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Jones v. McDonald Farms Inc.

Court of Appeals of Nebraska

May 9, 2017

Diannne Jones, individually and on behalf of McDonald Farms, Inc., a Nebraska corporation, appellant,
v.
McDonald Farms, Inc., a Nebraska corporation, et al., appellees.

         1. Actions: Equity: Accounting. A derivative action which seeks an accounting and the return of money is an equitable action.

         2. Actions: Equity: Corporations. An action seeking corporate dissolution is an equitable action.

         3. Equity: Appeal and Error. In an appeal of an equitable action, an appellate court tries factual questions de novo on the record and reaches a conclusion independent of the findings of the trial court, provided that where credible evidence is in conflict on a material issue of fact, the appellate court considers and may give weight to the fact that the trial judge heard and observed the witnesses and accepted one version of the facts rather than another.

         4. Corporations: Courts. Although the Business Corporation Act gives the courts the power to relieve minority shareholders from oppressive acts of the majority, the remedy of dissolution and liquidation is so drastic that it must be invoked with extreme caution.

         5. Corporations. The ends of justice would not be served by too broad an application of the authority to dissolve and liquidate a corporation under the Business Corporation Act, for that would merely eliminate one evil by the substitution of a greater one-oppression of the majority by the minority.

         6. ___. A corporation is not required to pay dividends to its shareholders.

         7. Corporations: Stock. Stock transfer restrictions are generally enforceable under Nebraska law unless they are unreasonable.

         8. ___: ___. A stock restriction provision providing for book value as determined by independent certified accountants for a company in [24 Neb.App. 650] accordance with generally accepted accounting principles is sufficiently certain to be enforced.

         9. Appeal and Error. An appellate court is not obligated to engage in an analysis that is not necessary to adjudicate the case and controversy before it.

         Appeal from the District Court for Hamilton County: Rachel a. Daugherty, Judge. Affirmed.

          Andre R. Barry and Jonathan J. Papik, of Cline, Williams, Wright, Johnson & Oldfather, L.L.P., for appellant.

          Daniel M. Placzek, of Leininger, Smith, Johnson, Baack, Placzek & Allen, for appellees.

          Moore, Chief Judge, and Riedmann and Bishop, Judges.

          RIEDMANN, JUDGE

         INTRODUCTION

         A minority shareholder of a closely held family farm corporation brought an individual and a derivative action against the corporation and the majority shareholders claiming breach of fiduciary duty, misappropriation of corporate assets, and corporate oppression. Essentially, the minority shareholder took issue with the corporation's failure to pay dividends, its refusal to purchase her shares at a price she thought was fair, and its payment of commodity wages to the majority shareholders. Following a bench trial, the district court for Hamilton County entered judgment in favor of the corporation and majority shareholders. Finding that the minority shareholder failed to prove oppressive conduct, misapplication or waste of corporate assets, or illegal conduct by the majority shareholders, we affirm.

         BACKGROUND

         McDonald Farms, Inc., was incorporated in 1976 by Charles McDonald and Betty McDonald. Charles and Betty were the parents of four children: Donald McDonald, Randall McDonald, Dianne Jones, and Rosemary Johns (Rosemary). [24 Neb.App. 651] Donald and Randall began farming with Charles in the mid-1970's. Charles resigned as president of the corporation in 1989, at which time Randall became president and Donald became vice president. At the time McDonald Farms was incorporated, Charles and Betty held majority interests in the corporation and Donald and Randall each held a minority interest. Upon Betty's death in 2010, her shares were devised equally to her four children. In June 2012, Charles gifted his stock equally to Donald and Randall. As a result, Donald and Randall each currently own 42.875 percent of the shares and Jones and Rosemary each own 7.125 percent of the shares. Charles passed away in March 2014.

         McDonald Farms' assets include approximately 1, 100 acres of irrigated farmland and dry cropland. Since 1991, McDonald Farms has leased its land to two corporations: D & LA Farms, Inc., a corporation owned by Donald and his wife, and R & T Farms, Inc., a corporation owned by Randall and his wife. The land is leased on a 50-50 crop share basis, and Donald and Randall perform the farming duties such as planting, harvesting, and selling the crops.

