PATRICIA A. SULLIVAN, Magistrate Judge.
Defendant/Counterclaim Plaintiff James R. Larkin is the 50% owner of two Rhode Island entities, a close corporation, Custom Built, Inc. ("CBI"), and a limited liability company, Custom Built Windows Manufacturing, LLC ("CBWM") (collectively, the "Companies"). In 2018 and 2019, he was fired from and frozen out of first CBWM and then CBI (a business he was principally responsible for building) by the owners of the other 50%, John Gardner, IV ("Johnny"), David Gardner and John E. Gardner, III (John Sr.) (collectively, the "Gardners"). This case was launched when two of the Gardners sued Larkin, claiming that he had breached a contract set out in a document titled "Ownership Agreement" that they allege required him to transfer to CBWM ownership of an entity he owned, BluShield Window Systems, LLC ("BluShield"). Larkin met this complaint with a counterclaim alleging, inter alia, that the Gardners had engaged in illegal, oppressive, and fraudulent conduct in breach of their fiduciary, contractual and statutory duties in managing the Companies' finances, in firing him and in denying him access to the books and records and that both CBI and CBWM were deadlocked.
Since May 6, 2019, Larkin's emergency motion for appointment of temporary receiver pendente lite and associated preliminary injunctive relief has been pending before the Court. ECF No. 18 (the "Emergency Motion"). Over the months following its filing, the Court has been addressing the issues raised in the motion incrementally, including holding an evidentiary hearing, issuing interim orders appointing a Special Master and Interim Receiver pendente lite, and entering an interim preliminary injunction. With the receipt of the Special Master/Receiver's third report, ECF No. 140 ("Report III"), and the parties having been afforded time to object as required by Fed. R. Civ. P. 53(f), I now recommend that the motion for appointment of temporary receiver pendente lite be granted and that the requested preliminary injunction should issue.
On March 21, 2019, Johnny and David Gardner filed their First Amended Complaint (ECF No. 6 ("FAC")) against Larkin and BluShield.
The Special Master's report, his first of three, was timely filed on June 14, 2019. ECF No. 60 ("Report I"). Report I is based on sworn testimony taken by the Special Master from Larkin, Johnny and John Sr. Gardner and two of the Companies' independent financial advisors, as well as on various documents that are authenticated and explained by the testimony.
Mindful of the financial fragility of the Companies and of the dysfunction that the evidence establishes had tainted the parties' relationships, the October 31 Order assigned the Special Master/Receiver additional tasks related to the Emergency Motion's prayer for injunctive relief. These included the duty to investigate further and to make recommendations and advise the Court regarding the impact of reinstating Larkin as an employee of the Companies with a salary and health benefits in connection with his status as an employee, shareholder, manager or member of either or both of the Companies; a well-qualified Financial Consultant was appointed to assist and advise.
The landscape shifted on November 20, 2019, when the Special Master/Receiver filed his second report, ECF No. 117 ("Report II"), and petitioned the Court for interim instructions. After the parties filed responses, ECF Nos. 119, 120, the Court held an expedited hearing on November 25, 2019. Report II brought disturbing new factual information to the attention of the Court: after firing and freezing out Larkin, the Gardners had embarked on a major restructuring of CBI without informing, consulting or conferring with Larkin, despite his status as the owner of 50% of CBI's shares and despite the reality that CBI's business had been built largely by Larkin's efforts.
The Special Master/Receiver's third report (Report III) was timely filed on December 27, 2019. As contemplated by the October 31 Order, which permits ex parte communications with any party, Report III is grounded in the Special Master/Receiver's communications with the parties and their counsel and the observations he made while attending the parties' weekly business meetings. Report III at 3. In addition, it relies on a report from the Special Master/Receiver's well-qualified Financial Consultant, which sets out summary information reflecting the Companies' financial performance prepared by the Gardner side and financial forecasts provided at the Special Master/Receiver's request by the Gardners and Larkin.
Report III's core recommendations are that the Court should remove the Gardners from de facto control, reinstate Larkin, reset all owner salaries at a uniform rate loosely based on their original agreement as reflected in their dealings prior to November 2018 and expand the scope of the receivership by authorizing the take-over of the management of the Companies through a pendente lite appointment of an independent chief executive officer ("CEO") assigned to run them. Report III ¶¶ 34-62. Foundational to Report III's recommendations is the Special Master/Receiver's conclusion that the ongoing "tremendous dysfunction" between the Gardners and Larkin is such that "it is not in the best interest of the Companies for the high-level decision-making of the Companies to remain in the hands of the Owners."
In response to Report III, Larkin and the Gardners generally object to the Court treating its conclusions as "proposed findings" pursuant to Fed. R. Civ. P. 53(a) because Report III does not rely on newly procured evidence. ECF Nos. 150, 154. Both appropriately ask the Court to be mindful of the degree to which, by contrast with Report I, Report III is based on the Special Master/Receiver's observations and experience, as well as on the Financial Consultant's presentation of financial information and forecasts prepared by the Gardners and by Larkin. ECF Nos. 150 at 7-13; ECF No. 154 at 2-4. They argue, and I agree, that the findings that support my recommendations must be based on the evidence.
As to the substance of the Report III recommendations, the parties are largely in synch with much of what the Special Master/Receiver proposes. The Gardners' objection reemphasizes their intent to challenge again the Court's finding
1. From 1961 until 2017, the Gardner family was engaged in the business of manufacturing and selling custom-built windows and related products to building contractors and homeowners through an entity known as Custom Built Windows and Doors Systems, Inc. ("Oldco"). FAC ¶ 8. Over the decades following its founding by John Gardner, Jr., Oldco provided employment to many Rhode Islanders, some for more than thirty-five years. Ex. 50.
2. By the mid-2000s, Oldco was struggling financially, suffering from two serious problems.
3. In 2016, to expand Oldco's focus on retail marketing and sales, as well as to facilitate a better understanding of profitability, Oldco spun its retail business into a newly formed company, CBI. ECF No. 60-2 at 26-28. CBI was incorporated as a close corporation on October 31, 2016, and began operating on January 1, 2017. Report I at 14; ECF No. 60-2 at 33. However, the Gardners struggled to get CBI off the ground; during the early months of 2017, CBI had almost no employees, no assets, and was doing very little business. Tr. 6/21/19 at 10-11; ECF No. 60-2 at 138-39. It needed a leader with strong experience in retail window sales.
4. Larkin is a Connecticut resident who has worked for thirty-three years in the window business, particularly in retail sales and window installation, for many of those years as a self-employed entrepreneur. Tr. 6/21/19 at 4-9; ECF No. 60-2 at 122-129. Based on this experience, Larkin has built up an extensive network of industry contacts and friends in the New England region. Tr. 6/21/19 at 33, 149. Larkin's reputation in the window industry is critical to his success and ongoing ability to work.
5. Larkin is the designer of a proprietary specialty window product known as the "BluShield Window," which is owned by BluShield.
6. Larkin is an individual with a wife, children and elderly parents, all of whom are dependent on his income for their support. Tr. 6/21/19 at 15-16, 61 ("I needed to be assured that money was going to be coming in."). His family is also dependent on him for health insurance.
7. In February 2017, the Gardners and Larkin were introduced to each other and, in March 2017, began a series of meetings "to explore the opportunity of a partnership" that would bring Larkin into the Gardner orbit to build up CBI and to construct an infrastructure to drive its retail sales, largely of products manufactured by Oldco or its successor, at the same time that the Gardners would continue to oversee administrative matters, including the financial books and records.
