Business and Corporate Section Monthly Article

Busse v. United PanAm Financial Corp., 222 Cal. App. 4th 1028, 1047 - 1050  (2014): The Remedies Available to Dissenting Shareholders Under Corporations Code §1312, subdivision (b), are Limited to Either an Appraisal, or an Action to Stop or Rescind the Merger.  Shareholders can Never Recover Monetary Damages.


California Corporations 1 Code section 1312 generally governs the rights of minority shareholders who dissent from mergers and buyouts.2  In Steinberg v. Amplica, Inc., 42 Cal.3d 1198 (1986), the California Supreme Court held that section 1312, subdivision (a), limits the rights of dissenting minority shareholders to an appraisal of their shares.  Section 1312, subdivision (b), provides an exception to subdivision (a) where the entities in the merger are under direct or indirect common control.  In Busse v. United PanAm Financial Corp., 222 Cal. App. 4th 1028, 1047 - 1050  (2014), the California Court of Appeal for the Fourth District, Division Three, in a case of first impression, interpreted the subdivision (b) exception and held that minority shareholders who object to a merger of corporations under direct or indirect common control are limited to the remedies of either appraisal, or an action to stop or rescind the merger.  The court held that a shareholder is never entitled to damages (Busse, supra, at 1048), and must choose between the appraisal and rescission remedies.  Id. at 1050.

The Busse court also interpreted the common control language of subdivision (b) to determine that the plaintiffs properly alleged common control.  The court explained that given the standard of review and the language of subdivision (b), even an inference of indirect control is sufficient to defeat a demurrer.

Busse is consistent with the historical limitations placed on dissenting minority shareholders’ rights regarding mergers and corporate reorganizations.  The overarching theme in California jurisprudence concerning disputed mergers and reorganizations is that “the needs of the many – at least measured by the shares they own – outweigh the needs of the few.”  See, Busse, supra, at 1039-1050.  Courts and commentators have been consistently hostile to minority shareholders obstructing or preventing mergers and reorganizations through litigation.  Id.  Busse should reduce litigation concerning mergers and reorganizations because it eliminated any potential for monetary damages and it emphasized that minority shareholders must forfeit their right to an action for appraisal to pursue a rescission action under subdivision (b).  Realistically, in the vast majority of cases, dissenting minority shareholders will have little hope of stopping or rescinding a merger because courts will be reluctant to unwind the transaction.  Subdivision (b) cases will be quintessential uphill battles, and therefore, they likely will be confined to the most egregious cases of majority shareholder overreach.

Busse Facts

Guillermo Bron, the majority shareholder of United PanAm Financial, founded the company in 1994. The company made subprime loans on used cars.  The company went public in the late 1990s.  By 2006, the company’s shares were selling at $26, but the recession hit the company hard and the share price dropped to $5 at the beginning of 2008, and to $1.59 by the end of 2008.  In May 2010, after the company’s management group instituted cost-cutting measures and reduced its portfolio of poor loans, Bron and his financial partner, the Pine Brook Financial Group, developed a buy-out scheme to acquire the corporation’s stock and take the company private.  The Bron group had the board of directors establish a supposedly independent special committee to value the stock for a buyout.  At the time, Bron owned 38 percent of the company’s stock and controlled the board of directors.  In mid-November 2010, the committee agreed to a share price of $7.05, even though the book value of the company was no less than $8.54 per share.  On December 27, 2010, the special committee and the board of directors recommended the shareholders approve the Bron group’s buyout, and the company announced the buyout the next day.

Two groups of minority shareholders filed suits for breach of fiduciary duty and sought injunctions to prevent the reorganization, or alternatively, if the transaction was consummated before judgment, they sought alternative remedies of either a rescission of the transaction, or damages.  Neither set of minority shareholders secured an injunction, and the merger was approved and consummated.  The trial court consolidated the actions, and after several rounds of demurrers, the minority shareholders filed a second amended complaint in which they alleged causes of action for breach of fiduciary duty in violation of section 1312, subdivision (b), and aiding and abetting breach of fiduciary duty under section 1312, subdivision (b).  The minority shareholders sought “rescissionary damages,” or alternatively, to rescind the merger.

