Jack E. Lynn et al. v. Robert J. Bosco, Sr. et al. (2013)

MEMORANDUM OF DECISION ON MOTION TO STRIKE

In this two-count action the plaintiffs allege that their preemptive rights as stockholders were violated (Count One) and that defendants breached their fiduciary duties to the plaintiffs (Count Two).   The defendants moved to strike both counts.   On March 27, 2013, the plaintiffs, Jack E. Lynn and Jeffrey Lynn filed an amended complaint against the defendants, Robert J. Bosco, Sr. (Bosco, Sr.), Robert J. Bosco, Jr. (Bosco, Jr.), Anthony Parillo, Jr. (Parillo, Jr.), Richard B. Polivy (Polivy), Clyde Warner (Warner) and Aerospace Techniques, Inc. (ATI), alleging the following facts.   Jack E. Lynn is the founder of ATI, and up to June 2011 was chairman of the board.   The certificate of incorporation provides that the stock is subject to preemptive rights in favor of all stockholders to acquire additional shares of stock if and when they are made available for acquisition.   Prior to July 31, 2011, the ownership of ATI was as follows:  Jack E. Lynn 617 shares;  Jeffrey Lynn, 333 shares;  Warner, 604 shares;  Joseph Dube (Dube), 111 shares;  Jay Emmette (Emmette), 19 shares;  Bosco, Sr., 237 shares;  Patricia Klein (Klein), 16 shares;  Ellen Pipkin (Pipkin), 3 shares;  Bosco, Jr., 3 shares;  and Mario Tardif (Tardif), 3 shares.   Prior to the annual meeting of the shareholders in October 2011, the defendants received a sufficient amount of proxies from other shareholders to constitute the majority, and thereafter they removed Jack E. Lynn as director and reconstituted the board of directors to consist of Polivy, Parillo, Jr., Bosco, Sr. and Warner.   ATI later acquired shares from Dube, Klein, Tardif, Emmette and Pipkin as treasury stock.   The defendants then purchased the shares from ATI without first offering preemptive rights to the plaintiffs and maintained that the shares were not subject to preemptive rights.   After the manipulation of the stock holdings, the ownership was as follows:  Jack E. Lynn, 617 shares;  Jeffrey Lynn, 333 shares;  Parillo, Jr., 67.5 shares;  Polivy, 46 shares;  Warner, 605 shares;  Bosco, Sr., 304.5 shares;  and Bosco, Jr., 3 shares.   With the exception of Bosco, Jr., the defendants were acting as officers and directors of the company and defendants Parillo, Jr., Polivy and Bosco, Sr. were aided and abetted by Warner, all of whom owed fiduciary duties to the plaintiffs.

On January 31, 2013, the defendants filed a motion to strike count one on the grounds that the plaintiffs:  1) fail to establish that they have preemptive rights pursuant to ATI's incorporation documents;  2) ATI's treasury shares are not subject to preemptive rights;  and 3) the plaintiffs have not alleged any special harm or damage because their proportional ownership of ATI was not altered.   The defendants move to strike count two on the ground that the plaintiffs fail to meet the pleading standards for alleging a breach of fiduciary duty owed to the plaintiffs.   The defendants also move to strike counts one and two and the prayer for relief on the ground that the plaintiffs failed to join a proper and necessary party defendant, ATI.

On February 15, 2013, the plaintiffs filed a motion to cite in ATI as a party defendant.   On March 1, 2013, the defendants filed a response to the plaintiffs' motion, requesting that the court decide the motion to strike prior to the motion to cite and it was granted.   The plaintiffs cited in ATI as a party defendant in the amended complaint, filed on March 27, 2013.   At oral argument, the defendant conceded that the motion to strike with respect to the plaintiff failing to join a proper and necessary party defendant was moot.

