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$45M judgment over stock demand reversed

kevin martinA corporate executive who accepted money from a friend’s charitable foundation to purchase company stock for himself, with the understanding that he would sell it at some point and share the proceeds with the foundation, did not commit bad faith by declining to sell upon his friend’s request, the Appeals Court has found.

The case involved plaintiff Robert James, a veteran investor who, through his foundation, fronted defendant Daniel Meyers, chief of Boston student loan company First Marblehead, $650,000. The money was to enable Meyers to purchase newly issued shares of company stock and avoid seeing his corporate interest diluted. In return, the foundation was to receive a significant chunk of any proceeds when Meyers sold the shares.

The contract, which consisted of a pair of single-page letter agreements, did not specify any terms under which Meyers actually had to sell the stock. By 2006, the stock’s value had exploded, and when James asked Meyers, who was collecting significant dividends on the stock, to liquidate, Meyers did not take steps to do so.

In 2011, a Superior Court judge found that though Meyers did not breach his contract with James, an “old-fashioned, trusting, gentleman’s agreement” nonetheless existed between the two obligating Meyers to seek to sell the stock upon James’ reasonable request. Finding that the defendant’s failure to do so violated the implied covenant of good faith and fair dealing, the judge awarded the plaintiff foundation nearly $45 million in damages.

But the Appeals Court reversed.

“[T]he ‘scope of the covenant is only as broad as the contract that governs the particular relationship,’” Judge R. Malcolm Graham wrote for the court, quoting the Supreme Judicial Court’s 2005 decision in Ayash v. Dana-Farber Cancer Institute, et al. “Simply put, a demonstration of James’s own good faith in asking for the agreements’ resolution does not make Meyers’s refusal to unwind an act lacking in good faith.”

The 21-page decision is Robert and Ardis James Foundation, et al. v. Meyers, Lawyers Weekly No. 11-011-15.

Meyers’ defense attorney, Kevin P. Martin of Goodwin Procter in Boston, said the decision is “a straightforward application of SJC precedent” precluding the use of the implied covenant to create contractual rights.

“As this decision confirms, the implied covenant does not allow parties to use litigation to obtain contractual rights that they could have bargained for, but did not,” Martin said. “If an investor in an illiquid investment wants a liquidation right, he needs to negotiate that right in the contract itself.”

Plaintiffs’ counsel Joseph L. Bierwirth Jr. of Hemenway & Barnes in Boston said in reversing the findings of breach and damages, the Appeals Court “utterly failed” to give proper regard to the trial judge’s careful and detailed decision. The judge had found that Meyers did, in fact, act with a lack of good faith and fair dealing in ignoring the plaintiffs’ “reasonable requests for a sale of the stock and essentially stonewalling them for two years,” Bierwirth said, adding that the defendant’s conduct denied the foundation millions of dollars in return on its investment.

Bierwirth said his clients are reviewing the decision and would explore further legal options.

Boston business litigator Kevin J. O’Connor, who was not involved in the case, said the decision demonstrates the challenges that breach-of-implied-covenant cases present.

“They’re difficult to prove because they’re very fact-intensive, and they’re difficult to sustain [on appeal] because the court will not lightly cast aside the technical rights and obligations of parties to the contract,” said O’Connor, a lawyer at Hinckley, Allen & Snyder.

At the same time, he said, the trial court verdict serves as a reminder to private entities negotiating deals with charitable foundations that such foundations are saddled with a much different set of obligations and expectations, and courts may expect private parties to act accordingly.

“[In this case,] the trial court may have charged the defendant with the responsibility of working in good faith to help achieve the objectives of the foundation, such as the avoidance of adverse tax consequences and the obligation of a foundation to realize the benefits of stock holdings or to liquidate them on a different timetable,” O’Connor said.

Dmitry S. Herman of Boston said the decision represents a simple concept: Determine the important aspects of an agreement and get them down on paper.

“If you go to a state like Delaware, where it’s a strict construction state, you’ve always known that a court won’t go further than the four corners of the document,” said Herman. “But in Massachusetts, there’s always been a little more of a precedent where judges would be willing to essentially look at equities and merits and come up with interpretations that are a little more favorable in terms of equitable arguments, like good faith. This is a case where it seems this Appeals Court wasn’t willing to do that.”

Herman said he also found it interesting that the court, in closing, stated that Meyers still had a good-faith obligation to liquidate the stock at some point.

“They don’t say when that actually is,” he said. “In a week? Ten years? After six generations of holding the stock? It’s really unfortunate if you’re the plaintiff, because what are you going to do with this?”

