objective compliance with applicable statutory requirements."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.