Wu v. Kelmon et al

OCR transcription for search; preserved printed pages are authoritative

Entered on Docket
September 30, 2010

GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA

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aa NORTHERN DISTRICT OF CALTFORNIA
-) 10
‘e) In re ] Case No. 08-55393-ASW
3S) 11 ]
iS 4 KELMOORE INVESTMENT CO., INC., ] Chapter 7
5 12 ]
s B= Debtor. ]
Yd 13 ]
ES CAROL W. WU, Trustee, ] Adv. No. 08-5337
nn 14 7]
a 2 Plaintiff, ]
PQ .2 15 ]
nA vs. ]
fA & 16 ]
< a RALPH KELMON; SHAWN YOUNG; AND ]
fH 3 17 || MATT KELMON, j
2 ]
RB S 18 Defendants. ]
EX ]
Se 19
é MEMORANDUM DECISION RE
20 MOTION FOR PARTIAL SUMMARY JUDGMENT
21 Before the court is the motion for partial summary judgment
22] (“Motion”) filed by Trustee in the adversary proceeding brought by
23 || Trustee against three former officers and directors of debtor
24 | Kelmoore Investments Co., Inc. (“Debtor”). The Motion is opposed
25 || by the three officer/director defendants sued by Trustee.
26 || Defendant Ralph Kelmon (“Ralph”) was Debtor’s CEO from September
2711992 to August 2008. Defendant Matt Kelmon (*Matt”) is Ralph’s son
28 || and was Debtor’s senior vice president of investments from 1994 to

GPO

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17

1] January 2008. Defendant Shawn Young (*Shawn”) is Ralph’s daughter
2 || and was Debtor’s chief financial officer from 1999 to January 2008.
3 A continued hearing on the Motion was held on August 24, 2010
4j}and the matter has been submitted for decision. Trustee is
5] represented by Linda Sorensen, Esq. of Stromsheim & Associates.
6] Ralph, Matt and Shawn (collectively, “Defendants”) are represented
7) by Fenn C. Horton III, Esq. Of Pahl & McCay.
8 This Memorandum Decision constitutes the Court’s findings of
HH 9] fact and conclusions of law, pursuant to Rule 7052 of the Federal
fe 10} Rules of Bankruptcy Procedure.
ee 2 I.
5 a 13 FACTS
so 14 Debtor is a corporation that filed a chapter 7 bankruptcy
Ag 15 | petition on September 24, 2008. Plaintiff is the Trustee of
BS 16 |] Debtor’s chapter 7 bankruptcy case. Debtor was founded by Ralph
aE 17 | and operated as a family business for many years. In 2001, outside
Re 18 |] shareholders were brought into Debtor. Debtor earned management
oe: 19} fees and commissions by serving as the investment advisor and
~ 20 | broker/dealer to the Kelmoore Strategic Trust (*KST”) which managed
21 three mitual funds. Debtor also earned advisory fees from
22 || separately managed accounts.
23 Between January 2001 and January 2006, Debtor made the series
24 |} of loans to Matt, Shawn and Ralph. Specifically:
25 (1) Matt borrowed an aggregate of $251,000, based on:
26 (a) a note payable for $75,000 dated and signed
(27 September 26, 2001;
28 (b) a note payable for $28,500 dated and signed
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October 15, 2002; and

2 (c) a note payable for $127,500 dated October 31, 2005
3 and signed January 19, 2006.
4 (2) Shawn borrowed an aggregate of $80,000 based on:
5 (a) a note payable for $25,000 dated and signed
6 August 12, 2002;
7 (bob) a note payable for $30,000 dated and signed
8 December 30, 2002; and
tH 9 {c) a note payable for $25,000 dated and signed
5 10 December 7, 2004.
S « 11 (3) Ralph borrowed an aggregate of $75,500, based on:
28 12 {a) a note payable for $16,000 dated and signed
ons 13 December 2, 2002;
= 14 (b) a note payable for $40,000 dated and signed
as 15 September 9, 2003; and
BE § 16 (c) a note payable for $19,500 dated and signed
as 17 October 31, 2005.
A 18 || Each promissory note has an interest rate at the short term
Se 19 || applicable federal rates published monthly by the IRS for the month
P 20 || in which the promissory note was dated. Interest accrues monthly
21 || on the unpaid balance and the note is due in full at the time of
22 || separation from Debtor.
23 Bach of the three notes executed by Matt and the three notes
24 || executed by Shawn bear the notation: “Paid in Full / Ralph M.
25 ||Kelmon / C.E.0O. / 1-3-2008." According to Defendants, at the time
26 || that the notes were made, Shawn and Matt were informed that the
27 || loans were a form of additional compensation and that if both
28 | individuals continued working for Debtor, the loans would
Ca