The Bron group demurred to the second amended complaint.  The trial court sustained the demurrer without leave to amend on the grounds that section 1312, subdivision (b), does not allow a shareholder to recover damages, even when couched as an equitable remedy under the rubric of rescissionary damages, and that the second amended complaint did not sufficiently allege Bron’s common control.  The minority shareholders appealed.

The Busse Court Emphasized that Common Control may be Based on Indirect Control and is a Factual Question that is Rarely Susceptible to Disposal on the Pleadings

The Busse court stressed three points when it evaluated whether the minority shareholders adequately alleged common control to entitle them to relief under section 1312, subdivision (b).   First, the court explained that because the shareholders appealed from a judgment based on a sustained demurrer, it was required to accept the minority shareholders’ version of the facts properly alleged in their second amended complaint and all reasonable inferences that could be drawn from those factual allegations.  Id. at 1033.  Secondly, the court recognized that “[section 1312, subdivision (b)] is clear that allegations of common control can be founded on even indirect control,” and therefore, even an inference of indirect control is sufficient to defeat a demurrer.  Id. (italics in original).  Finally, the Busse court cited Hellium v. Breyer, 194 Cal. App. 4th 1300 (2011), for the proposition that control is a factual question, and therefore, dismissal based on insufficiency of allegations of control is appropriate only when a plaintiff does not plead any facts from which it can reasonably be inferred the defendant was a control person.  Id. at 1033-1034 (quoting Hellium, supra, at 1317).

The Busse court considered Hellium, supra, because it construed Corporations Code section 25504, which provides for liability of everyone who “directly or indirectly controls” an entity that sells unqualified securities.  Busse, at 1033.  The court noted that, in Hellium, the appellate court reversed a judgment on a sustained demurrer because it found that the plaintiffs’ allegations that three outside directors had the power to control the general affairs of the corporation were sufficient to establish direct or indirect control at the pleading stage.  Id.  Specifically, the plaintiffs in Hellium alleged that the three directors had: (1) ownership interest in the company that gave them “significant voting power” (their collective ownership exceed 50 percent); (2) management responsibility under the company’s bylaws; (3) presumptive authority to sign key corporate documents, and (4) affiliations with outside firms on which the company relied, all of which supported the “inference” they could directly or indirectly influence the company’s corporate policies and descisionmaking.  Id. at 1033-1034 (citing Hellium, supra, at 1317-1318).

Applying Hellium, the Busse court found that the minority shareholders’ factual allegations that: (1) Bron controlled about 40 percent of the company’s stock throughout its history, and no other shareholder even came close to his percentage ownership at the time of the buyout; (2) no director Bron supported for election ever failed to receive the requisite votes for election or reelection; (3) in public filings in 2007 and 2008, the company admitted Bron would have substantial influence over the management and affairs of the company, including the ability to control substantially all matters submitted to the shareholders for approval; (4) all of Bron’s fellow directors owed their jobs to him and were dependent on his good graces; and (5) that Bron was as chairman of the board, all taken together, readily supported an inference of at least indirect control.  Busse, supra, at 1033-1035.

After Reviewing the Judicial History of Section 1312, and Analyzing the Section in the Context of the Surrounding Statutory Scheme, the BusseCourt held that the Legislature did not Intend to Create a Damages Remedy When it Enacted Subdivision (b)

The minority shareholders argued that subdivision (b) established a broad exception to subdivision (a) that restored all common law rights in cases of common control, including the right to sue the majority shareholders and collaborating board members for damages based on breach of fiduciary duty during a merger.  Id. at 1031-1032, 1036-1037.  The Bron group contended that subdivision (b) expanded dissenting shareholders’ remedies in common control cases to include the ability to rescind the merger, in addition to the appraisal remedy available in all mergers.  Id. at 1032.

The Busse court acknowledged that section 1312 is not the clearest statute, but explained that the judicial history of section 1312 shows that the Legislature neither established, nor recognized a monetary remedy under subdivision (b).  Id. at 1038-1039.  The Legislature merely added “one additional big, but wholly equitable, stick” to minority shareholders’ remedies – the ability to sue to rescind the merger.Id. at 1039 (italics in original).

