Vernon v. Cuomo,
2009 NCBC 6.
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
WAKE COUNTY 06CVS8416
PAUL VERNON and JOEL WILLIAMS,
individually and derivatively on behalf
TRIBOFILM RESEARCH, INC.,
Plaintiffs,
ORDER & OPINION
v.
JEROME CUOMO, VINAY
SAKHRANI, CHARLES TOMASINO,
CHARLES K. CHIKLIS, ROBERT A.
MINEO, and TRIBOFILM RESEARCH,
INC.,
Defendants.
Northen Blue, LLP by Samantha H. Cabe and David M. Rooks, III for
Plaintiff Paul Vernon.
Manning Fulton & Skinner, P.A. by Michael T. Medford, David B. Efird, and
William S. Cherry, III for Plaintiff Joel Williams.
Smith, Anderson, Blount, Dorsett, Mitchell & Jernigan, LLP by Mark A. Ash,
Addie K.S. Ries, Heather Adams, and Kelli A. Ovies for Individual
Defendants Jerome Cuomo, Vinay Sakhrani, Charles Tomasino, Charles K.
Chiklis, and Robert A. Mineo.
Tennille, Judge.
{1} This action was filed in Wake County Superior Court on June 8, 2006.
Plaintiffs Vernon and Williams filed the Notice of Designation simultaneously with
the Complaint on June 8, 2006. This action was designated a mandatory complex
business case by Order of the Chief Justice on June 12, 2008, and subsequently
assigned to the undersigned Chief Special Superior Court Judge for Complex
Business Cases.
{2} This matter was bifurcated for trial. The issues involving liability were
tried without a jury in the North Carolina Business Court in Wake County from
February 2, 2009 to February 9, 2009. Based upon the evidence presented at trial,
the Court makes the following Findings of Fact and Conclusions of Law and enters
the following Orders:
FINDINGS OF FACT
TriboFilm
{3} TriboFilm Research, Inc. (“TriboFilm” or “the Company”) was founded in
1997 as a research and development company. TriboFilm initially focused on
vacuum deposited coatings for use on syringe stoppers and optical lenses. All five
original shareholders were scientists with connections to North Carolina State
University (“N.C. State”), and they were the only “employees” of the Company.
{4} TriboFilm’s syringe coating was aimed at eliminating silicone as a
lubricant in syringes. The elimination of silicone as a lubricant in syringes was
desirable because silicone can migrate from the surfaces to which it is applied. The
migration can have two harmful effects. It can contaminate the fluid in the syringe,
and it can cause friction that makes delivery of the fluid less consistent. Almost all
syringes now use some form of silicone lubricant. Using silicone makes it difficult
for the medical device industry to provide pre-filled syringes, especially for high
priced medications. A breakthrough that eliminates the use of silicone has great
commercial potential and will improve the administration of medications by syringe
from a health standpoint.
{5} The Company first applied its vacuum deposited coating to syringe
stoppers, then to syringe plungers, and, later, to the interior barrel of the syringe.
TriboFilm had little success in coating the interior barrel of syringes until 2003,
when it switched to the use of atmospheric plasma, rather than vacuum plasma, as
the application method. This change spawned the development of TriboFilm’s
silicone-free syringe coating that is now known as the “TriboGlide” technology.
Development of this technology was funded largely by grants from the National
Institute of Health (“NIH”), the last of which ended in late 2006. TriboFilm
achieved Federal Drug Administration (“FDA”) 510k approval for TriboGlide in
2007 and was awarded a patent for the TriboGlide technology in 2008. Both Vernon
and Williams were named as inventors on the TriboGlide patent. While the
TriboGlide technology has a promising future, it has not yet achieved acceptance or
widespread use by syringe manufacturers.
{6} TriboFilm’s optical lens coating also developed over time from a vacuum
deposited coating to a “wet chemistry” coating known as “StaClear,” which offers
superior scratch resistant and graffiti resistant properties to optical lenses as well
as other types of plastics. Like TriboGlide, the development of StaClear has been
funded largely by NIH grants, which grants have been successfully completed.
TriboFilm received a patent for its StaClear technology in 2007. TriboFilm has not
yet found a commercial market for StaClear.
TriboFilm’s Shareholders
{7} The initial idea for TriboFilm resulted from a conversation between Mr.
Vinay Sakhrani (“Sakhrani”), who was doing his graduate course work at N.C.
State, and his graduate professor, Dr. Jerome Cuomo (“Cuomo”). Mr. Paul Vernon
(“Vernon”), who was working as Dr. Cuomo’s lab administrator at the time, was
later included in the conception of TriboFilm, as were the other founding
shareholders, Dr. Charles Tomasino (“Tomasino”) and Dr. Charles Chiklis
(“Chiklis”). Drs. Tomasino and Chiklis were professors at N.C. State. They have
both since retired from N.C. State.
{8} Sakhrani graduated with a Master’s Degree in Materials Science and
Engineering from N.C. State in 1997. He was the youngest and least experienced
member of the original group. Mr. Sakhrani now serves as Vice President of
Technology for TriboFilm, and he has been a member of TriboFilm’s Board of
Directors since its inception. Sakhrani performs research in TriboFilm’s lab on all
areas of technology, with his major concentration in TriboGlide research. He has
served as the primary investigator on the NIH grants for both the TriboGlide and
StaClear technologies. Sakhrani has had direct contact with potential TriboFilm
clients and has prepared samples for their evaluation. Since the termination of
Plaintiffs’ employment with TriboFilm in 2005, Sakhrani has also assumed
responsibility for TriboGlide’s business development and grant drafting, and the
coordination of TriboFilm’s day-to-day business operations. Sakhrani has been a
full-time employee at TriboFilm since 2002.
