Plaintiffs appeal a judgment entered after the trial court's grant of summary judgment to defendants on plaintiffs' claims for breach of contract and on defendants' counterclaims for breach of fiduciary duty, restitution, and breach of contract. We reverse.
Because the trial court granted defendants' motions for summary judgment, we state the facts in the record most favorably to plaintiffs, including drawing all reasonable inferences in their favor. ORCP 47 C; Flug v. University of Oregon, 335 Or. 540, 542, 73 P.3d 917 (2003); Jones v. General Motors Corp., 325 Or. 404, 420, 939 P.2d 608 (1997). Plaintiff Roger M. Pollock (Pollock) is the sole shareholder in plaintiff KMP Properties, Inc., formerly known as RMP Properties, Inc. (RMP). In 1990 RMP began building homes in the Portland area, focusing on the market for first-time buyers. It built homes on speculation, without having buyers for them, and then sold them after construction began, usually after completion. Such homes are known in the trade as "spec" homes, in contrast to "custom" homes, which are sold before being built. The business grew rapidly; by 1997 RMP was the largest builder of spec homes in the Portland area. In that year, it started 303 homes, sold 187, and had profits of over $3 million.
Pollock's goal was for RMP to continue its rapid growth, but he was uncertain whether it could do so on its own. By 1997, he was also concerned that changes in the local banking climate, particularly the purchase by a Minnesota bank of the bank that financed RMP's business—which was the last large locally owned bank in Oregon—would affect his ability to obtain the necessary financing. In addition, he was uncertain whether his and RMP's credit would be sufficient to obtain that financing from any other source. He therefore sought to sell RMP or its assets to a large regional or national homebuilder that would have the necessary resources to continue the business's growth. His goal was to remain in charge of the business after the sale and to participate in the benefits of its expansion. In order to find a purchaser, Pollock hired a local investment banker, who prepared an offering memorandum and sent it to several interested companies. The memorandum described the nature of RMP's business, including its focus on spec homes.
Defendant D.R. Horton, Inc. (Horton), was one of the companies that received the offering memorandum. It expressed interest and eventually agreed with Pollock on the terms for it to purchase RMP's assets. Under the agreement, Horton would form D.R. Horton, Inc.-Portland (Horton-Portland) as a new subsidiary, and Horton-Portland would purchase
Pollock believed that the business was worth approximately $12 million rather than the $7.75 million in cash and stock that Horton-Portland paid at the closing. As a way to make up the difference, the "Asset Purchase Agreement" (APA), which was the primary document for implementing the purchase, provided a profit-sharing arrangement that it described as the "earn-out."
The APA reflects the above considerations. Article 9 included a noncompetition provision that prevented Pollock and RMP from engaging in a competitive business for three years after the end of the earn-out period or three years after the termination of Pollock's employment, whichever came first. It also contained confidentiality and enforcement provisions. Among those provisions was Section 9.06:
Article 10 of the APA provided for the earn-out payments that plaintiffs would receive. They were based on the performance of the business that plaintiffs sold, which was Horton-Portland's only business during this period. Section 10.01 defined the earn-out and established the accounting procedures for determining its amount. Section 10.02 limited Horton-Portland's management and evaluation of the business during the earn-out period:
"At all times during any Earn-Out Year, in managing the operations of the Acquired Business, the Purchaser shall apply operating, performance and financial criteria to the business of the Acquired Business substantially similar to the criteria
(Underscoring in original.)
Finally, and as a part of the overall transaction, Pollock and Horton-Portland entered into an employment agreement under which Pollock was to be responsible for Horton-Portland's day-to-day operations. The employment agreement was expressly tied to the earn-out, expiring at the end of the earn-out period. It could also terminate earlier for a number of reasons, including cause, which the agreement defined in part as that Pollock had "committed any act of fraud, embezzlement or theft in connection with his duties hereunder."
Before Pollock sold RMP's assets to Horton-Portland, he had routinely used its money to pay for work on his own homes and for other personal matters. RMP showed those expenses on its books as shareholder loans. After the sale, Horton-Portland paid some equipment rental fees for work on Pollock's personal residence and his beach home. Pollock did not become aware of those payments until after plaintiffs filed the complaint in this case. In addition, Pollock moved Horton-Portland's offices from the location that RMP had used to a building that he owned.
