Introduction. The case of Jang Won Cho v. Kun Sik Kim, involves a dispute between 3 investors who invested in a retail strip shopping mall venture in Houston, Texas. No. 14-16-00962-CV, 2019 WL 1442412 (Tex. App.—Houston [14th Dist.] Apr. 2, 2019, no pet. h.). The 3 investors formed a corporation in which they became shareholders and the corporation purchased the land for the shopping mall. A strip center was built and became part of the property owned and managed by the corporation. The shopping center’s occupancy declined over time and relations between the investors became strained.
Two investors, the plaintiffs, sued the third investor, the defendant, who was also a director and officer of the corporation. The plaintiffs accused the defendant of abusing “their trust and confidence by secretly gaining personal benefits at their expense and driving the business off a financial cliff.” More specifically, the plaintiffs alleged that the defendant refused to contribute his fair share of capital, engaged in self-dealing including by awarding a construction contract to a company he owned and making misrepresentations regarding the cost of construction.
Trial court judgment. The case proceeded to trial and the jury found that the defendant failed to comply with his fiduciary duties owed to the plaintiffs, committed fraud, committed negligent misrepresentation, and converted property belonging to the plaintiffs. Based upon the jury’s verdict, the trial court signed a final judgment against the defendant in the amount of $1,128,283 in actual damages and $6,769,698 as exemplary damages plus prejudgment interest. The defendant appealed the judgment.
Appellate decision. First, the court of appeals addressed the jury’s affirmative finding that the defendant breached his fiduciary duties. The court found that the circumstances did not give rise to a formal fiduciary relationship because a “co-shareholder in a closely held corporation, as a matter of law, does not owe a fiduciary duty to his co-shareholder.” The court stated that, as the corporation’s director, the defendant owed fiduciary duties to the corporation but not to the individual shareholders. The plaintiffs were not asserting a derivative claim on behalf of the corporations so this was not before the court. The court also found that no informal fiduciary relationship existed since there was no evidence that a “long-standing personal or business relationship existed between the parties.” Thus, the court reversed the trial court’s judgment regarding liability and damages for breach of fiduciary duty.
Next, in addressing the jury’s affirmative finding regarding fraud by nondisclosure, the court found that there was insufficient evidence to support this finding. In regard to fraud by misrepresentation, the court found that there was no evidence to support the allegations that the defendant had made misrepresentations about management fees, interest paid on a loan, attorney’s fees paid, and profits. However, the court found that there was sufficient evidence to support a finding based upon misrepresentations pertaining to the construction costs.
The court then examined the award of damages and after correcting what the court considered to be a double recovery, the court found that the total amount of actual damages that should have been awarded was only $352,600. Given that this was much lower than the actual damages set forth in the judgment, the court also reduced the amount of the exemplary damages award to $1,057,800. Thus the judgment awarding a total of $7,897,981 was reduced to $1,410,400. The case was remanded to the trial court for recalculation of prejudgment interest.
Lessons learned. Shareholders in a closely held corporation should diligently monitor the activities and finances of the corporation, and carefully scrutinize any self-dealing transactions between the corporation and its principals. Carefully drafted shareholder agreements can also help avoid these problems and the expense of protracted litigation. Further, in the event that one or more shareholders wants a business divorce from the other shareholders, these agreements can also provide a formula to liquidate the shares of unhappy shareholders.