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17

FOR PARTIAL SUMMARY JUDGMENT

a

eventually be forgiven Matt and Shawn would each have the

2 || opportunity to turn in stock at the rate of $1 per share as
3 || collateral for the loans.
4 In January 2004, Debtor settled a lawsuit with a former
5 || officer, Thomas Killilea (*Killilea”). Pursuant to that settlement
6| Debtor agreed to repurchase Killilea’s shares of Debtor’s stock to
7\| Sl per share. In order to fund the settlement, Debtor resold most
8 ||of Killilea’s shares to outside investors for $1 per share and
- 9] Debtor repurchased 150,000 shares for $150,000.
: 10 In 2005, Debtor entered into a voluntary settlement with the
~ < 11 || Securities and Exchange Commission (‘the SEC Settlement”) which,
OE 12 | according to Defendants, dramatically altered Debtor's business
ans 13 |} medel going forward as well as Debtor’s ability to generate revenue
ae
= 141 from advisory fees and commissions. Defendants contend that,
a 15} mainly as a result of the SEC Settlement, Debtor’s revenues
2 E 16 || declined from $14.5 million in 2005 to $8 million in 2006 and $5.1
<
are 17 |} million in 2007.
Ae 18 According to Defendants, in 2007, relations between the inside
Se 19 |} members of Debtor’s board of directors and the outside members grew
Y 20 || increasingly hostile and antagonistic as Debtor’s income continued
214} to drop. According to Defendants, Ralph and Matt made some general
22 || inquiries regarding a possible sale, partial sale, or merger of the
23 || business. According to Defendants, around June 14, 2007, Debtor
24 |} received a non-binding letter of interest from CIT/CCM partners to
25 || acquire all of Debtor’s assets with a purchase price left open.
26 || According to Defendants, around June 28, 2007, Debtor received a
27 || £ixrm proposal from Dunham & Associates to acquire Debtor where
28 || Debtor was valued between $5 million and $10 million.
Ca

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17

FOR PARTIAL SUMMARY JUDGMENT

According to Defendants, Ralph asked the Debtor’s board to

2 | consider the CIT/CCM partners and Dunham offers at a board meeting
3} held on August 15, 2007. Page 7 of the approved minutes from the
4l| August 15 board meeting states that the Board of Trustees: ‘“[T]hat
5 || Management is authorized to pursue with all due speed the sale of
6|| the firm for not less than the appraisal value to be determined
7\| from the appraisal firm now engaged to report in approximately 3
8 || weeks.”
9 On September 24, 2007, Debtor’s board of directors met and
BD
a 10 |} passed a resolution approving the letter of intent with CIT/CCM
~ « 11} partners and also passed a resolution requiring the collection of
re ; ;
0 & 12 || outstanding employee promissory notes by January 2, 2008.
Ks
~ 5 13 |] Regarding the repayment of the employee loans, page 11 of the
et
4 14} approved minutes from the September 24, 2007 board meeting states:
<# ;
m2 15 WHEREAS, the Board of Directors, after due
nA deliberation and discussion, deems it to be in the best
Me 16 interests of the Company and its shareholders, to require
EX o :
ts that all loans from the company made to officers,
Kb 6 17 directors, employees or shareholders shall be repaid by
DZ, January 2, 2008, or if the company is subject to a
RB = 18 legally binding agreement for sale by said date, that the
mF first proceeds distributable to the borrowing officers,
F © 19 directors, employees or shareholders shall be used to
5 satisfy their loan obligations to the company -
20
NOW, THEREFORE, BE IT RESOLVED, that the Board of
21 Directors hereby directs that the CFO require repayment
of all employee loans by January 02, 2008 or if the
22 company is subject to a legally binding agreement for
sale by said date, that the first proceeds distributable
23 to the borrowing officers, directors, employees or
shareholders shall be used to satisfy their loan
24 obligations to the company.
25 RESOLVED FURTHER, that Ralph Kelmon, the Company’s
CEO, and Shawn Young, the Company’s Chief Financial
26 Officer, be, and hereby are, authorized and directed to
take any and all actions that they may deem necessary or
27 appropriate to effect the intent of the foregoing
resolution.
28
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FOR PARTIAL SUMMARY JUDGMENT 5

