United States Court of Appeals, Fourth Circuit
United States Court of Appeals, Fourth Circuit
United States Court of Appeals, Fourth Circuit
2d 1259
This appeal arises out of a civil action commenced by C. Thomas Clagett, Jr.,
and others who were minority shareholders of the Laurel Harness Racing
Association, Inc. (Laurel). Jurisdiction was predicated upon diversity of
citizenship. The plaintiffs sought recovery of monetary damages from Richard
H. Hutchison, Jr. (Hutchison), once the majority controlling common
In relevant part, plaintiffs alleged that through certain stock transfers, the
various defendants had breached two of the fiduciary duties they owed to the
plaintiffs as minority shareholders.
First. Plaintiffs charged that, under Maryland law, defendant Hutchison, in the
sale of his controlling common stock to defendants, Steven Sobechko, James
Sobechko and Joseph Shamy, an attorney, had a duty to investigate the ability
of that group to manage Laurel and to make inquiry into their characters and
financial stability. (Count I). The same duty was alleged to exist between the
Sobechkos and Shamy in the subsequent transfer of a portion of their stock to
defendant Mike Brown. (Count II). And finally, the same duty was alleged to
exist between the Sobechkos, Shamy and Brown in their transfer of the
controlling common stock to defendant Daniel J. Rizk. (Count III).1
Second. Plaintiff charged that, under Maryland law, Hutchison, as the majority
controlling common shareholder of Laurel, owed a fiduciary duty to the
minority shareholders, including plaintiffs, to afford to them an equal
opportunity to sell their shares on the same terms and conditions which were
offered to him. (Count I). In Count II as against Hutchison's purchasers the
same duty was alleged, and the Sobechkos and Shamy were charged with
aiding and abetting Hutchison's violation of the "equal opportunity" rule.
All six defendants moved to dismiss, arguing that the Complaint failed to state
a claim upon which relief could be granted under Maryland law. F.R.C.P.
12(b). The district court held, on the facts of this case, that neither of plaintiffs'
theories of recovery stated a claim upon which relief could be granted, and the
suit was dismissed. Plaintiffs appeal, and we affirm.
I.
FACTS
6
The actual stock transfer from Hutchison to the Sobechkos and Shamy occurred
on May 12, 1975. The plaintiffs discovered the pending stock transfer just
before it occurred through a news article on April 27, 1975.
Next, between May 12, 1975, and November 5, 1975, while Laurel was under
the control of the Sobechkos and Shamy, some unspecified portion of their
common stock was transferred to defendant Mike Brown. The foursome
continued in control of Laurel.
Finally, on March 25, 1976, the Sobechkos, Shamy and Brown transferred their
stock and the controlling majority of Laurel to defendant Daniel J. Rizk. This
was the final stock transfer involved in this litigation.
10
Summarily, the plaintiffs sought recovery of monetary damages for the loss in
value of their common stock in Laurel due to the alleged breaches of the duty to
investigate and the breach of the equal opportunity rule.
II.
THE DUTY TO INVESTIGATE
11
Plaintiffs contend that a majority shareholder who sells the controlling interest
in a corporation owes a fiduciary duty to the minority shareholders to
investigate the character, integrity, financial stability and managerial ability of
the prospective purchasers where such a seller is in a position to foresee the
likelihood that the purchasers will defraud, loot or mismanage the company.
And, on appeal, plaintiffs point to four factual circumstances which they argue
were of sufficient gravity to place a duty upon Hutchison to investigate the
purchasers of his stock.
12
First, a significant premium was paid to Hutchison for the price of his stock.
14
15
16
17. . the sellers of control are in a position to foresee the likelihood of fraud on the
".
corporation, . . . or on the remaining stockholders, at the hands of the transferee,
their fiduciary duty imposes a positive duty to investigate the motives and reputation
of the would-be purchaser (or purchasers); and unless such a reasonable
investigation shows that to a reasonable man no fraud is intended or likely to result,
480 F.2d at 578; McDaniel v. Painter, 418 F.2d 545, 547-8 (10th Cir. 1969).
19
Applying Swinney to the four circumstances set forth by plaintiffs which are
alleged to be "suspicious", we hold that upon this record, they are insufficient
to state a claim upon which relief could be granted.
