Opinion ID: 1123091
Heading Depth: 1
Heading Rank: 3

Heading: Majority Shareholders' Fiduciary Responsibility

Text: Defendants take the position that as shareholders they owe no fiduciary obligation to other shareholders, absent reliance on inside information, use of corporate assets, or fraud. This view has long been repudiated in California. The Courts of Appeal have often recognized that majority shareholders, either singly or acting in concert to accomplish a joint purpose, have a fiduciary responsibility to the minority and to the corporation to use their ability to control the corporation in a fair, just, and equitable manner. (7) Majority shareholders may not use their power to control corporate activities to benefit themselves alone or in a manner detrimental to the minority. Any use to which they put the corporation or their power to control the corporation must benefit all shareholders proportionately and must not conflict with the proper conduct of the corporation's business. ( Brown v. Halbert, 271 Cal. App.2d 252 [76 Cal. Rptr. 781]; Burt v. Irvine Co., 237 Cal. App.2d 828 [47 Cal. Rptr. 392]; Efron v. Kalmanovitz, 226 Cal. App.2d 546 [38 Cal. Rptr. 148]; Remillard Brick Co. v. Remillard-Dandini Co., 109 Cal. App.2d 405 [241 P.2d 66].) The extensive reach of the duty of controlling shareholders and directors to the corporation and its other shareholders was described by the Court of Appeal in Remillard Brick Co. v. Remillard-Dandini Co., supra, 109 Cal. App.2d 405, where, quoting from the opinion of the United States Supreme Court in Pepper v. Litton, 308 U.S. 295 [84 L.Ed. 281, 60 S.Ct. 238], the court held: (8) `A director is a fiduciary ... So is a dominant or controlling stockholder or group of stockholders ... Their powers are powers of trust ... (9) Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein ... (10) The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm's length bargain. If it does not, equity will set it aside.' (11) Referring directly to the duties of a director the court stated ...: `He who is in such a fiduciary position cannot serve himself first and his cestuis second. He cannot manipulate the affairs of his corporation to their detriment and in disregard of the standards of common decency and honesty. He cannot by the intervention of a corporate entity violate the ancient precept against serving two masters. He cannot by the use of the corporate device avail himself of privileges normally permitted outsiders in a race of creditors. He cannot utilize his inside information and his strategic position for his own preferment. He cannot violate rules of fair play by doing indirectly through the corporation what he could not do directly. He cannot use his power for his personal advantage and to the detriment of the stockholders and creditors no matter how absolute in terms that power may be and no matter how meticulous he is to satisfy technical requirements. (12) For that power is at all times subject to the equitable limitation that it may not be exercised for the aggrandizement, preference, or advantage of the fiduciary to the exclusion or detriment of the cestuis. Where there is a violation of these principles, equity will undo the wrong or intervene to prevent its consummation.' This is the law of California. (109 Cal. App.2d 405, 420-421.) In Remillard the Court of Appeal clearly indicated that the fiduciary obligations of directors and shareholders are neither limited to specific statutory duties and avoidance of fraudulent practices nor are they owed solely to the corporation to the exclusion of other shareholders. Defendants assert, however, that in the use of their own shares they owed no fiduciary duty to the minority stockholders of the Association. They maintain that they made full disclosure of the circumstances surrounding the formation of United Financial, that the creation of United Financial and its share offers in no way affected the control of the Association, that plaintiff's proportionate interest in the Association was not affected, that the Association was not harmed, and that the market for Association stock was not affected. Therefore, they conclude, they have breached no fiduciary duty to plaintiff and the other minority stockholders. (13) Defendants would have us retreat from a position demanding equitable treatment of all shareholders by those exercising control over a corporation to a philosophy much criticized by commentators and modified by courts in other jurisdictions as well as our own. In essence defendants suggest that we reaffirm the so-called majority rule