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Liu v. Sun, Cal: Court of Appeal, 2nd Appellate Dist., 3rd Div. 2013

Posted on March 1, 2013. Filed under: Uncategorized |

In Liu v. Sun, Cal: Court of Appeal, 2nd Appellate Dist., 3rd Div. 2013, the appellate court considered an appeal after a bench trial between two 50 percent shareholders of JSL, a corporation. Since this is an unpublished case, I would ordinarily not blog about it. However, there are so many good issues touched on in the court’s decision, that it deserves consideration.

Sun and Liu were both insurance brokers and decided to do business jointly under JSL Insurance Solutions, Inc. However, the parties agreed that the revenues and clients from their earlier solely owned businesses, would remain with the individual and not be part of JSL. Inevitably, the relationship broke down, and numerous instances of wrongful conduct were alleged. In one instance, Liu took $39,000 from the JSL bank account without Sun’s consent. When Sun found out she was angry but did not demand it back right away, because Liu said he needed it for his family. Sun successfully sued him for conversion, and the Court of Appeal rejected Liu’s argument that Sun had ratified the conversion.

Liu contends that Sun “ratified” his wrongful taking of $39,000 of JSL funds during conversations she had with him shortly after he took the money. The testimony Liu cites, however, does not support his argument. Sun testified that she told Liu he had to “return the money,” but he did not have to do so immediately. This testimony does not show that Sun gave her consent to Liu’s conversion before or after he misappropriated $39,000 from JSL. It merely shows that Sun granted Liu leniency in making amends for his tortious conduct.

A couple things to note about this. First, shareholders need to be aware that if they withdraw large amounts of money from the corporate bank account without express authority or consent from the remaining shareholders, they can be held liable for the tort of conversion. Second, taking money out of a bank account that does not belong to you will support cause of action for conversion – even though its not a tangible chattel. Lastly, this is yet another example of why it is important not to rely on oral agreements for significant transactions.

When there is a dispute between shareholders, one side will often claim the other defrauded them or cheated them by not honoring an oral agreement. Of course, there are frequently cases of actual fraud where this happens. But at least as often (if not more so) what one side believes to be fraud is actually an honest misunderstanding about the terms of the agreement. Unfortunately, when it gets to the trial stage it is difficult for either side to believe their adversary was innocently mistaken. Thus, it bears repeating: put your agreements in writing.

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Involuntary Dissolution of a Limited Liability Company under California Law: How is it different from involuntary dissolution of a Corporation?

Posted on January 22, 2013. Filed under: Uncategorized |

California Corporations Code section 1800 provides minority shareholders of corporations a remedy when the controlling ownership abuses its powers.   Corporations Code section 17351 offers similar remedies for aggrieved members and managers of limited liability companies.   Section 17351 provides that a court of competent jurisdiction may decree the dissolution of a limited liability company whenever any of the following occurs:

  1. It is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.
  2. Dissolution is reasonably necessary for the protection of the rights or interests of the complaining members.
  3. The business of the limited liability company has been abandoned.
  4. The management of the limited liability company is deadlocked or subject to internal dissention.
  5. Those in control of the company have been guilty of, or have knowingly countenanced persistent and pervasive fraud, mismanagement, or abuse of authority.

(Corp. Code, § 17351, subd. (a).)

Unlike involuntary dissolution of corporations, section 17351 does not require a minimum level of ownership in order to have standing to petition for dissolution.  Indeed, a manager without any ownership interest in the company would apparently be authorized to bring a dissolution action, although in practice this would almost never happen because the members would remove and replace the manager if they opposed his action.

Section 17351 also differs from Section 1800 (involuntary dissolution of corporations) insofar as it removes (1) persistent unfairness to to a complaining owner; and (2) waste of company property as separate and independent basis for dissolution.  However, these grounds will almost always overlap with mismanagement and abuse of authority, or the protection of the rights and interests of the complaining members, so their omission from the statute is better understood as removing a redundancy than intending to allow persistent unfairness and waste in the context of limited liability companies.

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What is a “minority discount” and why does it matter?

Posted on January 14, 2013. Filed under: Uncategorized |

The “minority discount” is a common issue that arises when valuing someone’s stake in a business.   As one court described it, “[a] minority discount adjusts for lack of control over the business entity on the theory that noncontrolling shares of stock are not worth their proportionate share of the firm’s value because they lack voting power to control corporate actions.” (Maughan v. Correia (2012) 210 Cal.App.4th 507, 520, quoting [Lawson Mardon Wheaton, Inc. v. Smith (1999) 160 N.J. 383, 734 A.2d 738, 747].)  This is distinct from a “marketability discount” which “adjusts for a lack of liquidity in one’s interest in an entity, on the theory that there is a limited supply of potential buyers in a closely-held corporation.”  (Ibid.)

