RESCH v. TROY MALIN POTTINGER

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Court of Appeal, Second District, Division 3, California.

Ronald M. RESCH, Lee M. Polster, Herbert E. Schwartz, Peter H. Alpert and Shelton P. Berger, Plaintiffs and Appellants, v. TROY, MALIN & POTTINGER, etc., et al., Defendants and Respondents.

Civ. 67548.

Decided: January 26, 1984

Rosenberg, Nagler & Weisman, Mark L. Weisman and Laurie J. Butler, Beverly Hills, for plaintiffs and appellants. Musick, Peeler & Garrett and Macklin Fleming, Los Angeles, for defendants and respondents.

SUMMARY

Plaintiffs, former employee attorneys of the defendant law corporation, filed a complaint 1 against the law corporation and the defendant shareholders of record, seeking in the first cause of action to involuntarily dissolve the law corporation pursuant to Corporations Code section 1800.2  Plaintiffs claim they are “beneficial owners” of shares in the law corporation, admitting they are not shareholders of record;  we find the conflict in their exact ownership status inconsequential to the issue in this appeal.   The Law Corporation Rules of the State Bar of California (State Bar) 3 provide that shares in a law corporation may be held only by active members of the State Bar who practice law on behalf of such corporation.   Since plaintiffs have terminated their employment with the defendant law corporation, they are no longer eligible to hold shares in the corporation.   Accordingly, the trial court's grant of summary judgment in favor of the defendants was proper.

FACTS AND PROCEDURAL HISTORY

Plaintiffs, Ronald M. Resch, Lee M. Polster, Herbert E. Schwartz, Peter H. Alpert, and Shelton P. Berger, were employed as attorneys for the law corporation of Troy, Malin & Pottinger, a Professional Corporation (“TMP”).4  As a result of certain disputes, plaintiffs left the employment of TMP and formed their own law firm.   It is undisputed that none of the five plaintiffs became shareholders in any other law corporation through July 14, 1982.

The individual defendants, Ronald H. Malin, Joseph F. Troy, J. Stanley Pottinger, William J. Feis, Sanford J. Hillsberg, and Derek W. Hunt, are shareholders of record in TMP.   Plaintiffs and the individual defendants were unable to resolve their dispute regarding plaintiffs' claims to distributions of equity interests in TMP and subsequently brought an action seeking, among other things, the involuntary dissolution of TMP.   Plaintiffs assert that they are beneficial shareholders in TMP and are thus entitled to bring such an action.

Among the various documents introduced by plaintiffs to establish their beneficial ownership in TMP, was a 1978 State Bar Annual Report of TMP, which report listed plaintiffs as five of the ten shareholders.

TMP's 1979 State Bar Annual Report, and subsequent reports, listed only two shareholders.   TMP's 1980 report states that:  “1.   Reconciliation of shareholders prior to 1980:  [¶]  1.1 Except for Ronald H. Malin and Joseph F. Troy, the lawyers listed as shareholders in the 1978 Law Corporation Annual Report were inadvertently so listed.   In fact, shares had not been issued to them, nor had a shareholders agreement with respect to such issuance been concluded.  [¶]  1.2  In 1979, shareholders agreements as well as employment agreements were concluded, but issuance or purchase of further shares was not accomplished, and therefore as of the close of the year 1979 Ronald H. Malin and Joseph F. Troy remained as the sole shareholders.”

Plaintiffs' original complaint states three causes of action:  involuntary dissolution, breach of fiduciary duty, and constructive trust.   TMP demurred to all three causes of action and raised other affirmative defenses.   TMP also cross-complained, alleging fraud, breach of fiduciary duty, misappropriation of property, intentional interference with advantageous relationships, and breach of contract.

 On August 4, 1982, TMP filed a motion for judgment on the pleadings and/or summary judgment on plaintiffs' first cause of action.   After a hearing on the merits of the motion, the motion was granted on December 13, 1982, in favor of TMP.   Plaintiffs' filed a timely notice of appeal.5

ISSUE

 Whether former lawyer-employees of a law corporation claiming beneficial ownership of shares in that corporation are entitled to seek involuntary dissolution of the corporation pursuant to Corporations Code section 1800, subdivisions (a)(2) and (b)(4).

DISCUSSION

IReview of Summary Judgment

 The summary judgment procedure, inasmuch as it denies the right of the adverse party to a trial, is drastic and should be used with caution.   (Eagle Oil & Ref. Co. v. Prentice (1942) 19 Cal.2d 553, 556, 122 P.2d 264.)   Summary judgment is properly granted only when the evidence in support of the moving party establishes that there is no issue of fact to be tried.   (Code Civ.Proc., § 437c;  Lipson v. Superior Court (1982) 31 Cal.3d 362, 374, 182 Cal.Rptr. 629, 644 P.2d 822.)