The Busse court analyzed the statutes, cases, articles and treatises that defined and explained dissenting minority shareholders’ rights, starting in 1931, with the enactment of former Civil Code section 369, subdivision (17), which limited minority shareholders to the appraisal remedy (id. at 1039-1040 & n. 8), through the enactment of section 1312 in 1975,3 and up to the most current decisions that construed the statute.4

Before the enactment of Civil Code section 369, minority shareholders could block a merger by withholding consent.  Id. at 1039.  The Bussecourt explained that “there were ‘two principled reasons’ for the  enactment of the Civil Code section 369: one was to ‘permit mergers over the objection of a defined minority of shareholders’ while the other was to give such minority shareholders the chance to obtain compensation for their stock.’” Id. at 1039 (quoting, Gallois v. West End Chemical Co., 185 Cal. App. 2d 765, 771 (1960)).

By 1975, a string of California cases, three of which concerned common control situations,5 held that appraisal was the exclusive remedy of dissenting shareholders.  Id. at 1043, 1047.  After the enactment of section 1312, every California case that construed the statute reaffirmed that appraisal is the exclusive remedy available to dissenting shareholders under subdivision (a).  Two cases, Sturgeon Petroleums, Ltd. v. Merchants Petroleum Co., 147 Cal. App. 3d 134 (1983) and Steinberg v. Amplica, Inc., 42 Cal.3d 1198 (1986), mentioned that subdivision (b) provided an exception to subdivision (a), but neither case defined the extent of the exception because neither case concerned a common control merger.  Busse, supra. at 1043-1944.  The Busse court further noted that in Steinberg the California Supreme Court endorsed appraisal as a truly adequate remedy because even breaches of fiduciary duty could be redressed through the appraisal process.  Busse, supra, at 1045 (citing, Steinberg, supra, 42 Cal. 3d at 1209-1210).

Based on this history, the Busse court concluded that, as of 1975, minority shareholders had no common law remedies in the reorganization context.  Id. at 1047.  The court explained that, “[t]he enactment of subdivision (b) did not involve a situation in which the Legislature was restoring a remedy that subdivision (a) otherwise took away.  Rather, when subdivision (b) was enacted in 1975, the question was whether the Legislature would create something that clearly wasn’t there.”  Id. (italics in original).

The Busse court emphasized that the Legislature is presumed to have known of the cases  that established appraisal as the exclusive remedy for dissenting shareholders when it enacted section 1312.  The court remarked that “[s]ilence often speaks loudly when it comes to ascertaining the intent behind text,” and concluded that if the Legislature had intended to give minority shareholders the right to monetary damages under subdivision (b), it would have said so.  See, id. at 1048. (“[T]he 1975 amendments presented a perfect opportunity to say that monetary damages could be sought if a reorganization did involve common control.”).

The Busse court also based its interpretation of subdivision (b) on its perception of how section 1312 fits within the entire context of the surrounding statutory scheme, sections 1300 through 1313.  Id. The court was particularly struck by section 1309, subdivision (c), which provides that shareholders who do not avail themselves of the appraisal remedy “cease to be entitled” to be cashed out by the corporation for their shares.  Id. at 1048-1049.  The court noted that allowing a common law damages remedy under section 1312, subdivision (b), would run counter to section 1309 because dissenting shareholders could avoid the appraisal process, but still be effectively cashed out in later litigation.

Likewise, the Bussecourt found that a damages remedy would subvert the appraisal remedy and allow for gamesmanship that the Legislature sought to avoid by passing section 1308, which prevents dissenting shareholders from reneging on their demand for an appraisal without the corporation’s consent.  Id. at 1049.  The court explained that a damages remedy would allow dissenting shareholders to hedge their bets by disclaiming an appraisal remedy on the theory the company’s offer was submarket because of breach of fiduciary duty, and if the gamble did not pay off because the share price unexpectedly declined, they could simply dismiss their case, the effect of which would be to give the shareholders a free stock option.  Id.

