Tender Of Inflated Price Under Right Of First Refusal Does, And Doesn’t, Confer Standing

In a short ruling, U.S. District Court Judge Jeffrey S. White recently tackled a claim by a former employer that its departed employee had committed securities fraud when he allegedly failed to disclose that the price offered by his new employer for his shares of the former employer were “inflated and fraudulent”.  The price mattered to the former employer because it had a right of first refusal with respect to its erstwhile employee’s shares and the inflated price allegedly caused it not to be able to exercise its right of first refusal.  Integral Dev. Corp. v. Tolat, 2013 U.S. Dist. LEXIS 153705 (N.D. Cal. Oct. 25, 2013)

The former employee argued that there could be no Rule 10b-5 claim because his quondam employer’s right of refusal did not count as a contract to purchase or sell securities because it constituted a counteroffer.  Judge White ruled that under California law he must take a “common sense” approach, reviewing both the circumstances and commercial realities, to determining whether the right of first refusal was materially equivalent to the third party contract to constitute a contract for sale.  He then found that at the pleading stage, the employer had “alleged exercise of its right of first refusal is sufficiently similar to the EBS [new employer] Stock Purchase Agreement for the purpose of qualifying as an underlying contract to sell or purchase securities.”

The employer also alleged a claim under California Corporations Code Section 25501.  Here, Judge White found that California law does not provide standing to a plaintiff who is neither a purchaser or seller of securities.  The different results under Rule 10b-5 and Section 25501 serve to highlight the folly of the legislature’s recent bouleversement of Section 25401.  See Die Verwandlung: How The Legislature Likely Raised The Bar On Securities Fraud Actions.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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