According to Defendants, shortly after the September 24, 2007

2 | board meeting, Matt and Shawn informed Ralph that Matt and Shawn
3 ||} were going to resign to pursue other employment opportunities.
4}| According to Defendants, Ralph was particularly concerned with this
5 || news because the value of Debtor to a suitor would be seriously
6] impaired is Debtor lost Debtor’s senior vice president of
7 || investments and Debtor’s CFO shortly before a sale could be
8 completed. Matt also sat on the board of directors of KST --
H 9 | Debtor’s main customer and revenue source. According to
> 10 | Defendants, Ralph was concerned that if Matt left Debtor, the KST
~ < 11 || contract could be put in jeopardy. According to Defendants,
ve 12 |] between September 24, 2007 and October 31, 2007, Ralph negotiated
5a 13 | agreements on behalf of Debtor to keep Matt and Shawn employed with
om
. 14 || Debtor until a sale could be completed.
A 15 Based on an email string included in Trustee’s supplemental
or 16 || papers, sometime on or before 10:29 a.m. on Wednesday, October 24,
as 17 | 2007, Shawn sent an email to Scott Rodde -- one of the outside
Ae 18 | directors. Shawn’s email addresses the repayment of a note held by
5 19 |] an employee, Alex Kim, who was being terminated and that the
» 20 | repayment of the note could not be made from accrued vacation or
21 || payroll or Debtor would be in violation of the Labor Code. With
22 || respect to the notes receivable from Ralph, Matt and Shawn, Shawn’s
23 || email states in relevant part: |
24 The Board is advised to approach them individually and
work out a mutually agreeable repayment plan. It is not
25 advised to threaten firing them. Rather, the Board may
advise them that not having a repayment schedule
26 established may impact their bonus or raise next year.
Repayment of notes out of stock proceeds makes sense
27 because we are not up against the labor code.
28

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FOR PARTIAL SUMMARY JUDGMENT 17

—_—

Scott Rodde’s reply sent at 10:29 a.m. on October 24, 2007,

2 | provides in relevant part:
3 please provide a schedule to show how the CIT sale
(assuming only the minimum payments are made) will
4 provide the funds to liquidate the notes of Ralph, Matt
and you. This schedule should be specific to each
5 borrower, show the total owed to the corporation by each
individual, including accrued and continuing interest,
6 the number of the corporation’s shares held by each
borrower and the schedule of payments flowing from the
7 sale to CIT that will be applied to the debt based on
individual shares owned. Please provide this schedule by
8 the end of the week. =
- 9 If any of the individual borrowers wish to pay their debt
faa by a date certain, rather than from share proceeds that
-) 10 must be communicated to the Board by Wednesday
e) October 31. It [sic] there is a shortfall from the CIT
0 1] sale, based on your analysis, the individual borrower’s
Pig plan to liquidate the debt to the corporation must also
Og :
m6 12 be communicated to the Board by Wednesday October 31.
QR. =
~ 35 13 |] Shawn replied that Shawn would provide the requested schedules by
et
2 S$ 14] rriday.
< +
pa 15 Per an email sent by outside board member Richard Hajijar
- j
ee g 16]} (*“Hajjar”) on Tuesday, October 30,-.2007 at 9:56 a.m., further
y c= ;
are 17 || communications between Ralph and the outside board members was to
RB = 18 || go through Hajjar. Hajjar’s October 30 email provides in relevant
ms 19 .
Ae part:
~ 20 Larry Klein is in the process of putting together a
resolution regarding the repayment of loans for Kelmoore
21 employees. Once the resolution is complete, I’1l forward
a copy to you for review. In conjunction with this,
22 Scott had asked Shawn to provide a detailed schedule of
the notes with various scenarios for repayment. Could
23 you get with Shawn and then e-mail the schedule to me
when it is comoleted.
24
25 Ralph replied to Hajjar’s email at 1:09 p.m. on Tuesday,
26 October 30, 2007, stating in relevant part:
27 IT am more than happy to deal with you on issues from here
on out. I propose that KIC [Debtor] take shares at $1
28 each as repayment for the notes. This is the exact
figure that was paid to Tom Killilea for his shares.
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FOR PARTIAL SUMMARY JUDGMENT 17

