Lawton v. Nyman
2003 U.S. App. LEXIS 8069, 327 F.3d 30, 2003 WL 1964407 (2003)
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Rule of Law:
In a closely held corporation, directors, officers, and majority shareholders owe a heightened fiduciary duty of 'complete candor' to minority shareholders. This duty requires the disclosure of all germane information when the corporation redeems the minority's shares, including a significant financial turnaround and management's decision to explore a sale of the company.
Facts:
- Nyman Manufacturing was a closely held family corporation where Robert and Kenneth Nyman held all voting stock, and their sister, Judith Lawton, and her family (the Lawtons) were minority, non-voting shareholders.
- After years of poor performance, the company hired consultant Keith Johnson in 1994, who, along with the Nyman brothers, engineered a significant financial turnaround.
- By the end of the fiscal year on March 29, 1996, the company had earned a $3.5 million profit, a stark contrast to previous losses.
- In March 1996, the defendants (Robert Nyman, Kenneth Nyman, and Keith Johnson), acting as the board of directors, decided to hire a consultant to explore strategic options, which included a potential sale of the company.
- On May 8, 1996, the company sent an offer to the Lawtons to redeem their shares for $200 per share.
- This offer letter failed to disclose the company's recent profitability and the decision to explore a sale; it also contained misrepresentations, including a false expiration date and a claim that the offer was made in response to shareholder inquiries.
- Robert Nyman called Judith Lawton and described the offer as a 'once in a lifetime' opportunity but did not disclose any of the positive financial or strategic information.
- Relying on the incomplete and misleading information, the Lawtons sold their 952 shares back to the company on May 30, 1996, for $200 per share.
- Approximately sixteen months later, on September 29, 1997, the defendants sold Nyman Manufacturing to Van Leer Corporation for a price that valued each Class A share at $1,667.38.
Procedural Posture:
- Judith Lawton and her family (plaintiffs) sued Robert Nyman, Kenneth Nyman, Keith Johnson, and Nyman Manufacturing (defendants) in the U.S. District Court for the District of Rhode Island.
- The plaintiffs alleged breach of fiduciary duty, securities fraud, and common-law fraud.
- After a bench trial, the district court found the defendants liable for breach of their common-law fiduciary duty but dismissed the federal securities claims.
- The district court awarded the plaintiffs $2,096,798.50 in damages, plus prejudgment interest.
- The defendants (appellants) appealed the liability finding and the damages award to the U.S. Court of Appeals for the First Circuit.
- The plaintiffs (appellees/cross-appellants) cross-appealed, arguing the damages awarded were insufficient.
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Issue:
Do officers and directors with voting control of a closely held corporation breach their fiduciary duty to minority shareholders by causing the corporation to redeem their shares without disclosing material information, such as a dramatic financial turnaround and the decision to explore a sale of the company?
Opinions:
Majority - Lynch, Circuit Judge
Yes, the officers and directors breached their fiduciary duty to the minority shareholders. In a closely held corporation, insiders like the defendants owe a heightened duty of disclosure, described as an obligation of 'complete candor,' when purchasing shares from minority stockholders. This duty requires the disclosure of all 'germane' information. The court found that the combination of non-disclosures—including the company's dramatic financial turnaround and the decision to hire a consultant to explore a sale—was material information that would have been important to the plaintiffs in evaluating the redemption offer. The materiality standard in a close corporation context is more expansive than in a public company setting. The defendants' concerted effort to buy up minority shares, coupled with affirmative misrepresentations like a false deadline, provided ample evidence to support the finding of a breach of fiduciary duty.
Analysis:
This decision reinforces the principle that fiduciaries in a closely held corporation are held to a higher standard of disclosure than their counterparts in publicly traded companies. It establishes that even the 'possibility' of a future sale can be material information that must be disclosed to minority shareholders during a stock redemption, especially when part of a larger pattern of non-disclosure about the company's improving health. The case serves as a strong precedent protecting minority shareholders from being 'squeezed out' by insiders using superior information. By remanding on the issue of damages, the court also highlights the complexity of fashioning an appropriate remedy, signaling that while liability may be clear, calculating damages requires a nuanced analysis of causation and unjust enrichment, not merely awarding the final sale price.
