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Flores v. Murray

October 19, 2007

GEORGE FLORES, LARRY MILBY, ANN MARIE MILBY, KEITH SAVEL, HOWARD ZIMMERMAN, DAVID SEE, AND CHARLES RIZKALLA, PLAINTIFFS-RESPONDENTS,
v.
JOHN MURRAY, DEFENDANT/THIRD-PARTY PLAINTIFF-APPELLANT,
v.
CRYSTEX COMPOSITES, LLC, THIRD-PARTY DEFENDANT.



On appeal from the Superior Court of New Jersey, Law Division, Passaic County, L-769-05.

Per curiam.

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

Submitted September 17, 2007

Before Judges Lintner, Parrillo and Sabatino.

Following a five-day bench trial, the judge rendered a decision in favor of plaintiffs, George Flores, Larry Milby, Ann Milby, Keith Savel, Howard Zimmerman, David See, and Chares Rizkalla, investors/shareholders in Crystex Composites, LLC (Crystex) against defendant John Murray. The judge found that defendant had no employment contract with Crystex and had violated his contractual obligation with plaintiffs and Crystex by failing to contribute $200,000 as promised, thus forfeiting his ownership interest. The judge also found that defendant breached his fiduciary duty to the investors/shareholders by repaying a personal loan with Crystex funds and making unauthorized payments to his son from the company's operating account. He found that defendant fraudulently induced plaintiffs to invest in Crystex by promising that he would invest $200,000 of his own money in the LLC and fraudulently induced Larry Milby (Milby) to pledge stock as collateral for a loan to Crystex by promising him a minimum distribution of $94,500 per year, and created ultra vires documents for the purpose of paying personal debt.

The judge also ordered that defendant pay 50% of plaintiffs' counsel fees, an amount totaling $68,049.95. A judgment order memorializing the judge's findings was executed on July 28, 2006. Defendant's motion for reconsideration of the counsel fee award was denied, following which defendant appealed.*fn1 We now reverse the judgment insofar as it found that defendant fraudulently induced plaintiffs to invest in Crystex and awarded counsel fees. In all other respects, the judgment is affirmed.

The following facts are relevant to the disposition of this appeal. In 1969, George Flores began employment as a production machinist with Mykroy/Mycalix (M&M), a manufacturer of glass and ceramic electronic components and a division of Spaulding Composites Company, Inc. (Spaulding). Eventually, Flores rose to the position of general and plant manager for M&M. In 2001, Spaulding filed for bankruptcy, at which time Flores was approached by many potential investors who were interested in buying M&M on the condition that Flores remain with the company. One of those individuals was defendant, who had been employed as a temporary accountant for Spaulding through a staffing agency and become a best friend of Flores.

Defendant introduced Flores to his longtime friend Milby, with whom defendant had served in the Air Force. Flores, defendant, and Milby each agreed to invest $200,000. However, they believed they needed another $200,000. The group then borrowed $100,000 from Milby's niece, Donna Franks, in return for which defendant executed, as CEO of Mykroy Composites, LLC, a promissory note stating that Mykroy Composites, LLC agreed to pay Franks $200,000 with interest from November 1, 2005, on the unpaid principal at the rate of 6% interest per year.

Flores consulted with an attorney to assist the group in purchasing M&M. The total purchase price was $764,290.50, which included a $400,000 initial deposit, a $100,000 second deposit, and the remaining $264,290.50 to be financed by a loan from CIT Corporation.*fn2 Thus, the group did not have to put up a $600,000 deposit as originally discussed. Flores put in his $200,000 while Milby put in $190,000, which he raised by selling his and his wife's IRAs, increasing his home equity loan, and borrowing from his brother.

Defendant did not come up with his $200,000 but instead told Flores that "he had [American Bio Medica Corporation (ABMC)] stock that was going to go through the roof" and it would be foolish to cash the stock in because "he knew people [at ABMC who] could tip him off about the stock." Milby also had ABMC stock. Defendant told Milby that they needed to pledge their combined shares of stock to be used as collateral for the loan from CIT. Milby had reservations about pledging his shares if he did not have control over when he could sell them. Defendant promised to guarantee Milby $94,500, as a minimum distribution, if he would pledge his shares. Consequently, defendant executed a guarantee to Milby and Milby's wife, dated October 1, 2003, and endorsed the guarantee as the "CEO/Chairman" of Crystex. The letter stated:

As an inducement for your investment in CRYSTEX COMPOSITES, LLC this letter serves as our guarantee that you will receive a 13.5% distribution of minimum annual net earnings of seven hundred thousand dollars ($700,000) annually during the first five years beginning January 1, 2004.