“The moving party bears the burden of furnishing supporting documents that establish that the claims of the adverse party are entirely without merit on any legal theory.”  (Lipson v. Superior Court, supra, 31 Cal.3d at p. 374, 182 Cal.Rptr. 629, 644 P.2d 822.)  “The affidavits of the moving party are strictly construed and those of his opponent liberally construed, and doubts as to the propriety of summary judgment should be resolved against granting the motion.”  (Slobojan v. Western Travelers Life Ins. Co. (1969) 70 Cal.2d 432, at p. 437, 74 Cal.Rptr. 895, 450 P.2d 271.)

Our review of this appeal shall be in accordance with these standards.

II

The Law Corporation Rules of the State Bar Provide That Shares in a Law Corporation May Only Be Held by Active Members of the State Bar Who Practice Law on Behalf of the Law Corporation.  Plaintiffs Are Disqualified Under These Rules Even if They Are Entitled To Have Shares Issued to Them Pursuant to Their Claim of Beneficial Ownership

A primary reason for professional incorporation is to achieve for professionals the tax advantages available to nonprofessional corporate executives.   Initially, one of the most advantageous features of professional incorporation was the right of the professionals to participate as corporate employees in a qualified pension or profit-sharing plan.   Contributions to such plans are deductible by the corporation and not presently taxable to the employee-professional.  (CEB Attorney's Guide to California Professional Corporations (3d ed. 1977), Tax Problems, § 1.2, p. 2.)   Recent changes in section 451 of the Internal Revenue Code by the enactment of the Tax Equity Fiscal Responsibility Act of 1982 may have made corporate practice less advantageous than in former years.

In California, the incorporation of professionals was first permitted by the enactment of the Moscone-Knox Professional Corporation Act.  (Corp.Code, §§ 13400, et seq.) 6  Section 13403 makes the provisions of the general corporation law applicable to professional corporations, “except where such provisions are in conflict with or inconsistent with the provisions of this part [§§ 13400, et seq].”   Under section 13406, “[s]hares of capital stock in a professional corporation may be issued only to a licensed person, ․”  Pursuant to section 13407, shares in a professional corporation may be transferred “only to a licensed person or to such professional corporation, and any transfer in violation of this restriction shall be void.”

Section 13410 provides that “[a] professional corporation shall be subject to the applicable rules and regulations adopted by, and all the disciplinary powers of, the governmental agency regulating the profession in which such corporation is engaged․”

The State Bar is authorized by Business and Professions Code sections 6160 to 6172 to regulate and register law corporations, and it is specifically authorized by section 6171 to formulate rules and regulations dealing with articles of incorporation and by-laws of a law corporation and to require that shares owned by disqualified or deceased persons be sold to the law corporation or its remaining shareholders within a given time.  Business and Professions Code section 6171 reads in part:  “With the approval of the Supreme Court, the State Bar may formulate and enforce rules and regulations to carry out the purposes and objectives of this article, including rules and regulations requiring (a) that the articles of incorporation or bylaws of a law corporation shall include a provision whereby the capital stock of such corporation owned by a disqualified person (as defined in the Professional Corporation Act) or a deceased person shall be sold to the corporation or to the remaining shareholders of such corporation within such time as such rules and regulations may provide, ․”

Pursuant to these sections of the Business and Professions Code, the State Bar enacted revised Law Corporation Rules (“Rules”) in February 1975.   Section IV of the Rules is entitled “Requirements for Issuance of Certificate of Registration.”   Section C governs the ownership and transfer of such shares.   This section of the Rules provides, in pertinent part, as follows:  “C. Shares;  ownership and transfer.  [¶] (1) The shares of a law corporation may be owned only by (a) that corporation or (b) by an active member of the State Bar who [¶] (i) is an employee or retired employee of that corporation and is not a director, officer, or shareholder of any other law corporation, and [¶] (ii) does not practice law except on behalf of that corporation;  provided, however, a member may be a shareholder although he or the law corporation by which he is employed, acts as attorney pursuant to the court order, or acts on behalf of a legal aid or similar organization, or is associated or employed as an attorney by another active member, law partnership, or law corporation.   [¶] (2) The shares of a law corporation owned by a person who [¶] (a) dies, [¶] (b) ceases to be an eligible shareholder, or [¶] (c) becomes a disqualified person as defined in § 13401(d) of the Corporations Code [temporarily suspended or permanently disbarred attorney], for a period exceeding 90 days, [¶] shall be sold and transferred to the corporation or its shareholders on such terms as are agreed upon by the corporation and its shareholders.   Such sale or transfer shall occur not later than 6 months after any such death and not later than 90 days after the date he ceases to be an eligible shareholder, or 90 days after the date he becomes a disqualified person․”  (Emphasis added.)

