Mid-Pacific Construction Co, Inc v Semes (I) [1993] FMSC 44; 6 FSM Intrm. 171 (Pon. 1993) (31 August 1993)

THE SUPREME COURT OF THE
FEDERATED STATES OF MICRONESIA
Cite as Mid-Pac Construction Co. v. Semes (I), [1993] FMSC 44; 6 FSM Intrm. 171 (Pohnpei 1993)

[1993] FMSC 44; [6 FSM Intrm. 171]

MID-PACIFIC CONSTRUCTION CO., INC., on Assignment for Benefit of Creditors,
and AMBROS T. SENDA,
Plaintiffs,

vs.

HERMAN SEMES and HATLER GALLEN,
Defendants.

HERMAN SEMES and HATLER GALLEN,
Third Party Plaintiffs,

vs.

FEDERATED STATES OF MICRONESIA,
Third Party Defendant.

CIVIL ACTION NO. 1992-041

ORDER AND MEMORANDUM OF DECISION

Martin Yinug
Associate Justice

Decided: August 31, 1993

APPEARANCES:

For the Plaintiffs:
Daniel J. Berman, Esq.
Rush, Moore, Craven, Sutton, Morry & Beh
2000 Hawaii Tower
745 Fort Street
Honolulu, Hawaii 96813

For the Defendants (Herman Semes):
Sungiwo Hadley, Trial Counselor
Micronesian Legal Services Corporation
P.O. Box 129
Kolonia, Pohnpei FM 96941

For the Defendants (Hatler Gallen)
John Brackett, Esq.
P.O. Box 208
Kolonia, Pohnpei FM 96941

[6 FSM Intrm. 172]

* * * *

HEADNOTES

Statutes of Limitation
The applicable period of limitations on actions arising under the Corporations, Partnerships and Associations Regulations is six years. 6 F.S.M.C. 805. Mid-Pacific Constr. Co. v. Semes (I), [1993] FMSC 44; 6 FSM Intrm. 171, 174 (Pon. 1993).

Statutes of Limitation
Since the statute of limitations does not commence running until after the cause of action accrues a prerequisite to determining the when the cause of action accrues is a precise clarification of the cause of action. Mid-Pacific Constr. Co. v. Semes (I), [1993] FMSC 44; 6 FSM Intrm. 171, 174 (Pon. 1993).

Statutes of Limitation
In general, a cause of action accrues when the right to bring suit on a claim is complete ) the true test in determining when a cause of action arises or accrues is to establish the time when the plaintiff could have first maintained the action to a successful conclusion. Mid-Pacific Constr. Co. v. Semes (I), [1993] FMSC 44; 6 FSM Intrm. 171, 176 (Pon. 1993).

Statutes of Limitation
In cases where a cause of action is contingent on a condition precedent, the statute of limitations does not begin to run until the condition has occurred, and as to a continuing injury until damages are actually sustained. Mid-Pacific Constr. Co. v. Semes (I), [1993] FMSC 44; 6 FSM Intrm. 171, 176 (Pon. 1993).

Statutes of Limitation
A cause of action based on violation of Corporations, Partnerships, and Associations Regulation 2.7 accrues from the point of insolvency of the corporation. Mid-Pacific Constr. Co. v. Semes (I), 6 FSM Intrm. 165, 176-77 (Pon. 1993).

Statutes of Limitation
In general, the statute of limitations in an action for fraud begins to run from the time of discovery of the fraud, or when reasonable diligence should have led to discovery of the fraud. Mid-Pacific Constr. Co. v. Semes (I), [1993] FMSC 44; 6 FSM Intrm. 171, 177 (Pon. 1993).

* * * *

COURT'S OPINION

MARTIN YINUG, Associate Justice:

This matter came before me on defendants' Motions for Summary Judgment and plaintiffs' Motion for Partial Summary Judgment. Defendants have also filed an Opposition to Plaintiffs' Motion for Partial Summary Judgment. Earlier, the Court issued an Order (August 3, 1993) stating that a ruling on the motions would issue based on the written submissions only. The Court having reviewed the parties' motions and supporting documents denies the defendants' Motions and grants the plaintiffs' Motion for Partial Summary Judgment on the limited issue of applicability of the statute of limitations to the complaint in this matter. The Court's reasoning and decision of law follows.