8. The parties also discussed the possibility of a "partnership" with BluShield, allowing the BluShield Window to be manufactured by a Gardner family entity pursuant to a "Lic. Agreement," following which Larkin would "negotiate % ownership in [Oldco] for BSW asset." Ex. 49C at 4; ECF No. 60-2 at 28, 149-50. As described by Johnny Gardner, "Mr. Larkin brought in a window design that he was trying to find a manufacturer to partner with to build it. We had a mutual attraction to that. We liked the overall idea behind it and thought it would be a great way to basically direct the next 20 years of the business." Report I at 16.
9. These early discussions reveal that the parties had and would continue to have starkly contrasting business approaches. As described by Johnny Gardner, "[s]o we had taken a very farming approach. . . . [s]o it is very much like you plant seeds and at some point in the future you hope to harvest that becomes business[, while] Mr. Larkin's approach was very much a hunter." Tr. 7/1/19 at 67;
10. By the end of March 2017, Larkin agreed to work for CBI for a "prove-it" period, during which he would be paid a modest salary with the oral understanding that he would become an owner of CBI if he was able to bring in $1 million in sales. FAC ¶ 13; ECF No. 41 ¶ 13; Tr. 6/21/19 at 8-10. Larkin threw himself into the effort of building CBI, and by May 2017, he had hit the mark. Tr. 6/21/19 at 10. On May 24, 2017, he was issued 33.5% of CBI's stock; his CBI salary was substantially increased to $2000 per week and he began to receive a significant salary from Oldco; he also began to receive health benefits. Report I at 40; ECF No. 60-2 at 39-40. Johnny Gardner believed that Larkin was "getting off the ground and starting to grow that presence, revenue, customer base, [and] profitability." ECF No. 60-2 at 45. During this period, Larkin opened new offices for CBI. Tr. 7/1/19 at 80. By the end of 2017, under Larkin's leadership, CBI's top-line revenues exploded from de minimis to $2 million. Ex. 52.
11. In late May 2017, Larkin and the Gardners continued discussions of options for their business alliance. Tr. 6/21/19 at 13-15. These options contemplated that Larkin would become an owner of 50% or more of CBI, and potentially an owner of a percentage of Oldco, based on which Larkin would be paid a specified salary (ranging between $100,000 and $150,000 per entity) and would serve in a key leadership position focused on business development, while Johnny Gardner would handle administration. Ex. 1. Some of the options discussed involved the transfer or sale of a minority share in BluShield to Oldco.
12. In testimony that I find credible, Larkin was consistently clear to the Gardners from the earliest phase of the parties' discussions of a possible relationship that brought Larkin in as an owner of the Companies that employment and a salary in the range being discussed ($100,000 or more paid by each entity) was critical to him and his family. Tr. 6/21/19 at 15-16 ("I needed to have a salary. I needed to make money every week."). In response, the Gardners did not advise Larkin that they rejected or disagreed with this concept. They never advised him (until they fired him) that his employment would be at-will or that he could be fired on a whim by the Gardner family.
13. The negotiations continued through the summer of 2017. Johnny Gardner and Larkin agreed to the principle of equal ownership (50% Larkin and 50% Gardners) in whatever the business would be. Tr. 6/21/19 at 17. They agreed that, for CBI, "Mr. Larkin and [Johnny] would be on the same level." Tr. 7/1/19 at 112. And Larkin came to understand that "estate planning" was one of the goals of the Gardners in that "the senior Gardners would be retiring and younger Gardners would be taking over." Tr. 6/21/19 at 16-17.
14. In August 2017, the discussions crystalized into an outline written by Larkin titled "Ownership Agreement." Ex. 2; Tr. 6/21/19 at 18-22. Larkin prepared this document to reflect "the evolution of discussions that we were having," capturing what he, Johnny and David Gardner had agreed to as of that point. Tr. 6/21/19 at 18-19. The "Ownership Agreement" is signed by Larkin, but only by the "younger Gardners," Johnny and David Gardner. Ex. 2;
15. According to the "Ownership Agreement," Oldco would be replaced by the new entity holding the assets of Oldco and BluShield, while CBI would continue as the retail sales entity. Ex. 2. Larkin's ownership share of CBI would increase from 33.5% to 50%, with the other 50% allocated among John Sr., Johnny and David Gardner. Ex. 2. Larkin would also own 50% of the Oldco successor entity, with Gardners owning the other half.
16. While he signed it, Johnny Gardner understood that the "Ownership Agreement" was not the final legal draft, nor was it the complete expression of the parties' agreement. Tr. 6/21/19 at 159, 161. Regarding the essence of the arrangement it describes, Johnny testified: "I would not have gone that route." ECF No. 60-2 at 83. Nor did Johnny ever have any discussion "in any length" with Larkin regarding the structure that he "would have pushed for."
17. The "Ownership Agreement" not only sets specific ownership percentages, but also links specific salaries to them. According to the "Ownership Agreement," Larkin would be paid $125,000 by CBI and the new entity (a total of $250,000), while Johnny Gardner would be paid $100,000 by CBI and David Gardner would be paid $100,000 by the new entity. Ex. 2. The "Ownership Agreement" does not address the salary of the fourth owner, John Sr.
18. After the "Ownership Agreement" was signed, Larkin and the Gardners continued talking, but the focus shifted to succession: which Gardners would retire and how the interests of two of the older Gardners (Scott and Greg) would be bought out. ECF No. 60-2 at 149-52. The parties came to conceive of a transaction that abandoned the "Ownership Agreement's" foundational concept — a merger of two entities of roughly equal value — but rather was an acquisition by a to-be-created manufacturing company (CBWM) of Oldco's assets for $1.8 million, to be paid through two notes. Tr. 6/21/19 at 22-23; ECF No. 60-2 at 49-52. A transfer of ownership of BluShield was no longer part of the transaction. ECF No. 60-2 at 150-52.
19. In September 2017, the Gardners engaged their attorney of "many, many years," Andrew Davis, Esq., to prepare final documents reflecting the parties' agreement, to be executed at a closing held on October 31, 2017 ("October 2017 closing"). Ex. 54 at 11-12, 16, 18, 31. Attorney Davis had one meeting with Gardner family members and Larkin on September 17, 2017.
20. Johnny Gardner never told Attorney Davis that BluShield was part of the arrangement to be reflected in the final documents.
21. In the weeks preceding the October 2017 closing, Larkin understood that the transaction had become a buy-out of the assets of Oldco by a newly formed entity — CBWM — in consideration for the purchase price of $1.8 million. Tr. 6/21/19 at 17, 23. He also understood that he would own 50% and be paid a salary but would not be an employee-at-will.
22. After Attorney Davis was advised that the purchase price was $1.8 million, he prepared drafts that included $1.8 million as the purchase price. Ex. 30 ¶ 3.1; Ex. 31 ¶ 3.1. However, as the closing approached, he became concerned about the tax implications of two of Oldco's owners being paid by secured notes totaling $1.8 million, while John Sr. Gardner got no compensation. Ex. 54 at 24. In testimony that I do not find credible, Attorney Davis claims he and the accountants devised a solution — to increase the purchase price by having the new entity sign a Third Note, raising the purchase price from $1.8 million to $2.7 million to avoid the appearance "that John Sr. was going to make a gift to Jim Larkin."