Pollock also had a Horton-Portland employee attend hearings concerning whether to include property that Pollock owned in the Portland metropolitan urban growth boundary. Inclusion would make the land potentially available for development and thus increase its value. The employee spent 53 hours on the project, time that he would otherwise have spent on Horton-Portland's business. Pollock believed that, because of the noncompetition provisions in the APA, Horton-Portland would be the only possible purchaser or developer of the land; it was not abnormal for the employee to attend hearings on land that the company was interested in purchasing.
The purchase of RMP's assets closed on June 8, 1998. During the rest of that year, Pollock prepared Horton-Portland for significant future growth by purchasing land and preparing to build houses on it and by increasing its staff. He also worked to fit the division's operations into the Horton system.
In accordance with Pollock's plan, in early January 1999 Horton-Portland began increasing the number of its housing "starts."
In early February 1999, without any warning or prior consultation, Pollock's superiors at Horton instructed him to limit Horton-Portland's inventory of unsold starts to 150. At that time, Horton-Portland had about 200 unsold starts; thus the restriction ended its ability to increase its inventory in preparation for the prime house-buying season, which would begin in the spring. According to defendants' witnesses, the primary reasons for imposing the limitation were Horton's concern about the low profitability of the business in 1998, the high percentage of spec homes in its inventory, and what Horton believed to be relatively low margins on each sale. Pollock's superiors had not previously expressed those concerns to Pollock and, in fact, had complimented him on his work with Horton-Portland. The limitation was not the result of a lack of resources; at the time Horton had more money available than it had opportunities.
Viewing the evidence most favorably to plaintiffs, the reasons that defendants give for the limitation do not justify it under the APA. Horton-Portland's lower profits in 1998 were the result of preparing for dramatic growth in the future by making precisely the kinds of investment that the parties contemplated at the time of the sale. Horton knew at that time that Pollock was primarily a builder of spec homes for the first-time buyer market, and it knew that he focused on the volume of sales, rather than the high margins on individual sales, as the source of his profits. Horton also had adequate information before the purchase to determine RMP's profit margins and other methods of operation; indeed, the offering memorandum showed profit margins similar to those about which defendants subsequently complained.
Pollock believed that, in part because of the seasonal nature of the Portland market for new houses, the restriction to 150 starts would make it impossible for Horton-Portland to earn sufficient profits for him to receive anything from the earn-out provision of the APA, let alone what the parties intended him to be able to receive. The required inventory reduction would make it impossible to build sufficient houses at the right time to
Pollock was also worried that the limitation would force him to renege on commitments that he had made on behalf of Horton-Portland, thus damaging his reputation in the community and making it impossible for him to continue to do business successfully. He was particularly concerned about one parcel that he had committed to purchase on which Horton executives wanted him to renege. The executives responded that they had purchased the right to dictate what he could build. After Pollock's resignation, the company decided to proceed with the purchase of that parcel. The company also told his successor that he could have as many as 250 starts in his inventory and that he should speak to a Horton executive if he wanted to increase that number.
Pollock's conversation with the Horton executives led him to conclude that he would not have an opportunity to receive anything from the earn-out. As a result, he handwrote a letter of resignation, in which he stated that he was resigning because Horton had breached its contract with him. A Horton executive persuaded him to withdraw that letter and replace it with one that did not give a reason for the resignation; the executive explained that the change would help make for a smoother transition. He told Pollock that the company needed his cooperation for the transition and promised that it would work out fair compensation for his earn-out rights. However, the executive never proposed any specific resolution and stopped returning Pollock's calls shortly after his resignation.
Pollock filed this action on March 16, 1999, alleging that defendants violated both Section 9.06 of the APA and the implied covenant of good faith and fair dealing in the APA by failing to provide adequate financial support to the business during the earn-out period. In a second claim, he alleged that defendants breached the employment agreement by terminating it and failing to pay his salary and benefits. Defendants denied Pollock's allegations and asserted affirmative defenses of waiver and estoppel based on his resignation. Defendants also counterclaimed for breach of fiduciary duty because of what they alleged to be his misuse of company funds and employees for his personal purposes. Those actions, defendants allege, also constituted cause for his termination. The trial court granted summary judgment to defendants on all claims on the ground that Pollock voluntarily resigned and that defendants did not act in bad faith. It also indicated that, if it had reached the issue, it would have ruled that Pollock's actions gave defendants cause for discharging him. Plaintiffs appeal.
