Opinion ID: 1923357
Heading Depth: 1
Heading Rank: 2

Heading: Consequences. What are the consequences of the Craigs' breach of fiduciary duty?

Text: A. The minority stockholders assert that they are not liable on the Bank's $49,000 note and that the proceeds of liquidation must be applied on the note for $36,000, relieving them of liability. We recently stated that we have never wavered from our insistence that those holding fiduciary positions must act with a high degree of fidelity; nor have we been reluctant to deny enforcement to contracts which violate that duty or which induce others to do so. Rowen, 282 N.W.2d at 650. In Rowen, we found that the transaction breached a fiduciary duty. We stated, The transaction was thus contrary to public policy. We have long held contracts contrary to public policy are unenforceable. Id. As between the corporation and minority stockholders, on the one hand, and the Craigs, on the other, the note for $49,000 to the Bank is a nullity because it was made in violation of the Craigs' fiduciary obligation and is contrary to public policy. B. What then is the situation as between the corporation and minority stockholders, on the one hand, and the Bank, on the other? If the Bank participated in the Craigs' breach of trust, it likewise stands responsible for the consequences. The editors state in 18 C.J.S. Corporations § 142 (1939): If there is not only not a full and fair disclosure by a promoter in dealings with the corporation, but affirmative misrepresentation, fraud, and deceit, then not only the promoter, but other persons as well, who stand in no fiduciary relation toward the corporation or its members, but who, with knowledge of the fraud, concur with the promoter in carrying out his fraudulent scheme, will become liable to the corporation in an action for what it has lost thereby. Likewise, third persons who participate with promoters in a fraud upon subscribers for stock in a corporation will be jointly and severally liable with the promoters to such subscribers for the fraud as in other cases of joint tort-feasors. Such liability on the part of third persons participating with promoters in a fraud upon the corporation or upon subscribers for its stock exists irrespective of their motives or the degree of their culpability, and although they originally may not have been parties to the fraudulent scheme and may not have shared at all in the profits of the fraud. To the same effect regarding breaches of fiduciary relations, see Rowen, 282 N.W.2d at 654 (We have already pointed out all who assist or cooperate in the breach of fiduciary dutieswhether directors or notare liable for the resulting damage.); Des Moines Bank & Trust Co., 243 Iowa at 1082, 51 N.W.2d at 217 (All persons conspiring or co-operating with or aiding and abetting the officers or directors of a corporation in defrauding the corporation are equally liable with them.); Adolf Gobel, Inc. v. Skipworth, 232 Iowa 382, 388, 3 N.W.2d 551, 554 (1942) (All persons participating in a breach of trust are liable as principals to the beneficiaries.). The question as to the Bank, therefore, is whether it knew of the Craigs' breach of trust and participated in it: If so, then the court will refuse to enforce the note for $49,000. The minority stockholders urge that Mr. Pechacek arranged the entire capitalization of the corporation, that he was attorney for the Bank and that his knowledge was the Bank's knowledge. The Bank responds that Mr. Pechacek was the attorney for the corporation and his knowledge could not be charged to his other client, the Bank. We need not decide the issue of vicarious knowledge through Mr. Pechacek, for we are convinced from the record that Emerine himself, senior vice president of the Bank and of long experience in banking, knew that the loan of $49,000 to the corporation was for the Craigs' stock. In addition to the testimony to this effect, the evidence shows that Emerine knew the background and development of this financing running back to the SBA loan application. He knew that the Craigs had only $3000 in money. The loan he made of $49,000 was the exact amount the Craigs needed above their own $3000 to acquire their 52,000 shares. Emerine verified that the other stockholders' money had actually been paid in before he made the loan. He made the loan to the corporation, not to the Craigs as principals, and participated with his eyes open in the Craigs' breach of trust. As between the corporation and minority stockholders on the one side, and the Bank, on the other, the note for $49,000 is a nullity. IV. Absence of stockholders' demand. The Bank contends that a derivative suit cannot be maintained by the minority stockholders because of their failure to allege efforts to have an