460 P.2d 464 (Cal. 1969)
June K. Jones owned 25 shares of the capital stock of United Savings and Loan Association of California and brought this action individually and on behalf of all similarly situated minority stockholders against United Financial Corporation of California, fifteen individuals, and four corporations who were present or former stockholders or officers of the Association.1 The Association, a California-chartered savings and loan association, first issued 6,568 shares of stock on April 5, 1956.2 Of these shares, 987 were purchased by depositors including Jones pursuant to warrants issued in proportion to their deposits, while the remaining shares allocated to unexercised warrants were sold to the then chairman of the board and later resold to defendants and others.3 No additional stock was issued after that date.4
Prior to 1959, fourteen of the nineteen defendants comprised 95 percent of the market for Association shares.5 The shares were not actively traded owing to their high book value, the closely held nature of the Association, and the failure of management to provide investment information or assistance.6 In 1958 investor interest in savings and loan stocks increased, but Association shares did not participate in the resulting price rise.7
On May 8, 1959, defendants incorporated United Financial Corporation of California in Delaware.8 On May 14, 1959, pursuant to a prior agreement, Association stockholders who among them owned a majority of the Association stock exchanged their shares for those of United Financial, receiving a “derived block” of 250 United Financial shares for each Association share.9 After the exchange, United Financial held 85 percent of the outstanding Association stock.10 Minority stockholders were not offered an opportunity to participate in the exchange.11 United Financial's first public offering of 60,000 units, each consisting of two shares and one $100 subordinated convertible debenture, occurred in June 1960 and produced a $6,200,000 return of capital distributed to the original United Financial shareholders.12 A second public offering of 50,000 additional shares plus 600,000 derived shares by the original investors took place in February 1961.13
Shortly after the first public offering, United Financial offered to purchase up to 350 Association shares at $1,100 per share when book value was $1,411.57 and earnings were $301.15 per share.14 In December 1960 the Association president notified minority stockholders that no dividends other than the regular $4 annual dividend would be paid in the near future.15 Defendants then proposed an exchange of United Financial shares for Association stock.16 Under this proposal each minority stockholder would have received approximately 51 United Financial shares of a total value of $2,400 for each Association share.17 When the application for a permit was filed with the California Corporations Commissioner on August 28, 1961, the value of the derived blocks of United Financial shares received by defendants in the initial exchange had risen to approximately $8,800.18 At the hearings held on the application by the Commissioner, representatives of United Financial justified the higher valuation of United Financial shares on the ground that they were highly marketable, whereas Association stock was unmarketable and poor collateral for loans.19 Plaintiff and other minority stockholders objected to the proposed exchange, contending that the plan was not fair, just, and equitable.20 Defendants then asked the Commissioner to abandon the application without ruling on it.21 Plaintiff commenced this action on January 30, 1962.22 The trial court sustained defendants' general and special demurrers to the third amended complaint without leave to amend and entered judgment for defendants; plaintiff appealed and defendants filed a protective cross-appeal.23
Whether a minority shareholder may bring an individual or class action for alleged injury to minority stockholders rather than a derivative action on behalf of the corporation?24
A shareholder's derivative suit seeks to recover for the benefit of the corporation when injury is caused to the corporation that may not otherwise be redressed because of failure of the corporation to act. An individual action lies when the gravamen of the complaint is injury to the shareholder or a class of shareholders that is not incidental to injury to the corporation.25
Yes. Plaintiff June K. Jones alleged injury to herself and other minority stockholders from the majority's creation of United Financial and the resulting destruction of any market for Association shares, without claiming any injury to the Association itself or seeking recovery for the corporation.26 The stipulated facts show that the exchange and public offerings transferred control benefits exclusively to the majority while rendering Association stock unmarketable except to United Financial.
This created an injury personal to the minority class rather than one shared by the corporation as an entity.
Plaintiff may maintain an individual and class action because the injury alleged is not incidental to any corporate injury.27
Related opinions on this issue
Justice McComb dissented from the holding that a cause of action was stated. He would have affirmed the judgment in favor of defendants. He adopted the reasons expressed by Mr. Justice Shinn and Mr. Justice Moss in the opinions prepared by them for the Court of Appeal.