[6 FSM Intrm. 173]

MEMORANDUM OF DECISION

Facts

The plaintiffs in this case are judgment creditors of Mid-Pacific Construction Company, Incorporated (hereinafter "Mid-Pac"), a now insolvent corporation originally organized under the laws of the Trust Territory of the Pacific Islands, and Ambros Senda, one of the original incorporators and directors of Mid-Pac. For purposes of the Motion for Partial Summary Judgment, the movant is the Mid-Pac creditors. Mr. Senda has related but separate claims against the defendants and has not joined in this motion.

Mid-Pac became insolvent in 1987. Several Mid-Pac creditors were granted writs of execution, which were returned unsatisfied in 1988. Collection actions were subsequently instituted against the three original incorporators, Ambros Senda, Herman Semes and Hatler Gallen, for outstanding balances on their respective stock subscriptions. In early 1989, during the course of discovery in the Mid-Pac creditors' action against Senda, it was revealed that the original stock affidavit signed by Senda and Semes in November 1978 falsely represented that the prerequisites for obtaining a corporate charter and engaging in business had been fulfilled. The complaint in the action against Senda was subsequently amended to include claims of violation of the Corporation, Partnership and Association regulations (hereinafter "C.P.A. Reg.").^[1] Plaintiffs prevailed on this claim and this Court's Trial Division ruled on December 14, 1990 that Mid-Pac had engaged in business in violation of part 2.7 of the regulations. Mid-Pac v. Senda, [1990] FMSC 23; 4 FSM Intrm. 376, 384 (Pon. 1990). The Court found Ambros Senda jointly and severally liable to the Mid-Pac creditors in the aggregate amount of $222,073.36. Id. at 386.

One judgment creditor filed a lawsuit against the other incorporators, Semes and Gallen, in the wake of the decision in Mid-Pac v. Senda. Ambros Senda also filed a lawsuit against his former colleagues for contribution. These suits were consolidated in April 1992 by court order as the current Civil Action No. 1992-041, and included as intervenors all Mid-Pac creditors. The creditors and Senda filed new complaints the same month. Since then some discovery has been completed, some opposed or unanswered, several motions filed, and two pretrial conferences held.

[6 FSM Intrm. 174]

Legal Standard

The applicable standard on motion for summary judgment is given by FSM Civ. R. 56(c). The Court shall grant summary judgment if the pleadings, discovery, and any other affidavits submitted reveal no genuine issue of material fact and the movant is entitled to judgment as a matter of law. Alik v. Kosrae Hotel Corp., [1992] FMSC 5; 5 FSM Intrm. 294, 295 (Kos. 1992); FSM Development Bank v. Rodriguez Corp., [1985] FMSC 2; 2 FSM Intrm. 128, 130 (Pon. 1985); Wainit v. Truk (II), 2 FSM Intrm. 86, 87 (Truk 1985). All of the parties agree for purposes of this motion that no genuine issue of material fact exists. Therefore, the issue raised by the motion is ripe for summary adjudication as a matter of law.

Question of Law

While the parties agree that no factual dispute exists pertinent to the subject matter of this motion, the application of the statute of limitations, they pose different questions of law to the Court. In divining the precise matter of law before me, it is useful to review first the elements of the relevant statute of limitations.

The limitation of actions in the Federated States of Micronesia is primarily governed by Title 6, chapter 8 of the FSM Code.^[2] Since the present case does not involve claims of the types described in 6 F.S.M.C. 802 (limitation of twenty years) or 6 F.S.M.C. 803 and 804 (limitation of two years), the applicable period of limitation is six years, as given by 6 F.S.M.C. 805: "All actions other than those covered in the preceding sections of this chapter shall be commenced within six years after the cause of action accrues." (emphasis added). In order to assess, therefore, whether a statute of limitations bar exists in a given case covered by section 805 the Court must determine when the cause of action accrued, since the limitation period only begins to run at such time. Creditors of Mid-Pac Constr. Co. v. Senda, [1989] FMSC 18; 4 FSM Intrm. 157, 159 (Pon. 1989). It follows that a prerequisite to even this exercise must be a precise clarification of the cause of action.