—

Clearly, Matthew, Shawn and I have been greatly more
valuable to the company during our 14, 8 and 16 years of

2 service, respectively. I told Matthew and Shawn that the
loans could be repaid with Kelmoore Stock at a time when
3 I, as CEO and Chairman, had complete and explicit
authority and voting control via the voting trust. I
4 propose this be part of our completion agreement. I
believe this will be beneficial for KIC shareholders in
5 two ways. Firstly, money coming in from the sale will be
taxable, the note forgiveness will increase next year’s
6 loss, and the more we shelter proceeds, the higher the
payout to the individual shareholders. Secondly, as key
7 employees going forward during both the extremely
important transition and “workout” periods, having the
8 note issue behind us is in the best interest of all.,
[SIC] both the Buyer and the Seller, inciuding the
- 9 Directors and employees -- which is ultimately in the
aa best interest of shareholders. The three noteholders
=) 10 stand ready to deliver the shares at “high noon” on
(oe) January 2, 2008 or any other time after that date the
0 11 Board determines is more appropriate for business
iS 4 reasons.
a. =
~ } 13 On October 31, 2007, Debtor issued letters to Shawn and Matt
aed
BS 14 || stating in consideration for the years of service and dedication to
<= | | | |
pos 15 || Debtor and consistent with the previous stock buy-back entered into
wn
- g 16 || by Debtor with another employee, Debtor offered to redeem no than
<i
Bs 17 || January 4, 2008 the amount of Debtor’s common shares at the rate of
As 18 $1 per share necessary to cancel all of the outstanding promissory
=
F £ 19 || notes Matt and Shawn owed to Debtor.
- 20 According to Defendants, on Thursday, November 1, 2007, Ralph
21 |} received an email from Hajjar stating that Debtor’s board had
22 || discussed Ralph’s proposal regarding the repayment of the notes and
23 | the outside board members agreed that the $1 per share price was
24]} too high. Hajjar’s November 1, 2007 email states in relevant part:
25 The group of outside directors have discussed your
proposal regarding the repayment of the notes. We are
26 all in agreement that the value of $1.00 per share is too
high, although this price was used in the Tom Killilea
27 transaction, we currently have an outside valuation and
an offer on the table for about 10.9 cents per share. We
28 used the low end of the sale price per share because this
is the amount that is guaranteed.
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FOR PARTIAL SUMMARY JUDGMENT 17

Keep in mind that when we send out the proxy for KIC
shareholders to vote for the sale to CIT we have to

