Jagan M> Reedy v. MBKS Company Limited

Jagan M. Reddy ("Reddy"), the defendant below, appeals from an order of
the Court of Chancery granting summary judgment in favor of the plaintiffs below,
MBKS Company Limited, a British Virgin Islands corporation ("BVI"), and its
subsidiaries, MKBS Inc. and MKBS II Inc., both Delaware corporations (the
"MKBS companies").1 The legal issue presented on this appeal is whether the
Court of Chancery correctly determined that certain actions by Reddy constituted a
cancellation of shares of the MKBS companies. The Court of Chancery held that
they did, and that because the charters of those companies had not been amended
to authorize that alteration of their capital structure, Reddy's actions were legally
ineffective. As a consequence, the Court of Chancery determined that BVI
remained the 100% owner of both MKBS companies. We hold that the Court of
Chancery properly granted summary judgment to the plaintiffs, and affirm.

FACTS2
In late 1995, BVI formed two Delaware subsidiary corporations, the
MKBS companies, as vehicles to acquire two apartment complexes in Colorado.

At that time, BVI owned ten (10) shares in each MKBS company and was the
100% record owner of both. In turn, the 100% record stockholder of BVI was
Sultan Khalid Bin Mahfouz ("Bin Mahfouz"). Reddy was a personal employee of
Bin Mahfouz's cousin, Sami Baarma ("Baarma").3

At the core of this dispute are certain oral agreements that Reddy and
Baarma made before Baarma died on March 12, 2005. The Court of Chancery
assumed (and no one here disputes) that those oral agreements were, in fact, made.
Reddy and Baarma conducted their business substantially on the basis of oral
agreements and mutual trust, as evidenced by a nearly complete lack of formal
documentation of various transactions involving the MKBS companies.

A. The 1996 "Share Purchase Agreement"

As Later Modified

In 1996, Reddy and Baarma agreed that, in exchange for making a capital
contribution, Reddy would receive an equity interest in both MKBS companies.
Reddy's contribution was intended to finance the acquisition of a third apartment
building in Colorado. The record contains two sets of resolutions of the MKBS
companies that reflect this "share purchase agreement." The original resolutions -
signed by Baarma and Reddy but undated - authorize the sale to Reddy of 3.4
shares of each MKBS company at a price of $200,000 per share. A second set of
resolutions, produced by Reddy, consisted of copies of the original resolutions that
were dated May 20, 1996 and contained two modifications that Reddy had
handwritten and initialed. Specifically, the number of shares of each MKBS
company to be issued to Reddy was increased from 3.4 to 10 shares, and the per
share consideration was decreased from $200,000 to $68,000 per share. Although
Baarma did not sign or initial those changes, Reddy asserts that Baarma consented
to the modifications, but provides no explanation for why those changes were
made. In any event, under both the original and the modified resolutions, the total
consideration Reddy would pay for his stock in each MKBS company was
$680,000. The only substantive difference between the two sets of resolutions is
the increase in the number of shares Reddy would receive in exchange for that total
consideration.

Those resolutions, as drafted, were not implemented. That is, Reddy did not
pay any cash consideration to the MKBS companies for the shares because (he
claims) at some point in 1997, it became apparent that additional capital infusions
were not needed. As a result (Reddy further claims), he and Baarma orally
modified the (previously modified) resolutions, with the result that Reddy would
receive 10 shares in each MKBS company, but would pay the cash consideration
not to the MKBS companies, but instead to certain persons to be named by
Baarma. Those persons would include Baarma's mistresses and household staff.

According to Reddy, the payments would be made on Baarma's death and were
structured in this manner in order to circumvent the estate administration process.
Baarma died in March 2005. But, Reddy paid no monies to Baarma's
designees, despite his earlier agreement to do so. The reason, Reddy claims, is that
it was "impossible" to make payments to Baarma's designees, so instead he made
the payments to the MKBS companies, in 2006. Although Reddy made payments
totaling $1,360,000 to the MKBS companies, he did that only after this lawsuit had
been brought against him in the Court of Chancery by BVI and the MKBS
companies.