The defendants have asserted the statute of limitations as an affirmative defense to plaintiffs' cause of action, and are now seeking summary judgment to the effect that the statute had already lapsed prior to the filing of the complaint and thus bars plaintiffs' suit in its entirety. Defendants Gallen and Semes trace the plaintiffs' cause of action to C.P.A. Reg. 2.7. Mr. Gallen argues that a cause of action under Reg. 2.7 arises on the date a corporation commences business in violation of the regulation's requirements. Therefore, applying 6 F.S.M.C. 805 would result in the statute of limitations beginning to run from 1978. Alternatively, Mr. Semes argues that the cause of action arises under Reg. 2.7 when the plaintiff should have known by discovery of the violation. This date, he asserts, would have been before 1985 when creditors first began collection actions against Mid-Pac. Although Semes is not specific as to exactly when "before 1985" the fact of the false stock affidavit would have been discoverable, we assume him to mean, at the latest, 1984. Under this analysis, as under Mr. Gallen's, the statute of limitations would have run before the filing of the case at bar in April 1992 as well as the predecessor independent actions, Civil Actions No. 1991-001 and 1991-017.

[6 FSM Intrm. 175]

Plaintiffs argue the issue from a different standpoint, focusing on the original claim for payment of stock subscriptions. They state the question of law before me as whether or not the statute of limitations applies to an action to collect the unpaid stock subscriptions of incorporator/directors, where no demand or call was made upon the subscription. Plaintiffs argue for a rule, supported by case law from the United States, that the statute of limitations on a claim for unpaid corporate stock subscriptions which do not specify a date of payment does not begin to run until a call is made by the corporation, or if the corporation is insolvent, until the creditors demand payment through leave of court. In the present case, creditors first demanded payment of the stock subscription balances through court-ordered assignment in 1988. Therefore, the statute of limitations would not have expired until 1994, well after the filing of the present action.

Alternatively, plaintiffs argue that 6 F.S.M.C. 809 applies to delay the commencement of the statutory period until plaintiffs' discovery of the fraudulent stock affidavit.^[3] Three different dates are proposed as plausible starting dates: (1) December 1990, when the fraud was found as judicial fact in Mid-Pac v. Senda, [1990] FMSC 23; 4 FSM Intrm. 376, 382 (Pon. 1990); (2) 1989, when depositions of Ambros Senda and Hatler Gallen revealed the stock affidavit allegations were false; or (3) the earliest possible date plaintiffs had the opportunity to discover the fraud, the assignment of the accounts of Gallen and Semes to plaintiffs for collection in 1988.

The parties have thus proposed a variety of dates for accrual of the cause of action in this case, depending on how one defines the cause of action. The primary determinant of the cause of action is the complaint. The complaint filed by the Mid-Pac creditors in this case lists two claims for relief. The first charges defendants with liability to the creditors for willful violation of C.P.A. Reg. 2.7. The second charges the defendants with fraud. These are entirely distinct claims from the collection of unpaid stock subscriptions. The rule plaintiffs wish me to adopt on summary judgment regarding actions on unpaid stock subscriptions has already been adopted by this Court in previous litigation. See Creditors of Mid-Pac Constr. Co. v. Senda, [1989] FMSC 18; 4 FSM Intrm. 157, 161 (Pon. 1989). However, application of this rule is inapposite to the facts and posture of the present case because the plaintiffs are not pursuing the same cause of action. While the plaintiffs' claims based on the C.P.A. regulations and alleged misrepresentation by the defendants grew out of earlier lawsuits to collect unpaid stock subscriptions, these later claims exist independently of the original collection claims. They are grounded on different facts and different legal theories. Therefore, the Court agrees with defendants that the proper question of law in this matter on summary judgment is whether or not a cause of action based on C.P.A. Reg. 2.7 accrues from the date of the regulatory violation.

We note at the outset of our inquiry that no FSM case law or enacted law exists instructing when a cause of action arising under C.P.A. regulations accrues, and we find no applicable customary law for guidance. We rely, therefore, on interpretation of the language of the regulation itself and common law principles.