23. Attorney Davis, Larkin, Johnny, John Sr., David, Scott and Greg Gardner all attended the October 2017 closing. Ex. 54 at 13. Larkin understood that Attorney Davis was representing all of the individuals present, including himself. Tr. 6/21/19 at 27. In one of the documents executed at the closing (the Agreement of Purchase and Sale of Assets, Ex. 5), all present initialed an advisement that: "(1) the parties have been advised by Mr. Davis that a conflict exists among their individual interests; and (2) the parties have been advised by Mr. Davis to seek the advice of independent counsel; and (3) the parties have had the opportunity to seek the advice of independent counsel." Ex. 5 ¶ 13.11.
24. At the closing, Larkin was "[v]ery much" surprised to be asked to sign three notes of $900,000 each, owed by CBWM to Oldco, totaling $2.7 million, far more than the discussed purchase price of $1.8 million. Tr. 6/21/19 at 24-25; ECF No. 60-2 at 154 ("[I]t was supposed to be $1.8 million . . . At the last minute, it became a third note of $900,000 to John Senior, which was an issue for me because I didn't know about it until we were signing paperwork."). Attorney Davis confirmed that Larkin "wanted to understand the reason for the third note again. So we went through it again." Ex. 54 at 23.
25. At the closing, one of the Gardners promised Larkin that the Third Note was never going to have to be paid.
26. According to its terms, the Third Note required monthly payments of $4545.24 beginning on December 1, 2017, until paid in full. Ex. 8C. If not paid, at the option of Oldco or the assignees to whom the Third Note might be transferred, "all principal and interest . . . shall become immediately due and payable."
27. John Sr. Gardner testified that the Third Note has been assigned to him and to his two sons, Johnny and David Gardner, and that he had an understanding among himself and his two sons (but not with Larkin or CBWM) that the Third Note was not going to be enforced. Tr. 7/1/19 at 40. John Sr. also testified that, as of July 2019, none of the payments required by the Third Note have been made, so it is in default, but it has not been enforced.
28. Inconsistent with an agreement that the Third Note is not enforceable, John Sr. Gardner averred that his "personal tax returns for the calendar year 2017 were consistent with the third note, Note C, being valid and enforceable," as well as that the tax return "was not consistent with an unwritten agreement between my sons, David and John Gardner, IV, not to enforce the third note." ECF No. 95 at 2-3. Contrary to his testimony, his attorney's objection asserts that John Sr. Gardner does not admit "that there [was] a binding enforceable agreement amongst the Gardners (John, III, David and John, IV) not to enforce" the Third Note.
29. Inconsistent with the promise made to Larkin, who acted on behalf of CBWM when he signed the Third Note, CBWM, whose books are controlled by the Gardners, carries the obligation of the Third Note as part of its long-term debt. ECF No. 60-12 at 2.
30. At the October 2017 closing, the parties executed an Amended Stockholders' Agreement for CBI confirming that it was owned as follows:
Ex. 3 at 21. The Gardners agreed to issue to Larkin 50% of the shares of CBI to make him an equal owner to continue to drive retail sales principally of products manufactured by CBWM.
31. As a close corporation, the CBI Bylaws (Ex. 14) dispense with a board of directors, vesting the president with the powers normally vested in a board and assigning him the duty to have general and active executive management of CBI's operations. Ex. 14 Art. III, Art. IV § 5. The Bylaws provide for the election by the shareholders of a president, secretary and treasurer, who may be the same person.
32. Regarding meetings, the CBI Bylaws require that "[t]he annual meeting of the shareholders shall be held in each year, for the purpose of electing officers" and that special meetings of shareholders must be called if requested by the holders of 10% or more of the outstanding shares. Ex. 14 Art. II § 1-2. A majority of the outstanding shares is a quorum.
33. Section 3 of Article IV of the CBI Bylaws addresses the removal of officers and "agents," which may be done only by "the shareholders whenever in their judgment the best interests of the Corporation would be served thereby."
34. At the October 2017 closing, Larkin and the Gardners also signed CBI's Amended Stockholders' Agreement. Ex. 3. It reflects the shareholders' belief "that they will be able to deal easily and comfortably with each other and that it is in their best interests and in Custom Built's best interests that all corporate activities be controlled by persons who deal comfortably with each other." Ex. 3 at 1 ¶ D.
35. CBI's Amended Stockholders' Agreement expressly supersedes any prior agreements "with respect to [its] subject matter."
36. CBI's Amended Stockholders' Agreement calls for the application of Rhode Island law.
37. None of CBI's formative documents (Articles of Incorporation, Bylaws, and Amended Stockholders' Agreement) contain any provision providing for dissolution by a shareholder at will or upon the occurrence of a specified contingency as permitted for a close corporation by R.I. Gen. Laws § 7-1.2-1701(a).
38. Created pursuant to R.I. Gen. Laws § 7-16-5 on September 13, 2017, CBWM is a Rhode Island limited liability company. Ex. 4A (Operating Agreement); Ex. 15. At the October 2017, closing, Oldco transferred all of its assets to CBWM in consideration for three notes (including the Third Note) for a total of $2.7 million, securitized by three mortgages/security agreements. Exs. 8A-C, 9A-C. As a limited liability company, CBWM is owned by its members with its profits and losses to be allocated as follows:
Ex. 4A, Schedule B, Art. V § 5.04;
39. CBWM's Operating Agreement vests the power to carry on the business and affairs of CBWM in its managers. Ex. 4A Art II § 2.01. The Operating Agreement names all four of the members (Larkin, Johnny, David and John Sr. Gardner) as the "Initial Managers" and provides that, if any of the Initial Managers are unable to serve, a "successor Manager" must be elected for a one-year term by the members.
40. According to the Operating Agreement, the managers of CBWM are obliged to "keep just and true books of account . . . [to which] all members . . . shall at all reasonable times have access," and that managers must prepare annual financial reports which must be furnished to each member. Ex. 4A Art. IV §§ 4.01, 4.03.
41. The Operating Agreement provides that CBWM's managers act by majority vote with each manager entitled to one vote.
42. The CBWM Operating Agreement expressly permits its managers to own other business ventures.
43. Regarding meetings, CBWM's members must hold an annual meeting during September each year.
44. CBWM's Operating Agreement recites that it "constitutes the full and complete agreement of the parties hereto with respect to the subject matter hereof."
45. CBWM's Operating Agreement calls for the application of Rhode Island law.
46. After the October 2017 closing, into the fall of 2018, Larkin continued working successfully on a full-time basis to amplify the retail business of CBI, including the hiring of key new employees, the opening of new offices and the acquisition of a window company in New York. Tr. 7/2/19 at 32-33, 83-85. Although CBI was formed before Larkin became an owner, the significance of his efforts in building its business makes him a virtual founder.
47. Because a substantial percentage of the products sold at retail by CBI were manufactured by CBWM, CBWM benefited from the CBI retail sales growth created by Larkin. ECF No. 60-2 at 22 ("overwhelming majority" of CBI products sold are manufactured by CBWM); Report I at 42 (approximately 20-23% of CBWM's sales are to CBI). Due to Larkin's efforts, the leveraging of his sales skills, his ability to forge a new sales strategy and his industry contacts, the consolidated total revenues of CBI and CBWM grew to approximately $10.4 million by the end of 2018, more than doubling what Oldco's sales had been in 2015. ECF No. 60-10.
48. After the October 2017 closing through the fall of 2018, Larkin was working with Scott Gardner, on behalf of CBWM, to develop the manufacturing capability to bring the BluShield Window from prototype to production and to market, which Scott Gardner estimated "was going to take a while," potentially "a year" or longer. Tr. 7/1/19 at 72-73. The ability to manufacture pursuant to the BluShield design was a preliminary task that had to be completed before CBWM could produce it for sale or develop a dealer network to purchase it.