{9} Cuomo is a Distinguished Research Professor at N.C. State, where he
serves as Director of the Institute for Maintenance Science and Technology
(“IMST”) and head of the Center for Advanced Materials Processes and Materials
(“CAMP-M”). Prior to joining N.C. State, Cuomo had a thirty (30)-year career at
IBM. While at IBM, Cuomo was charged with management of a large staff, and he
developed several coatings techniques. Cuomo serves as President and Chairman of
the Board of Directors for TriboFilm, where he advises TriboFilm about new
development opportunities relating to the application of plasma process, assists
with client presentations, and handles other business matters.
{10} The concept of creating entrepreneurial or intrapreneurial companies that
combine N.C. State faculty resources and equipment with startup companies was
Cuomo’s idea. Premitec and TriboFilm were small research and development
companies designed to create technology on a shoestring or through government
grants in the hope that the technology could then be licensed or sold commercially.
Cuomo had the contacts and influence within N.C. State to foster these
entrepreneurial efforts. He was the creator of the TriboFilm group and its
acknowledged leader. He did not, however, contribute significantly to the day-today research and development work. He functioned as a sounding board for
technical issues, an idea generator, and, at times, a referee among the scientists.
{11} Prior to becoming a professor at N.C. State and joining TriboFilm,
Tomasino had a career in the textile industry with Burlington Industries. At
Burlington Industries, Tomasino was involved with coatings processes and
atmospheric plasma. Chiklis previously had a long career at Polaroid, where he
served as a senior manager and developed polymer coatings for Polaroid’s products.
At TriboFilm, Tomasino and Chiklis are primarily responsible for the development
of the StaClear product, interfacing with patent counsel regarding StaClear, and
marketing the StaClear technology. In addition, Tomasino helped develop the
TriboGlide technology. He now assists with TriboGlide research and marketing.
Tomasino also assists with the day-to-day business operations of TriboFilm.
{12} Tomasino and Chiklis are both retired professors from N.C. State. Both
had experience in private industry before joining the N.C. State faculty. They were
not the driving forces behind the creation of the Company, but they did a
substantial amount of the day-to-day research and testing. They were the technical
workhorses, especially on the StaClear project. They were paid on an hourly basis
as provided in the various grants awarded to TriboFilm.
{13} While also working at TriboFilm, Vernon remained employed as a lab
administrator in Cuomo’s lab until 2002. Vernon initially served as the Secretary of
TriboFilm, with responsibility for corporate formation of the Company. Vernon
later assumed the role of President of the Company. Until his termination in
November of 2005, Vernon handled the Company’s accounting and business
operations and coordinated grant applications and grant administration. While he
helped some with research and experiments, his primary contribution was securing
the grant money that supported the research. He also kept the venture alive when
no funds were available and he was not being paid.
{14} In August 1998, Mr. Robert Mineo (“Mineo”) became a five (5) percent
shareholder in TriboFilm, primarily in exchange for providing legal services.
Mineo is a lawyer licensed to practice in North Carolina. He has a background in
the aerospace and mechanical engineering field. Mineo now also assists with
TriboFilm’s business operations and customer presentations and negotiations.
Prior to 2006, he did not play a substantial role in TriboFilm’s business operations
or research and development.
{15} Dr. Joel Williams (“Williams”) was not an original shareholder or employee
of TriboFilm. Williams provided consulting services to TriboFilm between 2000 and
2003, primarily assisting Vernon with drafting NIH grant applications. In
December 2003, the Board of Directors voted to issue stock to Williams. Williams,
like Cuomo, came from a business background. He had a long and successful career
at Becton Dickinson, one of the largest suppliers of medical devices in the United
States, before retiring from that company. Like Cuomo, he knew and understood
the value and means of commercializing research and development projects, and as
a result of his work at Becton Dickinson, Williams had particular knowledge and
expertise with respect to syringe technology.
{16} Each of the scientists has made some significant contribution to
TriboFilm’s current success. Mineo’s scientific contributions were not substantial;
he basically functioned as a lawyer who got his ownership interest in return for
providing legal services. Vernon’s primary contributions were in securing funding
for research and managing the operation. TriboFilm was the prototypical research
and development company in which the owners contributed their time and
individual expertise in the hope of producing a breakthrough commercial technology
that could be licensed or sold for a large profit.
{17} Williams, Cuomo, Chiklis, and Tomasino were not participating in hopes of
long-term employment. They were all at or near retirement age. This was not,
however, a hobby for them. They were all seriously working to find a commercially
viable technology. Their efforts may yet prove financially rewarding and also
benefit the public health. Vernon and Sakhrani were younger, and employment and
compensation were greater concerns to them.
Ownership of TriboFilm
{18} The following chart shows the ownership percentages of the individual
shareholders at times relevant to this lawsuit.
Original (%) 1998 (%) 2003 (%) 2006 (%) 2007 (%)
Cuomo 61.5 56.5 20.2 12.0 19.04
Vernon 14.25 14.25 20.2 20.0 2.4
Sakhrani 14.25 14.25 20.2 12.0 19.04
Tomasino 5.0 5.0 8.1 12.0 19.04
Chiklis 5.0 5.0 6.1 12.0 19.04
Mineo 0.0 5.0 5.0 12.0 19.
04
Williams 0.0 0.0 20.2 20.0 2.4
{19} Prior to the changes in 2007, all previous changes in ownership had been
accomplished with the consent of all shareholders. Often the changes resulted from
Cuomo’s reducing his ownership interest.
2000 to 2005
{20} By January 2000, Sakhrani had left TriboFilm and was working for
another company called Premitec, and Defendants Cuomo, Tomasino and Chiklis
were not playing an active role in the affairs of the Company. Vernon was the only
shareholder still actively engaged with the Company. Cuomo was also a
shareholder in Premitec, which was one of his entrepreneurial startup research and
development companies. Like TriboFilm, Premitec used N.C. State faculty and
students. Premitec was working on implant devices and did not compete with
TriboFilm. Cuomo and Sakhrani remained as directors and shareholders of
TriboFilm.