2 include how assets were/wili be accounted for. The notes
are on the books as an asset. Given the sentiment of
3 some of the more vocal outside shareholders, we cannot
justify a share price of $1.00 to pay off the notes due
4 vs 10.9 to 28.3 cents for the sale of the remaining
assets of KIc.
5
With the above in mind, we would like Larry Klein to go
6 forward with the resolution we originally mentioned
regarding the notes.
7
8 Ralph replied to Hajjar’s November 1, 2007 email stating:
KH 9 Hi Rick, The proposal is no a proposed idea. It is a
laa fact that while the Company was under the voting trust
2) 10 agreement, I agreed that the $1.00 per share price would
e) be used for repayment. The precedent for that price was
io) 11 the negotiated price that was paid to Tom Killilea in my
oe: settlement of his suit against Kelmoore Investment
a 5 12 Company and me. It was acceptable to Tom who was leaving
Qe the Company; it provided me with a basis for good, loyal,
~ 5 13 and productive employees in a difficult time. I had the
& 5 power and authority to do it under the Voting Trust
73 14 Agreement, and I did it. It enabled me to keep the
<e Company going and retain valuable employees. We are
FQ .2 15 having more difficult times now. I hope this ends the
mA discussion. There is no need for any resolution as my
ee g 16 actions resolved the note problem when the notes were
ts granted. Larry Klein drew up the trust and Duncan King
KE 6 17 was present and he acknowledged the power I was getting.
DZ, I hope this hurdle is behind us. Regards, Ralph
Az 18
aan
Be 19 On January 3, 2008, Matt, Shawn and Ralph each completed a
| 20 || form directing the corporate secretary to cancel the appropriate
21} number of shares of Debtor’s stock consistent with the outstanding
22 || loans for each individual. Also on January 3, 2008, Ralph wrote in
23 || each of the promissory notes of Matt and Shawn ‘Paid in Full.”
24 According to the minutes of a board meeting heid on January 8,
25 | 2008, the board moved to disapprove of Ralph’s actions relating to
26 || the notes receivable. The minutes from the January 8 board meeting
27 || at pages 5 to 6 provide in relevant part:
28 Mr. Rodde asked about the impairment of Notes Receivable.
The board then discussed the pluses and minuses of
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FOR PARTIAL SUMMARY JUDGMENT 17

employee notes that were retired with the return of
Kelmoore Common Stock. The CEO said he had made promises

2 to the employees before when the notes were initially
approved and he sought outside legal advice before he
3 approved the acceptance of Kelmoore Stock for repayment
of the personal notes. He stated that his primary
4 responsibility as CEO was to make sure the key employees
stayed on during this period of possible sale of the |
5 Company. He could not complete the deal, the audit, and
the SEC response without them. The notes involved Mr. R.
6 Kelmon, CEO, Mr. M. Kelmon, SEVP Portfolio Management and
Ms. Young, CFO. A lengthy discussion ensued about
7 whether the approval for the debt repayment was
appropriate and why the board had not been further
8 consulted before the final action. The CEO felt he was
given the authority to retire the notes, and, given the
= 9 critical time for the Company, he knew he would lose key
jaa employees that had recently accepted two large pay-cuts.
-) 10 Mr. M. Kelmon and Ms Young said the reason they stayed on
© through the audit and to remain to close the CIT deal was
0 11 because the CEO had agreed to accept the stock in
3 4 repayment as he had previously promised as CEO of the
an s 12 Company. The outside board members expressed their
pa dissatisfaction with the approval and the share price.
Yo 13 Mr. Rodde wanted it reviewed to assure there were no
& ro self-dealing and pricing issues and was of the opinion it
7% 14 was highly questionable.
tat
a 2 15 Mr. Rodde called for a vote to disapprove of this past
mA action. Mr. Hajjar highly recommended that the CEO get
fe . 16 another opinion and he did not feel there was a specific
ts precedent for this. Ms. Vanderweil said this board has
Kb 6 17 spent a lot of time with no pay to always try to do what
DZ is best for the shareholders and this action concerned
RB a 18 her. Mr. M. Kelmon believed that losing key employees at
= RB this time, however, would not be in the shareholders’
ra iS 19 best interest. Mr. Klein stated that he disagreed with
5 the action, but the CEO was free to seek another opinion
20 from an outside attorney.
21 Mr. R. Kelmon said that the CPAs had all the facts and
know there was a pricing discrepancy between the CIT
22 offer and this note transaction.
23 Mr. King reminded the Board that there was a motion on
the floor from Mr. Rodde for a vote to disapprove of this
24 past action. Ms. Vanderweil seconded the motion.’
25 Voting against the disapproval of the action were R.
Kelmon, M. Kelmon, and Ms. Young. Voting for the
26 disapproval were all the outside directors D. King, S.
Rodde, L. Vanderweil, D. Moore, and R. Hajjar.
27
28
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4 FOR PARTIAL SUMMARY JUDGMENT 17 1