As of January 1, 2009, your distribution will be based on your then current percentage against then current net earnings.

This guaranteed minimum ($94,500) shall remain effective:

1. If net annual earnings are less than seven hundred thousand dollars ($700,000).

2. Whether your investment percentage becomes diluted by additional stockholder memberships during the same five-year period.

Defendant testified that he had actually created this letter in November 2003, but had backdated it to October 1, 2003, "to give [Milby] credit for being in there before we commenced operations of the company." Milby did not receive the letter until April 2004.

Flores was unaware of the guarantee to Milby. Defendant contradicted Flores's account and testified that he was "sure [Flores] saw it." Flores was worried that the group did not have enough money to cover the down payment as well as the operating costs and attorney's fees. He contacted three investors: Keith Savel, Howard Zimmerman, and David See (the Prime Boys). Zimmerman and See had been part of Prime Environmental, a company that did consulting work for M&M. In early October 2003, the Prime Boys agreed to invest $150,000 for a 10% interest in Crystex. Charles Rizkalla, a ceramics engineer formerly employed by Spaulding, was given a 5% interest as "sweat equity" in return for working at a lower salary then he was used to.

The Prime Boys eventually contacted Flores when they learned that defendant had not put up his $200,000. Flores explained that defendant had stock that he claimed has "enough equity . . . to cover for his portion of the investment[] but does not want to cash in the stock because [it] . . . supposedly is going to go up in value within a six-month period." Savel and defendant had a discussion during which defendant reiterated his position regarding his stock and stated that he wanted to take out a loan from CIT in lieu of his cash contribution. Savel responded that he "was not favorable to that" and although he "understood [defendant's] predicament . . . [defendant could] get his $200,000 any way he liked to. It wasn't [Savel's] . . . job to determine how [defendant] should raise that capital." Savel was aware that the value of defendant's stock at the time was approximately $110,000. He "was very uncomfortable going into a deal without [defendant] having some liability and the liability up to $200,000, as we agreed to."

The Prime Boys set up a conference call with defendant and told him that they were going to prepare a Memorandum of Understanding (MOU) that set forth that defendant would come up with $200,000 and that at that time he would either cash in the stock or forfeit his interest. According to Flores, defendant was very angry after the conference call and stated that he would "come after" the Prime Boys and "kick them out at the end." After the Prime Boys faxed the MOU to Flores and defendant, they participated in several telephone conferences during which Savel made it clear that, if the MOU was not signed, they were not going to release their capital contribution.

The MOU states that it is "between the following two parties": (1) "Crystex Composites LLC - [defendant]/George Flores" and (2) "Investment Group - Keith Savel/Howard Zimmerman/David See." Defendant, George Flores, Larry Milby, Investment Group, and Charles Rizkalla are listed as "Key Investors." A handwritten notation by defendant dated October 14, 2003, set forth the parties' ownership interests as: (1) [defendant's] interest - 35.75%; (2) Flores' interest - 35.75%; (3) Milby's interest - 13.5%; (4) Investment Group's interest -10%; and (5) Rizkalla's interest - 5%.

The MOU further stated: "[Defendant] shall utilize his shares of ABMC as collateral against the Note held by CIT stipulated below. [Defendant] must execute the sale of said shares or otherwise contribute the $200,000 investment within a 6 month period ending in March of 2004 or forfeit his shares and ownership in Crystex."

