Md. high court will consider whether ‘de facto dividends’ exist

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The Maryland Supreme Court will consider whether the state recognizes pay raises to shareholding executives at privately held companies as “de facto dividends” that must also be paid to other shareholders.

The justices this month agreed to review a Maryland Appellate Court decision that cited the de facto dividend concept in reviving the shareholder lawsuit of a man who claims his mother and brother illicitly enriched themselves while not paying him for his 28% share of the family business from which he was fired.

The Appellate Court said a trial judge wrongly dismissed Edward Mekhaya’s claim that Vipa and Oscar Mekhaya violated their duty as company directors to acknowledge his 28% share in Eastland Food Corp. — stock he claims to still hold despite his firing.

In its successful petition for Supreme Court review, Eastland said Maryland law states that dividends be declared by “resolution” of the corporate board, thus eliminating the ability of these payments to be made by de facto implication.

Allowing the Appellate Court’s decision to stand would sow corporate confusion and cause protracted and costly litigation, wrote Eastland’s attorney, Stuart A. Berman, joined by counsel for Vipa, Oscar and another board member, Tisnai Thaitham.

The de facto dividend doctrine “makes virtually any allegation by a minority shareholder in a close corporation that claims entitlement to a ‘de facto dividend’ sufficiently plausible to survive a motion to dismiss and to trigger wide-ranging and expensive discovery,” wrote Berman, of Lerch, Early & Brewer Chtd. in Bethesda. “The Appellate Court’s decision creates substantial uncertainty for Maryland corporations regarding the proper accounting treatment of payments to shareholder officers and employees and accurate reporting of a corporation’s financial condition.”

Vipa is represented by Jeffrey M. Orenstein, of Wolff and Orenstein LLC in Rockville. Oscar is represented by James M. Hoffman and Michael N. Mercurio, both of Offit Kurman PA in Bethesda.  Thaitham is represented by David Hotes, of Bethesda Law Group in Bethesda.

In his failed request that the high court deny the appeal, Edward Mekhaya stated through counsel that Maryland courts have long recognized the concept of a de facto dividend — but by other names — when a shareholder has been denied a fair share of the profits.

“Under Maryland’s statutory scheme for protection of minority shareholders, Maryland courts have been granted broad powers both in law and in equity to fashion appropriate relief,” wrote attorney Paul N. Farquharson, of Semmes, Bowen & Semmes in Baltimore.

“In its decision below, the Appellate Court clarified existing Maryland law by explaining that Maryland’s statutory scheme … allows for the distribution of profits in forms other than dividends,” Farquharson added. “Thus, in the context of a shareholder oppression claim, under Maryland law, where distribution of profits is at issue, the operative inquiry is not what the distribution of profits is called but whether the distribution was made (or not made) to oppress or squeeze out the minority shareholder.”

The Supreme Court is scheduled to hear arguments in the case June 2. The justices are expected to render their decision by Aug. 31 in Eastland Food Corp. et al. v. Edward Mekhaya, No. 37 September Term 2022.

According to court papers, Vipa holds a 35% interest in Eastland, while Oscar – like Edward – holds a 28% interest. Oscar’s children hold the other 9%.

Edward, whose salary was $400,000, was fired from the Jessup-based food importer and distribution company in the spring of 2018 and filed suit in 2021 in Howard County Circuit Court.

He alleges Vipa and Oscar received such “excessively high” salaries from the company that the money paid to them amounted to a “de facto dividend” which must be distributed to all shareholders.

Edward claims their failure to pay him the dividend breached their fiduciary duty as directors of Eastland. In addition, their retention of money owed to him resulted in their unjust enrichment, and their thwarting of his “reasonable expectation” of payment amounted to oppressive behavior toward a shareholder, Edward alleges.

Eastland, Vipa and Oscar deny the allegations of wrongdoing and have noted that a dividend was never declared. The circuit court sided with them and dismissed Edward’s claim.

In reviving Edward’s lawsuit, the Appellate Court ruled in December that an excessive salary paid to employed shareholders could qualify as a de facto dividend.

“(Edward) Mekhaya’s flagship allegation was that, as a shareholder, he expected to share in company profits by receiving a de facto dividend as part of his salary,” Judge Glenn T. Harrell Jr. wrote for the Appellate Court.

“That expectation was reasonable, despite the fact that Eastland never declared officially a dividend,” added Harrell, a retired judge sitting by special assignment. “Thus when (the defendants) terminated Mekhaya’s employment and stopped paying his salary, thereby depriving him of the de facto dividend portion, arguably (they) defeated substantially Mekhaya’s reasonable expectation as a shareholder.”

Harrell was joined in the reported opinion by Judges Stuart R. Berger and Anne K. Albright.