The defendants move to strike the first count of the plaintiffs' amended complaint, which alleges that the plaintiffs' preemptive rights pursuant to the corporation's certificate of incorporation was violated.   The defendants argue:  1) that treasury shares are unissued shares and are not subject to preemptive rights;  and 2) the purpose of preemptive rights is to enable shareholders to maintain a proportional share of the stock of a company and the plaintiffs maintained their proportional share of ATI. The plaintiffs maintain:  1) that they have a preemptive right to the shares because the certificate of incorporation provides for preemptive rights;  and 2) that their proportional share was affected when the defendants bought the stock themselves because when ATI acquired the shares, the plaintiffs' ownership percentage of outstanding stock was affected.

General Statutes § 33–684(a) provides:  “A corporation may acquire its own shares and shares so acquired constitute authorized but unissued shares.”   General Statutes § 33–683(a) provides:  “The shareholders of a corporation do not have a preemptive right to acquire the corporation's unissued shares except to the extent the certificate of incorporation so provides or as set forth in subsection (d) of this section.”   Subsection (d) provides:  “Notwithstanding any provision of this section to the contrary, the shareholders of a corporation which was incorporated under the laws of this state, whether under chapter 599 of the general statutes, revised to January 1, 1995, or any other general law or special act, prior to January 1, 1997, shall, unless the certificate of incorporation expressly provides otherwise, have the preemptive rights provided in subsection (b) of this section.”   Subsection (b) provides in relevant part:  “A statement included in the certificate of incorporation that ‘the corporation elects to have preemptive rights', or words of similar import, means that the following principles apply except to the extent the certificate of incorporation expressly provides otherwise:  (1) The shareholders of the corporation have a preemptive right, granted on uniform terms and conditions prescribed by the board of directors to provide a fair and reasonable opportunity to exercise the right, to acquire proportional amounts of the corporation's unissued shares upon the decision of the board of directors to issue them.”  “The reason why a stockholder in a corporation has in general a pre-emptive or prior right to subscribe for or purchase additional stock in proportion to his holdings is that his ownership of a certain number of shares entitles him to a certain part in the assets and management of the corporation, and he is entitled of right to the opportunity to preserve his proportionate voice and interest.”  Klopot v. Northrup, 131 Conn. 14, 30, 37 A.2d 700 (1944).

In the present case, the plaintiffs have a preemptive right to purchase unissued stock pursuant to §§ 33–683(b) and (d).  According to the certificate of incorporation attached to the amended complaint, ATI was incorporated in Connecticut in 1965.   Because ATI was incorporated in Connecticut before January 1, 1997, § 33–683(d) is controlling, and under the dictates of that subsection, the plaintiffs have the preemptive rights set forth in § 33–683(b) unless the certificate of incorporation “expressly provides otherwise.”

The certificate of incorporation does not expressly provide that the plaintiffs do not have such preemptive rights.   In fact, the certificate of incorporation states that they do have preemptive rights:  “4. The terms, limitations and relative rights and preferences of each class of shares and series thereof (if any), or an express grant of authority to the board of directors pursuant to Section 33–341, 1959 Supp. Conn. G.S., are as follows:  The holder or holders of any share or shares of said common stock shall have [a] preemptive right to subscribe to stock, obligations, warranties, rights to subscribe to stock or other securities of said corporation of any class whether now or hereafter authorized.”   Accordingly, pursuant to § 33–683(b), the plaintiffs had the option “to acquire proportional amounts of the corporation's unissued shares” when the defendants decided to issue them.   These “unissued shares,” according to § 33–684, include shares that were repurchased by the corporation, such as those acquired by ATI from Dube, Klein, Tardif, Emmette and Pipkin.