{21} In 2000, Cuomo introduced Williams to Vernon. Vernon arranged for
Williams to begin working as a consultant on an hourly basis for TriboFilm. A few
months earlier, Cuomo and Sakhrani had arranged for Williams to begin working
as a consultant for Premitec. Both companies sought to take advantage of Williams’
knowledge in the medical device area and his familiarity with NIH grant processes.
{22} In connection with the request by Cuomo and Sakhrani that Williams
serve as a consultant for Premitec, Williams told them that he was doing his own
research and development work following his retirement from Becton Dickinson. In
fact, he had his own research and development startup that was working on projects
that did not compete with TriboFilm. Williams operated under the name Brighton
Development LLC (“Brighton”), which also did work under the name Genomex. He
applied for NIH grants under both names. Vernon helped Williams with the
Brighton grant applications, so he knew of Williams’ other projects. Neither Vernon
nor Williams discussed those projects with anyone else at TriboFilm. In March and
July of 2002, Williams submitted grant applications on behalf of Brighton for a non-stick labware and for a self-sterilizing bag. The non-stick labware and the self-sterilizing bag technologies did not compete with any of TriboFilm’s technologies.
{23} Williams signed a mutual confidentiality agreement with Premitec on or
about June 15, 2000. Sakhrani signed the mutual confidentiality agreement on
behalf of Premitec.
{24} Williams signed a mutual confidentiality agreement with TriboFilm on
August 15, 2000. Vernon, acting as President of TriboFilm, signed the mutual
confidentiality agreement on behalf of TriboFilm. Paragraph 8 of the mutual
confidentiality agreement stated that the agreement would terminate five (5) years
from the date of the agreement.
{25} Williams requested that the confidentiality agreements with Premitec and
TriboFilm be mutual in part because of the research and development work he was
doing on his own. All parties were content with these confidentiality agreements at
the time.
{26} Although the parties made much at trial of possible conflicts of interest on
the part of others, there was no substantial evidence presented that any conflict of
interest arose out of the work being done at Brighton, the work being done at
Premitec, or the work being done at other companies in which Cuomo was involved.
These were all research scientists who knew full well that the others had projects
and employment other than TriboFilm. TriboFilm was not structured to do
anything other than the specific grant-supported research it was conducting. No
party engaged in any serious conflict of interest or usurped any business
opportunity belonging to TriboFilm.
{27} Later in 2000, TriboFilm obtained a Phase I grant from the National
Heart, Lung, and Blood Institute (NHLBI) to explore certain medical coating
technologies to replace silicone oil. In April of 2002, TriboFilm was awarded a
Phase II grant of $758,000 by the National Institute of Biomedical Imaging and
Bioengineering (NIBIB) to develop a coating to eliminate silicone oil in medical
syringes. TriboFilm also obtained Phase I and Phase II grants to study lens coating
technology, which led to the development of the Company’s StaClear lens coating
technology. Vernon carried the administrative burden of preparing the grant
applications and dealing with the NIH. The other shareholders gave technical
assistance.
{28} After TriboFilm was awarded the grants, all of the Individual Defendants 1
developed renewed interest in TriboFilm and returned to active participation in the
affairs of the Company. Cuomo was designated Chief Technical Officer, and
Sakhrani was elected as Vice President. Sakhrani returned from Premitec to work
full time at TriboFilm. The grants provided that the researchers could be paid by
the hour for their research work.
{29} Williams’ medical device experience, polymer science expertise,
background in syringe technology, and business contacts in the medical device
industry were valuable in the development of technologies at TriboFilm. With
numerous patents on syringe technology, including plasma cross-linking of
1
The Individual Defendants are Cuomo, Sakhrani, Tomasino, Chiklis, and Mineo.
lubricants in syringes, he guided the research at TriboFilm in that area. Cuomo
also contributed his expertise and valuable business contacts to TriboFilm.
Sakhrani, Tomasino, Chiklis, and Williams all worked on various experiments, with
Sakhrani, Tomasino, and Chiklis doing more research than anyone else. Vernon
was the administrative manager. There were no employees other than the
shareholders.
{30} In discussions with Vernon and Cuomo in mid-2003, Williams promised to
take a more active role in TriboFilm and to provide the Company with his expertise
and knowledge in the syringe technology field, including his expertise and
knowledge relating to ionizing plasma cross-linking of lubricants in syringes. In
exchange for his more active role, Williams was given an ownership interest in
TriboFilm equal to the percentage held by Vernon, Cuomo and Sakhrani.
{31} There was a discussion at that time concerning a twenty-five (25) percent
commission on new business brought in by Williams. These discussions never
reached a definitive agreement for a number of reasons. At that time, TriboFilm
had only grant money and some minor payments from potential customers for
testing TriboFilm’s unproven technology. It had no patents and no idea what its
final product would be. The grants did not provide for payment of commissions, and
the testing was not really for profit but to promote the development of technology.
The agreement was never reduced to writing and was never approved by the Board
of Directors. Until the filing of this lawsuit, Williams never asked for any
commissions and none were ever paid to him or any other shareholder. No product
was sold, and only contract work was performed. In March 2004, Williams was
issued TriboFilm stock that gave him a twenty (20) percent interest in TriboFilm,
equal to that of Vernon, Cuomo and Sakhrani. He did not pay anything for his
stock. Prior to the issuance of the stock, Williams provided consulting services and
helped develop business for TriboFilm, services for which he was not compensated.
He was, however, compensated on an hourly basis for research done under the
TriboGlide grant proposals.
{32} None of the Individual Defendants or any other representative of
TriboFilm asked Williams to discontinue his other work (such as his ongoing work
at Brighton) when he became a consultant to TriboFilm, or later, when he became a
shareholder. Williams knew that they too had other business interests.
{33} Each of the shareholders, including Individual Plaintiffs, 2 undertook the
performance of his duties at TriboFilm with the reasonable expectation that each
would share in the potential gain if one or more of the Company’s technologies
proved commercially viable.