On August 5, 2009, Trustee filed a first amended complaint

2i|/against Ralph, Matt and Shawn seeking -- among other things -- a
3 | szudgment both jointly and severally for $407,550 for original
4] promissory notes the three defendants collectively owe to Debtor.
5 || There is no promissory note for the $1,050 loaned to Shawn in July
6} 2002.
7
8 Il.
= 9 ANALYSTS
: 10 Trustee’s motion raises three grounds for liability: (1) a
S < 11} claim for money lent; (2) a claim for corporate waste; and (3) a
Ot 12] claim under California corporations code section 310. Trustee
Ba 13 || seeks a separate judgment holding Defendants jointly and severaily
me
=e 14|| liable for the total promissory notes on the basis that Defendants
a 15 |] lacked corporate authority to cancel the promissory notes in
BS 16} exchange for surrendering shares of Debtor’s stock to Debtor for
as 17 || $1 per share in December 2008. Defendants assert that Ralph was
Ae 18 || pre-authorized to exchange the notes for shares of Debtor’s stock
5 19] based on the September 24, 2007 board resolution that granted Ralph
=) 20 || broad authorization to have the outstanding employee loan repaid.
21 As explained by the Court at the March 19, 2010 hearing on the
22 || Motion, the elements for a claim for money lent are: an allegation
23 || of indebtedness, and a failure to repay any part of the loan. Cf.
24 || Moya v. Northrup, 10 Cal. App. 3d 276, 280 (1970).
25 In this case, the promissory notes executed by Matt and Shawn
26}}all indicate that those notes were paid in full on January 3, 2008.
27 Although the payee has the burden of going forward
to rebut the presumption that a paper stamped “paid’ had
28 in fact been discharged by payment, this is merely a
burden of going forward and the ultimate burden remains
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FOR PARTIAL SUMMARY JUDGMENT 17

on the defendant to establish the defense of payment.
The fact that a promissory note is marked paid does not

2 bar suit on it but raises a rebuttable presumption of
payment that the payee may then rebut by proving that the
3 note was so stamped by mistake or by one acting without
authority.
4
5||6 Lary Lawrence, Anderson on the Uniform Commercial Code, §3-307:48
61] (3d ed. 2009). Thus, it appears that Trustee may rebut the
7 | presumption of payment by proving that the note was marked as paid
8} in full by Ralph acting without authority. There is a material
fH 9 |) dispute of fact as to whether Ralph was acting without authority.
: 10 || Namely, Ralph believed that Ralph had authority at the time that
~ : 11 |} Ralph both sent the October 31, 2007 letter to Matt and Shawn as
&: 12 }well as at the time that Matt, Shawn and Ralph tendered their
6 13 || respective shares of common stock in exchange for the outstanding
ae
3S 14 |} promissory notes. Debtor’s board of directors subsequently
a 2 15 |] disapproved of Ralph’s actions at the January 8, 2008 board of
BE 16 || directors meeting. However, there is a disputed issue of fact as
as 17] to whether Ralph had authority at the time Ralph entered into those
Ae 18 |] transactions on behalf of Debtor that precludes summary judgment at
oE: 19 || this time.
=) 20 Regarding Trustee’s claim under corporate waste, under
21 || Delaware law, directors are liable for corporate waste only where
22 || directors authorize an exchange that is so one-sided that no
23 ! business person of ordinary, sound judgment could conclude that the
24 || corporation has received adequate consideration. Glazer v. Zapata
25 || Corp., 658 A.2d 176 (Del. Ch. 1993).
26 As to Matt and Shawn, the defense for corporate waste is
27 |] presumably whether a business person of ordinary, sound judgment
28 | could conclude that Debtor received adequate consideration for the
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FOR PARTIAL SUMMARY JUDGMENT 17 12

