How California Contracts can be Held Void as Against Public Policy

In general, as long as San Diego and California contracts meet the requirements with respect to being properly formed, such are enforceable in California courts. However, there are some circumstances in which courts will refuse to enforce a contract or a provision in a contract because it contravenes the law or stands in violation of “public policy.” As an example, an attempt to enforce a non-compete agreement against a former employee will generally not be allowed because non-compete agreements are generally barred in California. This article discusses some of the circumstances under which California courts will void contracts based on public policy, using a case exahttps://sdcorporatelaw.com/business-newsletter/non-compete-agreements-san-diego-valid/mple from corporate law.

San Diego Corporate Law: General Legal Principles of Civil Code § 1668

In general, courts frown upon efforts by persons to contractually insulate themselves from their own negligent or wrongful behavior. This disfavor has been codified at Cal. Civil Code, § 1668 which states in pertinent part:

“All contracts which have for their object, directly or indirectly, to exempt anyone from the responsibility for his own fraud or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.”

Furthermore, if a contract is in contravention of “public policy,” the contract will not be enforced. As discussed below, these “public policies” are found in California statutes and cases.

San Diego Corporate Law: Neubauer v. Goldfarb

A good example comes from the case of Neubauer v. Goldfarb, 133 Cal. Rptr. 2d 218 (Cal. App. 2nd Dist. 2003). In that case, the two majority shareholders of a small, closely held corporation — holding 60% of the stock — entered into an agreement to buy out the shares of the 40% minority shareholder. After negotiations, the buy-out price was agreed to be $70 per share. The buyout agreement contained this language:

“[The Minority Shareholder] acknowledges that neither [Company] nor its officers, directors or controlling shareholders have any fiduciary duty to [minority shareholder] or [the Company] in connection with the execution of this agreement or a sale including, but not limited to, the fairness of the overall consideration or the allocation thereof.”

Less than 90 days later, the majority shareholders sold 65% of the shares for approximately $347 per share to a third party. The minority shareholder sued for breach of fiduciary duty and other causes of action.

In general, directors and majority shareholders owe a duty of fairness to minority shareholders. Among the key aspects of this duty is to not obtain for themselves a better bargain than is provided for the minority shareholders.

In response to the breach of fiduciary duty claim, the majority shareholders argued to the court that the above quoted language was a voluntary waiver of any claim of breach of fiduciary duty. The trial court agreed, but the California Court of Appeals reversed.

The Court of Appeals began by reciting the general legal principle that the law will not allow an individual to insulate themselves from their own negligence and/or wrongful behavior. The court also stated that the general legal principle was more vigorously enforced in situations in which there exists fiduciary position of trust or confidence. The courts do not countenance the betrayal of trust. Furthermore, the legal principle is more vigorously enforced if there is evidence of fraud or deceit. Finally, the court recited the general legal principle that these types of exculpatory provisions are not enforceable if they affect the public interest.

In this case, the Court of Appeals refused to enforce the waiver language, finding that all three of the above legal principles were violated. First, the court found the language to violate Civil Code § 1668. The court held that the sale of the stock at $70 a share — when the same shares were later sold at $347 per share — was a “willful injury to the … property of another.” Second, despite arguments to the contrary, the court held that the majority shareholders were fiduciaries in a position of trust with respect to the minority shareholder. Finally, the court found the attempted waiver to be against public policy. The court “found” the public policy in the laws and statutes of California. The court noted two “locations” for the “public policy.” First, the court highlighted that the sale/purchase of stocks and shares are “heavily heavily regulated.” This evidenced the importance to and impact on the public of stock transactions. Second, the court referenced Cal. Corp. Code, § 204(a)(10) which provides that articles of incorporation “may not eliminate or limit the liability of directors [to the corporation] for acts or omissions that involve intentional misconduct … or that involve the absence of good faith on the part of the director…” This too evidenced the public importance of stock transactions. If a director cannot be absolved of fiduciary duties in the articles of incorporation, a written contract will not succeed, either. Based on the foregoing, the court stated:

“We conclude, therefore, waiver of corporate directors’ and majority shareholders’ fiduciary duties to minority shareholders in private close corporations is against public policy and a contract provision in a buy-sell agreement purporting to effect such a waiver is void.”

San Diego Business Law: Contact San Diego Corporate Law

If you would like more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides a full panoply of legal services for San Diego and California businesses. Mr. Leonard has been named a “Rising Star” three years running by SuperLawyers.com and “Best of the Bar” by the San Diego Business Journal.  Mr. Leonard can be reached at (858) 483-9200 or via email.

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