The analysis of plaintiffs' first and second assignments of error is closely related, and we will consider them together. In their first assignment, plaintiffs assert that the trial court erred in concluding, as a matter of law, that defendants' decision to limit Horton-Portland's inventory was not an arbitrary decision designed to force plaintiff out and that there was no evidence of bad faith by defendants. In their second assignment, they assert that the trial court erred in concluding, as a matter of law, that plaintiff voluntarily resigned his position and thus terminated defendants' contractual obligations to him. Both assignments turn on whether there is evidence from which a jury could find that the inventory limitation was a material breach of defendants' express or implied obligation to act in good faith in the performance of the APA and the employment agreement. We first consider whether a jury could find that there was a breach; we then discuss whether it could find that the breach was material, which would discharge Pollock's duty to give further performance.
For at least 40 years, Oregon courts have held that every contract contains an implied obligation that the parties will perform it in good faith. See Comini v. Union Oil Co., 277 Or. 753, 756, 562 P.2d 175 (1977); Perkins v. Standard Oil Co., 235 Or. 7, 16, 383 P.2d 107, 383 P.2d 1002 (1963). Although it is impossible to define good faith in all circumstances, at its heart is each party's obligation to perform the contract, including exercising any discretion that the contract provides, in a way that will effectuate the objectively reasonable contractual expectations of the parties. See Hampton Tree Farms, Inc. v. Jewett, 320 Or. 599, 615-16, 892 P.2d 683 (1995); Best v. U.S. National Bank, 303 Or. 557, 563, 739 P.2d 554 (1987). The focus is on the parties' agreed common purpose and justified expectations, both of which are closely related to the express provisions of the contract. OUS v. OPEU, 185 Or.App. 506, 515-16, 60 P.3d 567 (2002). In Best, for example, the plaintiffs challenged the defendant bank's fees for processing nonsufficient funds checks. The fees were considerably greater than the costs that the banks incurred in processing such checks. The Supreme Court held that, although the bank had discretion under the checking account contract to set the fees, there was a question of fact of whether charging substantially more than the cost of the service was consistent with the parties' reasonable expectations when they entered into that contract. Best 303 Or. at 565-66, 739 P.2d 554.
In Section 9.06 of the APA, Horton-Portland expressly agreed to provide good faith financial support to the business during the earn-out period, subject to two limitations.
The APA does not define "good faith," and we therefore apply the meaning that Oregon law normally gives to the term.
The earn-out served at least two purposes. First, the APA expressly states that it was part of the compensation for the sale. The earn-out provided a way for Horton to acquire the business for less than Pollock thought it was worth and, at the same time, to give Pollock the potential of receiving considerably more. Second, by allowing Pollock to share in the profits of the business, the earn-out gave Pollock an incentive to use his best efforts, as its manager, to make it profitable after the sale. Each of those purposes benefitted both plaintiffs and defendants. Horton paid less for the business than Pollock wanted; in return, Pollock received the opportunity to receive more than he would have otherwise received. Horton obtained Pollock's experience and ability in managing the business; in return, Pollock had the opportunity to share the profits that he produced.
Section 9.06 recognizes that the earn-out created a good-faith obligation for Horton-Portland to provide substantial financing for the business. The reason for that obligation is clear: In order for the earn-out to serve its purposes, the business's profits had to be substantially greater than they had previously been. In order for plaintiffs to receive anything from the earn-out those profits had to be over $3.75 million for the first three years and over $4 million for the final year. Before the sale, RMP's largest yearly profit was approximately $3 million. Thus, the earn-out created a common goal for the parties of producing significant growth in the business's profits. Horton-Portland's contribution to that common goal was to give the financial support that would make substantial growth possible.