20
First. While the price paid for Hutchison's shares was indeed a premium price,
it was nevertheless a premium paid for the element of control of the
corporation. McDaniel v. Painter, 418 F.2d at 548. The premium payment is
further justifiable since Laurel was a commercial business subject to further
development as an on-going business. Thus, the premium price paid to
Hutchison cannot be said to be so unreasonable as to place him on notice of the
likelihood of fraud on the corporation or the remaining stockholders. Swinney
v. Keebler Co., 480 F.2d at 578-79; Insuranshares Corp. of Delaware v.
Northern Fiscal Corp., 35 F.Supp. 22, 26 (E.D.Pa.1940). Finally, as a matter of
logic, it seems farfetched to pay a 400% Premium for stock simply in order to
acquire control of a corporation in order to loot it. Certainly a cheaper corporate
enterprise could be acquired for such malevolent purposes.
21
Second. It is true that the written agreement between Hutchison, the Sobechkos
and Shamy provided that closing on the agreement was scheduled for some
time from six to twelve months following the execution of the agreement.
Third. It is also true that the agreement precluded any change in the financial
condition of Laurel pending closing on that transaction. We hold that these two
factors, whether taken alone or in conjunction with the premium price paid to
Hutchison, are not sufficiently suspicious in this case to invoke Swinney 's duty
to investigate. This argument was not entertained by the court below, and we
would not ordinarily pass on it. However, it is clear to us that postponing the
closing to attempt to obtain financing through a pledge of personal assets for a
personal loan,4 together with a contractual guarantee from the seller to the
buyers to preserve the financial condition of Laurel pending closing, constituted
prudent business practice rather than "suspicious" circumstances. The
agreement essentially preserved the Status quo Of Laurel while allowing the
purchasers to shop for financing favorable to them.
22
Fourth. It is true that Hutchison arranged for the purchase of some, but not all,
of the outstanding minority shares of Laurel, and that the plaintiffs were not
included in this group who were given the option to sell at the higher price
received by Hutchison. From this, plaintiffs argue that Hutchison had some
reason to believe that the future plans of the Sobechkos and Shamy were not in
the best interests of Laurel and its minority stockholders. Defendants counter
by noting that selling one's own stock and including others in such a sale, is a
private act, sanctioned in law, and not alone "suspicious." We agree. Llewllyn
v. Queen City Dairy, Inc., 187 Md. at 60, 48 A.2d 322; Cf. Ace Development
Co., Inc. v. Harrison, 196 Md. 357, 365-6, 76 A.2d 566 (1950).
23
Thus, we believe that no duty to investigate should, upon the record now before
us, have been placed upon Hutchison in his transfer of control to the Sobechkos
and to Shamy, and Count I of the Complaint was properly dismissed. We
further hold that the remaining counts of the Complaint were properly
dismissed by the district court.
24
Count II alleged the transfer of "a portion" of stock from the Sobechkos and
Shamy to Brown. (Complaint, Count II, paragraph 38). No allegation of a
transfer of "control" was set forth in this count of the Complaint, and no duty to
investigate arose absent a transfer of control. Swinney v. Keebler Co., 480 F.2d
at 578.
25
Count III alleged the transfer of control from the Sobechkos, Shamy and Brown
to Rizk through sale of their stock to Rizk. However, as the district court held,
there were no allegations of suspicious circumstances to place a duty to
investigate upon the trio of the Sobechkos, Shamy and Brown in their sale of
control to Rizk. Accordingly, dismissal here was proper also.
26
III.