49. Also after the October 2017 closing through the fall of 2018, with no meeting of the minds and no agreement regarding the terms on which CBWM would be legally able to manufacture and sell the BluShield Window, Larkin continued to own BluShield separately from his ownership of CBWM as permitted by the CBWM Operating Agreement (Ex. 4A Art III § 3.03). During this period, the Gardners made no effort to continue the negotiations regarding a BluShield license agreement or membership transfer that would legally entitle CBWM to proceed with manufacturing or selling the BluShield Window. In testimony that I do not find credible, Johnny Gardner explained that this delay was based on his belief that Larkin had promised that 50% "of BluShield [] would be, in some final form, transferred to us, meaning the Gardners." ECF No. 60-2 at 64. More credible is Johnny Gardner testimony that the Gardners dropped the ball: "We got busy. At a certain point, we trusted Jim would complete the deal. We let it sit and there was not really a rush to get the deal done."
50. As 2018 proceeded and CBI's top-line grew, its costs and expenses spiraled up and it was unable to transfer cash to CBWM to net out intercompany transfers.
51. In late September and October 2018, the three Gardners met and discussed what to do about CBWM's cash flow problem. Tr. 7/1/19 at 11-12. Larkin was totally excluded from these discussions and the meetings at which they occurred. Tr. 6/21/19 at 38-39; Tr. 7/1/19 at 11-12. While consideration was given to cutting the salaries of all owners, instead of cutting their own salaries, the three Gardners decided to address the problem by reducing CBWM's costs by firing Larkin from CBWM and cutting off his CBWM salary. Tr. 7/1/19 at 11-12. There was no discussion of the impact of this decision on CBWM's inchoate relationship with BluShield; nor was there any discussion of CBWM's and CBI's underlying issues with inadequate financial controls (such as the possibility of bringing in a non-Gardner financial officer). I do not find credible Johnny Gardner's testimony that the reason for this decision was "Job performance. Failure to perform his duties."
52. I further find that at least part of the real reason for the Gardners' abrupt decision to fire Larkin from CBWM lies in the cultural clash between the Gardners' business approach as "farm[ers]," and Larkin's assertiveness as a "hunter."
53. The decision was implemented in November 2018.
54. Johnny Gardner testified that this was the first time that he realized that the October 2017 closing documents had not addressed BluShield: "We found out, it took us a year to find out, that the balance of that transaction of the BluShield part was never completed." ECF No. 60-2 at 60-62. I do not credit this testimony to the extent that it is based on an assumption that the parties had reached agreement, or that Johnny Gardner believed that the parties had reached an agreement, regarding the transfer of an interest in BluShield to the Gardners or to CBWM.
55. Finally, in December 2018, for the first time since discussions broke off in August 2017, the parties began to negotiate in earnest about the BluShield Window. These discussions also focused on the Gardners' concerns over CBWM's cash flow problems caused by CBI's failure to pay its intercompany "debt" to CBWM. Tr. 6/21/19 at 41-46; Ex. 38. During January and February 2019, these discussions continued; Larkin and the Gardners met and exchanged many emails, some biting in tone, regarding the terms on which Larkin would agree to proceed with the manufacturing of the BluShield Window by CBWM. During these negotiations, the Gardners proposed giving Larkin control of CBI by issuing additional shares, while he would convey a minority ownership interest in BluShield to the Gardners; Larkin countered with the proposal that he would give up his ownership in CBWM in exchange for 100% ownership of CBI, with a contractual buy-sell relationship (including a BluShield license) with CBWM.
56. In February 2019, Larkin met with his senior team at CBI to advise them of arrangements then contemplated by these negotiations, including the possibility of a partial or complete separation of CBI from CBWM and the Gardners. Tr. 6/21/19 at 46-47, 126-27. One of these employees recalled that Larkin's distrust of the Gardners had soured to the point where this meeting was held at a mall in case the office had been bugged. Tr. 7/2/19 Vol. II at 57, 79. Based on these discussions and the toxicity of the relationship between Larkin and the Gardners, I find that these employees felt caught in the middle and that CBI's business was being adversely affected. Tr. 7/2/19 Vol. II at 55, 74, 91-92;
57. During the same period (February 2019), without any meeting of CBI's shareholders as required by § 3 in Article IV of CBI's Bylaws (¶ 33 supra), Johnny Gardner decided to fire Larkin from CBI and cut him completely out of both Companies; he began to consult with legal counsel about this decision. Tr. 7/1/19 at 16-17. Contradicting his own testimony that he knew that he and Larkin were "on the same level" at CBI,
58. Johnny Gardner's decision to fire Larkin from CBI was not implemented for another month.
59. On April 12, 2019, Larkin made a written demand for access to the books and records of CBI and CBWM in conformity with applicable law and the relevant corporate documents. Exs. 13A, 13B. Both demands were addressed to Johnny Gardner. Exs. 13A, 13B. In contravention of Rhode Island law, both demands were refused. Ex. 44;
60. Also on April 12, 2019, Larkin demanded a meeting of shareholders of CBI and a meeting of members of CBWM. Exs. 12A, 12B. Yet no meeting was held. From the October 2017 closing until meetings were held on May 30, 2019, presided over by the Special Master pursuant to the directive of the Court, and despite the requirement that CBWM's members must hold an annual meeting during September each year, Ex. 4A Art. II § 2.04, and that CBI's shareholders must hold an annual meeting at least once per year, Ex. 14 Art. II § 1-2, neither of the Companies held the required meetings. The meetings presided over by the Special Master resulted in deadlock. Exs. 18, 19.
61. In testimony that I find substantially credible, Johnny Gardner explained the reason for his actions:
ECF No. 60-2 at 110. That is, loyalty to family was paramount.
62. I further find that Johnny Gardner's actions were motivated in part by problems that were actually the fault of the Gardners, including himself, particularly by the Gardners' anger at Larkin arising from the failure of their belated negotiations to obtain a binding right to BluShield and their alarm about the lack of financial controls (which were the responsibility of the Gardners) leading to business losses caused by CBI's growth.
63. Larkin filed his counterclaim in May 2019. On June 11, 2019, claiming that the counterclaim amounted to a petition that triggered the shareholder right to buy-out the petitioning shareholder, the Gardners filed notices pursuant R.I. Gen. Laws § 7-1.2-1315 claiming the right immediately to terminate and buy-out Larkin's ownership interest in both Companies.
64. After Larkin was terminated and frozen out by CBWM and CBI and after this case was pending, the Gardners embarked on a major restructuring of CBI during which approximately twenty employees were terminated. Despite his ongoing status as the 50% owner of CBI, and despite Larkin having hired many of these employees in reliance on his industry contacts as part of his commitment to build up CBI's business, Larkin was not consulted, conferred with or even informed that the Gardners were taking these actions. Report II at 3;
65. In an attempt to ameliorate the Gardners' ongoing treatment of Larkin as if he is not an owner of 50% of the Companies as evidenced by the undisclosed restructuring, which I previously found evinces a disturbing tone-deafness to their fiduciary obligations to their equal co-owner,
66. Following Larkin's firing by CBI, Larkin and his family had no health insurance until it was restored by the Court's Order in
67. The "Ownership Agreement" was a preliminary outline of concepts that reflected: (1) Larkin's intent to negotiate with the Gardners to bring the BluShield Window to the new entity that became CBWM, which would develop the capability to manufacture, and then would manufacture and sell it to a dealer network to be developed; (2) Larkin's negotiating posture that the assets of Oldco and BluShield were of equivalent value that should be merged into a new entity owned 50/50 by Larkin and the Gardners respectively; (3) the intent and understanding of Larkin, Johnny and David Gardner that the owners of CBI and CBWM would be employed by the Companies and that their sharing of profits would be accomplished through the payment of weekly salaries and the provision of health insurance.