TMP claims that under Rule IV C(1) and (2), plaintiffs' termination of employment from it disqualified them from being eligible shareholders since they were not longer actively engaged in the practice of law with it but with another firm.   Accordingly, plaintiffs lack standing to seek involuntary dissolution pursuant to section 1800.

Plaintiffs, on the other hand, contend that the provisions of Business and Professions Code section 6160 to 6172 and the Rules were enacted for purposes other than amending and abridging general corporate shareholder rights and thus the Rules do not take away from California corporate shareholders the right to seek dissolution of a corporation which the Legislature has seen fit to specifically grant them in Corporations Code section 1800.   We disagree.

 Our interpretation of these Rules is that they prohibit any member of the State Bar from continuing as an eligible shareholder of a law corporation upon terminating employment with that law corporation.   It is undisputed that plaintiffs no longer practice law with TMP and have started their own firm.   The situation then is squarely within Rule section IV(C)(1) and (2).

We see no unfairness in our holding in this case.   First, all members of the bar who seek to be shareholders of law corporations are governed by these Rules.   Second, the financial arrangements with regard to the withdrawal of a shareholder of a law corporation can be governed by carefully drawn and executed shareholder agreements which can provide for the orderly liquidation of shares by the withdrawing shareholder-attorney.   Third, such result is consistent with public policy to ensure the continued and uninterrupted representation of clients in spite of internal conflicts between attorneys which result in attorneys leaving the law corporation.

At oral argument, counsel for plaintiffs strenuously argued that his clients were somehow at the mercy of the majority shareholders of TMP and had erroneously relied on the faith of the individual defendants' representations that shares would be issued.   That may have been the circumstances, but plaintiffs were always free to leave the corporation and perhaps should have if shares were promised and not issued promptly.   However, this type of situation is not peculiar to associates of law corporations but seems equally possible to associates of law partnerships and those who associate themselves with sole practitioners.

It would seem to us that our holding places great importance on attorneys who practice in the corporate form to cement their relationship by carefully drafted and promptly executed shareholder agreements.

In view of our holding in this regard, there was no triable issue as to whether the plaintiffs were entitled to be issued shares pursuant to any alleged agreements, oral or otherwise.   There being no triable issues of fact present in this case, the trial court properly ordered summary judgment in favor of the defendant TMP.

For the reasons stated above, the judgment is affirmed.

FOOTNOTES

1.   Although plaintiffs' original complaint was amended subsequently and deemed filed with the court's permission, the amendment is of no consequence in this appeal and concerns the plaintiffs' remaining causes of actions against the individual defendant shareholders seeking remedies other than the involuntary dissolution requested in the first cause of action.   Only the first cause of action is of concern in this appeal.

2.   Corporations Code section 1800 provides in pertinent part as follows:  “(a) A verified complaint for involuntary dissolution of a corporation on any one or more of the grounds specified in subdivision (b) may be filed in the superior court of the proper county by any of the following persons: ․ [¶] (2) A shareholder or shareholders who hold shares representing not less than 33 1/313 percent of (i) the total number of outstanding shares (assuming conversion of any preferred shares convertible into common shares or (ii) the outstanding common shares or (iii) the equity of the corporation, exclusive in each case of shares owned by persons who have personally participated in any of the transactions enumerated in paragraph (4) of subdivision (b), or any shareholder or shareholders of a close corporation․  [¶] (b) The grounds for involuntary dissolution are that: ․ [¶] (4) Those in control of the corporation have been guilty of or have knowingly countenanced persistent and pervasive fraud, mismanagement or abuse of authority or persistent unfairness toward any shareholders or its property is being misapplied or wasted by its directors or officers.”  (Emphases added.)