{34} By spring 2005, under the direction of Vernon, TriboFilm had significant
grants to work on promising technologies, including StaClear and TriboGlide.
{35} Based on the work performed by Williams and the other scientists, the
syringe coating technology attracted significant interest from private firms
interested in acquiring or obtaining the right to apply and market the technology.
{36} To aid in the commercialization of the plasma cross-linked lubricant
technology, TriboFilm obtained a Phase II-Continuation Grant for $687,000 to
receive FDA regulatory approval. Williams and Vernon contributed to the effort to
obtain that grant. During the interim proposal review period, both Williams and
Vernon, along with other TriboFilm shareholders, personally financed TriboFilm by
lending it money while waiting for NIH grant funding.
{37} In 2005, Williams and Vernon successfully negotiated a license agreement
for plasma cross-linked syringe lubricant technology with a German company. The
German company was one of the largest pre-filled syringe companies in the world.
Subsequently, TriboFilm declined to go forward with that agreement. Williams
contributed to the procurement of the agreement, and Vernon worked on the
administrative effort.
{38} Up until this point, this small band of researchers maintained productive
working relationships. While there were some personality conflicts between Vernon
and Sakhrani—Sakhrani was unhappy that he was not getting the full salary
authorized by the grants—no serious problem had arisen. TriboFilm had a mutual
2
Individual Plaintiffs are Vernon and Williams.
nondisclosure agreement with Williams, but it had no other agreements with
shareholders about disclosure or use of TriboFilm technology. All the shareholders,
however, owed fiduciary duties to the Company. At this point, no patents had been
issued.
The Shareholders Divide into Two Camps
{39} In the spring 2005, communication between the shareholders broke down,
and they began to split into two (2) camps—Vernon and Williams on one side and
the remaining shareholders on the opposite side. What followed was a classic
example of the loss of trust resulting from a failure to communicate.
{40} In April 2005, Sakhrani delivered confidential documents belonging to
Williams to Vernon and demanded an explanation. The confidential documents
related to Williams’ 2002 grant applications on behalf of Brighton, not work related
to TriboFilm. Williams believed Sakhrani could only have gotten the documents by
searching Williams’ briefcase. Sakhrani said, however, that he got the documents
from a trash bin or places where they were openly laying around. The documents
showed that Vernon had helped Williams with the Brighton grant applications.
{41} Despite Williams’ and Vernon’s multiple requests that Sakhrani return
Williams’ confidential documents, Sakhrani did not return all of the confidential
documents until after Williams filed a lawsuit against Sakhrani in September 2005
seeking return of the confidential documents. Sakhrani consulted with other
Individual Defendants regarding Williams’ confidential documents. None of the
other Individual Defendants looked at the documents because they believed them to
be confidential. The other Individual Defendants did not, however, require
Sakhrani to return the confidential documents to Williams.
{42} During this same period, Sakhrani and Vernon were having a
disagreement over Sakhrani’s compensation.
{43} In or about September 2005, Individual Defendants presented Williams
and Vernon with non-compete and non-disclosure agreements. The agreements
were drafted by Mineo using agreements prepared by an outside law firm as
templates. Mineo, as directed by a majority of the directors, added a provision to
the non-compete agreement making it retroactive in application. In addition, the
non-compete agreement did not call for any consideration other than continued
employment. Vernon, in his capacity as President of TriboFilm, contracted with an
outside law firm to prepare employment agreements as an alternative to those
prepared by Mineo. The Board of Directors, however, cancelled the contract with
the outside law firm and set October 3, 2005 as the deadline for executing the
agreements created by Mineo. The non-disclosure agreement created by Mineo was
not to be mutually binding on TriboFilm. Furthermore, the non-compete and non-disclosure agreements did not contemplate that anyone would execute the
agreements on behalf of TriboFilm.
{44} The Individual Defendants’ request that Plaintiffs sign the retroactive
non-compete agreement was motivated by Williams’ work at Brighton that had predated Williams becoming a shareholder in TriboFilm. Williams was reasonably
concerned that the retroactive provision in the non-compete would expose him to
litigation regarding his pre-existing Brighton work, which did not conflict with the
work at TriboFilm. Since Vernon had helped with the Brighton grant applications,
he was also concerned about the retroactive application of the proffered agreements.
{45} Individual Defendants Cuomo, Sakhrani, Tomasino and Chiklis signed the
tendered agreements with some minor modifications, but without change to the
provisions relating to consideration and retroactivity. Individual Plaintiffs declined
to sign the agreements as tendered. The whole process was characterized by a
failure of the parties to communicate and adequately express their concerns. The
process, which could have eliminated some of the lack of trust, contributed to a
further erosion of the relationship among the shareholders.
{46} At that time, Williams already had an existing employment agreement and
mutual confidentiality agreement in place with TriboFilm—signed by Vernon in his
capacity as president and by Williams—which the Board of Directors could have
ratified had it chosen to do so. Except for the retroactive provisions, the terms of
the proposed agreement were not unreasonable.
{47} Under all of the circumstances, Vernon’s and Williams’ decisions not to
sign the retroactive non-competition agreement were reasonable. All shareholders
had the right, however, to propose alternative provisions. Some shareholders did
propose revisions, and their changes were accepted. Williams and Vernon did not
communicate their problems in a way that the Company could address them. Nor
did the Company make a great effort to solve the problem. Each side foolishly
adopted a “my way or the highway” approach, and the failure to communicate
resulted in a further deterioration of trust among the parties. The issues of
language, compensation, and retroactivity were not unsolvable. They required
candid communication. The shareholders had clearly separated into factions that
did not trust each other. The lack of trust resulted from a number of factors,
including: the personality problems between Vernon and Sakhrani, Sakhrani’s
mishandling of what he mistakenly believed was a conflict of interest, Vernon’s
failure to disclose he had assisted Williams with the Brighton grants, all parties’
failure to openly discuss what else they were doing, Sakhrani’s failure to return all
of Williams’ confidential documents and the copies, the parties’ failure to sit down
and discuss resolution of their differences, the differences of opinion over the
German agreement, and the parties’ failure to agree on creation of an affiliated
company to manufacture syringes using TriboFilm’s technology (“Jetcon”).
