Yesterday, the California Court of Appeal issued an opinion addressing two important questions involving the liability of corporations and promoters Cleveland v. Johnson, Cal. Ct. of Appeal Case No. B233762 (Oct. 11, 2012). The facts of the case are somewhat complicated, but can be distilled to the following elements. The plaintiffs invested money in a proposed new business that was to be operated initially as a separate division of an existing corporation. The plaintiff investors were to be repaid their investment and then receive a percentage of the project’s gross receipts. Following the investment, the corporation recorded a fictitious business name for the project. After being told that the project had failed, the plaintiffs learned that the project was being operated successfully by a separate corporation involving the same shareholders, officers and directors of the first corporation.
Can A Corporation Be A Successor to a DBA?
In an opinion written by Justice Laurence D. Rubin, the Court of Appeal first tackled the question of whether successor liability could be imposed when a corporation takes over a specific line of business that was operated separately by another corporation. Justice Rubin noted that until now, successor liability has “almost always” couched in terms of liability flowing from one corporation to another. The rule in these cases has been that a purchaser of the assets of another corporation does not assume the seller’s liabilities unless:
There is an express or implied assumption;
The transaction amounts to a consolidation or merger;
The purchaser is a “mere continuation” of the seller; or
the transfer of assets is for the fraudulent purpose of escaping liability.
See Ray v. Alad Corp., 19 Cal. 3d 22 (1977). Although the instant case did not fit within the previous fact patterns, the Court of Appeal found no reason not to impose successor liability, concluding that successor liability is an equitable doctrine that requires an analysis of each case on its own unique facts.
Does A Promoter Owe A Fiduciary Duty To Investors Who Do Not Become Shareholders?
The jury also found the defendants liable for breach of fiduciary duty. Justice Rubin wrote that “it has long been held that ‘promoters are fiduciaries’”. The defendants, however, argued that a promoter’s fiduciary duty is limited to stockholders. The Court disagreed, but it was careful to say that this was not a rule to be applied to all cases:
We do not say that, under all circumstances, all corporations or promoters owe fiduciary duties to all ‘investors.’ The word ‘investor’ is used in common parlance to include holders of debt as well as equity in a corporation. But in this case, the terms of the investment were clearly defined, and Cleveland’s [the plaintiffs] position is indistinguishable in any pertinent way from the position of a stockholder . . . of the corporation ultimately formed. . . . We see no reason why a promoter, who undoubtedly has a fiduciary duty to investors who later receive stock certificates entitling them to share in the profits of the enterprise, should not likewise have a fiduciary duty to initial investors who do not receive stock but are entitled by contract to share in the profits of the enterprise.
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A Lamentable Example Of Public Notice And Transparency
Section 911 of the Dodd-Frank Act established an Investor Advisory Committee to advise the Commission on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. The Committee has held two meetings so far.
I was quite surprised to see that the Committee gave notice of a telephone meeting on October 9 for a meeting to be held on October 12. According to the notice, the purpose of the meeting is to discuss and vote on a recommendation from the Investor as Purchaser subcommittee regarding the Jumpstart Our Business Startups (JOBS) Act requirements on general solicitation and general advertising in Rule 506 private placements.
Three days notice may, or may not, be sufficient notice for the members of the committee. However, I do note that the Committee’s Charter and Bylaws each quite specifically require at least two weeks notice of meetings. If the public only received three days notice, was the required two week notice given to Committee members? If so, why did the Committee wait until the last minute to give notice to the public?
In any event, three days notice is clearly insufficient notice to the public. The federal Government in Sunshine Act requires that public announcement be given “at least one week before” the meeting. 5 U.S.C. § 552b(e)(1). Although that act may not apply when less than a quorum of the Commission is expected to attend a meeting of the Committee, the act nevertheless suggests a minimal best practice for open government which the Committee’s notice clearly does not meet.
Even more troubling is the Committee’s disingenuous invitation for public comment. How can the public comment when the Commission has failed to provide copies of the recommendations that will be discussed and voted on at the meeting?