Those opinions treated the claims as derivative and insufficient to state a cause of action. The dissent concluded that the majority's actions did not violate any fiduciary duty under the reasoning adopted from the Court of Appeal.28
Whether majority or controlling shareholders owe a fiduciary duty to minority shareholders when exercising control over the corporation?29
Majority shareholders, either singly or acting in concert, 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. They may not use their power to benefit themselves alone or in a manner detrimental to the minority. Any transaction in which control is material is subject to the test of inherent fairness from the viewpoint of the corporation and those interested therein.30
Yes. The defendants owned a majority of Association shares and, after the May 14, 1959 exchange, controlled the Association through United Financial's 85 percent ownership.31 They exercised that control by forming United Financial exclusively for themselves, marketing its shares publicly, and later offering to buy minority shares at a discount while withholding dividends, all without extending equivalent participation rights to the minority.32
Majority or controlling shareholders owe a fiduciary duty of good faith and inherent fairness to minority shareholders.33
Whether the formation of a holding company by majority stockholders, the public marketing of its shares, and related transactions with the savings and loan association breached any fiduciary duty owed to minority stockholders?34
Controlling shareholders breach their fiduciary duty when they use their power to obtain an advantage not made available to all stockholders. They must act without regard to the resulting detriment to the minority and in the absence of any compelling business purpose. Alternatives that would have benefited all proportionately, such as a stock split or inclusive exchange offer, must be considered. The transaction is subject to close judicial scrutiny.35
Yes. Defendants incorporated United Financial on May 8, 1959, exchanged only their majority shares for a 250-to-1 derived block on May 14, 1959, then marketed United Financial units publicly in 1960 and 1961 while excluding minority Association stockholders. They caused the Association to support the debentures with its assets, offered to buy minority shares at $1,100 when book value exceeded $1,411, and withdrew an exchange proposal after hearings, thereby destroying any public market for Association shares and locking the minority into a fundamentally altered enterprise.36
The majority's conduct breached the fiduciary duty of inherent fairness, and the complaint states a cause of action for relief.37
Related opinions on this issue
Justice McComb dissented from the holding that a cause of action was stated. He would have affirmed the judgment in favor of defendants. He adopted the reasons expressed by Mr. Justice Shinn and Mr. Justice Moss in the opinions prepared by them for the Court of Appeal.
Those opinions treated the claims as derivative and insufficient to state a cause of action. The dissent concluded that the majority's actions did not violate any fiduciary duty under the reasoning adopted from the Court of Appeal.
Whether the complaint states a cause of action for restraint of trade under the Cartwright Act?38
A cause of action under the Cartwright Act requires allegations of both a purpose to restrain trade and injury to the plaintiff's business traceable to actions in furtherance of that purpose. When the complaint affirmatively shows a purpose unrelated to elimination of competition, no inference of anticompetitive purpose will be drawn from the effect alone.39
No. The complaint alleged that defendants' exchange prevented competition in the market for Association stock and that defendants had comprised 95 percent of that market. It contained no allegation that defendants agreed not to purchase additional Association shares or that elimination of competition was a purpose of the transfer. Instead, the facts showed the purpose was to enable the majority to participate in public profit taking through United Financial.40
The complaint fails to state a cause of action for restraint of trade under the Cartwright Act.41
Whether the action is barred by laches?42
Mere lapse of time without a showing of prejudice to the defendant does not constitute laches. The defense requires both unreasonable delay and resulting prejudice.43
No. The exchange occurred on May 14, 1959, the first public offering in June 1960, the purchase offer in September 1960, the permit application in August 1961, and the action was filed on January 30, 1962. The stipulated facts and complaint contain no indication that this interval caused prejudice to the defendants.44
The action is not barred by laches.45
Whether the class plaintiff purports to represent is properly defined under Code of Civil Procedure section 382?46
A class action under Code of Civil Procedure section 382 requires an ascertainable class and a well-defined community of interest in the questions of law and fact involved. The class of minority stockholders who continued to hold Association stock after the majority exchange satisfies both requirements.47
Yes. The class consists of all minority stockholders of the Association who continued to hold shares after the May 14, 1959 exchange. They share a common interest in whether the majority's formation and marketing of United Financial breached fiduciary duties and caused them injury. The class is readily identifiable without limitation to persons who agree with the plaintiff.48
The class is properly defined and the demurrer on that ground was properly overruled.49