Under the heading, "Crystex/CIT Purchase Agreement," the MOU broke down the purchase price for M&M's business and property. In another handwritten revision by defendant, the figures showed that the total price was $764,000, which consisted of $500,000 in cash and $264,000 in a note "held by CIT (guaranteed by ABMC shares owned by [defendant])." The remaining portions of the MOU read as follows:

Key Employee Salaries: as stipulated in draft LLC Members Agreement dated 10/7/03. Profits Distribution/Compensation: Establishment of a Compensation Committee made up of (3) members. All decisions made by unanimous vote. Committee is formed from the following:

Crystex - [defendant] or George Flores - (1) member Larry [Milby] - Larry [Milby] - (1) member Investment Group - Keith S/Howard Z/ David S - (1) member Should the Purchase Agreement between Crystex and CIT not go through, all monies will be returned [to] all investors.

The MOU was dated October 10, 2003, and signed by defendant, Flores, Savel, Zimmerman, and See on October 14, 2003. Although Milby and Rizkalla did not sign the MOU at that time, they ratified and agreed to be bound by it on May 3, 2004.*fn3

According to Milby, defendant told him that the MOU did not "mean anything" and was "just garbage." Defendant testified that when he signed the MOU he had not seen it before and was told by Savel that "it's just a memo . . . outlining where we are right now."

The LLC Members Agreement, dated October 7, 2003, and referred to in the MOU, imposed a salary limitation on defendant and Flores, providing that each may elect to defer actual payment in the event funds are needed for ongoing capital investment, in which case they "will be treated as a loan and not an increase in Base Investment . . . [in which event] the company will pay interest at prime plus 2% for the use thereof." The LLC Members Agreement contained the following provision detailing "Profit Distributions":

At the end of each year all profits will be divided and distributed to the LLC members by March 30th of the following year. LLC members include All Investors or key employees given a membership percentage in the LLC. In the event there are further capital requirements to maintain or expand the business, All members of the LLC will be given an opportunity to invest amounts necessary to maintain their original ownership percentage.

A corrected Certificate of Formation naming Crystex Composites, LLC was filed on October 15, 2003.*fn4 That same day, the United States Bankruptcy Court for the District of New Hampshire issued an order granting the sale of M&M's assets and properties. Flores testified that upon the formation of Crystex, the attorney presented a form Operating Agreement. The attorney advised, "[p]lease make sure you fill out all of the forms. Then . . . please before you rip each other apart, will you please put an Operating Agreement restriction in place. I will be glad to sit down with you and help you put a proper Operating Agreement in place." When asked whether they followed the attorney's instructions, Flores related that "[defendant] said, are you kidding? We all do business. What else do we need? We're the majority."

The Operating Agreement, dated October 15, 2003, states that it is "by and between the Initial Members and all others admitted as Members pursuant to the terms hereof." It is signed by defendant, Flores, and Milby. The Operating Agreement states that a 51% interest is required for decisions regarding the "PURCHASE/SALE/MORTGAGE OF PROPERTY AND BUSINESS." Also, a 25% interest is necessary to call a meeting of the Members. The Operating Agreement provides a "Shareholder List" naming: (1) "[Defendant] Chairman, CEO," (2) "George Flores[,] Vice President, Sec.," (3) "Lawrence & Ann Milby," (4) "Ann Milby," (5) "Charles Rizkalla," (6) "Keith P. Savel," (7) "Howard M. Zimmerman," and (8) "David F. See." On separate pages of the Operating Agreement, "Initial Member Information" was provided for Defendant, Flores, the Milbys, and Rizkalla.

The remaining portions of the Operating Agreement set forth the "GENERAL PROVISIONS." Savel testified at trial that he was not made aware of the Operating Agreement until November or December 2003. According to Savel, none of the Prime Boys investors were ever asked to sign the Operating Agreement. Because he never signed the Operating Agreement, Savel believed that the MOU was still a viable agreement and defendant was required to contribute his $200,000 within the six months.

Crystex began operations in October 2003. According to Flores, by January 2004, defendant was "acting strange." Defendant refused to honor a financial obligation owed to one of the company's manufacturing representatives, wanted to penalize valued customers, and used offensive language when dealing with Crystex's accounts payable clerk.

Difficulties also developed when defendant hired his son. Flores agreed defendant's son would receive eighteen dollars per hour. Defendant wanted to pay his son twenty-five dollars per hour and agreed that the extra money would come out of his own pocket. Later, however, Flores discovered that defendant was paying his son extra money from the company's operating account. He found that "the cost was buried into . . . other expenses, ...


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