68. There was no meeting of the minds regarding the second concept (how to value and structure an arrangement between BluShield and CBWM whereby CBWM would have the right to manufacture and sell the BluShield Window).
69. Nevertheless, the "Ownership Agreement" is important evidence reflecting the parties' intent to negotiate an arrangement (perhaps a license agreement or a transfer of a membership interest) whereby the BluShield Window would be manufactured and sold by CBWM, as well as the parties' intent and understanding that Larkin's 50% ownership of CBI and the new entity (CBWM) would entitle him to employment and the payment of a salary by both entities of approximately $2000 per week.
70. I find credible Larkin's testimony regarding salaries that "[w]e looked at it as a way of splitting up what would be profits . . . If they thought we were going to make X amount of money, instead of it being profit at the end, everybody's salary went up to take that into account." ECF No. 60-2 at 169. As Larkin explained, "[t]he salaries were not really intended to reflect what the responsibilities would be, but rather a means to share in the success of the company."
71. Larkin had a reasonable belief, supported by a commonly held understanding with the other owners, that he would have ongoing employment with both of the Companies (despite his performing active work principally for CBI), and that the payment of his salary and health benefits was the "way of splitting up . . . profits," that is, the method by which owners of the Companies would share the profits of the Companies.
72. Consistent with this understanding and agreement, during the period before Larkin was fired by each of the Companies, Larkin was paid a salary and provided health insurance by CBI and paid a salary by CBWM, earning a total of approximately $4000 per week.
73. Larkin's signature on the Third Note was fraudulently procured in that the Gardners deceived him (and CBWM on whose behalf he was acting) because they did not in fact agree with CBWM and Larkin that the Third Note could not and would not be enforced. I further find that the Third Note has been and remains in default. Therefore, the existence of the Third Note creates an imminent risk that, at any time, the Gardners may call the Third Note, and if CBWM lacks the cash immediately to pay $900,000 plus interest, they may assert the security interest to take back all of the assets transferred to CBWM by Oldco, leaving CBWM in liquidation and Larkin owning 50% of an entity worth nothing. I find that this would amount to irreparable harm to Larkin and to CBWM. I do not accept or credit that Gardners' argument that CBWM benefits from the non-performance of the Third Note because its equity is increased; this argument is not supported by any evidence. The Gardners' conduct in fraudulently procuring the Third Note is a profound breach of their fiduciary duty to CBWM and to Larkin. In addition to the other harms caused by this conduct, it tainted the Gardner/Larkin working relationship right out of the gate by justifiably undermining Larkin's trust in his new business partners.
74. Larkin's abrupt firing by CBWM in November 2018, carried out by the Gardners, was — in form (made without calling a meeting of the managers or members) and substance (carried out to advance the interest of the Gardners, with little regard to the legitimate business concerns of CBWM and with no examination of whether the supposed justification could be addressed in another way) — a blatant breach of the parties' understanding regarding employment and salaries and in derogation of the fiduciary duty that the Gardners owed to Larkin as a fellow member/manager of CBWM.
75. Larkin's firing by CBWM, carried out by the Gardners, was a breach of the duty that the Gardners assumed in signing the CBWM Operating Agreement (Ex. 4A Art. III § 3.03) to act in the mutual interests of the members.
76. The Gardners, as controlling managers of CBWM, have engaged in a pattern of wrongful conduct, including refusing to hold mandated meetings and to allow Larkin access to the books and records, which has had the cumulative effect of freezing out Larkin, who is a 50% owner of CBWM, and of wrongfully depriving Larkin of any voice in the operations of CBWM, notwithstanding his status as a member and manager.
77. Larkin's firing by CBI in March 2019 was carried out by Johnny Gardner in his capacity as president of CBI. This decision to freeze out the 50% owner of CBI, who had actively worked to build it from virtually no revenues to an entity with top-line revenues of almost $7 million, was made by Johnny Gardner (without consulting the shareholders of CBI) for a pretextual reason that was actually and improperly based on the failure of the belated BluShield negotiations and on what Johnny Gardner believed would be in the interest of the Gardner family; it not based on his business judgment regarding the best interest of CBI. This action was a breach of the parties' understanding regarding employment and salaries and in derogation of the fiduciary duty that Johnny Gardner, as CBI's president and shareholder, and the other Gardners, as CBI's other shareholders, owed to Larkin, as a CBI 50% shareholder.
78. On the same day that Johnny Gardner wrongfully terminated Larkin's employment at CBI, he also locked Larkin out of the premises and barred him from access to "corporate information without permission to do so given by me or my authorized representative." Ex. 11 at 1. Even limited access to books and records was wrongfully withheld until the Court entered its initial Special Master appointment order and gave the Special Master the task of addressing this issue.
79. Larkin was wrongfully terminated from his employment with the Companies in that he had a reasonable expectation of continued employment as a 50% owner, that the Gardners breached their fiduciary duty to him when they terminated his employment and, to the extent that the business justification of the Companies' cash flow issues purportedly supported the Gardners' decision to terminate him, the firing was not the least harmful alternative.
80. With no salary and benefits and no meetings, Larkin has no way to participate in receiving distributions from the Companies despite his status as an owner of 50% of each.
81. Based on the foregoing findings, I accept and adopt the Special Master/Receiver's finding that the dysfunction at the owner level of CBI and CBWM is so crippling that it is not in the best interest of the Companies for high-level decision-making to remain in the hands of the Gardners or Larkin while litigation proceeds in this Court. Report III ¶ 9.
82. Based on the foregoing findings, I accept and adopt the Special Master/Receiver's overarching finding that the Gardners and Larkin have demonstrable skills that could benefit CBI and CBWM if managed by a neutral chief executive officer empowered to balance the Gardner focus on manufacturing against the Larkin focus on aggressive marketing and to upgrade the Companies' financial controls, including the management of intercompany accounts.
83. I find that CBI has experienced and will continue to experience harm as a result of the loss of the retail sales vision of its founder/leader Larkin, and that, in light of their history with Oldco, it is doubtful that the Gardners will be able effectively to manage the financial and administrative functions of CBI and CBWM.
84. Based on the evidence and mindful of the parties' submissions to the Special Master/Receiver forecasting their respective visions for CBI and (as to the Gardners) for CBWM and of the Financial Consultant's summary of the most up-to-date financial results (as prepared by the Gardners) through October 31, 2019, I find that it is likely that, with a neutral chief executive officer to allocate responsibilities and manage dysfunction, CBI and CBWM are sustainable entities that can and should continue as going concerns with adequate controls and sufficient revenue to make them viable.
85. The Companies will not be harmed by the payment of salaries in accordance with the parties' agreement and consistent with the status quo ante, prior to the Gardners' wrongful actions in freezing Larkin out of the Companies, which I find to be $2000 per week paid by one of the two Companies to each of the Gardner owners and $2000 per week by each of the Companies to Larkin.
86. The Companies will not be harmed by continuing to provide Larkin with health insurance benefits for himself and his family for the duration of this litigation consistent with the health insurance provided by the Companies to all of the other owners.
87. Larkin has been and continues to be at serious risk of irreparable harm because of his inability to procure health insurance at affordable rates for himself and his family since his salary was cut off by the actions of the Gardners.