EQUAL OPPORTUNITY
27
The plaintiffs further argue that Hutchison, as the seller of the controlling
shares of Laurel, owed a fiduciary duty to the minority shareholders of Laurel,
including the plaintiffs, to afford them an equal opportunity to sell their
minority shares or a Pro rata part of their shares to the purchaser of the
controlling stock on the same or substantially the same terms and conditions
which were offered to Hutchison. If the offer to purchase the minority shares is
extended, then the minority shareholders have the option to sell their shares or a
Pro rata portion of them at that price, or to continue their investment in the
corporation, despite the transfer. Further, it is argued that such a rule would bar
the controlling shareholder from securing an advantageous business
arrangement for himself while abandoning the minority shareholders to the
mercy of the new purchasers who would not control the corporation.
28
Plaintiffs cite no Maryland law precisely on point, but instead argue that the
equal opportunity rule should properly follow from the Maryland law which
prohibits a controlling stockholder from using his control for some ulterior
purpose adverse to the interests of the corporation and its stockholders. See, e.
g., Cooperative Milk Service, Inc. v. Hepner, 198 Md. 104, 81 A.2d 219
(1951); Baker v. Standard Lime and Stone Co., 203 Md. 270, 283, 100 A.2d
822, 829 (1953) (dictum).
29
Plaintiffs rely upon three decisions from other jurisdictions in support of the
equal opportunity rule: Jones v. H. F. Ahmanson & Co., 1 Cal.3d 93, 81
Cal.Rptr. 592, 460 P.2d 464 (1969); and Donahue v. Rodd Electrotype Co. of
New England, Inc., 367 Mass. 578, 328 N.E.2d 505 (1975); Perlman v.
Feldman, 219 F.2d 173 (2nd Cir. 1955), Cert. denied, 349 U.S. 952, 75 S.Ct.
880, 99 L.Ed. 1277 (1955). See also, Andrews, Stockholder's Right to Equal
Opportunity in the Sale of Shares, 78 Har.L.Rev. 505, 515 (1965).
30
Defendants counter that the rule of equal opportunity, while nice theoretically,
is simply not the law. Neither the Maryland cases cited, nor the Jones, Donahue
or Perlman cases, Supra, support such a holding. See also Jararas, Equal
Opportunity in the Sale of Controlling Shares: A Reply to Professor Andrews,
32 U.Chi.L.Rev. 240 (1965).
31
The district court distinguished Jones, Donahue and Perlman and held that the
Maryland courts would not adopt the equal opportunity rule. We agree.
32
First, the equal opportunity rule has been rather soundly rejected. McDaniel v.
Painter, 418 F.2d at 548 and n.13. Second, the rule, if applied, would likely
result in the stifling of many financial transactions due either to a purchaser's
inability to purchase the additional shares, or from a lack of inclination to
purchase those shares. See Andrews, 78 Har.L.Rev. at 517; Jararas, 32
U.Chi.L.Rev. at 425-6; Letts, Sale of Control Stock and the Rights of Minority
Shareholders, The Business Lawyer, January, 1971, at 631.5
IV.
CONCLUSION
33
34
AFFIRMED.
BUTZNER, Circuit Judge, dissenting:
35
36
37
The district court also correctly recognized that majority stockholders have a
fiduciary obligation to the minority when they transfer control of a corporation
to outsiders. Their fiduciary status places them under a duty not to proceed with
the transfer if the circumstances surrounding the transaction would awaken the
suspicions of a prudent businessman. Then, the majority stockholders must
make a reasonably adequate investigation and refrain from the transfer unless
they can reasonably conclude that no fraud is intended or likely to result. See
Swinney v. Keebler Co., 480 F.2d 573, 578 (4th Cir. 1973); 13 Fletcher,
Cyclopedia of Corporations 5805 (1970).
38
If my analysis of this case is correct, the district court erred by holding that the
complaint alleged no suspicious circumstances that would obligate the majority
stockholder to make the investigation that the rule requires. The district court
reached this conclusion by erroneously construing the allegations against,
rather than in favor of, the complainants in violation of the familiar principles
reiterated in Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 40 L.Ed.2d
90 (1974) and Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80
(1957).
