United States: California Court of Appeal Clarifies Rights Of Dissenting Minority Shareholders Under California Corporation Code § 1312(b)

In Busse v. United Panam Fin. Corp., No. G046805, 2014 Cal. App. LEXIS 11 (Cal. App. Jan. 8, 2014), the California Court of Appeal, Fourth Appellate District, held that when parties to a buyout are under common control, dissenting minority shareholders have the right to set aside or rescind an invalid corporate buyout under Section 1312(b) of the California Corporations Code.  The Court also held that dissenting minority shareholders may not seek monetary damages under Section 1312(b).  This decision clarifies that Section 1312(b) acts as a limited exception to Section 1312(a) of the California Corporations Code by providing dissenting shareholders not only with the general remedy of appraisal, but also with the right to stop or rescind a buyout if the transaction is invalid.  Furthermore, Busse emphasizes that dissenting shareholders may not seek damages arising out of a buyout, even in common control situations.

Plaintiffs were minority shareholders of United Panam Financial Corporation ("Panam"), a publicly traded company that made subprime loans on used cars.  Defendant Guillermo Bron ("Bron") owned 38% of Panam's stock and generally had power over the corporation's affairs.  Bron allegedly developed a buyout scheme in which he and his partner would acquire Panam's stock at a bargain price.  In furtherance of this plan, Bron allegedly had Panam's directors set up an independent committee that valued the stock far below book value.  Later, Panam's shareholders approved the buyout by Bron's group, and the transaction was completed sometime after February 24, 2011.

Plaintiffs filed a class action for breach of fiduciary duty and sought either to rescind the buyout or to receive rescissory damages under Section 1312 of the California Corporations Code.  Section 1312 governs the rights of minority shareholders who dissent from corporate buyouts or mergers.  Section 1312(a) limits the rights of dissenting minority shareholders exclusively to an independent appraisal of their shares' value.  Consequently, under Section 1312(a), dissenting shareholders do not have a right at law or in equity to attack the validity of a buyout or merger.  Section 1312(b), however, provides that, if the parties to a merger or buyout are under common control:

[Section 1312(a)]does not apply to any shareholder . . . who has not demanded payment of cash for that shareholder's shares pursuant to [chapter 13]; but if the shareholder institutes any action to attack the validity of the reorganization or short-form merger or to have the reorganization or short-form merger set aside or rescinded, the shareholder shall not thereafter have any right to demand payment of cash for the shareholder's shares pursuant to [chapter 13].

The primary question presented in Busse was whether Section 1312(b) provided dissenting minority shareholders with the right to sue for rescissory damages (i.e., monetary damages).

The trial court sustained Bron's demurrer, reasoning that (1) plaintiffs' complaint did not sufficiently allege Bron's common control and Section 1312(b) was therefore inapplicable and (2) rescissory damages are not available under Section 1312(b).  Plaintiffs appealed.

The Court of Appeal reversed the trial court's decision that plaintiffs failed to allege sufficient facts showing Bron held common control.  Common control — which occurs if one party is directly or indirectly controlled by, or under common control with, another party to a transaction — must exist for Section 1312(b) to apply.  The Court of Appeal determined Bron held at least indirect control over Panam because Bron possessed 38% of the voting power of Panam's shareholders, Bron was chairman of the board of directors, and Bron acknowledged he possessed substantial influence over the company's affairs.  Thus, the Court of Appeal concluded that plaintiffs sufficiently alleged facts showing Bron held common control.

Next, the Court of Appeal addressed whether under Section 1312(b) Panam's dissenting minority shareholders possessed the right to rescind the buyout or, in the alternative, to receive "rescissory damages."  The Court affirmed the trial court's judgment that under Section 1312(b) Panam's dissenting minority shareholders possessed the right to rescind or set aside the buyout.  Furthermore, the court affirmed that under Section 1312(b) Panam's dissenting shareholders were barred from seeking rescissory damages.

The Court of Appeal began its discussion of shareholders' rights under Section 1312(b) with a review of the legislative and judicial history of Section 1312.  The history of Section 1312 made clear that courts and the legislature intended to limit dissenting shareholders' remedies to an appraisal of their shares.  With this limitation in mind, the legislature recognized the potential for abuse in transactions where parties to a buyout are under common control.  Indeed, in these transactions the controlling party is, in effect, dealing with itself.  To protect minority shareholders from abuse in common control situations, the Court of Appeal determined Section 1312(b) provides a dissenting minority shareholder not only with an appraisal remedy, but also with the remedy of setting aside or rescinding a buyout.  However, the Court found this was the only additional remedy available to shareholders, and the courts and legislature never intended to provide minority shareholders with the right to seek monetary damages under Section 1312(b).

Thus, while the Court of Appeal affirmed the trial court's judgment that plaintiffs were precluded from seeking "rescissory damages," it reversed the trial court's judgment that plaintiffs did not allege sufficient facts to demonstrate Bron's common control and found that Section 1312(b) applied.  Consequently, the Court of Appeal remanded for the resolution of whether the minority shareholders of Panam may rescind Bron's buyout under Section 1312(b).

Busse clarifies what remedies are available to dissenting minority shareholders under Section 1312(b).  Shareholders have the general right to an appraisal of their shares' value.  Additionally, Section 1312(b) gives dissenting shareholders the right to rescind or set aside a merger or buyout.  This additional remedy helps protect minority shareholders in common control situations, which are particularly susceptible to fraud and abuse.  However, minority shareholders are still barred from seeking monetary damages or, as stated in Busse, rescissory damages under Section 1312(b).

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