[6 FSM Intrm. 176]

In general, a cause of action accrues when the right to bring suit on a claim is complete ) "[t]he true test in determining when a cause of action arises or accrues is to establish the time when the plaintiff could have first maintained the action to a successful conclusion." 51 Am. Jur. 2d Limitation of Actions § 107, at 679 (1970). The second sentence of C.P.A. Reg. 2.7 states that incorporators and directors of a corporation that has violated the regulatory requirements are liable to creditors "in the event of its bankruptcy or insolvency . . . for any loss suffered by the corporation or its stockholders or creditors." The plain meaning of the phrase "in the event of" is if and when a certain event occurs. The phrase indicates that a precondition to liability exists; namely, that the corporation must become insolvent before creditors can claim compensation for losses incurred. There is no cause of action created by Reg. 2.7 in either the corporation or creditors for mere discovery of a violation while the corporation is still solvent; the cause of action does not vest until the corporation can no longer pay its debts.

The statute of limitations does not begin to run as to a continuing injury until the damages are sustained; "if a condition precedent to a right of action exists, whether it is a demand and refusal or some other act or contingency, the cause of action does not accrue nor does the statute of limitations begin to run until the condition is performed." 51 Am. Jur. 2d Limitation of Actions § 111, at 682 (1970).

The Court takes note of defendant Gallen's equitable arguments that such a construction of the statutory meaning seems to leave original incorporators and directors open to liability far into the future from the date of incorporation. A corporation could violate the C.P.A. regulations in 1990, stay solvent for thirty years, and then in 2020 go bankrupt for reasons completely unassociated with the failure to comply with regulations thirty years earlier. Yet the original incorporators would remain jointly and severally liable to creditors under Reg. 2.7. While such a result may seem "an extremely harsh penalty to impose on incorporators and directors of a defectively organized corporation," Mid-Pac v. Senda, 4 FSM Intrm. at 378, I find no authority to alter the regulatory mandate and impose a lesser sanction. It is not the province of the Court to pass judgment on the wisdom of particular duly enacted laws. The choice of whom to hold liable and when under the corporate regulations belongs to other branches of government, and I find no judicial discretion ceded by the clear language of the regulation to fashion an interpretation mitigating the reach of liability.

Certainly a primary purpose of the C.P.A. regulations, as Mr. Gallen notes, is to provide a disincentive to the establishment of thinly capitalized corporations. It is also to provide a degree of protection to creditors in the event of insolvency or dissolution, regardless of whether the creditors losses are directly attributable to the regulatory violations.

The legislators and other officials responsible for enacting this set of regulations could have written in a requirement that liability only extends to those losses proven to be precipitated by the undercapitalization or incurred through direct reliance on the satisfaction of the regulatory requirements. However, the drafters declined to erect this barrier to plaintiffs' recovery. I do not agree with defendants' categorical assertion that, in every case, after six years the failure of a company would have nothing to do with the failure to meet minimum capital requirements, or that no rational creditor would rely upon the original stock affidavit in year seven or later in deciding whether to invest in the company. Other jurisdictions have done away with minimum capital requirements, but other jurisdictions have established comprehensive corporate codes and reporting requirements in their place. The state of business law in the FSM and the various states is not such. Creditors and investors have the right to rely on the stock affidavit as a true representation that the corporation began on financially sound footing. Likewise, if it is the case that the stock

[6 FSM Intrm. 177]

affidavit misrepresented the financial status of the corporation at inception, and the corporation had virtually no start-up capital, it is not unreasonable to presume that the company's later financial woes and eventual insolvency had its genesis in the initial capital shortfall.

Mr. Gallen's suggestion that the cause of action begins from the date of the violation, i.e. commencement of business without having fulfilled the regulatory requirements, does not comport with the intent of the second sentence of Reg. 2.7. According to Gallen's view, the cause of action on the violation would have lapsed in 1984, six years after Mid-Pac began to do business. However, in 1984 Mid-Pac was still solvent. What could the corporation or creditors have sued for in 1984, had they known of the regulatory violation? Nothing, because the corporation was not insolvent at that time. I do not read the regulation as incorporating the statute of limitations provision found at 6 F.S.M.C. 805 to limit insolvency of the corporation to six years from the date of violation or else the regulation does not apply.

