Debaun v. First Western Bank & Trust Co.

• Decision Date: 31 March 1975
• Court: California Court of Appeals Court of Appeals
• Parties: , 77 A.L.R.3d 991 James DeBAUN and Walter H. Stephens, Plaintiffs and Respondents, v. FIRST WESTERN BANK AND TRUST COMPANY, a California Corporation, and Alfred S. Johnson Incorporated, a California Corporation, Defendants and Appellants. Civ. 43994.

Page 354

120 Cal.Rptr. 354

46 Cal.App.3d 686, 77 A.L.R.3d 991

James DeBAUN and Walter H. Stephens, Plaintiffs and Respondents, v. FIRST WESTERN BANK AND TRUST COMPANY, a California Corporation, and Alfred S. Johnson Incorporated, a California Corporation, Defendants and Appellants.

Civ. 43994.

Court of Appeal, Second District, Division 1, California.

March 31, 1975.

Rehearing Denied April 25, 1975.

Hearing Denied May 28, 1975.

Newell & Chester and Robert M. Newell, Los Angeles, for defendant and appellant First Western Bank and Trust Co.

No appearance for defendant and appellant Alfred S. Johnson Inc.

Jackson & Goodstein, H. Walter Croskey, and Dennis R. Murphy, Los Angeles, for plaintiffs and respondents.

THOMPSON, Associate Justice.

This appeal primarily concerns the duty of a majority shareholder to the corporation whose shares he holds in selling the shares when possessed of facts establishing a reasonable likelihood that the purchaser intends to exercise the control to be acquired by him to loot the corporation of its assets. We conclude that in those circumstances the majority shareholder owes a duty of reasonable investigation and due care to the corporation.

FACTS

Alfred S. Johnson Incorporated (Corporation) was incorporated by Alfred S. Johnson in 1955 to process color photographs to be reproduced in printed form. All of the 100 outstanding shares of Corporation were originally owned by Johnson. Subsequently, Johnson sold 20 of his shares to James DeBaun, Corporation's primary salesman, and 10 shares to Walter Stephens, its production manager. In November of 1964, Johnson was seriously ill so that managerial control of Corporation was assumed by DeBaun, Stephens, and Jack Hawkins, Corporation's estimator.

Johnson died testate on January 15, 1965. His will named appellant First Western Bank and Trust Company (Bank) as executor and trustee of a trust created by the will. The 70 shares of Corporation owned by Johnson at the time of his death passed to the testamentary trust. George Furman, an employee of Bank, was charged with the direct administration of the trust. While Bank took no hand in the management of Corporation leaving it to the existing management team, Furman attended virtually all directors' meetings. Bank, through its nominee, voted the 70 shares at stockholders' meetings.

Under the guidance of DeBaun and Stephens, the net after tax profit of Corporation increased dramatically as illustrated by the following table:

                  Fiscal year
                ending August 31  Net Profit
                ----------------  ----------
                1964               $15,903
                1965               $42,316
                1966               $58,969
                1967               $37,583
                1968 (10 mos.)     $56,710
                

On October 27, 1966, Bank's trust department determined that the investment in Corporation was not appropriate for the trust and decided to sell the 70 shares. Bank also decided that no one connected with Corporation should be made aware of its decision to sell until a sale was firm. It caused an appraisal of Corporation to be made by General Appraisal Company which estimated the value of Corporation as a going concern at.$326,000. Bank retained W. H. Daum Investment Company (Daum) to find a buyer and to assist it in the sale.

DeBaun, and Stephens were not told of the Bank's plans. In March of 1968, a competitor of Corporation showed DeBaun a letter from Daum indicating that Corporation was for sale. Subsequently, both DeBaun and Stephens were contacted by two potential buyers who sought to purchase their shares. They refused to sell, agreeing to hold their shares because they had '. . . a good job . . . and percentage of the company . . ..' At the request of Daum's representative, DeBaun submitted an offer for the 70 shares held by Bank. The offer was rejected as inadequate.

On May 15 and 20, 1968, Bank received successive offers for the 70 shares from Raymond J. Mattison, acting in the name of S.O.F. Fund, an inter vivos revocable trust of which he was both settlor and trustee. A sketchy balance sheet of S.O.F. Fund was submitted with the second offer. The offers were rejected. Anticipating a further offer from Mattison and his trust, Furman, acting for Bank, ordered a Dun & Bradstreet report on Mattison and the fund. The report was received on May 24, 1968. It noted pending litigation, bankruptcies, and tax liens against corporate entities in which Mattison had been a principal, and suggested that S.O.F. Fund no longer existed.

