7 from ’07:
Pivotal Colorado Corporate Law Decisions in 2007

 

 

By: E. Lee Reichert & Hannah M. Wanebo

©2008, Kamlet Shepherd & Reichert, LLP

 

During 2007, Colorado appellate courts issued numerous opinions involving Colorado corporate law issues, including a number relating to the duties of directors of Colorado corporations.  Interestingly, in setting forth its analysis in these decisions, the Colorado courts generally did not look to Delaware law for guidance, as has sometimes been the case in previous corporate decisions. Nevertheless, the Colorado courts arguably ended up with even stronger protection for directors than Delaware, where most public companies are incorporated (in part because Delaware generally is considered to be management and director friendly).

 

Taken together, the cases decided in 2007 should provide more concrete guidance to the directors of Colorado corporations, as well as help to companies and individuals structuring buy-sell, non-compete and non-solicit covenants.

 

Fiduciary Duty Cases:

 

  1. Alexander v. Anstine, 152 P.3d 497 (Colo. 2007)

 

Facts:  BHW Corporation sold warranties for newly constructed homes.  BHW hired defendants (attorneys) after learning it had purchased fraudulent insurance policies on already-issued warranties.  The attorneys advised BHW’s president to either (a) shut down the company and file for bankruptcy, or (b) “warehouse” premiums by putting them in escrow accounts while searching for replacement insurance, which, they advised, was likely illegal.  The president of the company chose to warehouse.  After an injunction was sought, the president, with the help of the attorneys, transferred the funds to an offshore trust company which set up unlicensed insurance policies.  Eventually, however, BHW was forced to declare bankruptcy.

 

BHW’s trustee sued the president for breach of fiduciary duties, and the attorneys for malpractice and aiding and abetting the president’s breach of fiduciary duties.  The trial court found that the trustee had standing to bring the claim, and the jury concluded that the president had breached his duties and that the lawyers had aided and abetted that breach.  On appeal, the court of appeals also found, among other things, that the director had breached his fiduciary duties.

 

Holding:  Directors of insolvent Colorado corporations owe very limited duties to creditors. 

 

In Alexander, the Colorado Supreme Court ruled that directors of an insolvent corporation owe two (and only two) specific duties to the insolvent corporation’s creditors:

 

1.      Statutory Duty – a duty not to vote for distributions to shareholders that would preclude payment of corporate debts; and

 

2.      Common Law Duty – a duty to avoid favoring the director’s own interests over a creditor’s claim once the corporation becomes insolvent.

 

The Court was careful to note the limits of the common law duty.  It emphasized that the common law duty owed to an insolvent corporations creditors is not a “fiduciary” duty in the same sense that directors owe a fiduciary duty to shareholders.  Because the plaintiff creditor in this case failed to prove that the director had favored his own interests over the creditor’s interests, the case was dismissed.

 

Effective July 1, 2006, Colorado enacted a statute (C.R.S. § 7-108-401(5)) stating that directors and officers of corporations owe no fiduciary duties to the corporation’s creditors. While this provision did not apply in the Alexander case, the Colorado Supreme Court nevertheless expressly declined to comment on whether that statute applies when a corporation is insolvent.  It also is unclear whether this statutory protection supersedes Colorado’s common law duty of officers and directors to creditors.

 

  1. Paratransit Risk Retention Group Ins. Co. v. Kamins, 160 P.3d 307 (Colo. App. 2007)

 

Facts:  This case involved a creditor’s claims as to distributions made to the sole shareholder of an allegedly insolvent corporation.  CTS owned the majority interest in two Denver taxicab companies, which CTS insured through Paratransit.  The policy provided that Paratransit and CTS would each bear a portion of any claim.  In exchange, CTS paid premiums and a $40,000 letter of credit.   

 

Two years later, facing unsettled claims for four motor vehicle accidents involving its taxicabs, CTS sold its assets and deposited most of the proceeds into CTS bank accounts.  The president and sole shareholder of CTS then transferred over $500,000 to himself, leaving only a small amount in an escrow account to pay creditors and claims.  A trial court found that (a) CTS was insolvent at the time of the pending claims, and (b) CTS’s president had violated his fiduciary duty to pay debts owed to creditors before paying himself.  CTS appealed.

 

Holding: A sole creditor in an insolvent Colorado corporation has standing to directly sue the directors under Alexander, unless the director is protected by a safe harbor provision; however, the trial court applied an improper standard for determining whether CTS was “insolvent” when distributions were made to its shareholder.

 

Two days after Alexander was issued, the Colorado Court of Appeals issued its opinion in Paratransit, holding that where there is only one remaining creditor in an insolvent corporation, the creditor has standing to directly sue the directors for an unlawful distribution in violation of the statutory duty outlined in Alexander – a claim historically reserved for only the corporation and its own shareholders. 