Likewise, Mr. Semes' suggestion that the cause of action should attach at the time creditors first brought suit against Mid-Pac is not consistent with the regulatory language. The first lawsuits brought against Mid-Pac occurred while the company was still solvent. These lawsuits were not calls for unpaid stock subscriptions. As long as the company was solvent, there was no reason for creditors to inquire into the validity of the original stock subscription agreement of the company's incorporators. Therefore, plaintiffs cannot be charged as a matter of law with a responsibility to have discovered the regulatory violation before 1987, the date of Mid-Pac's confirmed insolvency. Even had they knowledge and notice of the violation before 1987, they could not have brought a claim for losses because at that point the company was still in business.

Plaintiffs' Second Cause of Action

Although neither party differentiated their discussion of the statute of limitations issue as between plaintiffs' first and second cause of action, I will do so in the interests of clarity and avoidance of doubt. Plaintiffs' second cause of action is fraud. The general rule as to the statute of limitations on fraud actions is that the running of the statute will "be suspended until the cause of action is known or should under the circumstances have been discovered." 37 Am. Jur. 2d Fraud and Deceit § 400, at 546 (1968). In other words, the statute runs only from the time of actual discovery of the fraud, or when reasonable diligence ought to have led to the discovery of the fraud. Holmberg v. Armbrecht, [1946] USSC 41; 327 U.S. 392, 397[1946] USSC 41; , 66 S. Ct. 582, 585[1946] USSC 41; , 90 L. Ed. 743, 748 (1946).

The alleged act of fraud in this case was the false stock affidavit and representation by Mid-Pac's original incorporators that the requirements of the C.P.A. regulations had been met. As stated in the preceding section, I find that the plaintiffs were not chargeable with either knowledge of the alleged fraudulent acts nor duty to know before 1988, when the demands for debts owed by the corporation were returned unsatisfied. Therefore, the earliest date that the statute of limitations could be said to run on the charge of fraud is 1994. Clearly then, plaintiffs' second cause of action in this case is not time-barred.

Conclusion

The cause of action of creditors against the original incorporators and directors of a corporation for violation of C.P.A. Reg. 2.7 accrues upon the date of the corporation's insolvency or dissolution. In the case at bar, Mid-Pac was declared insolvent in 1987. The statute of limitations on an action brought under Reg. 2.7 would have run in 1993. The statute of limitations on

[1993] FMCSC 1; [6 FSM Intrm. 178]

plaintiffs' second cause of action, alleging fraud, accrued from the time that plaintiffs could have reasonably been expected to discover the facts constituting fraud. This date was 1988, when collection actions on stock subscription balances were filed. The statute would therefore run in 1994. The complaint in this case was filed in 1992, before the end of the limitations period on both causes of action. Partial summary judgment is hereby entered in favor of plaintiffs in that the statute of limitations does not apply to the present action.

* * * *

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^[1] Specifically, part 2.7 of the C.P.A. Regulations states:

No corporation for profit shall upon the incorporation thereof engage in business in the Territory until three-fourths of its authorized capital stock has been subscribed for nor until ten per cent of its authorized capital stock has been paid in by the acquisition of cash or by the acquisition of property of a value equal to ten percent of the authorized capital stock nor until the affidavit or affidavits required by subpart 2.5 of chapter 1 have been filed, provided that in no case shall any corporation for profit upon the incorporation thereof engage in business in the Territory until not less than $1,000 of its authorized capital stock has been paid in by the acquisition of cash or by the acquisition of property of a net value of not less than $1,000. In case of any violation of this section by any corporation, the incorporators and the directors thereof at the time the corporation commences to engage in business shall in their individual and private capacities be jointly and severally liable to the corporation and the stockholders and creditors thereof in the event of its bankruptcy or insolvency or in the event of its dissolution for any loss suffered by the corporation or its stockholders or creditors.
^[2] Title 6, chapter 8 is the general statutory limitation of actions. It may be supplanted by specific statutory prescriptions concerning special causes of action with different time limits. See, e.g., 19 F.S.M.C. 403 (limiting the rights of certain seamen's claims to one or two years). The claims in the present case do not fall under any other special statutory prescription; therefore, the general provisions apply.
[3] 6 F.S.M.C. 809 states:

If any person who is liable to any action shall fraudulently conceal the cause of action from the knowledge of the person entitled to bring it, the action may be commenced at any time within the times limited within this chapter after the person who is entitled to bring the same shall discover or shall have had reasonable opportunity to discover that he has such cause of action, and not afterwards.