UNITED STATES BANKRUPTCY COURT

For The Northern District Of California

Ke) oo ~ ON 7A) & Go N —

I) —_ — — —= — — — —= — —
‘co 06 Oo SN DBD nA BP W NY KF OD

payment of the outstanding promissory notes executed by Matt and
Shawn for the continued services of Matt and Shawn in addition to
Debtor receiving outstanding shares of stock held by Matt and
Shawn. Defendants assert that Matt and Shawn were told at the time
that each received the original loans from Debtor that the loans
were a form of additional compensation which would be forgiven
eventually if each individual continued their employment with
Debtor. In the fall of 2007, the compensation for both Matt and
Shawn was reduced and both individuals threatened to resign from
Debtor to pursue other employment opportunities. Ralph allegedly .
negotiated the agreement on behalf of Debtor whereby Debtor agreed
to forgive the outstanding promissory notes in exchange for the
return of an equal number of shares of Debtor’s stock on a $1 per
share basis up to the value of the outstanding loans if Matt and
Shawn agreed to remain in Debtor’s employ.

What Matt and Shawn were told at the time that each received
the original loans from Debtor as well as whether both individuals
threatened to resign from Debtor to pursue other employment
opportunities in the fall of 2007 are material issues of fact that

are in dispute that would preclude partial summary judgment as to |

N N N N 1) N N N
oo ~ nN GN & es) No —_

Cas¢

corporate waste at this time as to Matt and Shawn.

There is no assertion that Ralph was told at the time that
Ralph received the original loans from Debtor that the loans were a
form of additional compensation which would be forgiven eventually
if Ralph continued his employment with Debtor or that Ralph
threatened to resign from Debtor in the fall of 2007. Any analysis
of corporate waste with respect to Ralph is whether Debtor received

adequate consideration for the payment of the outstanding

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17

FOR PARTIAL SUMMARY JUDGMENT

For The Northern District Of California

UNITED STATES BANKRUPTCY COURT

oO Oo NIN DB wT FP WY NY

| On
>> © OA N DBA FP W NY KF O&O

promissory notes executed by Ralph in exchange for Debtor receiving

outstanding shares of stock held by Ralph at the rate of $1 per

share. This question is also a question of disputed fact that

precludes granting Trustee’s motion for partial summary judgment.

Finally, per California Corporations Code § 310(a)(1) and
(a) (2), no contract or other transaction between a corporation and

one or more of the corporation’s directors is either void or

voidable because such director is present at the meeting of the

board which authorizes, approves or ratifies the contract or

transaction, if either: (1) the material facts as to the
transaction and as to such director’s interest are fully disclosed
or known to the shareholders and such contract or transaction is

approved by the shareholders in good faith, with the shares owned

by the interested director or directors not being entitied to vote

thereon, or {2) the material facts as to the transaction and as to
such director’s interest are fully disclosed or known to the board
ana the board authorizes, approves or ratifies the contract or

transaction in good faith by a vote sufficient without counting the

vote of the interested directors and the contract or transaction is

just and reasonable as to the corporation at the time it is

NV NY NY NY NY NY NY WN
Ha AN DBD A fF WO NH

Casq

authorized, approved or ratified. If the contract or transaction
is not approved as provided above, California Corporations Code
§ 310(a) (3) provides:

As to contracts or transactions not approved as provided
in paragraph (1) or (2) of this subdivision, the person
asserting the validity of the contract or transaction
sustains the burden of proving that the contract of
transaction was just and reasonable as to the corporation
at the time it was authorized, approved or ratified.