Williams and Vernon had supported creation of Jetcon, and the Individual
Defendants had opposed it.
{48} In the midst of all the turmoil, the Board of Directors created an Executive
Committee in an effort to get control of the situation. Cuomo and Tomasino were
named to the Executive Committee. They met with Vernon on several occasions,
but they were unable to obtain from him information to assess the condition of the
Company or information to assess his performance as President.
{49} To exacerbate the situation, Vernon conducted an employee evaluation of
Sakhrani without consulting with the other shareholders with whom Sakhrani
worked. The evaluation was Vernon’s personal assessment of Sakhrani, and it did
not accurately reflect the views of the other shareholders. It was critical of
Sakhrani on points unsupported by Sakhrani’s fellow workers. This action caused a
further deterioration in the working relationships among the small group of
shareholders.
{50} The situation with respect to Vernon’s and Williams’ continued
employment was further complicated by the post-termination conduct of Vernon
and Williams. Vernon conducted a personal vendetta against Cuomo. Vernon
wrote to the university where Cuomo had received his doctorate and accused him of
plagiarizing his thesis. Vernon then wrote to N.C. State and made demands for
extensive documents relating to Cuomo’s relationship with the University. In a
further effort to cause problems for Cuomo, Vernon also wrote to the Golden Leaf
Foundation. Vernon’s unjustifiable, spiteful actions were harmful to Cuomo and
created an intolerable relationship between the two.
{51} After his termination, Williams attempted to obtain the trademark rights
to TriboGlide and StaClear. His justification was to protect the names from loss
since TriboFilm had not applied for protection. Williams could have achieved the
same result by demanding that TriboFilm take action to protect its trade names.
His actions clearly diminished any remaining trust among the parties.
{52} By their own conduct, Vernon and Williams made their continued
employment at TriboFilm unrealistic, and ultimately justifying the Board of
Directors’ action in preventing them from working at TriboFilm.
{53} On November 3, 2005, acting on a Notice of Meeting sent on November 1,
2005, the Board of Directors held a special meeting where a majority of the directors
(such majority consisted solely of the Individual Defendants) placed Vernon and
Williams on administrative leave, changed the Company’s locks, and barred them
from the building.
{54} The Board of Directors held another special meeting on November 14,
2005, during which the directors voted to remove Vernon and Williams as officers of
TriboFilm and terminated their employment. This meeting was immediately
followed by a special meeting of the shareholders. At the shareholders meeting, a
majority of the issued and outstanding shares of TriboFilm (such majority consisted
solely of the Individual Defendants) voted to remove Vernon and Williams from the
Board of Directors.
{55} As a result of the November 2005 meetings, Vernon and Williams were
effectively divested of any and all management and control over TriboFilm’s
operations.
{56} In early March 2006, the Individual Defendants attempted to acquire all of
Plaintiffs’ TriboFilm stock for $2,000.00 each ($0.01 per share). Having been
excluded from the business, Plaintiffs were in no position to evaluate the offer.
{57} Later in March 2006, Vernon and Williams made a counteroffer to
purchase all of Defendants’ TriboFilm stock for $0.10 per share, ten (10) times the
amount offered for Plaintiffs’ shares. Each Defendant rejected Plaintiffs’
counteroffer. Sakhrani testified that he would not have accepted a billion dollars
for his shares. Tomasino testified that the opportunity to do the research and
development on TriboFilm’s technologies was more valuable to him than selling his
stock for $0.10 per share and that it was his belief that the other Individual
Defendants felt the same way.
{58} On or about June 7, 2006, shortly after the unsuccessful attempt to acquire
Plaintiffs’ interests in TriboFilm, the Individual Defendants voted themselves
annual salaries or, in Sakhrani’s case, a substantial salary increase, despite the fact
that none of them other than Sakhrani had ever been a salaried employee of the
Company. TriboFilm had never had the resources necessary to pay salaries at the
level the Individual Defendants approved for themselves. Also, on or about June, 7,
2006, the Individual Defendants, citing TriboFilm’s dire financial condition, voted to
“defer” portions of the increased salaries.
{59} The increased salaries were not necessary to keep the Individual
Defendants working at TriboFilm, as each of them had non-monetary incentives to
continue working, including the benefits that they would receive from completing
the grants and by virtue of their already existing stock ownership. Further, neither
the manner in which the salaries were determined nor the expert testimony offered
to support the salaries took into account the financial condition of the Company, the
fact that the “officers” were not supervising anyone other than themselves, or the
nature of the work being done. Both Mineo and the Defendants’ expert simply used
the Individual Defendants’ employment titles to compare salaries within the
industry without truly analyzing the real work situation, the Company’s ability to
pay, and the startup nature of the venture. The salaries were unrealistic and
inflated given TriboFilm’s lack of funding, and they support a finding that the
majority shareholders were not conducting the business affairs of the Company in
the best interests of all the shareholders.
{60} The Individual Defendants did not disclose to Plaintiffs the salary
increases or the vote to defer the increased salaries.
{61} On or about December 11, 2006, the Individual Defendants, acting as the
only members of the Board of Directors, and without disclosure to Plaintiffs, voted
to convert $15,000.00 of deferred salary into TriboFilm stock at a rate of $0.01 per
share. That price per share was one-tenth of the price per share of Plaintiffs’ arms-length offer in March 2006, an offer the Individual Defendants themselves had
rejected. In addition, the Individual Defendants gave themselves dollar-for-dollar
credit for the deferred salary even though the deferred salary had little to no actual
monetary value. The Individual Defendants were the only persons that would
benefit from this transaction.
