Tortious Deprivation of Corporate Interest – They Can’t Take That Away From Me!

Posted by William J. Piercy on

A common misconception held by many entrepreneurs is that their ownership interests in a Georgia business entity can simply be revoked by the business or taken by other owners.  Under Georgia law, an ownership interests in a business entity cannot be so easily lost.

All too often, disputes between and among the various owners of a business entity arise because one believes that another is not doing enough to contribute to the success of the business.  As a result, one owner (often with a controlling interest) will attempt to revoke, take, or simply ignore the ownership interests of others with whom he disagrees.  Often, a call is made to the company’s CPA or bookkeeper with instructions that one owner’s interest in the business is to be deleted from the corporate records, or perhaps transferred to another owner.  The disfavored (and unsuspecting) owner often first learns of his purported divesture when he receives his K-1 from the accountant the following year.

Yet without some pre-agreed upon procedure, an ownership interest in a Georgia business entity generally cannot be forfeited as a result of action or inaction on the part of the owner or the business.  Instead, a recent Georgia Court of Appeals decision Monterrey Mexican Restaurant of Wise, Inc. v. Leon, 282 Ga. App. 439 (2006), makes clear that once a business interest is granted, it generally cannot be revoked.  An attempt to do so can give rise to substantial liability for tortious deprivation of corporate interest among other causes of action.

In Monterrey, Raul Leon owned more than 50 business entities which in turn owned Mexican restaurants in several states along the eastern seaboard.  All were known as Monterrey, or some derivation of that name.  In 1995, Raul formed a new Georgia corporation, Monterrey Mexican Restaurant of Wise, Inc. (the “Corporation”), along with Hector Leon and Jose Onate for the purpose of opening and operating a new restaurant in Wise, Virginia (the “Restaurant”).  According to various corporate records, each of the three were (or were to be) issued 1,000 shares of stock in the Corporation, and each contributed $1,000 to the Corporation for those shares.  Although these corporate records, including stock certificates, were created, they were never signed or executed by any officer of the Corporation.  During the first few years of the Restaurant’s operation, Hector, Raul and Leon infused additional capital into the Corporation “pretty often.”  However, these transactions were rarely documented as equity infusions or loans and receipts were not maintained.

In addition to his own capital infusions, Raul also granted (albeit informally) the Corporation and the Restaurant the rights to the name Monterrey.  Raul owned the wholesale supply company from which the Restaurant obtained food and supplies.  Raul also signed the lease for the premises and Raul made all the substantial business decisions.  Hector and Jose called Raul “uncle”, considered him to be the boss, and took direction from him as to all issues concerning the operation of the Restaurant and the Corporation.  While Raul made strategic business decisions concerning the operation of the Corporation and his other businesses, it was Hector and Jose who worked in the Restaurant day to day from the beginning.

In 1996, Hector stopped working at the Restaurant and moved away.  At Raul’s request, Hector worked at another restaurant owned by Raul in Suwanee, Georgia for a time, but left that position in 1998 and did no further work for any restaurant or business entity in which he or Raul held any interest thereafter.  Although Hector apparently received distributions from the Corporation in 1995 and 1996 as though he were a one-third member, he did not receive any distributions for 1997 or any time thereafter.

In 1998, Raul instructed the Corporation’s bookkeeper that Hector no longer owned any interest in the Corporation and further directed the bookkeeper to transfer the 1,000 shares previously assigned to Hector, to Raul.  The Corporation’s records were amended in 1999 to reflect that Raul owned 2,000 shares, that Jose owned 1,000 and that Hector owned zero shares.  It was in April 1999 that Hector first learned that he was no longer considered a shareholder of the Corporation.  Thereafter, he filed suit and won, but not as much as he wanted.  Both sides appealed the trial court’s ruling.

On appeal, the Georgia Court of Appeals affirmed the trial court’s finding of liability on the part of Raul and the Corporation, but for reasons different than those relied upon by the trial court.  The trial court found Raul and the Corporation liable for ‘conversion’ of Hector’s corporate ownership interest.  The Court of Appeals determined that “[c]onversion is not available as a cause of action with respect to intangible property representing an interest in a business.”  Instead, the Court essentially created a new cause of action:  tortious deprivation of a corporate interest.

In so ruling, the Court of Appeals relied on the facts that both Raul and the Corporation held Hector out to the public as being a shareholder; Hector believed he was a shareholder; Hector convinced the trial court that he was a shareholder; and Hector was deprived of the benefits of his ownership interest in the Corporation from 1997 forward.  As a result, the Court of Appeals determined that Hector was entitled to recover damages in an amount equal to the distributions he should have received from 1997 on, plus a substantial award of attorney’s fees.

As should be clear from Monterrey, ignoring the business entity ownership interests of Georgia entrepreneurs is ill advised.

When disputes arise between and among the various owners of a business entity, a prudent first step is to engage experienced counsel to review the corporate documents so as to determine the rights and responsibilities of the entity and its owners with respect to each other.  Do those documents set out specific roles and responsibilities for each owner?  Are they required to perform certain tasks or work full time toward the success of the business?  If such provisions exist, and if those duties are not being fulfilled, the offending owner may be liable for breach of contract and/or for fiduciary duty.  Do the documents provide for a mandatory buy/sell provision that would compel one party to buy out the interests of the other under certain circumstances?  Even where corporate documents are silent on these issues (or where such documents do not exist), tort-based claims such as breach of fiduciary duty, misappropriation of corporate assets and tortious deprivation of corporate interest may provide an avenue for relief.