B. The 1996 "Distribution Agreement"

In order for this narrative to be complete, another agreement, also entered
into in 1996, is critical. Reddy claims that, in addition to the 1996 "share purchase
agreement" described above, he and Baarma entered into a separate oral agreement
(the "distribution agreement"). This separate agreement was that if a United States
citizen ever became a record shareholder of BVI, then BVI would distribute
proportionately all its shares in the two MKBS companies to its (BVI's)
stockholders. Reddy claims that this "distribution agreement" was entered into for
tax reasons. The "distribution agreement" was never reduced to writing and it was
never disclosed to anyone else, including Bin Mahfouz, who was one of BVI's two
directors. Not until October 2005 did Reddy inform Bin Mahfouz that this agreement
existed. The significance of the timing of that nondisclosure will soon appear.

According to Reddy, the 1996 "distribution agreement" remained dormant
until it sprang to life in 2005, when Reddy first became a BVI record shareholder.4
After Baarma's death in March 2005, Reddy began negotiating with Bin Mahfouz
(who knew nothing of the 1996 "distribution agreement"), seeking Bin Mahfouz's
formal recognition of Reddy's stock ownership interest in BVI. Reddy's claimed
equity interest in BVI was premised on certain investments he made in 1996 in
connection with BVI's initial purchase (through the MKBS companies) of the
Colorado properties. The result of these negotiations was reduced to written
resolutions signed by Reddy and Bin Mahfouz (who were BVI's only directors) on
April 7, 2005. Those resolutions recognized Reddy as the owner of a 25% interest
in BVI, retroactive to October 21, 1994. Reddy's 25% ownership in BVI is not
contested in this litigation. What is contested is Reddy's claim that he also owns a
62.5% stock interest in the MKBS companies, by virtue of the 1996 "share
purchase agreement" as modified, and the 1996 "distribution agreement."

C. The August 2005 Resolutions Implementing The

Share Purchase and The Distribution
Agreements

On August 23, 2005, Reddy, acting as the sole director of the MBKS
companies, unilaterally adopted resolutions that (he claims) implemented his 1996
agreements with Baarma. Those August 2005 resolutions - which contain various
"whereas" clauses that purport to explain Reddy's actions and to state his version
of the undocumented agreements with Baarma - recite that:

During fourth quarter 1995 and first quarter 1996 [...] it was further
agreed between [Baarma] and [Reddy] that, under certain
circumstances, [Reddy] would be issued stock amounting to 25% of
the transaction. With the unexpected and premature death of
[Baarma] on March 12, 2005, which was a special circumstance, a
April 7, 2005 resolution of the Board of Directors of [BVI] gave
[Reddy] a 25% ownership in the company as of October 21, 1994.

Pursuant to an agreement between [MKBS] and [BVI] that required
the shares of [BVI] [sic] to be held by [BVI's] shareholders if a US
citizen was a shareholder of [BVI], [Reddy] has now decided, for tax
reasons, to own the [MKBS] shares directly and not via [BVI].

About May 20, 1996 the Directors of [MKBS] approved the purchase
by [Reddy] of 10 shares of [MKBS]. [...]

Resolved that [Reddy] be granted 10 shares of MBKS, diluting
the ownership of [BVI].

Resolved that the 10 shares held by [BVI in MKBS] be reissued
in the names of the shareholders of [BVI]. Therefore, 7.5 shares
will be held in the name of [Bin Mahfouz] and [Reddy] will
hold 2.5 shares.5

Purporting to implement the first resolution (which is claimed to reflect the
1996 "share purchase agreement" as modified), Reddy caused the MKBS
companies to issue, to himself, certificates for 10 additional shares of each MKBS
company. Purporting to implement the second resolution (which is claimed to
reflect the 1996 "distribution agreement"), Reddy wrote the word "cancelled"
across the two certificates evidencing BVI's ownership interest in each MKBS
company. He then caused each MKBS company to issue new certificates to Bin
Mahfouz (for 7.5 shares) and to himself (for 2.5 shares). Based upon those actions,
Reddy claims that BVI no longer has any interest in the MKBS companies, and
that Bin Mahfouz has a 37.5% stock ownership interest, and that he (Reddy) has a
62.5% ownership interest, in the MKBS companies.

Reddy did not immediately inform Bin Mahfouz that he had adopted these
August 2005 resolutions. The reason is that at that time, Reddy and his family
were negotiating a settlement with Bin Mahfouz and others relating to Reddy's
claim of entitlement to a portion of Baarma's estate. Ultimately, in October 2005,
Reddy and Bin Mahfouz agreed that Reddy would receive a $6.1 million
settlement. Only after Reddy received the settlement proceeds did he then inform
Bin Mahfouz of the 1996 "share purchase" and "distribution" agreements, and of
the August 2005 resolutions purporting to implement these agreements.