All parties knew that, before the sale, Pollock relied on the volume of sales rather than high gross margins on each sale for the business's profits. Before the purchase, Horton told Pollock that it expected him to operate as an entrepreneur, relatively independently of central supervision, which could reasonably mean that it expected him to continue to function as he had previously done. If so, Horton-Portland's agreement in Section 9.06 to "provide good faith financial support to the Company during the Earn-Out Period" means that it would provide the necessary support for him to increase the business's profitability by following the precise policies that had made it profitable in the past—policies that had made it an attractive investment for Horton. Without that support, the earn-out would be worthless. Thus, a jury could find that the financial support that Section 9.06 obliged it to provide was reasonable support for the way that Pollock did business.
The APA includes criteria for evaluating what support was reasonable. Section 9.06 required that support unless it was not justified by the sales volume or pretax profit margin.
In the six or seven months after the purchase, Horton-Portland invested $30 million in the business. Pollock used that money to purchase land and to make other preparations to increase the number of starts in 1999. Both Pollock and Horton-Portland understood that the purpose of the investment
In imposing the limitation of 150 starts, defendants neither considered nor complied with their obligations under Section 9.06. That may in itself be evidence of bad faith. Defendants' expressed reasons for the decision were inconsistent with acting in good faith to achieve the purposes of the parties in entering into the APA. Defendants' concerns about the large number of spec homes in the Horton-Portland inventory was inconsistent with their knowledge that the business that they purchased was a spec home builder. In the same way, their concern about what they saw as a relatively low gross margin per house was inconsistent with their knowledge that the business operated on comparable margins at the time of the purchase. The reasons that defendants gave for imposing the limitation, thus, were contrary to things that were necessarily in the contemplation of the parties at the time of the purchase. They gave no consideration to their obligations to plaintiffs under Section 9.06. The jury could find that, in imposing the limitation, Horton-Portland did not act to fulfill its good faith obligations but, rather, exercised its power as the owner of the business to change an essential component of the agreement between plaintiffs and defendants without regard to the effect of the change on plaintiffs. It thereby frustrated rather than furthered the parties' objectively reasonable expectations.
Defendants argue that the evidence shows only that the parties had different ways of operating the business and that defendants were not willing to accept the level of risk that Pollock's method of operating imposed. They assert that the limitation involved only unsold houses and that Pollock could have met it simply by increasing sales without necessarily significantly reducing starts. They note that Horton-Portland invested a large amount in the business in the months after the purchase. According to defendants, the earn-out was simply a performance bonus and Pollock did not perform in a way that entitled him to any part of it; rather, he voluntarily resigned before the end of the first earn-out year. Their refusal to give Pollock carte blanche was not a failure to act in good faith under the APA.
The difficulty with defendants' arguments is that they are based in part on defendants' view of the evidence and in part on a misunderstanding of the nature of the earn-out. They might well be appropriate arguments at trial, but they do not fully engage with the more restricted role of contradictory evidence on summary judgment. In particular, defendants do not recognize the significance to plaintiffs' view of the case either of defendants' knowledge of plaintiffs' methods of operation before the purchase or of the nature of the earn-out as consideration for the purchase rather than as compensation for Pollock's services. Those things could lead a trier of fact to conclude that the good faith obligation limited defendants' ability to impose their preferred methods of operation on plaintiffs during the earn-out period and that the 150 starts limitation transcended those limits.
For these reasons, we conclude that there is an issue of fact of whether defendants breached their obligations to perform the APA in good faith. That requires us to consider whether the jury could also find that the breach was a material breach. Pollock was justified in resigning if defendants committed a material breach, and he did not give up his claim for damages by doing so.
In Bisio v. Madenwald, 33 Or.App. 325, 331, 576 P.2d 801, rev. den., 283 Or. 1, 580 P.2d 1030 (1978), we summarized and applied the criteria in Restatement of Contracts § 275 (1932) for determining whether a breach is material. Since Bisio, Restatement (Second) of Contracts § 241 (1981) has expanded on those criteria and now provides that the following circumstances are significant in determining whether a failure to render or offer performance is material:
Those are appropriate criteria and we adopt them in guiding our evaluation of the evidence on summary judgment.