39
40
No allegation of the complaint supports the court's assumption about the value
placed on control. The court's conclusion might ultimately be sustained by the
evidence, but I find no warrant for presently holding without any proof
whatsoever that this is the only inference that can be drawn from the payment
of such an excessive premium. To the contrary, it might well reflect the real
value of the stock, especially if assets carried at cost have increased in value. A
reasonably astute businessman should at least investigate the likelihood that the
purchasers were willing to pay such a large premium so they could convert
corporate assets to their own use, as they allegedly did here. Moreover, the
conclusion that the premium simply reflected the price of control is dispelled
by the allegation that the majority stockholder insisted that the purchasers
Another aspect of the case warrants vacating the order of dismissal and
remanding for disclosure of all the facts about the transfer of control. The
minority stockholders do not complain simply that they were denied an equal
opportunity to sell on the same terms as the majority. Their complaint also
alleges that the majority breached its fiduciary duty by causing the purchasers
to offer a premium price to certain minority stockholders who were selected by
the majority, but not to other minority stockholders. The minority's reliance on
state law rather than the federal securities acts does not defeat their claim that
the majority had a duty to refrain from discriminating among minority
stockholders. Their possible lack of standing to assert a federal cause of action
because they neither bought nor sold stock in reliance on the transfer of control
has no bearing on this state-based claim.
42
43
The only case that appears to have dealt with this situation is Ferraioli v.
Cantor, 281 F.Supp. 354 (S.D.N.Y.1968). There the court said:
44 view of plaintiff's claim that the defendants offered to some stockholders the
In
opportunity to sell their General Baking stock to Goldfield at a premium and did not
make the same offer to others, including the plaintiff, defendants are not entitled to
summary judgment dismissing plaintiff's complaint. 281 F.Supp. at 356.
45
46
I believe that the minority stockholders' allegation that the majority used its
leverage to favor some minority stockholders over others states a claim that is
sufficient to survive a motion to dismiss under Rule 12(b). A thorough
exposition of the facts may, of course, disclose that the majority and the
preferred minority were in fact a unit such as the members of the corporation's
management and their families or business associates who acquired the stock as
a joint venture. See 2 L.Loss, Securities Regulations 779 (1961); Kaplan,
Fiduciary Responsibility in the Management of the Corporation, 31 The
Business Lawyer 883, 909 (1975). At this stage of the proceedings, however,
the record does not suggest such a unitary relationship. It therefore seems to me
that the disadvantaged shareholders should be allowed to present proof that the
majority breached its duty to all minority stockholders by unjustifiably
preferring one group over another.
III
47
A third reason for vacating the order of dismissal is based on the corporation's
unique status as a racetrack licensee. Insuranshares suggests that the nature of
the corporation's business is a factor to be considered in assessing the majority
stockholder's duty to investigate the persons who wish to acquire control. 35
F.Supp. at 26. I think that this factor is particularly relevant to this case. The
complaint alleges that the corporation operated a racetrack pursuant to a license
granted by the Maryland Racing Commission. This license, of course, was one
of the most valuable assets of the corporation, for without it no races could be
run.
48
The importance that Maryland places upon the integrity and competency of
persons controlling a licensee is indicated by the requirement that the names of
its stockholders be disclosed and by the authority of the commission to suspend
or revoke a license "for any cause whatsoever which the Commission may, in
its discretion, deem sufficient." 7A Md. Code Ann. Art. 78B 10 and 13(c)(1)
(1975 Repl.Vol. and 1977 Supp.). Since the competency and integrity of new
owners will have an important bearing on the future of the corporation, it seems
In short, the peculiar nature of this corporation's business is another reason for
concluding that reasonably prudent business practices required an investigation
of the purchasers.
50
51
Consequently, for the three reasons which I have mentioned, or any one of
them, I think the complaint should not have been dismissed for failure to state a
claim. I respectfully dissent.
The facts presented in this case differ markedly from those presented in
Insuranshares, supra. There, the assets of the corporation were pledged for a
personal loan rather than pledging personal assets for a personal loan. 35
F.Supp. at 25. Other much more "suspicious" circumstances also were present
in Insuranshares