Opinion ID: 1123091
Heading Depth: 1
Heading Rank: 4

Heading: Formation of United Financial and Marketing its Shares

Text: (14) Defendants created United Financial during a period of unusual investor interest in the stock of savings and loan associations. They then owned a majority of the outstanding stock of the Association. This stock was not readily marketable owing to a high book value, lack of investor information and facilities, and the closely held nature of the Association. The management of the Association had made no effort to create a market for the stock or to split the shares and reduce their market price to a more attractive level. Two courses were available to defendants in their effort to exploit the bull market in savings and loan stock. Both were made possible by defendants' status as controlling stockholders. The first was either to cause the Association to effect a stock split (Corp. Code, § 1507) and create a market for the Association stock or to create a holding company for Association shares and permit all stockholders to exchange their shares before offering holding company shares to the public. All stockholders would have benefited alike had this been done, but in realizing their gain on the sale of their stock the majority stockholders would of necessity have had to relinquish some of their control shares. Because a public market would have been created, however, the minority stockholders would have been able to extricate themselves without sacrificing their investment had they elected not to remain with the new management. The second course was that taken by defendants. A new corporation was formed whose major asset was to be the control block of Association stock owned by defendants, but from which minority shareholders were to be excluded. The unmarketable Association stock held by the majority was transferred to the newly formed corporation at an exchange rate equivalent to a 250 for 1 stock split. The new corporation thereupon set out to create a market for its own shares. Association stock constituted 85 percent of the holding company's assets and produced an equivalent proportion of its income. The same individuals controlled both corporations. It appears therefrom that the market created by defendants for United Financial shares was a market that would have been available for Association stock had defendants taken the first course of action. [13] After United Financial shares became available to the public it became a virtual certainty that no equivalent market could or would be created for Association stock. United Financial had become the controlling stockholder and neither it nor the other defendants would benefit from public trading in Association stock in competition with United Financial shares. Investors afforded an opportunity to acquire United Financial shares would not be likely to choose the less marketable and expensive Association stock in preference. Thus defendants chose a course of action in which they used their control of the Association to obtain an advantage not made available to all stockholders. They did so without regard to the resulting detriment to the minority stockholders and in the absence of any compelling business purpose. Such conduct is not consistent with their duty of good faith and inherent fairness to the minority stockholders. Had defendants afforded the minority an opportunity to exchange their stock on the same basis or offered to purchase them at a price arrived at by independent appraisal, their burden of establishing good faith and inherent fairness would have been much less. At the trial they may present evidence tending to show such good faith or compelling business purpose that would render their action fair under the circumstances. On appeal from the judgment of dismissal after the defendants' demurrer was sustained we decide only that the complaint states a cause of action entitling plaintiff to relief. (15) Defendants gained an additional advantage for themselves through their use of control of the Association when they pledged that control over the Association's assets and earnings to secure the holding company's debt, a debt that had been incurred for their own benefit. [14] In so doing the defendants breached their fiduciary obligation to the minority once again and caused United Financial and its controlling shareholders to become inextricably wedded to a conflict of interest between the minority stockholders of each corporation. Alternatives were available to them that would have benefited all stockholders proportionately. The course they chose affected the minority stockholders with no less finality than does dissolution ( In re Security Finance Co., supra, 49 Cal.2d 370) and demands no less concern for minority interests. (16) In so holding we do not suggest that the duties of corporate fiduciaries include in all cases an obligation to make a market for and to facilitate public trading in the stock of the corporation. But when, as here, no market exists, the controlling shareholders may not use their power to control the corporation for the purpose of promoting a marketing scheme that benefits themselves alone to the detriment of the minority. (17) Nor do we suggest that a control block of shares may not be sold or transferred to a holding company. We decide only that the circumstances of any transfer of controlling shares will be subject to judicial scrutiny when it appears that the controlling shareholders may have breached their fiduciary obligation to the corporation or the remaining shareholders.