3.   We invited the State Bar of California to appear as amicus curiae in this appeal.   The State Bar declined such invitation but filed a letter dated December 16, 1983, which states in pertinent part as follows:“․ Our reaction upon first reading [the briefs of the parties] was that in some manner the Court was being asked to interpret Law Corporation Rules IV C(1) and IV C(2) adopted by the State Bar and approved by the Supreme Court ․  At that time we advised the Court we would appreciate the opportunity to file an amicus brief so that any interpretation of the Law Corporation rules that might appear in a Court opinion would have the benefit of State Bar analysis.“Because of the pressure of time and other commitments, we do not believe it possible to file an amicus brief.   Further, after a review of the record, we believe the decision in this case could well turn upon factors other than an interpretation of the State Bar rules.   For these reasons, we are writing this letter to the Court, with copies to opposing counsel, setting forth the interpretation the State Bar has followed in administering the Law Corporation rules (and the Law Corporation Act of 1968) since their enactment.“The parties both focus the Court's attention to Law Corporation Rule IV C(1) and IV C(2).“Rule IV C(1) pertains to who is eligible to own stock in a Law Corporation.  Rule IV C(2) states that stock in a Law Corporation owned by a person who dies or ceases to be an eligible shareholder shall be sold or transferred as provided in that rule.“The restrictions required by both rules must be contained in the bylaws of a Law Corporation before it will be certified as a Law Corporation by the State Bar and such certification is necessary if the corporation is to practice law.   If the Law Corporation, after certification, is found to be in violation of these provisions, its certificate of registration may be revoked after appropriate State Bar proceedings (Law Corporation Rules V C and D.)   It has consistently been the position of the State Bar Law Corporation administrators that neither of these rules by itself determines who owns stock in a corporation, and neither the Professional Corporation Act, the Law Corporation Rules or any other law gives authority to the State Bar to determine ownership of stock in a Law Corporation.  Rules IV C(1) and (2) are not rules of ownership but are only used to determine if a corporation is eligible to be certified or to remain certified.   Thus the fact that a shareholder left the employ of a Law Corporation or, for any other reason, became disqualified to own stock would not, under the Rules, cause him or her to automatically lose ownership in the stock.   It would only go to the question as to whether the Law Corporation would remain eligible for State Bar certification.“This foregoing information is consistently provided to members of the bar or the public who inquire at the State Bar Law Corporations office.“The State Bar is not a court with the authority to determine ownership of Law Corporation stock.   Nor does the State Bar take any position as to the legal or equitable ownership of the stock involved in this pending matter.   We do note that Article VII, section 2 of the bylaws of the corporation involved here [TMP] contains the following language:  [¶] ‘Such shareholders shall have no voting or other rights from and after the date of death or disqualification or of termination of eligibility except the right to receive ayment [sic] for the shares in accordance with the Agreement of Sale.’“This language is not required by the State Bar and since it does not limit or contradict the restrictions the State Bar requires we will certify a Law Corporation although its bylaws contain this language.   The State Bar expresses no view on the legal effect of this language.“․     “Very truly yours,     “[signed]     “Truitt A. Richey, Jr.     “Chief Assistant General     Counsel”In our view, the State Bar has misinterpreted the issue in this appeal.   The Law Corporation Rules IV C(1) and (2) are indeed crucial to the decision in this appeal.   We are not concerned with whether plaintiffs have some legal or equitable interest in the defendant law corporation shares.   In fact, we assume plaintiffs, as they alleged, have a beneficial interest in such shares since this appeal involves a summary judgment.   The question is whether these specific Rule provisions, which were in part incorporated into the defendant law corporation's bylaws, prevented plaintiffs' continued eligibility as shareholders to allow them to institute involuntary dissolution proceedings pursuant to Corporations Code section 1800.

4.   The law corporation has had several names since its inception.   Its first name was Troy, Malin & Loveland.   Subsequent to the filing of this complaint, the law corporation changed its name to Troy, Malin, Pottinger & Casden.   For simplicity, we will refer to the law corporation as “TMP” throughout this opinion.

5.   Plaintiffs appeal from the order granting the summary judgment.   Although an order granting summary judgment is generally not appealable, an appeal from a nonappealable order is not always fatal.  “If there is no appealable judgment or order in existence at the time of filing the notice, or at the time the reviewing court must determine the matter, the purported appeal will be dismissed․  But if there is, or can be, an appealable judgment or order at either of such times, the supposedly ineffectual appeal from the nonappealable order can be regarded as merely a mistake in the notice of appeal, curable in the reviewing court.”  (See 6 Witkin, Cal. Procedure (2d ed. 1971), § 63, p. 4077.)  (Emphasis in original.)In this appeal, an appealable judgment was filed.   Therefore, we deem the notice of appeal to be from the judgment subsequently entered so that we may reach the merits.

6.   Hereinafter all references shall be to the Corporations Code unless otherwise indicated.

LUI, Associate Justice.

KLEIN, P.J., and DANIELSON, J., concur.