Neuburger v. San Fran. Network, Inc.

KAREN NEUBURGER, Plaintiff and Appellant,

v.SAN FRANCISCO NETWORK, INC., et al., Defendants and Appellants.

A125443

COURT OF APPEAL OF THE STATE OF CALIFORNIA FIRST APPELLATE DISTRICT DIVISION TWO

Dated:August 10, 2011

NOT TO BE PUBLISHED IN OFFICIAL REPORTS

California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for publication or ordered published, except as specified by rule 8.1115(b). This opinion has not been certified for publication or ordered published for purposes of rule 8.1115.

(Marin County Super. Ct. No. CIV-045583)

INTRODUCTION

These appeals arise from a lawsuit filed by Karen Neuburger, a minority shareholder in defendants San Francisco Network, Inc. (SFN) and KN Ltd. (KN), against the majority shareholders and others in these garment industry closely-held corporations. Following a court trial, the court entered judgment in the amount of $530,557 plus interest in favor of plaintiff Neuburger and against defendants Leonard S. Eber (Eber), Richard Compton, Jr. (Compton), and Eber International, Inc. (EI) on Neuburger's claims for breach of fiduciary duties to her with respect to off-the-books loans and interest rate calculations, and in the additional sum of $303,456 plus interest against defendants Eber, Compton, Dustin Eber, Paul Ginsburg and Cypress IV Partners (Cypress) on Neuburger's claims for breach of fiduciary duties to her with regard to leases negotiated between Eber and SFN/KN.

Defendants appeal from the judgment, contending the court erred in finding they breached any fiduciary duty to Neuburger. Specifically, they contend the trial court erred(1) in finding Eber was a controlling shareholder; (2) in finding Neuburger's claims were properly brought as a direct shareholder action rather than as a derivative action; and (3) in making no findings on the issues of whether the interest rates for the loans and the lease rental rates were market rates and, consequently, fair to the company as a matter of law.

Neuburger also appeals from the judgment, contending the trial court erred in finding that defendants had sustained their burden of showing the fairness of the management agreements between SFN/SN and EI. We shall affirm the judgment.

FACTS AND PROCEDURAL BACKGROUND¹

Karen Neuburger began developing a line of women's sleepwear in the early 1990's. By 1994, she had perhaps eight to twelve people working for her and had developed accounts at various department stores. After receiving a large order from Mervyns, she realized she needed a bigger company in order to expand. She contacted Eber, for whom she had worked in the garment business in the past. She knew Eber had sponsored or provided financial assistance to at least one other small company, Harvey Celler, and she asked Eber if she could obtain his assistance using that same arrangement. Eber agreed and they formed SFN, a closely held corporation that purchased the assets of Neuburger's small company. Neuburger contributed $35,000 for 35 percent of the stock and Eber contributed $65,000 for 65 percent of the stock. At formation, Neuburger became president of SFN. Before forming the company, Neuburger had discussions with her husband and their accountant and reviewed the Harvey Celler agreement with Eber and Richard Compton, the chief financial officer (CFO) of EI, a company owned by Eber and his family. According to Neuburger, their accountant did not like the Harvey Celler agreement and did not like Eber's insistence upon at least a 60 percent management share. However, she had worked with Eber and believed that Eber and Compton had expertise in the clothing business that would be useful. She trusted them.

The parties entered into their first management agreement in 1994. Neuburger signed various notes whereby EI loaned sums of money to SFN to provide working capital for the fledgling company. Soon thereafter, Eber transferred a 43 percent interest in SFN to various irrevocable trusts that held the shares for his children. Ginsburg has been trustee of these trusts since the mid-1990's. At all relevant times, Neuburger held shares of stock in 35 percent of the company, Eber held 22 percent of SFN stock, and the Eber children's trust held the remaining 43 percent of the SFN stock. Neuburger was president of SFN, Eber was the chief executive officer (CEO) and chairman of the board, and Compton was the CFO and vice president.

