Obligations Arising Out Of Transactions In Shares

AuthorJames D. Cox/Thomas Lee Hazen
ProfessionProfessor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
12.11 Rule 10b-5 and the Duty to Disclose
12.12 Rule 10b-5 and Control of
Corporate Mismanagement
§ 1. T S  C C
A purchaser of a controlling interest in a corporation often pays a pre-
mium above the prevailing market price for the stock.1 Courts gener-
ally hold that any premium paid to acquire controlling stock is merely a
reflection of the greater value of that stock due to its control potential,
and as such it is a natural con sequence of stock ownership and can not be
considered a corporate asset.2 More generally, every stockholder, includ-
ing the controlling stockholder, is at liberty to dispose of her shares at
any price as long as there is no cause to believe or suspect t he sale will
proximately harm the corporation or its stockholders, or will necessa r-
ily interfere or mislead the other stockholders in exercising t heir same
right to sell.3
§ . F D  S
 C C
Numerous courts have held that a seller of control may become liable
in certain ci rcumstances for the harm to the corporat ion caused by the
purchaser. Clearly, however, the liability is far f rom absolute.4 In a lead-
ing case5 after the transfer of a controlling interest, the purchasers pro-
ceeded to loot the corporation. The court held the control sellers liable
and reasoned that, at a minimum, the transferor of a controlling block
of share s owes a duty to the cor poration to prot ect it when “the c ircum-
stances surrounding the proposed tra nsfer are such as to awaken suspi-
cion and put a prudent man on his guard—unless a reasonably adequate
investigation discloses such fact s as would convince a reasonable person
that no fraud is intended or likely to result.6 When the circumstances
do awaken suspicion in the reasonably prudent person, t he seller of con-
trol has a duty to make such inquiry as a reasonably prudent person
would make.7 Liability does not attach, however, merely for the exercise
248 | C  C G: C  L
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of poor business judgment.
8 A minority view requires proof that the
controlling stockholder had actual knowledge, not inquir y notice.9
The cases illustrate the highly factual nature of a court’s determi-
nation in sale of control litigation. This orientation is embraced by the
American Law Institute, whose provision makes t he controlling stock-
holders’ fiduciary obligation depend in part on t he transfer not occu r-
ring when “it is apparent from the circu mstances that t he purchaser is
likely” to violate the purchaser’s fiduciary obligations so as to acqu ire a
substantial f inancial benefit for himself.10
Looting and mismanagement by the purchaser of control are clas-
sic types of misbehavior that form the backdrop for inquiring whether
the sellers suspicions were sufficiently piqued for there to have been a
breach in disposing of control. Many cases do not involve looting or mis-
management by the new controlling stock holder but rather the diver-
sion of a potential premium from t he noncontrolling stock holders by the
former controlling stock holder. This occurs when the purchaser offers
to acquire at a substantial premium an asset of t he company11 or all the
shares of the company,12 and the controlling stockholder diverts most
or all of the premium to hi mself by converting t he offer for the asset
or all the shares to a transaction in which t he controlling stockholder
sells only his shares to t he third party at a substantia l premium. In these
situations, the courts embrace the idea that the f iduciary obligation of
controlling stock holders is not to divert or appropriate for themselves an
offer or opportunity that a third-party purchaser is prepared to extend
that would benefit all the stock holders proportionally. The language of
the American Law I nstitute’s provisions is broad enough to proscribe the
controlling stock holder’s appropriation of the corporation’s opportun ity
to sell its asset at a premium,13 but these provisions appear to proscribe
the conversion of an offer for all the stock holders’ shares only if the
controll ing stockholder se cretly acquire s shares from t he noncontrolling
shareholders as part of his disposition of a control block to a th ird party.14
No case has held, however, that the controlling stockholder breaches
its duty by failing actively to i nitiate transactions that are likely to yield
a premium for the noncontrolling stockholders’ shares.15 The control-
ling stockholder’s fiduciary dut y with respect to dispositions of control
is breached by commission, not omission.16
When there has been a breach of duty in the transfer of control,
the more frequently invoked remedy is to require t he vendor of control
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to disgorge the control premium.17 It is also possible to recover for any
assets or profits lost because of the misbehavior of the new controll ing
stockholder.18 The purchaser of control is liable for his seller’s breach on
a theory of civil conspiracy.19
§ 1. R  D  C
  S  C
In general, a director or other off icer, even though elected for a fixed
term, may resign at any ti me with definite notice.20 Unless a f uture date
or acceptance by the corporation is specified, resignation takes effec t at
once, and no acceptance is necessary.21 There are occasions, however,
when directors and officers are not free to quit with impun ity. Today it
continues to be true t hat directors can not accept payment in any form
or guise for their resignations and delivery of control or for the substi-
tution of others in their place, and they are accountable for any monies
so received.22
If directors ag ree to sell their shares, resign from t heir offices, pro-
cure other shareholders to sell their sha res, and hand over control to
irresponsible persons, they may be l iable under various theories. For
example, the directors m ay be liable to fellow shareholders for the profit
or excess price that they received over other shareholders whom they
persuaded to sell their shares, or to the corporation for secret profits
that were obtained by their off icial acts and for damages caused by the
wrongful acts of their tra nsferees and successors.
§ . T S   C O
The seller of a block of shares may lawfully arrange for sitting d irectors
to resign seriatim and for t he nominees of her purchaser to be appointed
to the board vacancies created by the resig nations, provided the block so
transferred represents working control. To be sure, it is always possible
for one who purchases control between the annual election of direc-
tors to simply wait until the next a nnual meeting or to seek a special
meeting at which the new controlling stockholder’s nominees can be
elected. This rarely occurs, because the new holder of control wishes
her influence to be felt immediately. There are sound policy reasons
supporting this desire.23 Even with a sale of less than a majority of the
250 | C C  G: C  L
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