NS Oassihu DRAGEROR: Ried, 09/23/10 Entered: 09/30/10 04:59:35 Page 14 of

FOR PARTIAL SUMMARY JUDGMENT 17 14

For The Northern District Of California

UNITED STATES BANKRUPTCY COURT

Oo Oo NIN Dn nO FP WO Ne

NO wo wp WN NH NY NO NB HN &F KF FF FF FPF PF OF OU SF hl S|
oO NN OO BR WD NY FY CD OD OH ND DH WH BP WO NHN KH OS

Cas

Trustee’s motion for partial summary judgment cannot be
granted at this time because there is an issue of material fact as
to whether defendants have sustained defendants’ burden under
California Corporations Code § 310(a) (3). If the court finds that
Ralph did not have authority under California Corporations Code
§ 310(a) (1) or (a) (2) to enter into the transactions that forgave
the outstanding loans of Matt, Shawn and Ralph in exchange for the
return of an equal number of shares of Debtor’s stock on a $1 per
share basis up to the value of the outstanding loans, under
California corporations code § 310(a)(3), the burden falls to each
defendant to prove that the transaction was just and reasonable as
to Debtor at the time that the transaction was authorized by Ralph.
Sammis v. Stafford, 48 Cal. App. 4th 1935, 1943-44 (1996).

Defendants assert that Matt and Shawn were told -- at the time
that each received the original loans from Debtor -- that the loans
were a form of additional compensation which would be forgiven
eventually if each individual continued their employment with
Debtor. In the fall of 2007, the compensation for both Matt and
Shawn was reduced and both individuals allegedly threatened to
resign from Debtor to pursue other employment opportunities. Ralph |
allegedly negotiated the agreement on behaif of Debtor whereby
Debtor agreed to forgive the outstanding promissory notes in
exchange for the return of an equal number of shares of Debtor’s
stock on a $1 per share basis up to the value of the outstanding
loans if Matt and Shawn agreed to remain in Debtor’s employ. What
Matt and Shawn were told at the time that each received the
original loans from Debtor -- as well as whether both individuals

threatened to resign from Debtor to pursue other employment

Er Passhr DRS Filed;,09/23/10 Entered: 09/30/10 04:59:35 Page 15 of

FOR PARTIAL SUMMARY JUDGMENT 17 15

opportunities in the fall of 2007 -- are material issues of fact

2 that are in dispute that preclude partial summary judgement as to
3}Matt and Shawn at this time.
4 In Ralph’s case, there is a material issue of fact as to
5 || whether the exchange at a value of $1 per share was just and
6 || reasonable as to Debtor at the time that Debtor forgave Ralph’s
7 || cutstanding loans in exchange for the return of an equal number of
8 || shares of Debtor’s stock on a $1 per share basis up to the value of
= 9] the outstanding loans. The Court finds that there is a material
> 10} issue of fact as to each of the three defendants as to as to
>, « 11 |} whether Ralph’s actions on behalf of Debtor fall within the
CE 12 || exception of California Corporations Code § 310(a) (3), and partial
56 13 | summary judgment is denied at this time.
BS
<&
- A 15 Trt :
Ee § 16 CONCLUSTON
as 17 For the foregoing reasons, Trustee’s motion for partial
Re 18 | summary judgment is denied. Counsel for Trustee shall prepare a
5 19 || form of order consistent with this ruling and shall submit the
~ 20 || proposed order to the Court after serving counsel for Defendants.
21
22 || Dated: |
23 | | vio Urb} y——
ARTHUR S. WELSSBRODT
24 UNITED STATES BANKRUPTCY JUDGE
25
26
27
28
Cas:

Werkagsum DE@ETOROE fdexbNO9/23/10 Entered: 09/30/10 04:59:35 Page 16 of

FOR PARTIAL SUMMARY JUDGMENT 17

—

Court Service List

2 || Linda Sorensen
Stromsheim & Associates
3201 California Street, Suite 350
San Francisco, CA 94111
4
5} Fenn. C. Horton IIT
Pahl & McCray
6/225 W Santa Clara Street, Suite 1500
San Jose, CA 95113
7
8 | Office of the U.S. Trustee / SJ
U.S. Federal Bldg.
i 9 280 S lst St. #268
faa San Jose, CA 95113-3004
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Case P8533 hr nDROGEAOns Filed}, 09/23/10 Entered: 09/30/10 04:59:35 Page 17 of
7

FOR PARTIAL SUMMARY JUDGMENT 17