         McDonald Farms was initially incorporated as a subchapter S corporation under the Internal Revenue Code, but in 1993, Charles decided to convert it to a subchapter C designation. A subchapter C corporation pays its own taxes and is treated as an entity separate from its stockholders. Phillip Maltzahn, who has worked as McDonald Farms' certified public accountant since 1990, testified that he recommends that farmers put their farming operation under a C corporation but leave the land out of the corporation.

         According to Maltzahn, as a C corporation employee, a farmer should receive wages for his work in planting, harvesting, and selling crops. There are two ways for an employee to receive wages from the corporation: cash, which would be subject to Social Security and Medicare taxes, or commodity wages. Commodity wages are paid by transferring grain or another such commodity from the corporation to the employee, [24 Neb.App. 652] and at the time of the transfer, a wage is created. It is the corporation's choice whether to pay wages in cash or commodities, but if it chooses commodities, the corporation avoids paying Social Security and Medicare taxes. Maltzahn's recommendation is that the farming corporation pay its employees via commodity wages. He said that it is not unusual for farmers to be paid in commodity wages in central Nebraska and that in fact, "[a]ll of [his] farm clients do that."

         Maltzahn explained that when Charles converted McDonald Farms to a C corporation, Charles' desire was to pay as little in taxes as possible in order to build the size of the corporation. Because the corporate tax rate on the first $50, 000 of net income is 15 percent, Maltzahn's goal, and Charles' goal, was to keep the corporation's annual taxable income at $50, 000. According to Maltzahn, all shareholders benefit from a C corporation designation because the book value for the corporation increases each year by $50, 000, minus the 15-percent federal tax liability. Maltzahn testified that he works for at least 100 other C corporations and that they all share the same goal of keeping net income around $50, 000 annually in order to take advantage of the 15-percent tax rate. He said that planning to reduce taxable income takes a lot of tax planning, including timing business functions such as paying crop inputs, replacing assets, and paying commodity wages.

         According to Maltzahn, Charles could have received compensation every year he ran the corporation, but he did not because he wanted to keep the cash in the corporation and grow it as large as possible. Donald and Randall also could have taken annual compensation for working for McDonald Farms since the 1970's, but they did not. However, McDonald Farms paid Charles commodity wages worth $10, 019 in 2004 and $8, 355 in 2005. Then in 2010, 2012, and 2013, grain prices were high, and McDonald Farms needed to reduce its income, so it again decided to pay commodity wages. In 2010, prior to Betty's death, Charles received 13, 100 bushels of corn at a value of $50, 173. Although Donald and Randall [24 Neb.App. 653] were minority shareholders at the time, they received no profits. In June 2012, Donald and Randall became majority shareholders and they, along with Charles, each received 10, 000 bushels of corn worth $77, 100 for that year. In 2013, Charles received 21, 667 bushels of corn valued at $157, 200, and Donald and Randall each received 16, 667 bushels of corn worth $120, 000.

         When considering the number of years Charles, Donald, and Randall worked for the corporation, Maltzahn did not believe the commodity wages they have been paid were dis-proportional. He said the commodity wages paid to Charles, Donald, and Randall in 2010, 2012, and 2013 were reasonable because the amount of unpaid wages accrued since 1976 was much larger than the actual amounts paid. Maltzahn said that McDonald Farms was not legally obligated to pay wages to Charles, Donald, and Randall, but it was optional for the corporation to do so. He recommended the corporation do so, however, as part of its tax planning strategy. Jones' expert, Christopher Scow, had no opinion as to whether the commodity wages paid were appropriate.

         Maltzahn also explained that paying compensation via commodity wages in the years after the compensation is earned does not fit the definition of deferred compensation as that term is used in the Internal Revenue Code. Under the code, deferred compensation means compensation earned in 1 year is spread out and paid over multiple years so it falls under a lower tax bracket and the employee pays less taxes. To the contrary, McDonald Farms took income earned over multiple years and paid it in a lump sum in 1 year, a strategy which works as a tax detriment to the employees because their tax bracket is higher in the years the income is actually paid.