Moreover, the plaintiffs' alleged proportional share allegedly was affected when the defendants purchased the stock that ATI acquired, because when ATI acquired the shares, the shareholders' ownership percentage of outstanding stock was affected.   According to the complaint, prior to ATI's reacquisition of the shares, there were 1,976 outstanding shares and the ownership percentage of the plaintiffs were as follows:  Jack E. Lynn, 617 shares, 31.22% of outstanding shares;  Jeffrey Lynn, 333 shares, 16.85% of outstanding shares.   The plaintiffs' ownership percentage, even when combined, was less than fifty percent and thus short of a controlling interest in ATI. After ATI's reacquisition of the shares and before the defendants' purchase, there were 1,794 outstanding shares and the plaintiffs' ownership percentage changed:  Jack E. Lynn, 617 shares, 34.39%;  Jeffrey Lynn, 333 shares, 18.56%. At this point, the plaintiffs' combined ownership percentage would be a controlling interest of 52.95%. If the plaintiffs had a preemptive right to repurchase those shares, they would have been able to retain their combined, controlling interest in ATI. The plaintiffs alleged that the defendants failed to afford them their preemptive rights, and therefore they have sufficiently pleaded that they have been damaged by the defendants' conduct.

The defendants claim that the plaintiffs' preemptive rights only pertain to “new stock issue” and not repurchased stock, citing the definition of “preemptive right” from Black's Law Dictionary but this dictionary definition is hardly persuasive given that § 33–684 explicitly states that “unissued shares” include stock repurchased by the corporation.   Moreover, the defendants' argument that the plaintiffs would have remained minority shareholders ignores the fact that the plaintiffs' ownership percentage grew when the stocks were repurchased by ATI. Their combined share would have constituted a majority of shareholders.

-II-

The defendants additionally argue that the plaintiffs' second count should be stricken because the plaintiffs fail to satisfy the requirements for pleading a breach of fiduciary duty, more specifically, that they failed to sufficiently plead bad faith, fraud, or self-dealing, and have not alleged facts that overcome the business judgment rule.   The plaintiffs argue that the defendants, with the exception of Bosco, Jr., breached their fiduciary duties to the plaintiffs because the defendants, as officers and directors of ATI, engaged in self-dealing by using their control of the corporation to obtain corporate assets for their own personal benefit to harm the legal interests of the plaintiffs.

A party cannot breach a fiduciary duty to another party unless a fiduciary relationship exists between them.  Sherwood v. Danbury Hospital, 278 Conn. 163, 195, 896 A.2d 777 (2006).  “An officer and director occupies a fiduciary relationship to the corporation and its stockholders ․ He occupies a position of the highest trust and therefore he is bound to use the utmost good faith and fair dealing in all his relationships with the corporation.”  Katz Corp. v. T.H. Canty & Co., 168 Conn. 201, 207, 362 A.2d 975 (1975).

The plaintiffs allege that prior to the annual meeting of the shareholders in October 2011, the defendants received a sufficient amount of proxies from other shareholders to constitute the majority, and thereafter they removed Jack E. Lynn as director and reconstituted the board of directors to consist of Polivy, Parillo, Jr., Bosco, Sr., and Warner.   The plaintiffs claim that as directors, the defendants had a fiduciary duty to use good faith and fair dealing in their relationship with ATI and the plaintiffs;  that the defendants breached their fiduciary duties because they engaged in self-dealing with an intention to take over the company because once ATI acquired the shares from Dube in January 2012.   The defendants acquired these shares by making loans to themselves from the corporation without first offering them to the plaintiffs pursuant to their preemptive rights as provided in the certificate of incorporation.   Had the plaintiffs been afforded their preemptive right to purchase their proportional share of the reissued stock, the plaintiffs' combined ownership percentage would have constituted a majority interest.   Therefore, the plaintiffs sufficiently alleged a breach of fiduciary duty by means of self-dealing because, as directors, the defendants breached their fiduciary duty of good faith and fair dealing in their relationship with the plaintiffs by purchasing the stock with company funds for their own self-interest without first offering the plaintiffs to purchase their proportionate share.

Since both counts are legally sufficient, defendants' motion to strike is denied.

Wagner, JTR

Wagner, Jerry, J.T.R.