Commonwealth v. Tauber

By Judge Alfred D. Swersky This matter is before the Court for a decision on the merits after trial. Upon consideration of the testimony, the exhibits filed, and foe argument of counsel, foe Court concludes that Complainant is entitled to foe relief sought in foe Bill of Complaint The Court will enter a declaratory judgment that the assets of Jefferson Memorial Hospital, Inc. (JMHI) remain in foe hands of Respondents as trustees; a custodian will be appointed to administer foe assets; an accounting will be ordered; and a constructive trust imposed on all assets of JMHI. The relief sought by way of money damages will be denied. The issues presented are dealt with as follows under foe laws of Virginia. I. Standing of Complainant to Bring Action The Court has previously ruled in foe pretrial proceedings that foe Attorney General has standing and authority to bring this action both at common law and pursuant to Code of Virginia, § 13.1-909(8). The Commonwealth’s — 6 — Attorney for the City of Alexandria is a proper party to the claims based upon Code of Virginia, § 55-29. hi view of foe express provisions of § 13.1-909(B), the fact that JMHI was incorporated in Maryland does not bar die Attorney General from bringing this action in Virginia. Respondents’ reliance on the prohibition against die Commonwealth from regulating die “organization and internal afiairs of a foreign corporation” found in § 13.1-923(C) is misplaced as this action does not seek to regulate any organization nor any internal affairs of JMHI. Therefore, the Court concludes that this action is property brought II. Burden of Proof In view of the Court’s finding that die transactions shown were void (as set forth later herein), the Court has allocated the burden of proof as follows. A. The burden rests upon Complainant to prove that die transactions are void as a breach of trust by Respondents by a preponderance of the evidence. Baylor v. Beverly Book Co., 216 Va. 22 (1975); Giannotti v. Hamway, 239 Va. 14 (1990). Since there is an indication by way of dicta in Willson v. Kable, 177 Va. 668 (1941), that the proof must be “clear, strong, and cogent," the Court also finds that Complainant has carried such a burden. B. Respondents have argued that the nature of transactions places this case in the line of authority that makes die transactions voidable not void. Hence, they argue they are entitled to show the fairness of die transactions. See, Owens v. Owens, 196 Va. 966 (1955). While die Court does not agree that the transactions are merely voidable, in such circumstances^ Complainant would be required to make a prima facie showing of misdealings and the burdens of going forward and ultimate persuasion would rest upon Respondents to show the fairness by convincing evidence. Owens, supra, at 972. m. Facts There is no real conflict in die evidence as to die facts surrounding the transactions and they are amply supported by die documents admitted into evidence. After die acquisition of real estate by deed and lease by die King Street Joint Venture (KSJV) during 1962, 1963, and 1964, held by Respondent Tauber as trustee for die joint venture, a for-profit corporation was formed to transact die business of operating a hospital. The for-profit corporation was — 7 — chartered in Maryland in 1963 and authorized to do business in Virginia in the same year. In 1964, the corporate chart»* was amended to a "Section 501 (cX3) charitable, non-profit corporation,” and JMHI did business as such until 1971. The Internal Revenue Service began investigating the possible revocation of the tax-exempt status of JMHI in 1969, culminating in the revocation in 1971. The Board of JMHI had retained counsel but withdrew its protests to IRS and accepted the revocation. Counsel was retained, according to the uncantradicted evidence, to make recommendations regarding the conversion of the corporation to for-profit status with an eye to a public sale of stock. A Delaware for-profit corporation, Jefferson Memorial Hospital Corporation (JMHC) was formed in 1971 and a putative merger was arranged. The merger, referred to as a "F” merger, was reported on tax returns filed in 1972. The record is devoid of documents to support the merger, but Respondents contend that the merger had occurred "in the minds of the directors." No evidence has been presented to show that at that time due diligence was used to protect the interests of the beneficiaries of the charitable hospital. Efforts were made later in 1971 mid again in 1973 to effectuate the merger. Documents indicate that JMHC assumed all of the liabilities of the charity in return for its assumption of JMHI assets. The charity was to receive 5,000 shares of stock in JMHC. No transfer of the stock has been made. There are numerous transactions shown, some of-record and some not, dealing with the real estate, the equipment, the leases, and the use of tax benefits. The transactions show an entire course of self-dealing by the directors of the charity. They were able to acquire interests in fee real estate, the equipment, and lease and were able to use tax benefits belonging to the former charity to enhance fee gain of fee for-profit corporation. The record is replete wife discussions among Respondents as to their personal profits and gains