If the jury were to find that the 150 starts limitation was a breach of the APA, it could also find that that breach will deprive plaintiffs of the benefit of the earn-out. Thus, the first criterion weighs in favor of materiality. It appears that plaintiffs could be compensated for the breach by money damages while Pollock continued to render his own performance under the employment agreement, so the second criterion weighs against materiality. The remaining criteria all weigh in favor of materiality. Defendants did not suffer a forfeiture from Pollock's resignation; rather, they retained the business and replaced Pollock with a new manager. Defendants' actions and statements at the time made it unlikely that they would cure their failure to perform in good faith, and the jury could find that their behavior did not comport with standards of good faith and fair dealing. On balance, the jury could conclude that defendants' breach was material and that Pollock's resignation was justified. The trial court erred by granting defendants' motion for summary judgment on the ground that Pollock waived his right to enforce the APA by resigning or that he was estopped from doing so.
In their third assignment of error, plaintiffs assign error to the trial court's conclusion that Horton is not liable for any failure by Horton-Portland to perform in good faith. They rely first on Section 11.02 of the APA, under which Horton and Horton-Portland, jointly and severally, agreed to "indemnify, defend, reimburse, and hold [plaintiffs] * * * harmless" from any and all claims that arose from or were related to "[a]ny failure to perform or observe any term, provision, covenant, or agreement to be performed or observed by" Horton or Horton-Portland. Plaintiffs argue that that indemnity agreement makes Horton liable to plaintiffs for any breach of Horton-Portland's obligations to them.
The threshold problem with plaintiffs' argument is that they did not comply with the procedural requirements for asserting rights under the indemnity provision. Section 11.03(d) of the APA provides that, if one party has a claim against the other that does not involve a third-party claim, which is the situation in this case, then the party seeking indemnity
"shall transmit to the indemnifying party a written notice (the `
(Underscoring in original.)
Plaintiffs assert that a letter that their attorney wrote to Horton on March 10, 1999,
Plaintiffs also argue that Horton directly violated its own implied good faith obligations under the APA. We agree with plaintiffs that there is sufficient evidence to avoid summary judgment on that issue. The jury could find that Horton directly made the decision to limit Horton-Portland's inventory of starts. The decision was made at Horton's headquarters in Texas by officers of Horton. They then communicated it to Pollock in Portland. The jury could reasonably infer that they were acting as Horton's agents and for its benefit when they did so. Horton is a party to the APA and has an implied duty to perform in good faith, even though it is not subject to the express good faith obligation of Section 9.06. Horton was fully aware of all of the circumstances that we previously described, and the jury could find that, by its decision to impose the limitation, it breached its implied obligation to perform the APA in good faith. The trial court therefore erred in dismissing plaintiffs' claims against it.
In their fourth assignment of error, plaintiffs assign error to the trial court's conclusion that defendants had the right to discharge Pollock because of his misappropriation of defendants' resources for his private benefit. The trial court apparently believed that, if Pollock breached the employment agreement to the extent that would justify his termination, defendants cannot be liable for any breaches of the APA that they may have committed.
The employment agreement permits Horton-Portland to discharge Pollock for cause, which it defines as including that Pollock committed "any act of fraud, embezzlement or theft in connection with his duties hereunder." We first consider whether there is an issue of fact of whether Pollock committed fraud. Because the employment agreement provides that it is to be construed in accordance with Oregon law, we begin with the Oregon definition of fraud. Under Oregon law, proof of fraud generally requires a showing that
Defendants' position, thus, is that a fiduciary who fails to disclose the fiduciary's alleged misconduct represents that there was no misconduct, and thereby commits fraud, even in the absence of some action that constitutes reliance. In support, it relies on Veale v. Rose, 657 S.W.2d 834, 837-38 (Tex.App.1983), in which the court held that one partner's misappropriation of partnership property for his own use was constructive, if not actual, fraud. However, as a subsequent Texas case makes clear, constructive fraud is distinct from actual fraud. Welder v. Green, 985 S.W.2d 170, 174-75 (Tex.App.1998), was also a dispute in which one partner recovered a judgment against the other for fraud. The trial court instructed a jury on both actual fraud and constructive fraud. The verdict was in the plaintiff's favor, but the trial court refused to enter judgment on it. On appeal, the appellate court analyzed the two theories of fraud as separate tort claims. It first held that there was no evidence that the defendant intended to breach his fiduciary duties at the time that the plaintiff left the partnership or that the defendant made any other misrepresentation. Thus, the court held, there was no proof of actual fraud. It then distinguished a claim for actual fraud from one for constructive fraud. In that respect, it said, a claim for constructive fraud was identical to a claim for breach of fiduciary duty, citing Veale as an example of constructive fraud. It then held that there was some evidence to support the constructive fraud claim.