The parties also agreed to a "management agreement" whereby EI received the greater of 12 percent of SFN's income or $15,000 per month in exchange for performing the company's management functions. Neuburger testified she believed Eber would also receive 0.5 percent as an administrative fee for his serving as a consultant and arranger of financing. According to Neuburger, the management agreement's 12 percent (or $15,000/month) allocation to EI was intended to cover the cost of handling all of the company's "back room functions," including data processing, credit and collections, accounting, production control, shipping and distribution, and piece goods warehousing. The 12 percent was broken down with individual percentages attributable to the six separate functions performed by EI. The agreement did not restrict EI to recovery of its costs.

Neuburger acted as president of SFN for approximately two years, after which Eber essentially took over the business because it had not turned a profit. Over time, the remaining business of EI with other small clothing companies and its own garment lines were reduced. By late 1995, Eber had sold off most of his other businesses and continued only in the business of managing SFN. At some point, Neuburger was moved to a new position as "chief lifestyle officer" and, in late 2002, Eber's son Dustin Eber was installed as president of SFN.

The management agreements continued and the company continued to make various loan payments in accordance with agreements signed by Neuburger and Eber. EIcontinued to handle management functions with Compton taking care of the accounting for EI and SFN. He was CFO and a board member of EI, SFN and KN. He accounted for loan payments and management fees that were paid in accordance with the original management agreement and the supplemental agreements that the parties entered over time. Neuburger agreed to the continuing management agreements (until the final agreement) and the continuing loans. She testified that she trusted Eber and the other defendants and did not question what was occurring.

In 1996, Neuburger was featured on the Oprah Winfrey show, after which business again improved and the sleepwear sales volume increased. SFN changed the pajamas brand to "Karen Neuburger," and Neuburger became the focus of publicity and appearances promoting the product line. She became less available for business decisions, and Eber became even more of the controlling authority for the company.

Also in 1996, the principals formed a separate company to hold the "trademarks" for the products sold by SFN. In 1999, this company became KN. The parties held stock ownership in KN as they had in SFN: Neuberger at 35 percent, Eber at approximately 22 percent, and the four irrevocable Eber children's trusts at approximately 43 percent. Martin Eber was the original trustee for these trusts. Attorney Paul Ginsburg has been the trustee since approximately 1996.

SFN was formed with a $100,000 capital investment. Neuburger knew that the company was undercapitalized. Since she did not wish to dilute her ownership interest, the company obtained working capital through loans. During 1995, EI loaned SFN $170,000, and Neuburger signed a promissory note to guarantee her 35 percent interest in that initial working capital loan. Beginning in 1996, Eber or EI loaned various amounts of money to SFN, pursuant to various terms describing interest at 15 percent and escalation clauses allowing interest to rise one percent per month to a maximum of 25 percent. Compton testified that he did not think that the interest rate on the loans ever got that high, although he agreed the terms allowed for such amounts and the written payment schedule he prepared shows interest payments at these high rates. Various sums of money were deposited with banks to obtain or secure letters of credit for merchantsproviding fabric and other goods. Other notes and loan agreements were signed over time by SFN with varying and relatively high interest rates that were to increase if they were not paid off. Defendants contended that either Eber or EI loaned or made funds available in amounts approaching $4,000,000 if the guarantees are considered. According to defendants, this was necessary because the parties' initial working capital was inadequate.

Much of the loan amount was kept "off the books" by Compton. He kept the loan agreements and the interest rate calculations in a separate safe that was inaccessible to Neuburger. Although Compton contended that Neuburger knew about the loans at relatively high rates of interest, he acknowledged that he had not provided anything in writing to her regarding the specifics of the interest rates or the mechanism of the charges. Defendants maintained this was necessary in order to create the appearance of a relatively solvent company in the event that the assets could eventually be sold. Eber and Compton advised Neuburger that "they were going to do something off the books so that the factors would not be aware of the debt of [SFN]." She left it to their expertise. However, she never knew about any loans being kept off the books with terms that could allow the charged interest rate to reach 25 percent. Eber testified he thought the interest charged on these loans was 1-1/2 percent per month, or 18 percent per year. However, he left the calculations to Compton. Compton never advised Neuburger of the high interest rates. The off-the-books interest payments on the loans were paid to Eber as salary bonuses...