 

The Court held that the creditor had standing and remanded the case to the trial court for a determination of whether the company was in fact “insolvent” at the time of the challenged distribution.

 

To provide guidance to the trial court, the Court of Appeals outlined the following factors to consider in determining whether a Colorado corporation is “insolvent” – i.e., whether distribution would impair the ability of the corporation to pay its debts as they become due in the ordinary course of business:

 

1.      The number of debts unpaid each month versus those that are paid.

2.      The amount of the delinquency.

3.      The materiality of the nonpayment.

4.      How the company conducts its financial affairs.

5.      The magnitude and value of the company’s contingent liabilities.

 

The Court also addressed the scope of the statutory safe harbor defense available to directors of Colorado corporations.  The safe harbor is found at §7-108-401 and provides that a director approving a distribution is not liable if he or she performs his or her duties in good faith, with the care of a reasonably prudent person and in the best interest of the corporation. 

 

  1. Kim v. Grover C. Coors Trust, 2007 WL 686923 (Colo. App.)

 

Facts:  Jeffrey Coors was the CEO and controlling shareholder of Graphic Packaging International Corp., Inc.  Graphic Packaging sought to acquire the assets of another company and entered into a credit agreement which required it to pay back $525 million of debt in one year or less.  Graphic Packaging planned on using the proceeds from the sale of a mill that it also owned to satisfy this obligation; however, the mill sale fell through.   Graphic Packaging then decided to raise funds to comply with the credit agreement by selling 1,000,000 shares of convertible preferred stock to the Grover C. Coors Trust (of which Jeffrey Coors was a trustee) for $100 million.

 

Kim, an owner of Graphic Packaging’s common shares, brought a breach of fiduciary duty action against the directors, controlling shareholders and the related trust (collectively, Coors).  The trial court found in favor of Coors; and the minority shareholder appealed. 

 

Holding: A non-controlling minority shareholder has standing to sue the directors of a corporation where he has alleged an injury that was not common to all other shareholders; however, in this case the conflicting interest transaction was fair to the corporation.

 

The Colorado Court of Appeals held that because the non-controlling shareholder alleged an injury that was not common to all other shareholders, he had standing to sue.  Typically, a shareholder may not assert a direct claim against directors of a Colorado corporation.

 

The Court of Appeals outlined the factors that courts (and directors) should examine in determining whether a conflict of interest transaction (e.g., one in which the corporation is involved with an officer or director of the corporation) is fair. Noting that the fairness test is a facts and circumstances balancing analysis, the court nevertheless identified the following significant factors:

 

·        Whether the transaction was accompanied by full and fair disclosure of the material facts to the shareholders;

·        Whether there was adequate consideration;

·        Whether the transaction benefited the corporation; and

·        Whether the directors siphoned benefits for themselves.

 

In doing so, the Colorado Court of Appeals refused to adopt Delaware’s “entire fairness” test which focuses on the fairness of the process and the price. Nevertheless, the case provides a good roadmap of steps that can be taken in conflict of interest situations to help establish fairness, including the following:

 

·        Obtaining a fairness opinion from a reputable investment banker;

·        Establishing a special committee comprised of directors that are not interested to review the proposed transaction;

·        Making sure the directors are experienced and understand their fiduciary duties; and

·        Examining other alternatives.

 

 

Noncompete/Nonsolicit Case:

 

 

  1. Phoenix Capital, Inc. v. Dowell, 2007 WL 2128339 (Colo. App.)

 

Facts:  As part of a corporate reorganization, Phoenix Capital purportedly assigned an employment agreement with Robert Dowell containing noncompete and nonsolicit covenants to a related entity.  Phoenix Capital sought to enforce the noncompete based on the “professional staff” exemption.

 

Holding:  “Professional staff” includes persons who report to managers or executives and who serve as key members of the manager’s staff in the implementation of management functions.  If an employee signs a non-compete at a time when none of the exceptions apply (rendering the agreement unenforceable), and then the employee grows into a position of “professional staff” or “management,” etc., the non-compete will not become enforceable unless the employee executes a new agreement at that time.

 

Professional Staff Exemption:  Non-compete agreements are unenforceable in Colorado unless any one of four exceptions apply:  See § 8-2-113(2):

 

                            (a)            Any contract for the purchase and sale of a business

                           (b)            Any contract for the protection of trade secrets

                            (c)            Any contract providing for recovery of education/training expenses

                           (d)            “Executive and management personnel and officers and employees who constitute professional staff to executive and management personnel.” (emphasis added).

 

Dowell represented the first appellate court examination of what is meant by “professional staff to executive and management personnel.”  The Colorado Court of Appeals concluded that “professional staff,” on its own, is a broad term, which could encompass anyone who has a learned profession or a high level of training or proficiency in a given occupation.  