{62} On or about December 21, 2006, the Individual Defendants, acting as the
only members of the Board of Directors, recommended to the shareholders that they
approve an amendment to the Articles of Incorporation increasing the number of
authorized shares of TriboFilm stock from one (1) million to fifteen (15) million
shares. The stated purpose of the additional shares was to raise additional capital
and pay certain obligations of the Company. The resolution adopting the
recommendation did not disclose the Individual Directors’ plan to each exchange
$15,000.00 of deferred salary for a portion of the newly authorized stock.
{63} On December 22, 2006, the Individual Defendants, acting as the only
members of the Board of Directors, issued a notice of special shareholders meeting
to vote on the amendment of TriboFilm’s Articles of Incorporation to increase the
Company’s authorized issue to fifteen (15) million shares. The meeting notice
disclosed neither the reason for the request to increase the authorized shares, nor
the Individual Defendants’ plan to exchange $15,000.00 of deferred salary for a
portion of the newly issued stock.
{64} At the special shareholders meeting on January 5, 2007, the Individual
Defendants voted over Williams’ and Vernon’s objection to approve the amendment
of TriboFilm’s Articles of Incorporation to increase the number of authorized shares
to fifteen (15) million. There was no discussion about, or disclosure of, the
Individual Defendants’ intent to exchange a portion of the deferred salary for a
portion of the newly issued stock. At the meeting, the Individual Defendants
offered no reason for the increase in the authorized issue other than to benefit the
Company.
{65} On January 26, 2007, without disclosure to Plaintiffs, the Individual
Defendants each transferred to themselves 1,500,000 shares of the newly
authorized TriboFilm stock in exchange for the forgiveness of $15,000.00 of deferred
salary. The transfer reduced Plaintiffs’ percentage of the issued and outstanding
stock of the Company from 20.2% each to 2.4% each. The transfer of stock to the
Individual Defendants substantially diluted the percentage interests of Vernon and
Williams in TriboFilm relative to the percentage interests of the Individual
Defendants. The practical effect of the Individual Defendants’ actions was to obtain
a substantial part of Plaintiffs’ interest in TriboFilm, an interest that the Individual
Defendants had been unsuccessful in purchasing only nine (9) months earlier.
{66} At the time of the conversion of deferred salary for additional stock, the
Individual Defendants’ deferred salary had almost no value. Plaintiffs were not
provided an opportunity to purchase any of the newly authorized TriboFilm stock.
Williams requested in writing that he be issued shares of the newly authorized
TriboFilm stock to maintain his equal percentage ownership with Cuomo and
Sakhrani, but Williams never received a response to that request.
{67} Plaintiffs did not participate in the unreasonable salary increases and the
resultant award of stock as payments for those increases. No one voted for the
salary increases that did not benefit from the vote in favor of the salary increases.
Only the Individual Defendants were permitted to vote on the resolution approving
the new salary structure, the resolution proposing the increase in the authorized
issue of the Company, and the resolution converting a portion of their deferred
salaries into stock. The Individual Defendants were interested parties in each of
these transactions since they were the only parties to benefit from the actions taken
by the Board of Directors.
{68} The Individual Defendants failed to establish the reasonableness of the
deferred salaries and the reasonableness of the exchange of the deferred salaries for
additional stock. This is especially true in light of the facts that the deferred
salaries had little to no actual value and the exchange was done at one-tenth of the
most recent arms-length offer for the stock.
{69} The stock exchange for deferred salary was not necessary to keep the
Individual Defendants working at TriboFilm. Each of them had non-monetary
incentives to continue working, particularly to get the patents issued.
{70} The undisclosed actions of the Individual Defendants—in unreasonably
increasing their salaries, deferring the salaries, and subsequently exchanging a
portion of the deferred salaries for newly issued stock—were self-dealing. The
Individual Defendants’ intended effect was to acquire Plaintiffs’ interests in
TriboFilm by substantially diluting their ownership interests. All of the
shareholders had worked in this startup venture with the reasonable understanding
that the ultimate benefit from their efforts would come from their stock ownership.
Were the Court to sanction the Individual Defendants’ action in diluting Williams’
and Vernon’s ownership interests, there would be no impediment to the Individual
Defendants issuing more stock for debt and virtually eliminating any minority
ownership.
{71} By letters dated November 8, 2005 and January 10, 2006, Plaintiffs served
TriboFilm and its directors with demands to take corrective actions as required by
N.C. Gen. Stat. § 55-7-42. Defendants did not take the corrective action demanded
by Plaintiffs within the time allowed by the statute or, indeed, within any time.
{72} Vernon and Williams had reasonable expectations that their ownership
percentage in TriboFilm in relation to the Individual Defendants’ ownership
percentage would not be changed without their consent. While the Bylaws and
Articles of Incorporation did not prevent dilution, and startup companies often have
to issue new stock to angel investors, Vernon and Williams could and did have a
reasonable expectation that the majority shareholders would not dilute their
ownership purely to benefit other shareholders.
{73} Williams had an expectation that he would maintain an ownership
interest in TriboFilm equal to the ownership interests of Vernon, Cuomo and
Sakhrani.
{74} Individual Plaintiffs’ expectations with respect to their ownership were
either known to or assumed by the other shareholders, officers, and directors of
TriboFilm.
{75} Individual Plaintiffs’ expectations with respect to their ownership, through
no material fault of their own, were frustrated by the Individual Defendants.
{76} The Individual Defendants terminated Vernon and Williams from their
employment with TriboFilm and divested them of their management and
operational duties. Individual Defendants were justified in doing so based on the
dysfunctional status of the Company. Reinstatement would not be in the best
interest of the Company given the post-termination actions of Vernon and Williams
and the disruption to the ongoing operation which would occur. Individual
Defendants were not justified, however, in diluting Vernon’s and Williams’
ownership of TriboFilm.
{77} Individual Plaintiffs have been excluded from the future financial benefits
of their original ownership if TriboFilm’s technologies become successful. Those
financial benefits may be substantial.
