120 Cal. Rptr. 354 (Cal. Ct. App. 1975)
Alfred S. Johnson Incorporated was incorporated in 1955 to process color photographs for reproduction in printed form.1 Johnson originally owned all 100 shares but sold 20 shares to James DeBaun, the primary salesman, and 10 shares to Walter Stephens, the production manager.2 Johnson died testate on January 15, 1965, and his will named First Western Bank and Trust Company as executor and trustee of a trust holding the remaining 70 shares.3 George Furman, a Bank employee, administered the trust directly while the Bank voted the shares at meetings but left management to DeBaun, Stephens, and estimator Jack Hawkins.4
Under DeBaun and Stephens' guidance, the corporation's net after-tax profits increased from $15,903 in fiscal 1964 to $56,710 in the first ten months of 1968.5 In October 1966, the Bank's trust department determined the investment unsuitable and decided to sell the 70 shares without notifying anyone connected with the corporation.6 The Bank obtained an appraisal from General Appraisal Company valuing the corporation at $326,000 as a going concern and retained W.H. Daum Investment Company to find a buyer.7
In 1968, Raymond J. Mattison offered to buy the shares through S.O.F. Fund, an inter vivos revocable trust.8 The Bank received a Dun & Bradstreet report on May 24, 1968, noting pending litigation, bankruptcies, and tax liens against Mattison's entities.9 Bank vice-president I. Earl Funk knew of an unsatisfied 1957 superior court judgment against Mattison for fraud obtained by the Bank's predecessor.10 After Mattison proposed using corporate assets to secure the purchase price balance, the Bank entered an exchange agreement on July 11, 1968, transferring the shares to Mattison as trustee while retaining a pledge and requiring a security agreement on corporate assets.11
Mattison assumed control on July 11, 1968, and began diverting $73,144 in cash and assigning receivables to his shell company MICO.12 DeBaun left the corporation in September 1968, and Stephens left in December.13 Although aware of some misconduct, the Bank took no action until April 25, 1969, when it filed for a receiver.14 It later voted to replace the board but did not pursue ouster until June 20, 1969, when it shut down operations.15 At that point, the corporation's debts exceeded assets by over $200,000, and the Bank sold remaining assets for $60,000.16
DeBaun and Stephens filed an individual action for damage to their shareholdings and a derivative action on behalf of the corporation.17 After the Bank demurred to both complaints, the individual action was dismissed and the derivative action proceeded to trial before a judge.18 The trial court entered judgment for the corporation, and the Bank appealed.19
Whether a majority shareholder owes a duty of reasonable investigation and due care to the corporation when selling its controlling shares if possessed of facts establishing a reasonable likelihood that the purchaser intends to loot the corporation?20
In any transaction where the control of the corporation is material, the controlling majority shareholder must exercise good faith and fairness from the viewpoint of the corporation and those interested therein.21 That duty of good faith and fairness encompasses an obligation of the controlling shareholder. When in possession of facts such as to awaken suspicion and put a prudent man on his guard that a potential buyer of his shares may loot the corporation of its assets, the shareholder must conduct a reasonable and adequate investigation of the buyer.22
Yes. The Bank was the controlling majority shareholder of Alfred S. Johnson Incorporated because it held and voted the 70 shares originally owned by Johnson at the time of his death.23 As the Bank negotiated the sale with Mattison through S.O.F. Fund, it possessed facts that would have alerted a prudent person that Mattison was likely to loot the corporation.24
The facts included the Dun & Bradstreet report received on May 24, 1968, which noted pending litigation, bankruptcies, and tax liens against entities controlled by Mattison.25 Bank vice-president I. Earl Funk had personal knowledge of an unsatisfied 1957 superior court judgment against Mattison for fraud obtained by the Bank's predecessor.26 Armed with that knowledge, the Bank owed a duty of reasonable investigation and due care to the corporation and its minority shareholders.27
Knowing of counsel McCarrol's refusal to express an opinion on pending litigation, and that the information was publicly available, the Bank closed its eyes to the obvious source of further information in the public records of Los Angeles County.28 Instead, it relied on Mattison's reception at the Jonathan Club and his representation by a former trust officer of the Bank's predecessor.29 The Bank further agreed to terms that invited looting by permitting the use of corporate assets to secure the unpaid balance of the purchase price.30
The Bank also required Mattison to maintain the corporation's banking business with the Bank.31 The record establishes both the existence of the duty and its breach by the Bank in its sale of the controlling shares.32
The Bank breached its duty of reasonable investigation and due care to the corporation.33
Whether the conduct of minority shareholders in agreeing not to sell their shares without mutual consent constitutes contributory negligence barring assertion of the corporation's claim?34
Contributory negligence requires that the conduct of the minority shareholders induce or cause the majority shareholder to sell the controlling shares to a purchaser who loots the corporation.35
No. DeBaun and Stephens agreed between themselves not to sell their combined 30 percent of the shares unless both consented, but that agreement did not induce or cause the Bank to sell its 70 shares to Mattison.36 The decision to sell to Mattison originated entirely with the Bank after it determined the investment was unsuitable for the trust and retained Daum to find a buyer. DeBaun and Stephens refused offers from other potential buyers and submitted their own offer for the Bank's shares, which the Bank rejected as inadequate.37 Their conduct in limiting the market for the shares played no role in the Bank's choice of Mattison as purchaser or in the subsequent looting of the corporation.38
The conduct of DeBaun and Stephens does not constitute contributory negligence.39
Whether the trial court's findings of fact adequately cover material matters and are supported by substantial evidence?40
Findings of fact that are immaterial are of no significance on appeal so long as the material findings support the judgment and are in turn supported by substantial evidence.41 An appellant's argument that findings lack support must address all evidence rather than only the evidence favorable to the appellant.42
Yes. The trial court's findings include those that support the judgment on the theory that the Bank breached its duty as controlling shareholder by failing to investigate Mattison and by structuring the sale to permit looting of corporate assets.43 The findings rest on substantial evidence in the record, including the Dun & Bradstreet report, the unsatisfied fraud judgment known to Bank vice-president Funk, the public records of 38 unsatisfied judgments and 54 pending actions against Mattison or his entities, the terms of the exchange agreement permitting use of corporate assets as security, and the rapid diversion of $73,144 in cash and assignment of receivables to MICO after Mattison took control.44
The Bank's argument recites only evidence favorable to it and ignores the mass of evidence supporting the material findings.45
The trial court's findings of fact adequately cover material matters and are supported by substantial evidence.46
Whether the trial court's measure of damages, including net asset value plus anticipated future earnings and an obligation to discharge valid creditor claims, is excessive?47
Damages must compensate for all detriment proximately caused by the breach, including loss of assets and loss of earning power.48 Because the derivative action is equitable in nature, the court may frame part of its judgment in terms of an obligation dependent upon future contingencies rather than at a fixed dollar amount.49
No. The trial court properly determined the value of the corporation as a going concern at the time of the breach by adding to the value of tangible assets a goodwill factor computed on the basis of future net income reasonably anticipated from the corporation's past record of earnings, which showed dramatic increases under DeBaun and Stephens.50 This measure compensates for the loss of both assets and earning power.51
The order requiring the Bank to pay all valid claims of creditors is necessary to restore the corporation to the condition in which it existed prior to the Bank's breach, when it was a going concern with substantial net assets rather than a negative net worth of about $218,000.52 Total damages therefore equal the sum necessary to restore the negative net worth plus the value of tangible assets plus going business value determined with reference to future profits reasonably estimated from the past record.53
The trial court's measure of damages is not excessive.54