 

The Court of Appeals held, however, that in order to qualify as “professional staff to executive and management personnel” (emphasis added) the professional must not only report to managers or executives, but must serve as a “key member of the manager’s or executive’s staff in the implementation of management or executive functions.”  Therefore, although the defendant in this case was likely “professional staff,” and although he reported primarily to managers and executives, “most of them doubled as sales persons and eighty to ninety percent of [the employee’s] work was performed in support of the sales staff, rather than in support of executive or management functions.”

 

Time Frame for Measuring Exemptions:

 

Another important aspect of the decision is its direction as to the applicable timeframe for determining whether any of the exceptions is present. If an employer and employee execute a non-compete or non-solicit agreement at a time when none of the exceptions apply (because, for example, the employee is neither an executive or management employee nor professional staff to one), but the employee later grows into such a position, the decision indicates that the non-compete or non-solicit clause will not apply.

 

According to the Court of Appeals, if the employee grows into a position that might subject him or her to the non-compete statute, it is up to the employer to induce him or her to sign a new agreement containing an enforceable non-compete or non-solicit clause at such time.  Thus, the burden is on employers to monitor and obtain new agreements with each new promotion.

 

Customer Nonsolicits:

 

The Court of Appeals determined that a nonsolicit of customers was the equivalent of a noncompete and therefore was subject to analysis under Colorado’s statutory provisions regarding noncompetes.

 

Time Period for Restrictive Covenants:

 

The Court of Appeals refused to extend the duration of an enforceable non-compete or non-solicit clause beyond the period set forth in the provision itself.  Thus, in this case, the duration of the non-solicit clause one year, and it took nearly that long to complete the trial on the employer’s motion for preliminary injunction. The plaintiff succeeded on only one aspect of its case—an injunction barring the employee from soliciting the employer’s employees for one year after he terminated his employment. The employer asked the trial court to commence the one-year period as of the date of the trial (rather than the date of termination), but the trial court refused. The Court of Appeals agreed, holding that the duration of the injunction “must be co-extensive with the terms of the contract.”

 

Applicability to Successors & Assigns:

 

The Court of Appeals did not engage in an in-depth analysis of one of the more interesting aspects of the case (and one on which courts in other jurisdictions have split) –  i.e., whether the restrictive covenants in the employment agreement could be assigned to another entity without the consent of the employee.  As a factual matter, the Court of Appeals concluded that the inclusion of a standard “successors and assigns” provision constituted assent by the employee to any subsequent assignments of the agreement.

 

Other Corporate Law Cases of Note:

 

  1. The Fort Lyon Canal Co. v. High Plains A&M, LLC et. al, 167 P.3d 726 (Colo. 2007)

 

Facts: A nonprofit corporation’s bylaws required shareholders to pay all legal and engineering expenses associated with seeking a change of water rights from the water court.  However, when certain shareholders, in addition to seeking a change of water rights also challenged certain limitations imposed by the board of directors, the corporation was forced to defend itself in the water court proceeding and sought compensation for its own additional legal costs under the terms of the bylaws.

 

Analysis & Holding:  Without clear language in the bylaws to the contrary, a corporation must shoulder its own legal expenses.  Because the bylaws did not explicitly entitle the corporation to costs and fees incurred in defending its board’s decisions in legal proceedings – even where those proceedings were directly related to an application seeking a change of water rights – the corporation has no right to reimbursement from the shareholders for such legal costs. 

 

  1. Svanidze v. Kirkendall, 169 P.3d 262 (Colo. App. 2007)

 

Facts:  The president, chairman and sole shareholder of a corporation filed a quiet title action claiming that the sale of the corporation’s sole property (a Winter Park bed and breakfast) was void because the vice-president of the corporation had sold the property without the knowledge or consent of the shareholder.

 

Analysis & Holding:  The real estate conveyance statute, § 7-103-102, C.R.S. (2007), that applies to real property conveyances by corporations, does not require evidence of shareholder approval, which in this case was required under the Colorado Business Corporation Act as the real property constituted substantially all of the corporation’s assets.  Rather, it requires that certain corporate documents be filed with the clerk and recorder if there is any limitation on the general power of officers of the corporation to convey real estate.  If such corporate documents are not properly filed, the conveyance statute abrogates any protection that the corporation otherwise would have against a party who acquired the property from a corporation.  The bona fide purchaser had no notice of limitations on the sale or on the vice president’s corporate powers.

 

  1. In re the Marriage of Nevarez, 170 P.3d 808 (Colo. App. 2007)

 

Facts:  In this legal separation proceeding, a wife appealed from the final orders regarding property division, maintenance and attorney fees.  In the order, her husband was required to pay $1,750 per month in maintenance based on the husband’s calculation of the net present value of his professional medical partnership interest based on the terms of the partnership agreement.

 

Analysis & Holding:  The Court of Appeals determined that the price fixed in a partnership buy-sell agreement is not binding on the other spouse for equitable distribution purposes when the other spouse did not consent to it or agree to be bound by its terms.