Letter agreements

In 1991, defendant Daniel Meyers founded First Marblehead, which provides college and graduate loan origination and services.

Plaintiff Robert James, a professional investor who taught economics at the Massachusetts Institute of Technology, became acquainted with Meyers through the involvement of two of his children in First Marblehead, and he invested $360,000 of his own money in the company.

In 1998, First Marblehead issued a letter offering shareholders the opportunity to purchase additional shares in a rights offering. Specifically, each shareholder could purchase up to a maximum number commensurate with the shareholder’s existing percentage ownership at a price of $20 per share. That gave Meyers the right to buy up to 18,627 shares.

Meyers could not buy the shares on his own, so he secured an agreement from James in a one-page letter executed Feb. 20, 1998, that James — through his charitable foundation, the Robert and Ardis James Foundation — would provide him the money to do so. In exchange, James would have the right to share in the proceeds of the future sale of the stock.

The parties executed a nearly identical letter agreement a year later in connection with another rights offering. Between the two agreements, Meyers purchased 31,107 shares with $653,000 of foundation money. Neither letter agreement stated if and when Meyers would be required to liquidate the shares.

First Marblehead, which went public in 2003, thrived and the value of its stock increased significantly. The company also effectuated several stock splits between 2003 and 2006, increasing the number of shares subject to the letter agreements from 31,107 to 1.8 million by the time of trial in 2011. The value of each share peaked at more than $56 in early 2007.

In 2005, First Marblehead co-founder Stephen Anbinder, who had also bought company stock with foundation money under terms similar to those enjoyed by Meyers, agreed to liquidate his shares. James’ portion of the proceeds totaled $8.7 million. Anbinder apparently asked Meyers if he was interested in doing the same, and Meyers answered, “Not particularly.”

A year later, a lawyer who was advising the foundation on its tax-exempt status urged that it secure its fair share of proceeds from the Meyers stock so it could be put toward the foundation’s charitable purpose. The attorney also advised the foundation to take legal action against Meyers if he did not cooperate.

In a letter dated July 10, 2006, James approached Meyers about liquidating the stock, offering to “negotiate a resolution.” Through a letter from his attorney, Meyers implied that he would not do so under the threat of litigation but would consider proposals that would make him “reasonably whole” in exchange for surrendering control of a portion of his company stock and foregoing future dividends.

No further progress was made, and on Nov. 16, 2006, the foundation sued Meyers in Superior Court, alleging that his failure to unwind the agreements upon request constituted a breach of contract and bad faith.

Following a 2011 bench trial, Judge Christine M. Roach found that Meyers did not breach any contractual duty to sell on demand but did act in bad faith by unfairly rewarding his own interests at the expense of the plaintiffs’ “reasonable expectations.”

Setting the date of the breach at July 31, 2006, Roach awarded James and the foundation $45 million based on the fair market value of the shares at that time.

Meyers appealed.

Scope of the covenant

The Appeals Court disagreed with the trial judge’s finding that, because Meyers no longer needed the agreements to prevent his stake in the company from being diluted after it went public in 2003, he had no good-faith basis under which to keep holding the stock.

“Meyers’ intent in entering into the agreements was not limited to protecting his percentage interest in First Marblehead, but also included holding the stock and sharing in its appreciation … as evidenced by the formula in the agreements for distributing the sales proceeds,” Graham wrote. “Moreover, Meyers and James were knowledgeable parties to a commercial transaction who freely negotiated the terms of their agreements, and could act in their own self-interest so long as they honored their contractual obligations.”

The court also found that Meyers’ refusal to unwind the agreements did not deprive the plaintiffs of the benefit of the bargain, given that the stock value was continuing to rise as of the date of the alleged breach and that James himself continued to hold shares of his own for investment purposes well into the litigation.

Meanwhile, Graham said, the court could not create rights or duties that were not provided for in the existing contractual relationship.

Accordingly, the court concluded, the trial judgment should be reversed.

Still, Graham wrote, “Meyers cannot refuse to sell the stock or otherwise to resolve his relationship with the plaintiffs indefinitely without violating the implied covenant of good faith and fair dealing.”


CASE: Robert and Ardis James Foundation, et al. v. Meyers, Lawyers Weekly No. 11-011-15

COURT: Appeals Court

ISSUE: Did a corporate executive who accepted money from a friend’s charitable foundation to purchase company stock for himself, with the understanding that he would sell it at some point and share the proceeds with the foundation, commit bad faith by declining to sell upon his friend’s request?


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