         Under McDonald Farms' articles of incorporation, before selling, giving, or transferring any shares of stock, a shareholder must first offer the shares to the board of directors for purchase by the corporation "at the book value of said stock as determined by the books of the corporation by regular and [24 Neb.App. 654] usual accounting methods." In January and August 2012, Jones offered to sell her shares to the corporation for $240, 650. She claimed the price offered was the fair market value of the shares based on a December 2010 valuation report prepared by a certified public accountant for purposes of Betty's estate. Donald and Randall declined Jones' offer, but offered to purchase her shares for $47, 503.90, a sum which represented the shares' book value as of December 2011 minus $6, 000 which they claimed was lost by the corporation due to Jones' failure to return a form to the Farm Service Agency. At one point, Donald and Randall offered Jones more than book value for her shares, but no agreement was ever reached.

         Jones commenced this action on April 1, 2013. She sought an accounting, damages for breach of fiduciary duty and conflicting interest transactions, and judicial dissolution of the corporation based on oppressive conduct, misapplication and waste of corporate assets, and illegal corporate conduct. Trial was held in January and February 2015, and the district court subsequently issued an order denying Jones' requests for relief. Relevant to this appeal, the district court found that the corporation's subchapter C designation and tax strategy, the payment of commodity wages, and the corporation's purchase of expensive equipment were not unreasonable or inappropriate. In addition, the court determined that the failure to purchase Jones' shares at her requested price did not establish oppressive conduct. Jones now appeals to this court.

         ASSIGNMENTS OF ERROR

         Jones claims the court erred in failing to dissolve the corporation under Neb. Rev. Stat. § 21-20, 162 (Reissue 2012) because Donald and Randall (1) denied her any economic benefit from her shares while attempting to force her to sell her shares below their fair value, (2) misapplied and wasted corporate assets by making improper payments to themselves and Charles, and (3) acted illegally by taking improper deductions for payments to themselves and Charles. She also alleges [24 Neb.App. 655] the court erred by not requiring Donald and Randall to return to the corporation improper payments directed to themselves and Charles to reduce the corporation's net income and in failing to recognize its power to require Donald and Randall to pay her fair value for her corporate shares.

         STANDARD OF REVIEW

         A derivative action which seeks an accounting and the return of money is an equitable action. Woodward v. Andersen, 261 Neb. 980, 627 N.W.2d 742 (2001). An action seeking corporate dissolution is also an equitable action. Id.

         In an appeal of an equitable action, an appellate court tries factual questions de novo on the record and reaches a conclusion independent of the findings of the trial court, provided that where credible evidence is in conflict on a material issue of fact, the appellate court considers and may give weight to the fact that the trial judge heard and observed the witnesses and accepted one version of the facts rather than another. Id.

         ANALYSIS

         Although Jones' complaint asserted four causes of action, on appeal, she only challenges certain decisions made by the district court. She asserts that the court erred in failing to provide a remedy pursuant to § 21-20, 162 for corporate oppression, misapplication and waste of corporate assets, and/or illegal conduct. She asks that we remand this cause to the district court with directions ordering Donald and Randall to purchase her shares for fair value. We decline to do so, because we agree with the district court that Jones was not entitled to a remedy under § 21-20, 162.

         At the time this action was commenced, the Business Corporation Act provided in relevant part: [T]he court may dissolve a corporation: . . . .

(2)(a) In a proceeding by a shareholder if it is established that:
[24 Neb.App. 656] . . . . (ii) The directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent; [or]
. . . .
(iv) The corporate assets are being misapplied or wasted.

§ 21-20, 162. Although the Business Corporation Act gives the courts the power to relieve minority shareholders from oppressive acts of the majority, the remedy of dissolution and liquidation is so drastic that it must be invoked with extreme caution. See Woodward v. Andersen, supra. The Supreme Court has stated that the ends of justice would not be served by too broad an application of the statute, for that would merely eliminate one evil by the substitution of a greater one-oppression of the majority by the minority. Id.

         Through this action and her arguments on appeal, Jones is essentially challenging McDonald Farms' tax strategy. Rather than attempting to reduce net taxable income to $50, 000 per year in various ways such as paying commodity wages and timing the purchase of new assets, Jones argues the corporation should maximize its income and pay dividends to its shareholders. She claims its failure to do so constitutes oppressive conduct, misapplication or waste of corporate assets, and/or illegal conduct. The evidence presented at trial established that there is nothing inherently inappropriate about McDonald Farms' tax strategy or decision not to pay dividends.

