As a brief background to the settlement deal, Floorgraphics initiated a lawsuit against News America Marketing in 2004 due to News America’s illegal practices, such as eleven hacking incidents of Floorgraphics’s protected website to gain the confidential information of its clients. After trial, News America agreed to settle with Floorgraphics for a sum of $29.5 million.  Out of the settlement sum, $13 million would be allocated to Floorgraphics and its assets, $12 million towards the four corporate officer’s personal goodwill, and $4.5 million for the officer’s non-compete and consultation agreements. Out of the $12 million, Defendants Richard and George Rebh each received $4.8 million, and Chief Financial Officer Yves Anidjar and Senior Vice President Michael Devlin each received $1.2 million.

Plaintiff and minority shareholder of Floorgraphics, Fred Potok, filed suit in 2009 alleging improper diversion of the $12 million for the personal benefit of the majority shareholders. Plaintiff argued that the settlement and sale of Floorgraphics had not been disclosed to the shareholders, noticeably that defendants never included copies of the personal goodwill purchase and noncompete and consulting agreements.

In determining whether the settlement transaction was fair, plaintiff argued the fairness standard should be used. In Pennsylvania, if a party to a transaction is a fiduciary that gained personal benefits while acting in a fiduciary role, the burden to prove the fairness of such a transaction falls on that individual. Defendants tried to assert the claim that the transaction was necessitated by the fact that Floorgraphics would have lost its lawsuit against News America. Plaintiff argued that while the actual value of the contracts were not a problem, the distribution of the $16.5 million only amongst the majority shareholders posed the problem. Since, out of the $29.5 million settlement amount, only $13 million went directly to the corporation, the transaction could only fail the fairness test.

This is the first time that a court in Pennsylvania had applied the entire fairness standard to determine the appropriate threshold on which minority shareholders can question the self-dealings of majority shareholders. As can also be seen in another recent event involving minority shareholder oppression (read here), it appears more and more that majority shareholders can face repercussions for self-dealing.

As a brief background, plaintiff, Gary Miller Imports, Inc., filed the action alleging that the defendants, brothers Carter, Brent, and Kevin Dolittle, who were minority shareholders of plaintiff, had been embezzling extra pay, vacation pay, and bonus payments, stealing cars, and engaging in racketeering activity. Before the lawsuit, the Dolittle brothers had formerly retained the Macdonald Illig firm as corporate counsel for Gary Miller Imports, Inc., to assist in the company’s next steps arising out of a failed deal with Mazda and Chevrolet.

Upon the start of this present action, the Dolittle brothers once again engaged the Macdonald Illig firm. The motion to compel arose after plaintiff sought from the firm communications under the belief that these communications pertained to the corporation. The plaintiff believed that the information the communications contained related to the defendants acting as corporate agents. Also, plaintiff argued that the law firm had even billed the corporation for its services for this action.

In order for a corporate officer to assert his or her claim of attorney-client privilege with communications with corporate counsel, five steps set forth in In re: Bevill, Bressler & Schulman Asset Management Corp. must apply. Summed up, this test enables the determination of whether there exists a clear distinction as to communications related to the corporation and to the individual.

In the opinion by Judge Cohill, he states that there is no reason to doubt that the firm’s representation of the minority shareholders, the Dolittle brothers, was in the capacity of representing them as individuals. Concurrently, the Judge agreed with defendants’ argument that there does in fact exist a distinction between the communications, for after review of the eight documents, the legal counsel sought were as individuals and not acting for the corporation. As such, the Bevil test applies, and the communications are considered privileged.

2014 has been a staple year in Pennsylvania in determining the level of privilege extended to attorney communications with experts and clients. As noted in our two past blog entries, the courts have leaned towards more protection towards attorney-expert communications (read here and here), and now it has truly defined further the limits of what corporations can seek from shareholders in the event of a dispute.