88. Larkin is irreparably harmed by being cut off from participating in the formulation of the business strategy for CBI, the entity that he built by tapping into his network of people (friends and business associates) in the industry. Tr. 6/21/19 at 62. Larkin is further irreparably harmed by the limitations on his ability to compete in the regional window industry as a result of his ongoing fiduciary obligations to CBI and CBWM.
89. As a person who relies on his salary to support his family, who abandoned other endeavors to work for CBI and CBWM, who marshaled his industry contacts and relationships to the benefit of CBI and CBWM and who has been stigmatized in the industry where he has worked all his life by the wrongful conduct of the Gardners, Larkin has been and continues to be at serious risk of irreparable harm because of the impact on himself and his family of the loss of income, health insurance and employment.
90. To the extent that the public interest is implicated by this case's impact on the ongoing viability of two Rhode Island business entities employing not just the Gardner family members, but also a cadre of long-time employees (Ex. 50), as well as on the ability of Larkin to sustain his family and address their health issues as they arise, I find that it tips in favor of judicial intervention.
A trial court confronted with a motion for preliminary injunction must mull four elements: the probability of the movant's success on the merits, the prospect of irreparable harm absent the injunction, the balance of the relevant equities (focusing upon the hardship to the movant if an injunction does not issue as contrasted with the hardship to the nonmovant if it does), and the effect of the court's action on the public interest.
The purpose of a preliminary injunction is to preserve the status quo until a trial on the merits can be held; it protects the "last uncontested status which preceded the pending controversy."
Preliminary injunction rulings are, by definition, premised on a tentative development of the facts, which will be fleshed out as trial approaches.
Whether jurisdiction is derived from a federal question or from state law in a diversity action like this one, a federal court may exercise its inherent equitable power at the behest of a private party to protect purely private interests by appointing a receiver.
The appointed receiver must be a non-governmental employee, 28 U.S.C. § 958, who acts as an officer of the court and, as such, does not owe allegiance to either party, but rather acts as a fiduciary on behalf of both.
In its seminal decision,
One circumstance in which a receiver may be appointed is when the owners of an entity — whether shareholders of a corporation or members of a limited liability company — are in deadlock. This is not necessarily as an anticipatory adjunct to dissolution, but rather to serve as a temporary custodian or manager of the corporate assets and business when deadlock has paralyzed corporate functioning and threatens serious detriment to the interests of the stockholders and the corporation as a solvent prosperous entity. Theresa Ludwig Kruk, Annotation,
While the federal court's authority to appoint a receiver pendente lite flows from its inherent powers, the federal court may not ignore state law — the internal affairs of a corporation, "including but not limited to the rights, powers, and duties of its board of directors and shareholders and matters relating to its shares," are governed by the laws of the jurisdiction of incorporation.
Section 7-1.2-1323 makes no distinction between solvent and insolvent corporations; it provides that, acting as a court of equity and in the interests of justice, the court "has full power to appoint a receiver, with any powers and duties that the court, from time to time, directs." R.I. Gen. Laws § 7-1.2-1323(1-2). This plenary power to appoint a receiver arises "[u]pon the establishment of any of the grounds for liquidation of the assets and business of . . . [a] domestic corporation," but that "liquidation would not be appropriate."
While the Rhode Island Supreme Court has not directly addressed the appointment of a receiver pendente lite in circumstances analogous to those presented here, several cases from Delaware are instructive.
Decisions from other states are similar. For example, in Pennsylvania, a court found that the commission by the 50% controlling owner of illegal acts — breach of fiduciary duty and breach of contract — towards the other 50% owner was sufficient to result in the appointment of a custodian to resolve the shareholder dispute even though the business was prospering.
Whether the Court is focused on the preliminary injunction or on the motion for appointment of a receiver pendente lite, the "main bearing wall" of the analysis is Larkin's likelihood of success on the Counts in his counterclaim that are pivotal to the determination.
The first three substantive Counts
The Court's legal analysis is anchored by the time-honored default principle that corporate entities are to be democratically governed unless otherwise provided by their foundational documents.
This heightened duty applies to the Gardners as owners of CBI. CBI is a close corporation that has only four shareholders, whose operations (before the Gardners froze Larkin out) required intimate working relationships between the two owners (Larkin and Johnny Gardner) who were actively participating like partners in CBI's management.
The same principles apply to CBWM, as a limited liability company. While the Rhode Island Supreme Court has not addressed the precise issue, in reliance on
These duties provide the standard against which this Court must measure the Gardners' conduct towards Larkin and towards CBI and CBWM.
First, the evidence overwhelmingly establishes that the Gardners have engaged in oppressive conduct in their treatment of Larkin with respect to both CBI and CBWM. In this context, "oppression" is defined as conduct that deviates from the heightened good faith standard that exists in closely held corporations "that substantially defeats the `reasonable expectations'" held by the owners when they became involved with the enterprise.
The denial of employment is particularly pernicious here. The evidence establishes that Larkin abandoned other endeavors and embarked on becoming an investor in CBI (with collateral benefits to CBWM) by dedicating his experience, sales savvy and industry contacts in reliance on the clear understanding that he would work — in effect as a founder — to build CBI's retail sales and would be paid a salary in excess of $100,000 by each entity.
In these circumstances,
The evidence here establishes that the Gardners forced Larkin out of CBWM and then out of CBI because, as with Oldco, the financial controls (for which the Gardners, particularly Johnny Gardner, were responsible) were not keeping pace with the rapid growth created by Larkin; because after the clumsy firing of Larkin by CBWM, the Gardners realized they had failed to negotiate a binding agreement to bring BluShield to CBWM; and because, at bottom, Larkin was an outsider, not a member of the Gardner family, whom the Gardners considered expendable. ¶¶ 51-55, 61-62 supra. The Gardners acted as a cabal in making the decisions to fire their co-owner in that there was no communication to Larkin and no shareholder or member meeting. ¶¶ 51, 57 supra. Moreover, as in
Another extremely troublesome breach of fiduciary duty committed by the Gardners is the fraudulent procurement of Larkin's signature on behalf of CBWM on the Third Note. ¶¶ 21-29, 73 supra. The Gardners procured Larkin's signature in reliance on their promise that the Third Note was not enforceable, yet John Sr. reported the Third Note to the IRS as an enforceable obligation; he testified that the agreement not to enforce it was just between him and his sons and not with CBWM; and the Gardners have since caused the Third Note to be carried on CBWM's books as if it were a real obligation. As a non-performing promissory obligation, the Third Note effectively gave the Gardners a tool that empowered them to claw back CBWM assets leaving CBWM potentially with nothing and Larkin owning half of nothing. And the circumstances of its procurement poisoned the parties' subsequent working relationship. I find that the procurement of the Third Note was fraudulent and a profound breach of the Gardners' fiduciary duty to CBWM and to Larkin.
The last of the serious breaches committed by Gardners is the foundation for Count IV of the Larkin counterclaim — the denial of Larkin, as a 50% owner, of his right of access to the books and records of both CBI and CBWM. ¶¶ 40, 58-59, 76, 78 supra. By law, CBI is obliged to allow any shareholder to inspect and copy its books and records of account, minutes and record of shareholders upon the making of a written demand stating the purpose of the demand. R.I. Gen. Laws § 7-1.2-1502(b). This shareholder right of inspection is grounded in ownership status, based on the right and interest of shareholders to ensure that the corporation is efficiently and profitably managed; proper purposes for the demand include to investigate the conduct of management, to determine the financial condition of the corporation, and generally to seek an accounting of the stewardship of the officers and directors.
