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Stock Price: Majority Shareholders Owe Fiduciary Duties to Minority Shareholders
Under California law, majority shareholders of a corporation owe various fiduciary duties to the other shareholders. This has long been the case. See Jones v. H.F. Ahmanson & Co., 1 Cal.3d 93 (Cal. Supreme Court 1969). In general, majority and/or controlling shareholders 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. As the court in Ahmanson stated: “Majority shareholders may not use their power to control corporate activities to benefit themselves alone or in a manner detrimental to the minority.” Put simply, there can be no self-dealing.
The most common type of self-dealing is with respect to the price of shares. It is almost the definition of a breach of fiduciary duty if the majority shareholders negotiate a higher price for their shares than the price that is paid for the shares of the minority shareholders. Here is a brief discussion with an example from a recent case out of the US District Court for the Southern District of California
San Diego Corporate Law: Fiduciary Duties
As noted, Ahmanson is the leading case in California. In that case, the 85% of the stockholders in a savings and loan company set up a holding company. These majority stockholders then — amongst themselves — set up a stock swap whereby the stockholders exchanged their stock in the parent company with those of the holding company. The holding company thereby became the 85% owner of the parent. No swap or exchange was offered to the 15% minority stockholders. Subsequently, through various actions taken by the parent company, the value of the shares of the holding company were vastly increased but, essentially, the 15% of shares for the parent company became unsaleable.
The minority shareholders in the parent company sued for breach of fiduciary duty. They argued that majority had engaged in self-dealing. The California Supreme Court agreed. The court held that the majority had breached their fiduciary duties by using their majority control to obtain an advantage not made available to all stockholders.
San Diego Corporate Law: The Case of Melcher v. Fried
A recent case gives us another good example of a majority scheming to defraud minority shareholders. See Melcher v. Fried, Case No. 16-cv-02440 BAS (BGS) (US Dist., SD California May 29, 2018) which we discussed on a different legal point in another article.
Melcher involved a corporation called Face It Corp. which was a “social engagement and mobile customer care solution provider.” In 2011, the founders and majority shareholders of Face It obtained an investment from Carl Melcher and his limited partnership called Melcher Family Limited Partnership (“MFLP”). MFLP purchased 30.875% of Face It’s stock for $3 million.
However, by 2013, Face It was having financial troubles. After Melcher and MFLP refused to make an additional investment, the President and CEO of Face It, Lance Fried, began negotiating with another company to buy out Face It. The purchase price discussed was $10 million. Had MFLP sold its shares to the new company, it would have recouped its $3 million investment (30.875% of $10 million).
However, Fried did not tell MFLP about the negotiations with the other company. Rather, Fried suggested to Melcher that Face It repurchase MFLP’s shares for $1.5 million. MFLP agreed and eventually resold its shares to Face It, losing half of its original investment. About a month later, Fried consummated the sale of Face It Corp. to the other company for about $10 million.
San Diego Corporate Law: Clear Breach of Fiduciary Duty
The case cited above has not yet moved forward on the issues concerning Fried’s breach of fiduciary duty owed to MFLP. The opinion cited dealt with other issues in the case. But it is clear from the facts that MFLP has a very good and compelling case of breach of fiduciary duty by Fried. On the facts described by the court, there is no question that Fried engaged in self-dealing. Without disclosing the possible buyout by another company, Fried arranged to purchase MFLP shares at half their original price and then sold those shares a month later at about twice what he paid.
Contact San Diego Corporate Law Today
If you would like more information about the fiduciary duties owed by shareholders of a California corporation, or if you need legal assistance with business contracts, forming corporations, partnerships, or limited liability companies, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. For three years running, Mr. Leonard has been named a “Rising Star” by SuperLawyers.com. Mr. Leonard can be reached at (858) 483-9200 or via email.
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