wife no reference to fee best interests of fee beneficiaries nor of fee charitable corporation. The result was fee total obliteration of fee non-profit corporation. As one example, fee subdivision of fee real estate in 1970 in which JMHI had a 65% undivided interest resulted in the loss of this interest In its place, JMHI obtained a 20% interest consisting of an allocated parcel. No explanation is offered. In 1973, fee non-profit corporation was dissolved by fee State of Maryland for failure to file necessary property taxes and filing fees. In spite of this, Respondents caused to be filed a certificate wife fee Commonwealth that fee corporation remain»! in good standing. — 8 — The record reveals that the interests of the charitable corporation (and hence, the beneficiaries of die charity) were given no consideration by the directors who were operating out of motives of self-gain and inurement The transactions are convoluted and complex With off-record real estate transactions conflicting with the state of the tide as shown on-record. Net operating losses were used as tax deductions by JMHC that had become deductions as a result of the revocation of JMHl’s ti» exempt status. When Respondents had exhausted diese deductions, they began seeking ways to benefit their own tax status through a complicated series of notes and bonds, and while some personal risk was taken, the Respondents and others were participating in the venture in basically a risk-free manner. Respondents claim that JMHl had no value at the time it was changed to a for-profit corporation, and therefore, die transactions by which they assumed control of the corporate assets by the assumption of its liabilities were fair. The evidence as to the valuation of this entity is conflicting. The experts have: disagreed not only in their conclusions but with the methodology employed. The Court finds that in 1971, the time of the change to for-profit, die corporation (JMHI) had value. It had value as a “going concern" with growing revenues hut an erratic pattern of net earnings. However, Respondents’ experts are the more persuasive, and die Court finds that Respondents have carried their burden of showing that the value of die corporation did not exceed its liabilities. However, this does not constitute a defense to the claims made here for reasons that follow. IV. Trusts As used in this opinion, the term “void” is construed to mean voidable at the election of the cestui que trust The directors of a not-for-profit corporation hold the assets in trust for the beneficiaries, and their duties are identical to those imposed on trustees of a trust Adelman v. Conotti Corp., 215 Va. 782, 789 (1975). In Rowland v. Kable, 174 Va. 343 (1940), the Court drew a distinction between those cases where the directors profit from die property of their corporation, in which event the transaction is void, and those cases where the director deals with the corporation with its consent, in which event the transaction is merely voidable if unfair. The Court, quoting Deford v. Ballentine Realty Corp., 164 Va. 436, 440 (1935), said in stating the majority rule: — 9 — There is a distinction to be made between transactions occurring directly between a trustee and bis cestui que trust and toóse transactions in which toe trustee deals with himself in respect to toe trust estate. The latter class of transactions are voidable by the cestui que trust at his election without giving any reason or alleging any fraud, or any advantage or inadequacy of price. Rowland, supra, at 368-69. The actions of these directors are voidable at toe optical of toe beneficiaries of toe trust imposed upon them without proof of an actual injury. See, Rowland, supra, at 366; see also, Kessler v. Commonwealth Doctors Hosp., 212 Va. 497 (1971). In toe case of a charitable non-profit corporation, toe public as represented by Complainant is toe beneficiary of toe trust. At common law, then, Respondents hold the assets of JMHI in trust for toe public. hi addition, it is clear under Virginia law (Maryland law being similar) that directors of a dissolved corporation become formal trustees upon dissolution and hold for toe benefit of toe creditors and shareholders if for-profit or fro* toe public if non-profit Since toe Court finds that no merger of JMHI and JMHC has occurred and that toe transactions by directors of JMHI are void, toe assets remained in JMHI until its dissolution. At toe tin» of dissolution, these assets passed into and remain in toe hands of Respondents as trustees. Under Code of Virginia, § 13.1-909(B), tins Court has toe authority to liquidate the assets and business of JMHI at any time after termination of its existence and whether toe corporation was domestic or feign. The corporation (JMHI) has property and interests located here and nowhere eh». Section 13.1-910 provides toe method tor liquidation by appointing receivers to manage, wind up, and liquidate toe corporation. Pursuant to Code of Virginia, § 55-29, where trustees of any trust, such as that imposed on directors of a non-profit corporation, refuse to act, then the Court may, in an action against toe trustees, appoint trustees to execute toe hast. Here there is little doubt tost toe trustees, toe directors of JMHI, have refused to execute toe trust; tints, this