Here, the employment agreement makes fraud a ground for termination, but it does not refer to either constructive fraud or breach of fiduciary duties. Like Texas law, Oregon law distinguishes constructive fraud from actual fraud. The Supreme Court has cited authorities that emphasize that constructive fraud is simply a catch-all term for a variety of transactions in which the courts have decided that fraud-type relief is appropriate; many of those transactions do not require either intent to deceive or actual dishonesty of purpose. See U.S. Nat. Bank v. Guiss et al, 214 Or. 563, 585-86, 331 P.2d 865 (1958). It has also expressed some skepticism about the theory. See Knight v. Woolley Logging Co., 278 Or. 691, 694-95, 565 P.2d 748 (1977). We have recently referred to constructive fraud in describing those provisions of the Uniform Fraudulent Transfer Act, ORS 95.220 to 95.310, that void transfers without requiring a showing of actual intent to defraud a creditor. See Doughty v. Birkholtz, 156 Or.App. 89, 96, 964 P.2d 1108 (1998); Morris v. Nance, 132 Or.App. 216, 222, 888 P.2d 571 (1994), rev. den., 321 Or. 340, 898 P.2d 192 (1995). Constructive fraud, thus, is not common-law actual fraud. Nothing in the employment agreement suggests that the parties intended to make constructive fraud a ground for termination. Indeed, the employment agreement couples "fraud" with "embezzlement or theft," each of which involves actual dishonesty of purpose. We conclude that the parties meant actual fraud when they referred to "fraud."
There is a genuine issue of fact of whether Pollock committed actual fraud. Defendants assert that three actions were fraudulent: charging Horton-Portland for equipment that was rented for use at his own homes; charging Horton-Portland for the cost of remodeling the building where Horton-Portland
The charges for equipment rentals followed Pollock's practice when he was the sole owner of the business, and a jury could find that the bookkeeper simply continued the practice without Pollock's knowledge. He testified that he was not aware before his termination that the charges had continued. He agreed that he should reimburse Horton-Portland for those costs and has done so.
There are two aspects to the remodeling issue. The first involves the cost of remodeling the upper floor of the building, where Horton-Portland had its offices, and the second involves the remodeling of the lower floor. There is an issue of fact in each case. Pollock testified that defendants knew that he intended to charge Horton-Portland for the cost of remodeling the upper floor, giving it a below-market rent in return. He also testified that charging Horton-Portland for the cost of remodeling the lower floor was a mistake, which he took steps to correct when he learned that it had happened. In both cases, there is at least an issue of fact as to whether he committed actual fraud.
Finally, the jury could find that Pollock believed that having a Horton-Portland employee attend meetings concerning making Pollock's property available for development was at least in part for the benefit of Horton-Portland. Pollock expected that Horton-Portland would ultimately purchase and develop the property. He believed that he would be unable to sell it to anyone else or develop it on his own without breach of the noncompetition provisions of the APA. Attending meetings concerning property that Horton-Portland was interested in purchasing was not inconsistent with the employee's duties. Thus, there is a genuine issue of whether Pollock committed fraud as the employment agreement uses the term.
Finally, in their fifth assignment of error plaintiffs assign error to the trial court's grant of summary judgment on defendants' counterclaims for breach of fiduciary duty. Pollock has reimbursed Horton-Portland for the rental equipment used at his own homes and for the cost of remodeling the lower floor of the office building. The remaining issues concern the improvements to the Horton-Portland offices and having the employee attend land use hearings. Assuming that these actions involve self-dealing that Pollock did not adequately disclose, he did not breach his fiduciary duties if they were entirely fair to the corporation. See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 366 n. 34 (Del. 1993); Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del.1988);
Reversed and remanded.