reflected in our early decisions. This rule, exemplified by the decision in Ryder v. Bamberger, 172 Cal. 791 [158 P. 753], but since severely limited, recognized the perfect right [of majority shareholders] to dispose of their stock ... without the slightest regard to the wishes and desires or knowledge of the minority stockholders; ... (p. 806) and held that such fiduciary duty as did exist in officers and directors was to the corporation only. The duty of shareholders as such was not recognized unless they, like officers and directors, by virtue of their position were possessed of information relative to the value of the corporation's shares that was not available to outside shareholders. In such case the existence of special facts permitted a finding that a fiduciary relationship to the corporation and other shareholders existed. ( Hobart v. Hobart Estate Co., 26 Cal.2d 412 [159 P.2d 958].) We had occasion to review these theories as well as the minority rule that directors and officers have an obligation to shareholders individually not to profit from their official position at the shareholders' expense in American Trust Co. v. California etc. Ins. Co., 15 Cal.2d 42 [98 P.2d 497]. Each of the traditional rules has been applied under proper circumstances to enforce the fiduciary obligations of corporate officers and directors to their cestuis. ( Lawrence v. I.N. Parlier Estate Co., 15 Cal.2d 220 [100 P.2d 765] [directors may not engage in any transaction that will conflict with their duty to the shareholders or make use of their power or of the corporate property for their own advantage]; Hobart v. Hobart Estate Co., supra, 26 Cal.2d 412 [officer must disclose knowledge of corporate business to shareholder in transaction involving transfer of stock]; In re Security Finance Co., 49 Cal.2d 370 [317 P.2d 1] [majority shareholders' statutory powers subject to equitable limitation of good faith and inherent fairness to minority].) The rule that has developed in California is a comprehensive rule of inherent fairness from the viewpoint of the corporation and those interested therein. ( Remillard Brick Co. v. Remillard-Dandini Co., supra, 109 Cal. App.2d 405, 420. See also, In re Security Finance Co., supra, 49 Cal.2d 370; Brown v. Halbert, supra, 271 Cal. App.2d 252; Burt v. Irvine Co., supra, 237 Cal. App.2d 828; Efron v. Kalmanovitz, supra, 226 Cal. App.2d 546.) The rule applies alike to officers, directors, and controlling shareholders in the exercise of powers that are theirs by virtue of their position and to transactions wherein controlling shareholders seek to gain an advantage in the sale or transfer or use of their controlling block of shares. Thus we held in In re Security Finance Co., supra, 49 Cal.2d 370, that majority shareholders do not have an absolute right to dissolve a corporation, although ostensibly permitted to do so by Corporations Code section 4600, because their statutory power is subject to equitable limitations in favor of the minority. We recognized that the majority had the right to dissolve the corporation to protect their investment if no alternative means were available and no advantage was secured over other shareholders, and noted that [t]here is nothing sacred in the life of a corporation that transcends the interests of its shareholders, but because dissolution falls with such finality on those interests, above all corporate powers it is subject to equitable limitations. (49 Cal.2d 370, 377.) The extension of fiduciary obligations to controlling shareholders in their exercise of corporate powers and dealings with their shares is not a recent development. The Circuit Court for the Southern District of New York said in 1886 that [w]hen a number of stockholders combine to constitute themselves a majority in order to control the corporation as they see fit, they become for all practical purposes the corporation itself, and assume the trust relation occupied by the corporation towards its stockholders. ( Ervin v. Oregon Ry. & Nav. Co. (S.D.N.Y. 1886) 27 F. 625, 631.) Professor Lattin has suggested that the power to control, or rather its use, should be considered in no lesser light than that of a trustee to deal with the trust estate and with the beneficiary. Self-dealing in whatever form it occurs should be handled with rough hands for what it is  dishonest dealing. And while it is often difficult to discover self-dealing in mergers, consolidations, sale of all the assets or dissolution and liquidation, the difficulty makes it even more imperative that the search be thorough and relentless. (Lattin, Corporations (1959) 565.) The increasingly complex transactions of the business and financial communities demonstrate the inadequacy of the traditional theories of fiduciary obligation as tests of majority shareholder responsibility to the minority. These theories have failed to afford adequate protection to minority shareholders and particularly to those in closely held corporations whose disadvantageous and often precarious position renders them particularly vulnerable to the vagaries of the majority. Although courts have recognized the potential for abuse or unfair advantage when a controlling shareholder sells his shares at a premium over investment value ( Perlman v. Feldmann, 219 F.2d 173 [50 A.L.R.2d 1134] [premium paid for control over allocation of production in time of shortage]; Gerdes v. Reynolds, 28 N.Y.S.2d 622 [sale of control to looters or incompetents]; Porter v. Healy, 244 Pa. 427 [91 A. 428]; Brown v. Halbert, supra, 271 Cal. App.2d 252 [sale of only controlling shareholder's shares to purchaser offering to buy assets of corporation or all shares]) or in a controlling shareholder's use of control to avoid equitable distribution of corporate assets ( Zahn v. Transamerica Corp. (3rd Cir.1946) 162 F.2d 36 [172 A.L.R. 495] [use of control to cause subsidiary to redeem stock prior to liquidation and distribution of assets]), no comprehensive rule has emerged in other jurisdictions. Nor have most commentators approached the problem from a perspective other than that of the advantage gained in the sale of control. Some have suggested that the price paid for control shares over their investment value be treated as an asset belonging to the corporation itself (Berle and Means, The Modern Corporation and Private Property (1932) p. 243), or as an asset that should be shared proportionately with all shareholders through a general offer (Jennings, Trading in Corporate Control (1956) 44 Cal.L.Rev. 1, 39), and another contends that the sale of control at a premium is always evil (Bayne, The Sale-of-Control Premium: the Intrinsic Illegitimacy (1969) 47 Texas L.Rev. 215). The additional potential for injury to minority shareholders from majority dealings in its control power apart from sale has not gone unrecognized, however. The ramifications of defendants' actions here are not unlike those described by Professor Gower as occurring when control of one corporation is acquired by another through purchase of less than all of the shares of the latter: The [acquired] company's existence is not affected, nor need its constitution be altered; all that occurs is that its shareholders change. From the legal viewpoint this methodological distinction is formidable, but commercially the two things may be almost identical. If ... a controlling interest is acquired, the [acquired] company ... will become a subsidiary of the acquiring company ... and cease, in fact though not in law, to be an independent entity. This may produce the situation in which a small number of dissentient members are left as a minority in a company intended to be operated as a member of a group. As such, their position is likely to be unhappy, for the parent company will wish to operate the subsidiary for the benefit of the group as a whole and not necessarily for the benefit of that particular subsidiary. (Gower, The Principles of Modern Company Law (2d ed. 1957) p. 561.) Professor Eisenberg notes that as the purchasing corporation's proportionate interest in the acquired corporation approaches 100 percent, the market for the latter's stock disappears, a problem that is aggravated if the acquiring corporation for its own business purposes reduces or elminates dividends. (Eisenberg, The Legal Role of Shareholders and Management in Modern Corporate Decision-Making (1969) 57 Cal.L.Rev. 1, 132. See also, O'Neal and Derwin, Expulsion or Oppression of Business Associates (1961) passim; Leech, Transactions in Corporate Control (1956) 104 U.Pa.L.Rev. 725, 728; Comment, The Fiduciary Relation of the Dominant Shareholder to the Minority Shareholders (1958) 9 Hastings L.J. 306, 314.) The case before us, in which no sale or transfer of actual control is directly involved, demonstrates that the injury anticipated by these authors can be inflicted with impunity under the traditional rules and supports our conclusion that the comprehensive rule of good faith and inherent fairness to the minority in any transaction where control of the corporation is material properly governs controlling shareholders in this state. [12] We turn now to defendants' conduct to ascertain whether this test is met.