Court may appoint substitute trustees. V. Laches and Good Faith Respondents claim that an undue delay, some twenty-four years from toe date of the initial transaction complained of, coupled with toe death and disability of witnesses and parties, has resulted in prejudice to their ability to present a defense. Complainant argues that laches, as raised by Respondents, — 10 — does not apply to the Commonwealth and that the real party in interest is the Commonwealth. The Court ruled at pretrial that Respondents would not be barred from presenting evidence on this issue, relying on authorities that seemed to hold that laches may apply in cases of a charitable corporation but that equity was reluctant to apply the doctrine in such cases. See, Bogert, The Law of Trusts & Trustees, § 411, 948 and 949 (1984). It has been said that courts of equity are less inclined to apply the doctrine to a charitable trust or against a government Mount Vernon Mortgage Corp. v. United States, 236 F.2d 724 (D.C. Cir. 1956), cert. denied, 77 S. Ct. 386 (1957). In Virginia, neither the statute of limitations nor laches may be asserted as a defense in an equitable proceeding to bar the state Scorn assarting a claim on behalf of the public. Supervisors v. N. & W. R. Co., 119 Va. 763, 790 (1916), as cited in City of Manassas v. Board of Supervisors, 250 Va. 126 (1995). The Court concludes that this cause is brought by the Commonwealth "on behalf of the public” and not to protect private interests as argued by Respondents. Hence, laches does not apply. Even if the doctrine could be asserted, Respondents have not carried their burden of showing that the doctrine should bar this action. While the passage of time is significant, no evidence of substantial prejudice has been shown. The transactions questioned by Complainant are clearly documented and are basically not in dispute. No showing has been made as to what evidence Respondents have been prevented from presenting as a result of the deaths and disabilities alleged. There is one example in which JMHC was identified by an accountant who has since died as JMHI well afier the purported merger. Respondents argue that this would have been shown to be a mistake by the accountant The circumstances surrounding the document are evidence from which the Court could conclude such an error and no prejudice resulte to Respondents. In addition, there is no persuasive evidence that the Commonwealth had such notice of the change in the corporate structure as to trigger its right to act Hue documente reveal at best confusion and at worst an intent to mislead the authorities as to the structure of the hospital. The continued use of JMHl's tax identification number, tire off-record transactions, the use of JMHl’s operating license to operate die hospital, tire attempts to "clean up” the transaction in later years, and Mure to record and file proper documente all serve to indicate a lack of notice to Complainant With the heavier burden resting on Tauber’s shoulders because of the nature of the claim, it is clear that there has been no showing of laches in this case. — 11 — Respondents argue that they were operating in good faith and argue that many of the transactions were done with advice of counsel. In view of the Court’s finding that the nature of the transactions renders them void, not voidable, the good faith of Respondents, even if shown, would not be a defense and the transactions are voided at the election of the cestui que trust. Kessler, supra, at 503. ha any event, the record reflects a Mure on Respondents’ part to give full and complete information to counsel when advice was sought and, therefore, the advice could not be asserted as a defense. If this defense was available, it would require a showing of acting in good faith on advice of reputable counsel after full disclosure of the facts. Edwards v. Carey, 219 Va. 90 (1978) (a case dealing with an action for malicious prosecution). VI. Res Judicata Respondents in 1994 filed a bill in this Court to quiet title to the real property at issue in this case. Service was had by publication against unknown, parties claiming an interest The Commonwealth was not identified as a party nor served with process. Respondents now claim that Complainant is barred by its Mure to intervene and respond in that suit to protect its interests. Res judicata would not apply under these circumstances. O’Hara v. Pittston Co., 186 Va. 325, 344-46(1947). Respondents Med to join the Commonwealth when they knew of the existence of the potential claim, and they now assert that the Commonwealth was a necessary party to the quiet title action so that it is bound by the judgment Having Med to join a known party whom they claim to be necessary to mi adjudication of the issues, the Respondents cannot now be heard to complain of the failure of the Commonwealth to respond. VII. Remedies Having granted the relief sought, toe Court must fashion toe remedy. Counsel should schedule a prompt hearing to discuss toe possible methods for carrying out toe Court’s ruling, including appointment of a Commissioner in Chancery, substitute trustees, or custodians. Counsel may also wish to consider whether judicial economy is best served by an appeal pursuant to Code of Virginia, § 8.01-670(B)(3), if they are so advised.