The BusseCourt found that the “Big Stick” Remedy of a Rescission Action Under Subdivision (b) was Intended to Keep Management Honest in Common Control Mergers and Reorganizations

The Busse court observed that despite the historical antipathy towards litigation intended to stop or unwind mergers, by 1975, the Legislature recognized the potential for abuse in common control situations and perceived that there was a need for something more than just the appraisal remedy.  Id. at 1049-1050.  The concern, the court explained, is that “[i]n common control scenarios, management has better and quicker access to information about a company’s prospects than its stockholders and yet it’s management who are the buyers”. . . “in effect, management [is] dealing with itself.”  Id. at 1050 (italics in original).

The Busse court analogized the rescission remedy to Schroedinger’s cat in a box, which might, or might not, have been exposed to a puff of deadly gas.  Id.  If a management buyout is the cat, one would never know if the box contains a live cat or a dead cat until the outcome of the set-aside litigation becomes final and the box, so to speak, is opened.  Id.  A rescission action under subdivision (b) is an all or nothing proposition.  As the court put it, “the Legislature is willing to allow a little dice to be played over the survivability of a corporate reorganization [in a common control situation]” . . . “[i]t was willing to tolerate some dead cats to keep management honest.”  Id.

The Busse court concluded its analysis by mentioning with approval the Rutter Group’s interpretation of subdivision (b), and adding that shareholders who choose the big stick of a set aside remedy cannot also have the alternative of an appraisal.  Id. (citing, Friedman, Cal. Practice Guide: Corporations (The Rutter Group 2013) ¶¶ 8:358, 8:365 to 8:366, pp. 8-65, 8-66.1 (rev. #1, 2013)).

The Standard of Review is an Important Aspect of Busse – Pleading a Subdivision (b) Case is a Far Cry from Winning One

The Busse court emphasized that “[t]here is only so much a court can do on demurrer,” and there could be valid defenses to the minority shareholders’ action to set aside the merger, but those defenses need a much more factual record than is possible on a demurrer.  Id. at 1051.

The court expressed no opinion regarding the merits of the rescission claim beyond its determination that the second amended complaint alleged a cause of action for rescission under subdivision (b).  Id. at 1052.  The court’s clear message: don’t waste your time and ours’ challenging subdivision (b) cases on the pleadings.  It will not be difficult for plaintiffs to allege sufficient facts to raise an inference of indirect control in appropriate cases.

Pleading issues aside, Busse is a pro majority shareholder/management decision that is consistent with the prior 80-plus years of California jurisprudence concerning minority shareholder rights regarding mergers and reorganizations.  Although the Busse court described the rescission remedy as the “big stick,” the court’s holdings that shareholders have no right to monetary damages and cannot maintain an alternative action for appraisal if they pursue the “big stick” remedy will likely have far greater impact, no pun intended.

As equitable claims, subdivision (b) cases will be tried to the court, not to a jury.  See, id. at 1051 & n. 21.  Section 1312, subdivision (c), provides that in common control situations, the burden of proof shifts to the parties to the merger and the controlling shareholders to show that the transaction is fair and reasonable to the dissenting shareholders, but even with that advantage, subdivision (b) cases will likely be uphill battles for dissenting shareholders.  Management and controlling shareholders will invoke the business judgment rule in their defense.  Trial courts will be reluctant to unwind mergers except in the most egregious cases.  The trial court in Busse pressed the minority shareholders to abandon their rescission claim because it did not want to “unscramble any eggs.”  Id. at 1050 & n. 20.

It will be very difficult for minority shareholders to restrain or enjoin the consummation of a merger before judgment because subdivision (b) requires that the shareholder show “clearly that no other remedy will adequately protect the complaining shareholder.”  Cal. Corp. Code § 1312, subd. (b).

When one also considers that the shareholder cannot simultaneously pursue alternative appraisal and rescission claims, but rather, must abandon the right to an appraisal to pursue rescission, the rescission remedy becomes exceedingly unattractive.

On the other hand, management and controlling shareholders should take heed not to overreach because they will have to defend their transaction to the court. The issue of whether the transaction is fair will be a question of fact and an adverse ruling will be virtually impossible to reverse on appeal.  See, id. at 1051, n. 21.  An appellate court will not substitute it’s judgment of fairness for the trial court’s judgment.  See, id.  To borrow the Busse court’s Schroedinger’s cat analogy, a trial court’s finding that the transaction is unfair kills the cat deader than a doornail.  