On November 1, 2005, in response to Reddy's opportunistic disclosure of
those facts, Bin Mahfouz caused BVI to execute written consents electing Abdul-
Elah A. Mukred ("Mukred") and Lawrence G. Smith ("Smith") to the boards of
directors of the MKBS companies. Next, on December 17, 2005, BVI executed a
second set of written consents, removing Reddy from the boards of directors of the
MKBS companies.

D. The Court of Chancery Litigation

On December 20, 2005, BVI and the MKBS companies filed an action in the
Court of Chancery, seeking a declaratory judgment and other relief against Reddy
for alleged breaches of fiduciary duty, fraud, negligent misrepresentation, and
other misconduct. Reddy counterclaimed for a declaratory judgment confirming
his claimed 62.5% ownership interest in the MKBS companies, and for a
determination of those companies' lawful directors under 8 Del. C. § 225. In his
counterclaim, Reddy named Mukred and Smith as third-party defendants.
Thereafter, the plaintiff corporations moved for summary judgment on all of their
claims. Opposing that motion, Reddy challenged the legality of his removal on
December 1, 2005 as a director of the MKBS companies, and also of the legal
sufficiency of BVI's November 1, 2005 written consents appointing Smith and
Mukred as directors of the MKBS companies. Reddy did not, however, crossmove
for summary judgment on his counterclaims and third-party claims.

The Court of Chancery granted summary judgment in favor of the plaintiffs
and against Reddy on the plaintiffs' claims, concluding that the actions recited in
Reddy's August 2005 resolutions were legally ineffective. The Vice Chancellor
reasoned that insofar as the August 2005 resolutions purported to implement the
1996 "distribution agreement" - by cancelling the shares held by BVI in the two
MKBS companies and issuing new shares to Reddy and Bin Mahfouz - an
amendment to the certificates of incorporation of both MKBS companies was
required and had not occurred. Moreover, insofar as the August 2005 resolutions
purported to implement the amended 1996 "share purchase agreement" - by
issuing 10 additional shares to Reddy in each MKBS company - those issued
shares were "void or voidable" for lack of consideration, and, accordingly, had no
voting rights. As a result, the Court of Chancery concluded that the November and
December 2005 written BVI consents adding Smith and Mukred to, and removing
Reddy from, the boards of the MKBS companies were legally valid.6
This appeal followed.

ANALYSIS OF THE CLAIM OF ERROR

This Court reviews a grant of summary judgment de novo.7 The Court also
reviews de novo the trial court's formulation and application of legal principles.8
Reddy's sole claim on appeal is predicated upon the 1996 "distribution
agreement." The Court of Chancery characterized Reddy's actions purporting to
implement the 1996 "distribution agreement" as a cancellation of BVI's shares in
the MKBS companies. Such a change in the corporate capital structure, the Vice
Chancellor concluded, could only be accomplished by a charter amendment
pursuant to 8 Del. C. § 242.9 Reddy contends that these rulings by the Court of
Chancery are erroneous as a matter of law.

Reddy claims that his actions did not require a Section 242 charter
amendment, because they amounted only to a cancellation of share certificates (as
distinguished from the underlying shares), in order to effectuate the transfer of
ownership that had previously occurred by reason of the 1996 "distribution
agreement." To say it differently, Reddy claims that his August 2005 actions did
not alter that capital structure, but merely reallocated ownership interests within
the existing capital structure of the MKBS companies.

We pause first to consider a threshold argument, advanced by Appellees,
that this Court should not consider Reddy's claim, because during the Court of
Chancery proceedings, Reddy repeatedly characterized his August 2005 actions as
a cancellation of stock, not of stock certificates as he now claims. But, Reddy
accurately points out that, at the Court of Chancery level, neither side ever referred
to Section 242 or advocated how Reddy's actions should be characterized with
reference to that statute. The likely reason is that the focus of the Chancery
proceedings was upon whether or not Reddy had breached his fiduciary (as
distinguished from statutory) duties by adopting the August 2005 resolutions.