To recap, the evidence clearly establishes that the Gardners' unilateral actions in firing and freezing out Larkin from CBI and CBWM and in fraudulently procuring the Third Note amount to paradigmatic oppressive and wrongful conduct in breach of their heightened duty of utmost care, loyalty and good faith. Therefore, Larkin is likely to succeed on the merits of Counts III, IV and V of his counterclaim.
Count VI of Larkin's counterclaim asks for declaratory judgment regarding the enforceability of the "Ownership Agreement," ¶ 14 supra, on which Johnny and David Gardner rely to support their claim to ownership of BluShield. Specifically, Larkin asks the Court to declare that the "Ownership Agreement" does not constitute a binding agreement but rather was an outline of an understanding among Larkin, Johnny and David Gardner that, at least as to BluShield, was abandoned as the negotiations continued. As my findings reveal, the conclusion that the "Ownership Agreement" does not reflect a meeting of the minds regarding the transfer of BluShield to CBWM is not a stretch — Johnny Gardner himself essentially admitted that there was no binding agreement.
Larkin is likely to succeed on the merits of Count VI of his counterclaim.
Count VII of Larkin's counterclaim asks the Court to declare the rights of the parties pursuant to R.I. Gen. Laws § 7-1.2-1315,
Count VII does not raise a hypothetical question — on June 11, 2019, the Gardners filed their § 1315 notices of elections to buy-out Larkin's ownership interests in CBI and CBWM. ECF Nos. 54, 55. They contend that these notices, by operation of § 1315's mandate that "all other rights of the petitioner as owner of the shares terminate," immediately stripped Larkin of his ownership interests in CBI and CBWM, leaving only the question of what he will be paid after all issues have been litigated to conclusion.
As to CBWM, the Gardners' § 1315 election may swiftly be dispensed with — § 1315 does not apply to limited liability companies.
Instead of § 1315, CBWM's remedy for owner deadlock and dissension is grounded in the Court's inherent equitable powers. As
By contrast, CBI is a close corporation to which § 1315 does apply. The Court's analysis of its applicability to this case must begin with examination of Rhode Island's overarching statutory scheme, of which § 1315 is just one part. As relevant here, the Rhode Island General Laws contain four provisions, which create four paths for a close corporation like CBI whose owner deadlock has given rise to one or more of the "grounds for liquidation" listed in R.I. Gen. Laws § 7-1.2-1314. First, if liquidation would not be appropriate, R.I. Gen. Laws § 7-1.2-1323 empowers the court to appoint a receiver, as well as to exercise the tools available pursuant to the "full powers of a court of equity." Second, if dissolution would be beneficial, the court can liquidate the assets and business. R.I. Gen. Laws § 7-1.2-1314. Third, if the entity is a close corporation, its foundational documents may provide for dissolution at the will of one or more shareholders or on the occurrence of a specified event. R.I. Gen. Laws § 7-1.2-1701. And fourth, if a disgruntled shareholder petitions for dissolution and either establishes that dissolution would be beneficial (§ 1314) or that, for a close corporation, there is a provision in the foundational documents of permitting dissolution (§ 1701), but other shareholders wish to avoid dissolution and buy-out the shares of the petitioning shareholder, the court can terminate the petitioning shareholder's rights as a shareholder and preside over the buy-out. R.I. Gen. Laws § 7-1.2-1315.
It is clear that this case should travel the first path: that CBI's issues with deadlock and internal dissension are controlled by R.I. Gen. Laws § 7-1.2-1323,
Examination of § 1315 itself confirms this conclusion. By its terms, the buy-out statute applies when a shareholder files a petition seeking dissolution clearly establishing the desire to terminate his or her status as a shareholder. As the Rhode Island Supreme Court has noted, it is typically used when a majority owner is accused by a minority owner of oppressive conduct.
Consistent with this purpose, the unambiguous language of § 1315 provides that it is triggered by the filing of a "petition for dissolution" by "one or more shareholders." R.I. Gen. Laws § 7-1.2-1315. The statute provides that a qualifying petition must be grounded in one of two specific circumstances: "
As applied by the Rhode Island Supreme Court, every case in which a buy-out has been ordered pursuant to § 1315 or its predecessor
By requiring an unambiguous dissolution petition, the Rhode Island Supreme Court's approach to § 1315 is straightforward and clear. It does not create the risk of a trap for the unwary victim of oppression who wants to remain active in the business,
Against this standard, it is clear that Larkin's CBI-based counterclaim is not a petition for dissolution — it complains of deadlock, oppression, lack of meetings, risk of loss of corporate assets and internal dissension, and mentions the risk of dissolution, ECF No. 41 ¶¶ 5, 41, but expressly states that it is not a petition for dissolution,
To buttress their argument that Larkin's counterclaim triggered an absolute and automatic buy-out right without regard to the equities, the Gardners rely on a Superior Court decision,
The Gardners invoke
In reliance on the plain language of § 1315 and the Rhode Island Supreme Court's many cases interpreting it, I decline to adopt the Gardners' interpretation of
What the Court faces in this case is profoundly different from
In considering harm, a motion for appointment of a receiver pendente lite requires the Court to assess whether the property is in imminent danger; whether the plaintiff's interest in the property might be susceptible to irreparable injury; whether available legal remedies are adequate; whether the harm to the plaintiff caused by the denial of appointment would exceed the harm to the defendant and others opposed to the appointment; and whether the interest of the plaintiff and others sought to be protected will be well served by the receivership.
Based on the facts developed over the course of this proceeding, I find that the evidence demonstrates significant risk that, without a receiver pendente lite and a preliminary injunction, irreparable harm will be inflicted on Larkin, CBI and CBWM, as well as that the recommended receivership will well serve the interests of all parties, including that the adverse impact on the Gardners of the interventions that I am recommending is not substantial. ¶¶ 81-83, 85-89 supra. Therefore, the irreparable harm analysis leans decisively towards both the appointment of a receiver pendente lite and a preliminary injunction. Relatedly, the evidence also demonstrates that the public interest would be served by an injunction.
For himself, Larkin has established that he is suffering irreparable harm that the payment of money damages at the end of this case cannot rectify. As an individual who needs his salary to support his family, Larkin abandoned other business endeavors and dedicated his time, sales skills and industry contacts to building CBI's business; fundamental to his investment was the proposition that he would actively participate in CBI's business as the leader of marketing and sales and that he would earn a salary in the agreed-upon range. Pivotal to Larkin's decision to become an owner of CBI and CBWM was the understanding and agreement with the Gardners that his business skills would complement the Gardners' skills in running a manufacturing facility, thereby addressing the underperformance that plagued the operations of Oldco when run by the Gardner family alone. The Gardners' actions have left Larkin potentially unable to work on corporate opportunities in the regional window industry due to his ongoing fiduciary obligations to CBI and CBWM (¶ 88 supra; Ex. 11), at the same time that his shares in CBI and his membership interest in CBWM are valueless. His business reputation is in tatters and his industry network, rallied to support CBI, is tapped out, yet he has been barred from any role in the business to which he dedicated these resources and is totally cut off from receiving any return.
Both Companies face serious risk of harm unless the Court intervenes. Both have been deprived of Larkin's sales skills. Both have been unable to hire legal counsel. Until the Court appointed the Special Master, May 17 Order; ECF No. 121, neither was able to hold meetings, including the meetings required by their respective organizing documents. Due to the Gardners' ongoing challenge with maintaining adequate financial controls, both face ongoing financial risk. And because of the Larkin/Gardner dissension, the court-ordered meetings (as the Court strived to protect the status quo with a less draconian remedy) failed, making clear that a more aggressive intervention is necessary.