– John J. Freni, Esq.

**This article is intended for informational purposes only and does not constitute legal advice. Any views expressed are those of the author only and not of the SDCBA or its Business & Corporate Law Section.**

1All further statutory references are to the California Corporations Code unless otherwise indicated.

2Section 1312, provides:

(a) No shareholder of a corporation who has a right under this chapter to demand payment of cash for the shares held by the shareholder shall have any right at law or in equity to attack the validity of the reorganization or short-form merger, or to have the reorganization or short form merger set aside or rescinded, except in an action to test whether the number of shares required to authorize or approve the reorganization have been legally voted in favor thereof; but any holder of shares of a class whose terms and provisions specifically set forth the amount to be paid in respect to them in the event of a reorganization or short-form merger is entitled to payment in accordance with those terms and provisions or, if the  principal terms of the reorganization are approved pursuant to subdivision (b) of Section 1202, is entitled to payment in accordance with the terms and provisions of the approved reorganization.

(b) If one of the parties to a reorganization or short-form merger is directly or indirectly controlled by, or under common control with, another party to the reorganization or short-form merger, subdivision (a) shall not apply to any shareholder of such party who has not demanded payment of cash for such shareholder’s shares pursuant to this chapter; but if the shareholder institutes any action to attack the validity of the reorganization or short-form merger or to have the reorganization or short-form merger set aside or rescinded, the shareholder shall not thereafter have any right to demand payment of cash for the shareholder’s shares pursuant to this chapter.  The court in any action attacking the validity of the reorganization or short-form merger or to have the reorganization or short-form merger set aside or rescinded shall not restrain or enjoin the consummation of the transaction except upon 10 days’ prior notice to the corporation and upon a determination by the court that clearly no other remedy will adequately protect the complaining shareholder or the class of shareholders of which such shareholder is a member.

(c) If one of the parties to a reorganization or short-form merger is directly or indirectly controlled by, or under common control with, another party to the reorganization or short-form merger, in any action to attack the validity of the reorganization or short-form merger or to have the reorganization or short-form merger set aside or rescinded, (1) a party to a reorganization or short-form merger which controls another party to the reorganization or short form merger shall have the burden of proving that the transaction is just and reasonable as to the shareholders of the controlled party, and (2) a person who controls two or more parties to a reorganization shall have the burden of proving that the transaction is just and reasonable as to the shareholders of any party so controlled.

3In 1947, the Legislature converted Civil Code section 369 into former Corporations Code section 4123, which was ultimately recodified in section 1312 in 1975.  See, Busse, supra, at 1040-1043.

4 The Busse court analyzed Beechwood Securities Corp. v. Associated Oil Co., 104 F.2d 537 (9th Cir. 1939), Gallois v. West End Chemical Co., 185 Cal. App. 2d 765 (1960), Giannini Controls Corp. v. Superior Court, 240 Cal. App. 2d 142 (1966), Jackson v. Maguire, 269 Cal. App. 2d 120 (1969), Sturgeon Petroleums, Ltd. v. Merchants Petroleum Co., 147 Cal. App. 3d 134 (1983), Steinberg v. Amplica, Inc., 42 Cal.3d 1198 (1986) and Singhania v. Uttarwar, 136 Cal. App. 4th 416 (2006).

The articles and treatises the court primarily considered were Ballantine & Sterling, Upsetting Mergers and Consolidations: Alternative Remedies of Dissenting Shareholders in California, 27 Cal. L.Rev. 644, 652 (1939), 1A Ballantine & Sterling, Cal. Corporation Laws (4th ed. 1986), Dunn, Steinberg v. Amplica: The California Supreme Court Holds Appraisal to be the Dissenting Shareholder’s Exclusive Remedy, 22 U.S.F. L.Rev. 293 (1988), and Friedman, Cal. Practice Guide: Corporations (The Rutter Group 2013).

5Beechwood Securities Corp. v. Associated Oil Co., 104 F.2d 537 (9th Cir. 1939), Gallois v. West End Chemical Co., 185 Cal. App. 2d 765 (1960), and Giannini Controls Corp. v. Superior Court, 240 Cal. App. 2d 142 (1966).