It is apparent to us that the issue presented on this appeal was never "fairly
presented" to the trial court, as Supreme Court Rule 8 requires.10 But, it does not
necessarily follow, in this specific case, that we should not consider the issue. In
his written opinion, the Vice Chancellor held sua sponte that Reddy's actions
constituted an attempted cancellation of shares that required a charter amendment
under Section 242. Because the parties were not heard on this specific issue, it
serves the "interests of justice" for us to consider Reddy's claim, as Supreme Court
Rule 8 permits.11

We turn to the merits of Reddy's position, which is that (i) a transfer of the
shares of both MKBS companies from BVI to BVI's shareholders had been validly
agreed to in the 1996 "distribution agreement" and (ii) that agreement was validly
implemented by Reddy's August 2005 resolutions. Reddy claims that his 2005
resolutions should be regarded as nothing more than ministerial steps to implement
the 1996 "distribution agreement." We agree that Reddy's actions might be
regarded as "ministerial," but only if there was a preexisting valid and enforceable
agreement for BVI to transfer its MKBS shares to its shareholders in the event that
a U.S. citizen ever became a BVI shareholder. It is upon this premise, however,
that Reddy's case founders. Viewing the facts in the light most favorable to the
non-moving party below (Reddy), we find that Reddy failed to make a prima facie
showing, sufficient to defeat summary judgment, that the 1996 "distribution
agreement" was a preexisting valid and enforceable agreement to transfer the
MKBS companies' shares.12

Even under Reddy's version of the facts, the 1996 "distribution agreement"
was negotiated by Reddy and Baarma without the knowledge or involvement of
Bin Mahfouz (BVI's other director). Reddy testified that during the "negotiation"
of that agreement, Baarma acted on behalf of the MKBS companies, and Reddy
acted on behalf of BVI.13 Reddy claims that BVI (as represented by himself)
"consented" to the "distribution agreement." We disagree and, for the reasons next
discussed, hold that Reddy's "consent" on behalf of BVI was legally ineffective.
Reddy did not inform, or obtain the approval of, the other BVI director (Bin
Mahfouz) when he "negotiated" the "distribution agreement" with Baarma in 1996.

Indeed, Reddy never informed Bin Mahfouz about the existence of the
"distribution agreement" until after Reddy concluded his settlement with Bin
Mahfouz nearly 10 years later. Nor did Reddy present any record evidence that
BVI had granted Reddy legal authority to approve that agreement unilaterally on
BVI's behalf. If the "distribution agreement" is viewed as an agreement to transfer
shares, as Reddy claims, then BVI must be deemed the transferor, and Reddy and
Bin Mahfouz must be deemed the transferees. Reddy has failed to show how an
agreement to transfer shares to which the board of directors of the transferor (BVI)
never validly consented can be legally enforceable.14 Therefore, Reddy did not
discharge his burden to prove that the 1996 "distribution agreement," even as he
describes it, was a valid enforceable agreement to transfer shares from BVI to
BVI's shareholders.15

Because there was no legally valid agreement to transfer shares requiring
implementation, Reddy's actions in August 2005 were not ministerial cancellations
of stock certificates, i.e., a reallocation of shares within the existing capital
structure of the MKBS companies. Those actions, if they amounted to anything at
all, could only have represented an effort to change the capital structure of those
companies. The Court of Chancery correctly concluded that Reddy's actions in
August 2005 - allegedly performed on behalf of the issuers of the shares (the
MKBS companies)16 and involving 100% of the common stock of each issuer -
amounted to a cancellation of stock followed by the issuance of new shares to
different shareholders. The cancellation of those shares could only be
accomplished by complying with the procedure mandated by 8 Del. C. § 242 - a
written charter amendment, authorized by the board of directors, approved by the
shareholders, and filed with the Delaware Secretary of State. Reddy concedes that
those requirements are applicable to cancellations of stock, and that no charter
amendment for either MKBS company was ever effected.

* * *

http://courts.delaware.gov/opinions/(rujjeyiljbbcun55caywv22o)/download.aspx?ID=103670

For the foregoing reasons, the order of the Court of Chancery granting
summary judgment to the Appellees is affirmed.
16 Reddy admitted in response to an interrogatory that “he was acting in his capacity as sole
director of [the MKBS companies]” when he “cancelled [BVI]’s 100% nominal interest in [the
MKBS companies] on August 23, 2005.”

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