In Maughan v. Correia, (2012) 210 Cal.App.4th 507, plaintiff bargained with her brother for an option to purchase approximately 22% of the corporation’s stock.  Her brother breached his obligations under the option agreement, and the trial court awarded damages equal to a 22% share of the company less the stock option price and a 40 percent minority discount.

The question on appeal was whether the trial court erred by applying the minority discount after subtracting the stock option purchase price.  The appellate court found that the minority discount should have been deducted from the value of 22% of the corporation first, and then the option purchase price should have been deducted from that value.
The trial court’s damages calculation is not consistent with the purpose of the minority discount, which, as the court acknowledged, is to “obtain a fair valuation of a minority interest.” …In addition, the $487,000 price at which [plaintiff] could exercise her option was a bargained-for, firm price mandated by the terms of the stock option agreement—specifically, $262,800 plus interest at two points over the prime rate. That option price was an independently negotiated sum, not tied to the fair market value of [plaintiff]’s interest. …
To be consistent with the law, the purpose of the minority discount, and the parties’ past treatment of this issue, and in fairness to [defendant], the trial court should have applied the 40 percent discount directly to the value of the additional minority interest [plaintiff] was entitled to purchase pursuant to the stock option agreement, so that [plaintiff]’s damages would reflect the true “intrinsic value” of her stock option.
Thus, the Court of Appeal modified the judgment to correct the trial court error by first subtracting the minority discount from plaintiff’s share of the corporation, and then subtracting the purchase price of the option from that amount.  It is worth noting that in the context of the “buy-out” alternative to dissolution proceedings under California Corporations Code section 2000, no minority discount is applied to determine the buyout price of the minority shareholders’ interests.
[I]t is clear that upon distribution of the dissolution proceeds each of the shareholders would have been entitled to the exact same amount per share, with no consideration being given to whether the shares had been controlling or noncontrolling. [¶] Under the valuation approach adopted by the majority commissioners and confirmed by the trial court, however, a controlling shareholder, especially an unscrupulous one, could avoid the proportionate distribution which would follow from an involuntary dissolution simply by invoking the buy-out provisions of [the Corporations Code].  Thus, the very misconduct and unfairness which provoked the minority shareholders to seek involuntary dissolution could, in this manner, be used to further oppress them.  This, the statutory scheme before us cannot be read as condoning. Rather, the statutes suggest that a minority shareholder who brings an action for the involuntary dissolution of a corporation should not, by virtue of the controlling invocation of the buy-out remedy, receive less than he would have received had the dissolution been allowed to proceed.
 
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Attorney Representing Shareholder Who Asserts Both Individual and Derivative Claims Not Subject to Disqualification

Posted on January 12, 2013. Filed under: Uncategorized | Tags: , , , |

In Chih Teh Shen v. Miller (2012) 212 Cal.App.4th 48, the California Court of Appeal held that an attorney may not be disqualified for simply representing an individual shareholder who alleges both individual and derivative claims. Shen and Miller were both 50 percent owners of Arnon Development Group, Inc. (Arnon).  Miller argued that Shen’s counsel should be disqualified for prosecuting derivative claims on behalf of Arnon in one action while simultaneously prosecuting individual claims against Arnon in another matter.

Typically, disqualification is not proper unless the offending lawyer represents or has represented the complaining party.  Here, Miller conceded that Shen’s attorney had no formal attorney-client relationship with Arnon.  Instead, he argued that Shen’s lawyer should be disqualified because he “represents the interests of the corporation” in the derivative action.  The Appellate Court rejected this argument. 

In essence, the corporation that is the subject of the derivative claim is generally a nominal party only. “ ‘Because the claims asserted and the relief sought in [the derivative] complaint would, if proven, advance rather than threaten the interests of the nominal defendant[ ], the nominal defendant [ ] must remain neutral in [the] action.’ [Citation.]” (Patrick, supra, 167 Cal.App.4th at p. 1007, 84 Cal.Rptr.3d 642.)
 
In this matter, Arnon is named in the derivative action both as a derivative plaintiff, and as a nominal defendant. However, Walton is listed as attorney for respondent Shen only. If Walton represented Arnon, there would be no need for a derivative action, as the corporation itself would be pursuing Shen’s claims.
 
Miller has presented no facts suggesting the formation of an attorney-client relationship between Walton and Arnon. Arnon has not sought or obtained legal advice from Walton at any time. Nor has Miller presented any authority for the proposition that Walton’s filing of the derivative action as Shen’s attorney is sufficient to create an attorney-client relationship between Walton and Arnon. Because Miller has failed to meet his burden of proving that an attorney-client relationship exists between Walton and Arnon, Miller’s motion for disqualification of Walton was properly denied.

(Chih Teh Shen v. Miller, supra, 212 Cal.App.4th at 53.)
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    Updates on the Law of Shareholder Oppression, Minority Rights, Corporate Dissolution and the Fiduciary Duties of Corporate Officers and Directors from a San Diego Lawyer

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