Corporations - Controlling Shareholders and Related Topics

Question 1

Traditional Rule regarding shareholder duties to each other

Answer 1

Outside the close corporation, shareholders generally do not owe fiduciary duties to each other or to the corporation. They can act in their own self-interest

Question 2

Controlling Shareholders Duties

Answer 2

OWES A DUTY - A shareholder who also occupies a control position (such as a director position) or whose ownership is such that she has working control over the corporation OWES A FIDUCIARY DUTY to minority shareholders and, sometimes, to others (including the corporation).

He cannot use a dominant position for individual advantage at the expense of minority shareholders of the corporation.

commonly a problem in CLOSE CORPORATIONS, but could come up in public as well

Question 3

Sale of Controlling Shareholder’s interest - What is a “Control Premium” ?

Answer 3

Because of his control, the controlling shareholder may be able to sell his shares at a premium. That means he can sell them for more than their economic value as a percentage of ownership in the company - this is because his stock carries with it the power to control the corporation - ie CONTROL PREMIUM

If he sells the stock for more than its economic worth, the excess he receives is called the “control premium”

GENERAL RULE: he gets to keep the control premium

BUT courts may impose liability in this situation IF something else happened too, like

(1) controlling shareholder sold to looters without making a reasonable investigation
(2) controlling shareholder de facto sells a corporate asset
(3) controlling shareholder sells a seat on the board

Question 4

In what situations will a court impose liability on a controlling shareholder for his sale of his interest?

Answer 4

Court will impose liability on the controlling shareholder for his sale of his interest in the following situations:

(1) LOOTERS - controlling shareholder sold to LOOTERS without making a reasonable investigation.
-watch for facts that would put a reasonable person on notice of a problem - e.g. agent approaches controlling SH on behalf of an undisclosed principal
REMEDY: we disgorge seller’s profit AND seller is probably liable for all damage to the corporation

(2) controlling shareholder de facto sells a corporate asset
-this s where the buyer has no interest in running the corporation, but bought the stock just to get access to corporation assets. If often comes up with looting. Because an individual has no right to sell corporate assets, what is the remedy?
REMEDY: all shareholders should share in the premium

(3) controlling shareholder SELLS A SEAT ON THE BOARD
- Fiduciaries cannot sell positions - e.g. controlling shareholder sells controlling interest and agrees that she and “her” directors will resign from the board. It is one thing to have the new controlling shareholder elect new directors. It is another, though, to sell seats on the board
REMEDY: DISGORGE PROFITS

Question 5

FREEZE OUTS

Answer 5

All mergers must have a legitimate corporate purpose, even though approved by the requisite number of shares.

FREEZE OUT mergers are aimed solely at cashing out minority shareholders unfairly. Usually, majority shareholders cause their corporation to merge with another corporation which they own. The minority shareholders’ shares are purchased for cash, so they have no interest in either corporation. Courts might protect the minority shareholders.

courts will look at the transaction as a whole to see if there is

(1) Fair price (whether the deal is tainted by self-dealing or fraud)
(2) fair dealing with the minority shareholders; and
(3) a legitimate corporate purpose for the merger

Question 6

INSIDER TRADING

Answer 6

MARKET TRADING ON INSIDE INFORMATION - in NY, If directors or officers profit from market trading in the corporation’s securities through the use of “inside” information gained in their official positions, they must account for the profits to the corporation because the Director or Officer has breached a duty to the corporation by doing this (so it would likely be DERIVATIVE suit bc claim brought by corporation)

Question 7

INSIDER TRADING: NON-DISCLOSURE of SPECIAL FACTS

Answer 7

NON-DISCLOSURE OF “SPECIAL FACTS” - all directors and officers (and probably controlling shareholders) owe a duty not to trade on “special facts” in a securities transaction with a non-insider. - ie they cannot trade on secrets; they must abstain or ensure disclosure so others are on the same footing - THIS IS COMMON LAW INSIDER TRADING
–what are “special facts” ? those a reasonable investor would consider important in making an investment decision

WHO can sue for insider trading on “special facts”? – a shareholder with whom the director or officer deals and violates the special facts

Note: it is a shareholder to whom the insider breaches a duty (this is a direct suit, not derivative, bc you are suing for personal damages)

MEASURE OF DAMAGES: difference between price paid and value of stock a reasonable time after public disclosure
A shareholder with whom the director or officer deals and violates the special facts doctrine

good example on p.62 of handout