CONCLUSIONS OF LAW
Based upon the foregoing Findings of Fact, this Court concludes as follows:
{78} While shareholders may hold reasonable expectations as a result of their
ownership of a small, closely held company, those expectations may be subverted to
the overall business interest of the company or may become unsustainable under
certain circumstances. At the outset of their involvement, Vernon and Williams had
a reasonable expectation that they would continue to work with TriboFilm. That
expectation ceased to be reasonable when the Company and the relationships
among the shareholders became dysfunctional. It is undisputed on this record that
by fall 2005, all trust among the parties had disappeared. The Company could not
operate and fulfill its function. There was no communication or cooperation among
the small group of researchers who were required to work closely together. A
company is not required to fulfill once-reasonable expectations of continued
employment where that employment may be detrimental to the ongoing survival of
the business. Something had to be done to keep the Company alive and functioning.
A majority of shareholders agreed on how to accomplish that goal. The majority
was within its rights to terminate the employment of Vernon and Williams, and it
did not breach a fiduciary duty by doing so under the circumstances that existed in
this case. Termination of employment does not automatically trigger a right to
dissolution or valuation under the statute. See N.C. Gen. Stat. § 55-14-30. Under
some circumstances, however, it may support a finding that dissolution was
necessary in order to protect the interests of all shareholders. Here, the
terminations standing alone would not result in a forced dissolution because the
contentious circumstances required some action and Individual Plaintiffs were not
without fault in creating the contentious circumstances.
{79} Directors are fiduciaries, and they may not use their position of trust to
further their own private interest. See Meiselman v. Meiselman, 309 N.C. 279, 308,
307 S.E.2d 551, 568 (1983). To do so is a breach of the duty of loyalty. See
id.
{80} The series of transactions by which the Individual Defendants diluted the
ownership of Williams and Vernon were transactions in which they had a direct
financial interest. Consequently, the Individual Defendants were self-dealing.
{81} The Individual Defendants are not entitled to the protection of N.C. Gen.
Stat. § 55-8-31(a), which provides:
A conflict of interest transaction is a transaction with the corporation
in which a director of the corporation has a direct or indirect interest.
A conflict of interest transaction is not voidable by the corporation
solely because of the director’s interest in the transaction if any one of
the following is true:
(1) The material facts of the transaction and the director’s
interest were disclosed or known to the board of directors or a
committee of the board of directors and the board of directors or
committee authorized, approved, or ratified the transaction;
(2) The material facts of the transaction and the director’s
interest were disclosed or known to the shareholders entitled to
vote and they authorized, approved, or ratified the transaction;
or
(3) The transaction was fair to the corporation.
N.C. Gen. Stat. § 55-8-31(a).
{82} Here, none of the transactions were authorized, ratified, or approved by a
majority of disinterested directors. The material facts were not disclosed to the
shareholders; rather, they were deliberately hidden from the minority shareholders.
The transaction was not fair to the corporation. The directors clearly received a
personal financial benefit from the transactions they approved. Thus, they are not
entitled to the benefit of the business judgment rule. See Brehm v. Eisner, 746 A.2d
244, 264 n.66 (Del. 2000) (stating that “directors’ decisions will be respected by
courts unless the directors are interested or lack independence relative to the
decision . . . .”); see also In re Brokers, Inc.,
363 B.R. 458, 474 (2007); see, e.g., Weiss
v. Temporary Inv. Fund, Inc.,
692 F.2d 928, 947 (3d Cir. 1982), vacated and
remanded on other grounds,
465 U.S. 1001,
104 S. Ct. 989 (1984) (“Of course, the
business judgment rule is inapplicable . . . when the directors’ judgment . . . is the
product of self-dealing . . . .”); Joy v. North,
692 F.2d 880, 886 (2d Cir. 1982), cert.
denied,
460 U.S. 1051,
103 S. Ct. 1498 (1983) (“[The business judgment rule] does
not apply in cases . . . tainted by a conflict of interest . . . .”); In re Fleming
Packaging Corp.,
351 B.R. 626, 634 (Bankr. C.D. Ill. 2006) (“The protection . . .
afforded by the business judgment rule does not apply where the plaintiff has made
an adequate showing that the directors breached their duty of loyalty . . . by having
. . . engaged in self-dealing . . . .”); In re Sheffield Steel Corp.,
320 B.R. 405, 422
(Bankr. N.D. Okla. 2004) (“[A]llegations of self-dealing disrupt the usual
presumption that directors have acted with reasonable business judgment.”);
Behradrezaee v. Dashtara,
910 A.2d 349, 363 (D.C. 2006) (finding that protections
of the business judgment rule are only available to disinterested directors whose
conduct otherwise meets the tests of business judgment).
{83} Individual Defendants have breached their fiduciary duties to TriboFilm
and to minority shareholders Vernon and Williams. Furthermore, Individual
Defendants have frustrated the reasonable expectations of Vernon and Williams in
the following ways:
a. by awarding themselves unreasonable and improperly high
salaries, without disclosure, knowing that the then current revenues of
TriboFilm would not cover such salaries;
b. by deferring the unreasonably high salaries, without disclosure
to Vernon or Williams, causing TriboFilm to incur substantial
additional debt;
c. by recommending that TriboFilm increase the number of
authorized shares to fifteen (15) million without disclosing to Vernon or
Williams the reasons for increasing the number of shares;
d. by voting as majority shareholders to increase the number of
authorized shares to fifteen (15) million without disclosing to Vernon or
Williams the reasons for increasing the number of shares;
e. by each exchanging, without disclosure to Vernon or Williams,
$15,000.00 of their deferred salary claims for TriboFilm stock at $0.01
per share (which was ten (10) times less than the most recent arms-length offer from Individual Plaintiffs nine (9) months earlier) at a time
when the market value of their claims for deferred salary was at or near
zero (0) in an attempt to acquire Williams’ and Vernon’s interests in
TriboFilm without paying valuable consideration;
f. by diluting, without disclosure or consent, Williams’ equal
ownership interest in TriboFilm relative to the ownership interests of
the Individual Defendants;
g. by diluting, without disclosure or consent, Vernon’s equal
ownership interest in TriboFilm relative to the ownership interests of
the Individual Defendants;
h. by continually failing to disclose material facts relating to the
acquisition of Individual Plaintiffs’ interests in TriboFilm by the
dilution of their ownership interests; and
i. by failing to act openly, honestly, and fairly in corporate
governance matters and procedures.