         A corporation is not required to pay dividends to its shareholders. See Neb. Rev. Stat. § 21-2050(1) (Reissue 2012) (board of directors may authorize and corporation may make distributions to its shareholders subject to certain restrictions). The articles of incorporation specifically make payment of dividends discretionary. Jones argues, however, that the failure to pay dividends constitutes oppressive behavior. She claims that the corporation has over $13 million in [24 Neb.App. 657] assets and no debt; therefore, it had the resources to pay a dividend.

         The evidence reveals, however, that McDonald Farms has never paid dividends. Instead, management has chosen to operate the business in a manner that best reduces its taxation. Its accountant, Maltzahn, recommends farming corporations operate under a subchapter C designation with the goal of keeping taxable income around $50, 000 in order to reduce its tax burden. Charles made the initial decision to select a subchapter C designation, and his desire was always to pay as little in taxes as possible in order to build the size of the corporation. Donald and Randall have continued to run the business as Charles had run it. Because Charles never paid dividends to shareholders, Donald and Randall never elected to do so either.

         In order to reduce its taxable income each year, McDonald Farms strategically times the purchase of new equipment, the sale of crops, and the payment of commodity wages. Randall testified that although the corporation would strategically time major purchases, it never purchased assets for the sole purpose of reducing taxable income. In the several years leading up to this action, McDonald Farms replaced irrigation pivots, installed a new irrigation system, and replaced a "[grain] dryer and a leg." The expenditures were large, but as the district court determined, the evidence demonstrates that the purchases were thought out and necessary. The irrigation pivots replaced equipment that was more than 30 years old. The irrigation system was purchased after a drought year in which water restrictions were discussed for the area, and McDonald Farms applied for and received grants toward its purchase. The evidence established that the new system would provide long-term benefits and cost savings to the corporation.

         When commodity prices were high and net income would have exceeded the $50, 000 limit, Charles paid himself commodity wages upon the recommendation of Maltzahn. This first occurred in 2004 and 2005, before Jones was a shareholder. [24 Neb.App. 658] Donald and Randall were both minority shareholders at the time, and no profits were distributed to them. Again, in 2010, Charles paid himself commodity wages. At the time, Donald and Randall were still minority shareholders and Jones had not yet received her shares. Neither of the minority shareholders received profits in 2010. In mid-December 2010, Jones and Rosemary became minority shareholders, and in 2012, Donald and Randall became majority shareholders. In 2012 and 2013, commodity wages were paid to Charles, Donald, and Randall.

         As Maltzahn explained, payment of commodity wages is common for farming corporations, and although the amount paid in wages was determined by the corporation's desire to reduce its income to $50, 000, Maltzahn was not concerned that the wages paid were unreasonable or excessive when considering the number of years Charles, Donald, and Randall had worked without pay. The payments equate to $302, 747 to Charles and $197, 100 each to Donald and Randall for their 35-plus years of work. Jones' own expert, Scow, could not opine whether the wages paid were appropriate, and he also conceded that an annual farm management fee of 7 percent to 10 percent of gross income would be reasonable. Maltzahn testified that using either the 71⁄2-percent rate or the 10- percent rate, Donald and Randall still have not been fully compensated. Although the dissent states that "[t]he commodity wages paid to Randall, Donald, and Charles for alleged unpaid (and undocumented) past services are an unfair and unjustified business decision that was disguised as an acceptable tax reduction policy, " no such opinion was offered at trial by any expert to contradict Maltzahn's testimony.

         The only commodity payments made while Jones was a shareholder were the payments made in 2012 and 2013. The question before us is whether payment of those wages constitutes oppressive acts by the majority shareholders. Given Maltzahn's uncontroverted testimony that the payments were reasonable; the number of years Charles, Donald, and Randall [24 Neb.App. 659] worked without compensation; and Scow's admission that an annual management fee of 7 to 10 percent of gross income would be reasonable, we find nothing illegal, fraudulent, or oppressive in either the decision to pay commodity wages or in the amount of the wages paid.

