Zahn v. Transamerica Corp.

United States Court of Appeals for the Third Circuit · 1947 · Corporations

Corporationsfiduciary dutiescontrolling shareholdersredemption of stockclass actionsfiduciary dutycontrolling shareholderdominated board

Facts

Axton-Fisher's charter allowed the board to redeem Class A stock at $60 per share plus accrued dividends, while on liquidation Class A would share in remaining assets at twice the rate of Class B after preferred stock and accrued Class A dividends were paid. Transamerica acquired control of Axton-Fisher, dominated its board through its officers or agents, and allegedly knew that Axton-Fisher's tobacco inventory had greatly increased in value. Zahn alleged Transamerica caused the board to call the Class A shares for redemption at $60 plus accrued dividends, then sold substantially all assets and liquidated Axton-Fisher so that the value of the tobacco would go largely to Class B, which Transamerica virtually owned. Zahn claimed Class A holders would have received about $240 per share on liquidation instead of $80.80 on redemption.

Issue

Whether a controlling shareholder that dominates a corporation's board may lawfully cause the board to redeem a class of stock under a charter redemption provision and then liquidate the corporation in order to capture for itself value that otherwise would have gone to that class. Also, whether Zahn could sue directly and as a class representative although he acquired his shares after some of the challenged events.

Rule

Under Kentucky law, directors and those who control a corporation stand in a fiduciary relation to minority stockholders. Even where a charter gives the board power to redeem stock, that power must be exercised by a disinterested board with due regard for fiduciary obligations; if directors act as instruments of a controlling shareholder to use the redemption for the controller's personal profit at the minority's expense, the redemption is voidable in equity at the suit of an injured stockholder. A shareholder may bring a direct, non-derivative action against the controller for such injury, and the contemporaneous-ownership requirement applicable to derivative suits does not apply.

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Blue Mesa Foods, a Kentucky corporation based in Louisville, has Class R shares redeemable at $50 per share at the board's option and Class S shares that receive a larger share of residual assets on liquidation. Ridgeway Holdings owns nearly all Class S shares, controls Blue Mesa's board through its officers, knows a hidden warehouse asset in Nashville has tripled in value, causes the board to redeem Class R at $50, and six months later causes Blue Mesa to liquidate so the surplus goes chiefly to Class S.

If a Class R holder sues Ridgeway Holdings directly, what is the strongest argument for allowing the claim to proceed?

Explanation. The majority held that a charter redemption power may be exercised only by a disinterested board acting with due regard for fiduciary obligations. Where directors are merely instruments of a controlling shareholder and use the redemption to secure the controller's private profit at the minority's expense, the act is voidable in equity at the suit of injured shareholders. The case does not condemn every redemption that benefits another class, nor does it treat this injury as exclusively derivative.