As to CBWM, it has been unable to select new managers, leaving it stuck — potentially in perpetuity — with the "Initial Managers" named in its formative document. Due to the fraudulent procurement and subsequent default of the Third Note, CBWM is potentially at risk that the entire principal ($900,000) could be called, permitting the Gardners to claw back its assets, at the same time that the Third Note is a non-performing obligation carried on CBWM's books, potentially impacting banking relationships.
As to CBI, despite his illegal and oppressive actions, it has been unable to select new officers and is stuck with Johnny Gardner as its president, secretary and treasurer, performing the functions of its board of directors. Due to Johnny Gardner's illegal action in depriving Larkin of access to CBI's books and records in violation of R.I. Gen. Laws § 7-1.2-1502(c), it is exposed to a substantial fine that could adversely impact its operations. And it is indirectly exposed to the risk of the Third Note because of its reliance on CBWM for products sold.
Fundamental to my recommendations is the now established fact (¶ 65 supra) that the less draconian interventions adopted by the Court in
Based on the foregoing, including Larkin's strong likelihood of success on the merits of all of his substantive claims and the irreparable harm to him and the Companies without an injunction, as contrasted to the lesser hardship to the Gardners that an injunction will cause, as well as the public interest, I recommend that the Court grant Larkin's motion for a preliminary injunction mandating that Larkin be reinstated by both CBI and CBWM, at an initial salary of $2000 per week
Based on the same factors (the merits and the balancing of the harms), as well as on the colorable allegation of fraud on the part of the Gardners in procuring the Third Note, which places CBWM's property in imminent danger, on the deadlock of the Companies and on the illegal, oppressive and fraudulent actions of the Gardners, pursuant to
The Receiver pendente lite's initial instructions are set forth below:
1. In his discretion, as needed to perform his duties, the Receiver pendente lite shall continue to use the Financial Consultant, whose engagement was previously approved by Text Order of October 31, 2019.
2. Using the method outlined in Report III, ¶¶ 63-64, the Receiver pendente lite shall promptly engage a chief executive officer (the "CEO") on behalf of both Companies to manage and operate them, including to deal with their legal and fiduciary obligations (such as legal representation in this litigation) as the Receiver pendente lite or the CEO may deem necessary and appropriate in light of the temporary nature of the receivership. The CEO shall report to the Receiver pendente lite with respect to the CEO's responsibilities as set forth below and with respect to such other duties and responsibilities as the Receiver pendente lite shall direct.
3. The CEO shall implement the reinstatement of Larkin as an employee of CBI as the senior middle-manager in the position of "Sales Manager" of all CBI locations, and as an employee of CBWM in the position of "Sales Agent." Upon reinstatement as "Sales Manager" of CBI, Larkin shall report directly to the CEO. Upon reinstatement as "Sales Agent" of CBWM, Larkin shall report to whomever the CEO may direct. Consistent with the need to develop a transition plan and to address that plan with other employees, the CEO shall determine the date on which Larkin will return to work at CBI and CBWM and shall determine the location of his office and the allocation of his time between CBI and CBWM.
4. The CEO shall implement the removal of Johnny Gardner as an officer of CBI and shall transition him to employment solely at CBWM so that he has no further responsibilities at CBI when Larkin resumes active employment for CBI. The CEO shall set the initial salaries for each of the Gardners (Johnny, David and John Sr.) at $2000 per week paid by CBWM based on the status quo ante (¶ 72 supra), with retention of existing benefits. The CEO, in consultation with the Gardners, shall determine the job descriptions for each of the Gardners at CBWM and determine which of them reports directly to the CEO.
5. The CEO shall determine what marketing model to use for CBI and may transition to whatever plan the CEO believes to be prudent and in the best interest of CBI.
6. Under the supervision of the Receiver pendente lite, with assistance from the Financial Consultant and consistent with the recommendations in Report III, ¶¶ 38-39, 52-53, the CEO shall focus on improving the financial practices of CBI and CBWM, which shall include the development of forecasts and monthly reports as directed by the Receiver pendente lite and the oversight of the check book and accounting methods, including intercompany accounts, and may include the replacement of staff as the CEO may determine to be in the interest of CBI and CBWM. Also, under the supervision of the Receiver pendente lite, the CEO shall discharge the obligation of the Companies to provide access to their books and records to all owners.
7. If, at any time, the CEO (or the Receiver pendente lite or his Financial Consultant) determines that either CBI or CBWM will not be able to pay its obligations as and when they become due in the ordinary course, the CEO shall notify the Receiver pendente lite, and the Receiver shall file a petition for instructions recommending next steps.
8. The CEO is authorized to make senior level business and strategic decisions regarding CBI and CBWM, including without limitation the hiring and firing of employees (consistent with any contractual obligations) and the appropriate use of offices. The CEO is further authorized to enter into contracts on behalf of CBI and CBWM, or to delegate the authority to do so to Larkin, the Gardners or any employee or agent of CBI and CBWM. In making all such decisions, including with respect to contracting authority, the CEO shall consult with the Gardners and Larkin, and with the Receiver pendente lite and/or his Financial Consultant as the Receiver pendente lite may deem appropriate. The CEO is specifically authorized to determine whether Larkin's reinstatement or Johnny Gardner's transfer to CBWM makes any other employee expendable and to terminate or modify the employment, mindful of any contractual commitments and applicable law.
9. With respect to Larkin and the Gardners, if any of them refuses to abide by decisions made by the CEO regarding CBI or CBWM, the CEO is authorized to terminate that individual's employment.
10. If the CEO determines that it would be in the business interest of CBI or CBWM to terminate Larkin or to terminate one or more of the Gardners from one or both of the Companies, and that the business interest of the respective Company cannot reasonably be achieved in a way that does not adversely impact the reasonable expectations of an owner to continued employment, the CEO is authorized to do so. Relatedly, to the extent that the CEO determines that Larkin or any of the Gardners are not providing sufficient value to CBI or to CBWM to justify their initial salaries or that it would be prudent to reduce any owner's salary based on the needs of the business of CBI and CBWM, including cash flow (which shall include consideration of the costs associated with the engagement of the CEO and the cost of the Receiver pendente lite and the Financial Consultant), the CEO is empowered to do so. If the CEO takes any of these actions, he or she is authorized immediately to reassess the manner in which CBI and CBWM allocate profits to their shareholders/members and, after taking direction from the Receiver pendente lite, based on the interests of the Companies and on the reasonable expectations of the owners, may establish an entirely different approach, which may include payment of salaries solely based on the value of services rendered with periodic distributions to owners as appropriate.
11. The Receiver pendente lite shall continue to act as custodian of the Third Note and shall continue to have the power to take actions sufficient to protect CBWM from enforcement of the Third Note.
12. To the extent that the Receiver pendente lite concludes that a business valuation to determine the relative values of CBI and CBWM is necessary to facilitate the business interests of CBI and CBWM, including without limitation their interests in this litigation, he is specifically authorized to engage an expert for that purpose, following consultation with Larkin and the Gardners.
Based on the foregoing, I recommend that the Emergency Motion (ECF No. 18) be granted in part and denied in part; that the Court enter a preliminary injunction as set forth above; and that the Court appoint Theodore Orson, Esq, as Receiver pendente lite subject to the terms, limitations and instructions set forth above.
Any objection to this report and recommendation must be specific and must be served and filed with the Clerk of the Court within fourteen (14) days of its receipt.
2019 WL 6337686, at *3. The same finding is proposed here, ¶¶ 69-72 infra.
