Jordan v. Duff and Phelps, Inc.

United States Court of Appeals for the Seventh Circuit · 1987 · Contracts

Contractsclosely held corporationsfiduciary dutydisclosurestock repurchase agreementsdamagesclose corporationmateriality

Facts

Duff & Phelps was a closely held corporation whose employee-shareholders were required by agreement to sell their shares back to the corporation at adjusted book value when their employment ended. Jordan, an employee-shareholder, told the firm on November 16, 1983 that he would resign for a higher-paying job in Houston, remained through year-end so his shares would be valued as of December 31, 1983, and then tendered his stock for book value. Before and during that period, Duff & Phelps had considered selling the firm, its board decided on November 14 to seek bids, and negotiations with Security Pacific later advanced to an agreement in principle announced on January 10, 1984. Jordan sued after learning that had he remained employed through the announcement, his shares would have been worth far more than book value.

Issue

When a closely held corporation repurchases an employee-shareholder's stock pursuant to a book-value buyback agreement triggered by termination of employment, must the corporation disclose ongoing sale or merger information that is material to the shareholder's decision whether to leave? Also, if disclosure was required, are the questions of materiality, timing of sale, causation, and damages for the jury, and is rescission available?

Rule

A closely held corporation that purchases its own stock owes a fiduciary duty to disclose to the selling shareholder all information that is material under TSC Industries: information for which there is a substantial likelihood that a reasonable shareholder would view it as significantly altering the total mix of available information. The public-company price-and-structure rule does not govern merely because the potential acquirer is public. A formula-price buyback agreement may redefine disclosure obligations in some settings, but it does not eliminate the duty here where the agreement fixes price only after the employee chooses when to leave, making departure an investment decision as well as an employment decision.

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Prairie Signal Advisors, a closely held Illinois consulting firm, lets senior employees buy shares but requires them to sell back the shares at adjusted book value when their employment ends. On March 3, the board votes to seek buyers for the firm, and management knows one potential acquirer recently floated a valuation far above book value; on March 5, employee-shareholder Lena Ortiz tells the chief executive in Chicago that she plans to leave for a job in Denver, and the firm says nothing before taking her shares back under the agreement.

If Lena sues for nondisclosure, which is the strongest argument against summary judgment for the firm?

Explanation. In a closely held corporation repurchasing its own shares, the corporation owes a fiduciary duty to disclose material information to the selling shareholder. Materiality is measured by the TSC Industries standard: whether there is a substantial likelihood a reasonable shareholder would consider the fact significant in the total mix of information. The majority held that a decision to seek a buyer, coupled with facts suggesting a valuation far above book value, may be material even before any agreement in principle. The duty does not depend on the shareholder’s asking the right question, and the formula-price provision does not eliminate disclosure duty when the employee chooses whether to trigger the sale. (Derived from Jordan v. Duff and Phelps, Inc. (1987).)