Remillard Brick Co. v. Remillard-Dandini Co.
241 P.2d 66, 109 Cal. App. 2d 405, 1952 Cal. App. LEXIS 1853 (1952)
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Rule of Law:
A transaction between a corporation and an entity controlled by its directors is not validated merely by disclosure and majority shareholder approval under California Corporations Code § 820 if the transaction is not just and reasonable to the corporation. Directors' fiduciary duties of good faith and inherent fairness to the corporation and all its shareholders remain paramount and can void an otherwise procedurally compliant but substantively unfair transaction.
Facts:
- Stanley and Sturgis were officers and majority directors of two brick manufacturing companies, Remillard-Dandini Company and San Jose Brick and Tile, Ltd. (the 'manufacturing companies').
- Plaintiff Remillard Brick Company, owned by Lillian Dandini, was a minority shareholder in Remillard-Dandini Company.
- Stanley and Sturgis formed and wholly owned a separate entity, Remillard-Dandini Sales Corporation (the 'sales corporation'), to handle sales.
- After failing to buy out the minority shareholder, Stanley and Sturgis used their majority control of the manufacturing companies' boards to approve exclusive sales contracts between the manufacturing companies and their own sales corporation.
- The contracts obligated the manufacturing companies to sell all their products to the sales corporation at a price that guaranteed the manufacturing companies only a minimal gross profit.
- The sales corporation, using the manufacturing companies' facilities, then resold the bricks for a large profit, which was retained by Stanley and Sturgis.
- Stanley and Sturgis acted as agents for both the manufacturing companies and the sales corporation in negotiating the contracts with themselves.
- The majority shareholders (whose shares Stanley and Sturgis were already under contract to purchase) provided written consent to the contracts over the dissent of the minority directors.
Procedural Posture:
- Remillard Brick Company filed a shareholder's derivative action in the trial court on behalf of the two manufacturing companies.
- The suit named as defendants the sales corporation and directors Stanley, Sturgis, and Gatzert.
- The trial court found that the 1949 contracts were unfair and void, ordering the defendants to repay approximately $26,000 in net profits to the manufacturing companies.
- The trial court also ordered that Stanley and Sturgis would be removed as directors unless they paid the judgment within 60 days.
- The trial court refused to invalidate the similar 1948 contracts, finding that their potential profits were speculative at the time of execution.
- Plaintiff Remillard Brick Company appealed from the trial court's judgment for failing to invalidate the 1948 contracts and for allowing defendants an offset for their services.
- Defendants Stanley, Sturgis, and the sales corporation appealed from the portions of the judgment invalidating the 1949 contracts and ordering their conditional removal.
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Issue:
Does a contract between a corporation and an entity wholly owned by its controlling directors, which diverts profits from the corporation to the directors' entity, become valid and immune from challenge under California Corporations Code § 820 simply because the directors' financial interest was disclosed and the contract was approved by a majority of shareholders?
Opinions:
Majority - Peters, P. J.
No. A transaction that is unfair to a corporation is not validated by mere disclosure and majority shareholder approval under Corporations Code § 820. The statute does not permit an officer or director to obtain an unfair advantage for himself at the expense of the corporation by abusing his power. Section 820 sets forth the basic duty that directors exercise their powers in good faith and with a view to the interests of the corporation, a duty which is not superseded by technical compliance with the statute's disclosure and approval provisions. The law scrutinizes transactions between corporations with interlocking directorates and will not uphold a transaction that is unfair to minority stockholders. Here, Stanley and Sturgis used their majority power to strip the manufacturing companies of their profitable sales functions for their own personal advantage, which is a clear breach of their fiduciary duty. The essence of the test is whether the transaction carries the earmarks of an arm's length bargain; if it does not, equity will set it aside. The court found these contracts were a vehicle to divert profits that rightfully belonged to the manufacturing companies to the directors personally, constituting a fraud upon the corporation and its minority shareholder.
Analysis:
This case establishes that California's statutory 'safe harbor' for interested director transactions (Corp. Code § 820) is not an absolute shield against claims of unfairness. The ruling clarifies that procedural compliance, such as disclosure and majority approval, does not immunize a self-dealing transaction from judicial scrutiny for its substantive fairness. The court firmly subordinated procedural formalities to the fundamental fiduciary duties of loyalty and good faith, placing the burden on interested directors to prove the 'inherent fairness' of their dealings. This decision strongly protects minority shareholders by ensuring that controlling directors cannot use their power to 'mulct' the corporation for personal gain, even if they disclose their intentions.