action brought by the directors or other shareholders or to allege sufficient reason for not making such effort. Iowa R.Civ.P. 44. This contention raises the threshold question whether the action is really a derivative suit. Actions against promoters by stockholders or creditors may be to redress wrongs against them rather than derivative suits to redress wrongs against the corporation. This is commonly the case, as where promoters induce prospective stockholders to buy worthless stock or persuade creditors to extend credit improvidently, by the promoters' fraudulent representations or machinations. Cases of that sort are Downey v. Byrd, 171 Ga. 532, 156 S.E. 259 (1930), and Frick v. Howard, 23 Wis.2d 86, 126 N.W.2d 619 (1964). See McCandless v. Furlaud, 296 U.S. 140, 56 S.Ct. 41, 80 L.Ed. 121 (1935), rehearing denied, 296 U.S. 664, 56 S.Ct. 304, 80 L.Ed. 473 (1936); H. Henn, Corporations § 105 (2nd ed. 1970) (Their remedies would be asserted in direct actions by themselves rather than direct actions by the corporation or derivative actions by shareholders.). On the other hand, actions by stockholders against promoters readily come to mind in which the objective is to obtain relief for the corporation for wrongs done to the corporation itself. These are essentially derivative actions whether the breach of trust is by promoters, directors, or others standing in fiduciary relationships. See Holden v. Construction Machinery Co., 202 N.W.2d 348, 365-66 (Iowa 1972) (demarcation between nonderivative and derivative aspects of suit). What is the nature of the present action? The action was initiated by the Bank as a creditor of the corporation against the Craigs, the corporation, and the three minority stockholders. The Bank held a fund obtained on liquidation and desired a declaration of rights and obligations. It claimed the right to apply the fund to its notes of $49,000 and $36,000 and it asked for judgment against defendants for the deficiency on the notes (to the amount of $12,000 and interest for each minority stockholder). The Craigs and the corporation answered and counterclaimed, praying for dismissal and for an accounting of the fund. The minority stockholders answered, asking for dismissal and for imposition of a trust on the corporation assets, application of the assets for the benefit of the minority stockholders, and application of the liquidation assets to the note of $36,000. They also counterclaimed and cross-claimed for breach of trust. They named the corporation as a co-party with them in these pleadings, but they alleged breaches running to themselves and requested relief for themselves. They prayed for judgment against the Craigs and the Bank for the price they paid for their stock, for punitive damages, and for attorney fees. Finally, this appeal is by the minority stockholders themselves; they have not included the corporation as an appellant. In their brief in this court the minority stockholders state their desired relief as follows: A declaratory judgment should have issued on the basis of the transactions as they were intended and not as prayed by the Bank for a declaratory judgment based upon a series of instruments prepared by their counsel. In view of the self-dealing, omissions, misrepresentations and overt fraud practiced by Guy and Diane Craig and the Bank herein, the declaratory judgment should have impressed a trust upon the proceeds of the sale of corporate assets and applied these proceeds to the note guaranteed by the minority stockholders. Any amounts remaining should have been paid to the corporation and applied towards attorneys fees for the minority shareholders. Finally, the minority shareholders should have been awarded exemplary damages against the Bank who acted as a catalyst throughout the entire course of dealing as being the only method of firmly punishing and deterring those similarly situated in the conduct of their future business affairs. From all of this and as the claims now stand, we conclude that in essence the case is a dispute between the Bank and the minority stockholders over the fund created by the liquidation, the foreclosure, and the checking account balance. The Bank desires to apply that fund in such way as to hold the minority stockholders on their guaranties, that is, by applying the fund to the notes of $49,000 and $36,000 and interest. The minority stockholders desire to have the fund applied to the note of $36,000 and to have the note of $49,000 adjudged invalid, so as to discharge them. They also want judgment for attorney fees and punitive damages. We hold that the minority stockholders are seeking relief for themselves, and that the action is not derivative in nature. Hence rule 44 of the Rules of Civil Procedure has no application.