{84} The above described actions constitute self-dealing by the Individual
Defendants as directors, officers, and majority shareholders of TriboFilm. As such,
the burden of proof was on the Individual Defendants to prove that the self-dealing
transactions were fair, just, and reasonable. See N.C. Gen. Stat. § 55-8-31(a)-(d);
Alford v. Shaw,
320 N.C. 465, 472−73,
358 S.E.2d 323, 327−28 (1987); Lowder v.
Allstar Mills, Inc.,
103 N.C. App. 479, 482,
405 S.E.2d 794, 796 (1991). The
Individual Defendants did not meet this burden.
{85} The exchange of worthless or discounted debt for more than one-third
ownership in the Company is not fair to the Company or the shareholders. The fact
that the individuals who benefited from the debt-for-stock exchange created the
debt at a time when the Company was financially strapped and unable to pay the
debt clearly indicates that a primary purpose was to dilute Vernon’s and Williams’
ownership. Individual Defendants’ other explanations of why they created the debt
are unconvincing. The secretive manner in which the manipulation occurred is
further evidence of bad motive, and the manner in which the allocation occurred
demonstrates that the majority shareholders had their personal interests in mind
when they acted.
{86} Individual Defendants had options in 2006 if they did not wish to work for
TriboFilm under circumstances in which Vernon and Williams owned forty (40)
percent of the Company. They could have easily engineered a squeeze-out merger
that would have resulted in Vernon’s and Williams’ shares being subject to
appraisal based on their value at that time. See N.C. Gen. Stat. § 55-13-02(a)(1).
They did not do so. Rather, they gambled that they could virtually eliminate
Vernon’s and Williams’ ownership by their manipulation of both compensation and
debt. If they were successful, they stood to receive a far greater percentage of the
ultimate value of TriboFilm. If they were unsuccessful, they would be in the same
position they were in before because, if the Court ordered dissolution pursuant to
N.C. Gen. Stat. § 55-14-30(2)(ii), the Company could elect to have the Vernon and
Williams shares valued under
N.C. Gen. Stat. § 55-14-31(d), and the Company could
purchase the shares at the valued amount. The only costs associated with their
dilution efforts were legal fees and the possibility that the value of the Company
had increased.
{87} Williams failed to present sufficient evidence to establish a contract for
commissions owed.
{88} The Individual Defendants’ salary increases were unreasonable under the
circumstances in which they were implemented and for the purposes for which they
were ultimately used.
{89} Equity requires that the issuance of additional shares to the Individual
Defendants be rescinded and Vernon and Williams be restored to their previous
20.2 ownership percentage.
{90} The Court concludes that the circumstances existing at the time of
Vernon’s and Williams’ termination do not support dissolution under the peculiar
facts of this case.
{91} The Court concludes that the attempted dilution of the minority ownership
was a breach of a fiduciary duty supporting invocation of the statutory procedure for
dissolution of the Company and, if necessary, valuation of Vernon’s and Williams’
shares. See N.C. Gen. Stat. § 55-14-30(2)(ii); see also
N.C. Gen. Stat. § 55-14-31(d);
Royals v. Piedmont Elec. Repair Co.,
1999 NCBC 1, ¶¶ 38-63 (N.C. Super. Ct. Mar.
3, 1999), http://www.ncbusinesscourt.net/opinions/1999%20NCBC%201.htm
(detailing the analysis for liquidation and valuation based on
N.C. Gen. Stat. § 55-
14-30(2)(ii) and
N.C. Gen. Stat. § 55-14-30(d)). While the Court recognized the need
to cure the dysfunctional state in which the Company found itself, the fact that the
majority shareholders, after having terminated the minority shareholders, would
then attempt to dilute the minority shareholders’ ownership in so significant a way
and with no other significant benefit other than to increase their own ownership
demonstrates that the majority is not operating, and will not operate, the Company
in the best interest of all the shareholders.
{92} There was insufficient evidence to support Plaintiffs’ claims that
Individual Defendants mismanaged TriboFilm’s grants or its business. To the
contrary, TriboFilm stands on the verge of commercial success.
{93} The Court has directed a verdict on Plaintiffs’ claims for diversion of
corporate opportunity.
CONCLUSION
{94} Based on the foregoing, it is hereby ORDERED, ADJUDGED, and
DECREED:
1. The shares issued to the Individual Defendants for debt shall be
returned to TriboFilm.
2. The Court sets aside the dilution of Vernon’s stock and
reinstates him to his 20.2 ownership percentage.
3. The Court sets aside the dilution of Williams’ stock and
reinstates him to his 20.2 ownership percentage.
4. The Company shall be dissolved pursuant to N.C. Gen. Stat. §
55-14-30(2)(ii).
5. TriboFilm shall have ten (10) days from the date of this Order to
notify the Court of its election to purchase the shares of Vernon
and Williams at fair value. If it so elects, the parties will have
thirty (30) days from the date of this Order to agree upon a
Court appointed valuation expert and the terms of his
engagement. Absent agreement, the parties will have (90) days
from the date of this order to complete discovery on valuation
issues.
6. The Court will specify the procedure to determine fair value.
7. In the event TriboFilm elects not to pursue purchase of the
Vernon and Williams shares, the parties will have thirty (30)
days from the date of this Order to submit recommendations for
a receiver to liquidate the company.
IT IS SO ORDERED, this 17th day of March, 2009.