As of May 24, I. Earl Funk, a vice-president of Bank, had personal knowledge that: (1) on October 24, 1957, the Los Angeles Superior Court had entered a judgment against Mattison in favor of Bank's predecessor in interest for compensatory and punitive damages as the result of Mattison's fraudulent misrepresentations and a fraudulent financial statement to obtain a loan; and (2) the judgment remained unsatisfied in 1968 and was an asset of Bank acquired from its predecessor in an acquisition of 65 branch banks.

On May 27, 1968, Mattison submitted a third offer to purchase the 70 shares of Corporation held by Bank. The offer proposed that S.O.F. Fund would pay $250,000 for the shares, $50,000 in marketable securities as a down payment with the balance payable over a five-year period. Bank made a counter offer, generally accepting the terms of the Mattison proposal but providing that: (1) the $200,000 balance of the purchase price was to be secured by a pledge of marketable securities valued at a like amount; and (2) Corporation would pay no dividends out of 'pre-sale' retained earnings. On June 4, 1968, representatives of Bank met with Oroville McCarrol, who had been a trust officer of Bank's predecessor in interest and was counsel for Mattison. McCarrol proposed that Corporation use its assets to secure the unpaid balance of the purchase price rather than Mattison supplying the security in the form of marketable securities. He proposed also the elimination of the restriction against dividends from pre-sale retained earnings. Despite reservations by Bank personnel on the legality of the use of corporate assets to secure an obligation of a major shareholder, Bank determined to pursue the McCarrol modification further. Troubled by the Dun & Bradstreet report, personnel of Bank met with Mattison and McCarrol on June 27. Mattison explained that it had been his practice to take over failing companies so that the existence of the litigation and tax liens noted in the Dun & Bradstreet report was not due to his fault. Not entirely satisfied, Furman wrote to McCarrol requesting a written report on the status of all pending litigation in which Mattison was involved. McCarrol telephoned his response, declining to represent the status of the litigation but noting that the information was publicly available. Partly because Ralph Whitsett, Furman's immediate superior at Bank, knew McCarrol as a former trust officer of Bank's predecessor in interest, and partly because during a luncheon with Mattison at the Jonathan Club Robert Q. Parsons, the officer at Daum in charge of the transaction, had noted that Mattison was warmly received by his fellow members and reported that fact to Furman, Bank did not pursue its investigation into the public records of Los Angeles County where a mass of derogatory information lay.

As of July 1, 1968, the public records of Los Angeles County revealed 38 unsatisfied judgments against Mattison or his entities totalling $330,886.27, and 54 pending actions claiming a total of $373,588.67 from them. The record also contained 22 recorded abstracts of judgments against Mattison or his entities totalling $285,704.11, and 18 tax liens aggregating $20,327.97. Bank did not investigate the public record and hence was unaware of Mattison's financial track record.

While failing to pursue the investigation of the known information adverse to Mattison, Bank's employees knew or should have known that if his proposal through McCarrol were accepted the payment of the $200,000 balance of the purchase price would necessarily come from Corporation. They assumed that the payments would be made by Mattison from distributions of the Corporation which he would cause it to make after assuming control. They were aware that Corporation would not generate a sufficient aftertax cash flow to pay dividends in a sufficient amount to permit the payments of interest and principal on the $200,000 balance as scheduled in the McCarrol proposal, and knew that Mattison could make those payments only by resorting to distribution of 'pre-sale' retained earnings and assets of Corporation.

On July 11, 1968, Bank accepted the McCarrol modification by entering into an exchange agreement with S.O.F. Fund. The agreement obligated S.O.F. to retain a working capital of not less than $70,000, to refrain from intercompany transactions except in the ordinary course of business for adequate consideration, and to furnish monthly financial statements and a certified annual audit report to Bank. It provides that Bank is to transfer its 70 shares of Corporation to Mattison as trustee of S.O.F. Fund, and that the stock will be held by Bank in pledge to secure the fund's obligation. There is provision for acceleration of the unpaid balance of the purchase price if Mattison defaults in any provision of the agreement. The contract obligated Mattison to cause Corporation to execute a security agreement to secure Mattison's obligation to Bank covering all 'furniture, fixtures and equipment of (Corporation).' Mattison agreed also to cause Corporation's principal banking business to be maintained with Bank.

The exchange agreement having been executed, Bank gave Mattison a proxy to vote the 70 shares of Corporation at a special meeting of shareholders of Corporation to be held on July 11 at 3 p.m. Furman attended that meeting and an ensuing directors' meeting, as did Mattison. At the shareholders' meeting, DeBaun and Stephens were told that the shares of Corporation...