On September 23, 2014, in Potok v. Rebh, the Philadelphia Court of Common Pleas held that the corporate officers of Floorgraphics, an advertising company, were held liable for appropriating $12 million from a settlement deal from the sale of their company in 2009 to News America Marketing.
As a brief background to the settlement deal, Floorgraphics initiated a lawsuit against News America Marketing in 2004 due to News America’s illegal practices, such as eleven hacking incidents of Floorgraphics’s protected website to gain the confidential information of its clients. After trial, News America agreed to settle with Floorgraphics for a sum of $29.5 million. Out of the settlement sum, $13 million would be allocated to Floorgraphics and its assets, $12 million towards the four corporate officer’s personal goodwill, and $4.5 million for the officer’s non-compete and consultation agreements. Out of the $12 million, Defendants Richard and George Rebh each received $4.8 million, and Chief Financial Officer Yves Anidjar and Senior Vice President Michael Devlin each received $1.2 million.
Plaintiff and minority shareholder of Floorgraphics, Fred Potok, filed suit in 2009 alleging improper diversion of the $12 million for the personal benefit of the majority shareholders. Plaintiff argued that the settlement and sale of Floorgraphics had not been disclosed to the shareholders, noticeably that defendants never included copies of the personal goodwill purchase and noncompete and consulting agreements.
In determining whether the settlement transaction was fair, plaintiff argued the fairness standard should be used. In Pennsylvania, if a party to a transaction is a fiduciary that gained personal benefits while acting in a fiduciary role, the burden to prove the fairness of such a transaction falls on that individual. Defendants tried to assert the claim that the transaction was necessitated by the fact that Floorgraphics would have lost its lawsuit against News America. Plaintiff argued that while the actual value of the contracts were not a problem, the distribution of the $16.5 million only amongst the majority shareholders posed the problem. Since, out of the $29.5 million settlement amount, only $13 million went directly to the corporation, the transaction could only fail the fairness test.
This is the first time that a court in Pennsylvania had applied the entire fairness standard to determine the appropriate threshold on which minority shareholders can question the self-dealings of majority shareholders. As can also be seen in another recent event involving minority shareholder oppression (read here), it appears more and more that majority shareholders can face repercussions for self-dealing.