         The dissent argues that the payment of commodity wages denies the minority shareholders their reasonable expectations of sharing in the profits. It relies upon Baur v. Baur Farms, Inc., 832 N.W.2d 663 (Iowa 2013), in which the Iowa Supreme Court adopted the reasonable expectations of a minority shareholder standard to assess minority shareholder claims of oppression. It is questionable whether the reasonable expectation standard applies to minority shareholders who have acquired their interest by gift or devise, because the test involves assessing the reasonable expectations held by minority shareholders "'in committing their capital to the particular enterprise.'" See, e.g., Edenbaum v. Schwarcz-Osztreicherne, 165 Md.App. 233, 256, 885 A.2d 365, 379 (2005); Ford v. Ford, 878 A.2d 894 (Pa. Super. 2005); Mueller v. Cedar Shore Resort, Inc., 643 N.W.2d 56 (S.D. 2002). See, also, Gimpel v. Bolstein, 125 Misc.2d 45, 477 N.Y.S.2d 1014 (1984) (explaining reasonable expectations test was not entirely appropriate where corporation had been in existence for many years and complaining shareholder had received share by gift or devise).

         To the extent the reasonable expectations test may apply, "'oppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the [minority shareholder's] decision to join the venture.'" Matter of Wiedy's Furniture Clearance Center Co., 108 A.D. 81, 84, 487 N.Y.S.2d 901, 903 (1985). Accordingly, even Fox v. 7L Bar Ranch Co., 198 Mont. 201, 209-10, 645 P.2d 929, 933 (1982), relied upon by the dissent, states that when defining oppression using the reasonable expectation standard, it must be done "'in light of the [24 Neb.App. 660] particular circumstances of each case'" and that "'courts will proceed on a case-by-case basis.'" The court in Fox continued, stating that "[b]ecause of the special circumstances underlying closely held corporations, court[s] must determine the expectations of the shareholders concerning their respective roles in corporate affairs. These expectations must be gleaned from the evidence presented. . . . That is the province of the District Court . . . ." Id. at 210, 645 P.2d at 933.

         The Montana Supreme Court addressed the reasonable expectations of a minority shareholder who claimed it was oppressive for the closely held corporation to deny dividends. Rejecting the argument, the court stated:

[Plaintiff] complains that the Corporation pays no dividends, but he is well aware from his long involvement with the Corporation that it has historically not paid dividends. While failing to issue dividends to shareholders could be an oppressive tactic, the mere non- issuance of dividends is not oppressive in all circumstances. Here, the District Court concluded that neither [minority shareholder] had any capital investment-having received their shares as gifts-which would lead to an expectation of profits . . . .

Whitehorn v. Whitehorn Farms, Inc., 346 Mont. 394, 401, 195 P.3d 836, 842 (2008).

         Likewise, in the present case, Jones did not have any capital investment-her shares were devised to her by her mother, Betty. She received her shares in December 2010 and sought to have the corporation buy her shares out in January 2012. During this 13-month duration, no commodity wages were paid, which makes suspect the dissent's claim that her reasonable expectations were violated as a result of payment of commodity wages. And based upon the history of the corporation, the minority shareholders had no reasonable expectation that profits would be paid out to them. Never, in the history of this corporation that was established in 1976, has a minority shareholder ever been paid profits.

         [24 Neb.App. 661] That is not to say that the majority shareholders can retain all profits to themselves if doing so constitutes oppression; indeed, after determining that the evidence did not establish that the majority shareholders deprived Jones of any return on her share, the district court cautioned that "[i]t is quite possible that continuation of payment of commodity wages without the payment of dividends to shareholders would result in that finding, but based upon the evidence as was presented, the evidence at this time does not support a finding of oppression." This conclusion implies that the district court found Maltzahn's uncontroverted testimony credible that the amounts paid thus far as commodity wages were not disproportionate to back wages and, therefore, did not constitute oppressive behavior.

         The dissent contends that payment of back wages in the form of commodity payments is "incredulous" in part because Donald and Randall were already "handsomely rewarded when they ultimately received 86 percent of a corporation with approximately 1, 100 acres of farmland and other assets appraised at over $9 million in 2012." It claims the exclusion of profits to the minority shareholders "fails to consider the decision made by their parents to give each of the sisters a 7.125-percent share of the corporation. Presumably that decision was intended to confer some benefit on the sisters."

         As correctly noted by the dissent, the value of the corporation was appraised at over $9 million when Jones was devised her 7.125-percent share in the corporation. The dissent attempts to shame Donald and Randall for the shares their parents obviously believed they deserved, stating:

Receiving almost $4 million in farmland and other assets might be considered a fairly substantial "payment" for the brothers' efforts. The brothers have been generously rewarded for their loyalty to the family's farm operation, as signified by Charles' transferring ...

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