As a general rule, claims against directors and officers based on promises to issue stock and share the profits of a corporation are subject to statutes of limitations for breach of contract (2 years for oral contract and 4 years for written contract), fraud (3 years) and breach of fiduciary duty (3 years). A key issue in any case is when the clock on the statute of limitations begins to run, known as accrual. What happens if the promise to issue stock was made 20 or more years before a lawsuit is filed? This was a hotly contested issue in a case where Mr. Dinsmore recently obtained a settlement for his client in the sum of $3,100,000. The other main issues were whether the Defendant who formed the corporation paid sufficient consideration for his stock and whether a binding agreement existed as to how the stock was to be divided.
Plaintiff purchased stock in a closely held corporation run by the Defendant who formed and ran the corporation. Plaintiff claimed that Defendant verbally promised shares would be issued to Plaintiff and Defendant in proportion to the capital invested by each of them. Approximately 20 years later, Plaintiff suspected that Defendant did not make the full capital contribution as promised and that Plaintiff was therefore entitled to greater percentage of the shares than he was issued. Plaintiff also claimed that he was entitled to share the profits of the corporation from its inception in accordance with his true equitable ownership interest. Mr. Dinsmore filed a lawsuit on Plaintiff’s behalf for declaratory relief, breach of contract, breach of fiduciary duty, fraud, conversion and related claims. Defendant asserted that all of the claims were long since barred by the statute of limitations. Defendant also claimed that he contributed sufficient consideration for his shares and denied promising to share the stock in accordance with the capital contributions of the parties.
Sufficiency of Consideration Paid for Stock Shares:
Immediately upon formation of the corporation, Defendant transferred 80% of the authorized stock shares to himself. Plaintiff asserted this transfer of shares was void for lack of consideration and the failure to comply with statutory requirements for transfer of the shares. The types of consideration which must be provided for stock shares are codified in Corporations Code §409(a)(1), which provides that shares may be issued “for consideration determined by the board, consisting of any or all of the following: money paid; labor done; services actually rendered . . .; debts or securities canceled; and tangible or intangible property actually received.” Future services shall not constitute consideration for shares of stock. (Corporations Code §409(a)(1).) Where the consideration is in a form other than money, the board must state by resolution its determination of the fair value, in monetary terms, of that consideration to the corporation. (Corporations Code §409(e).) Shares issued without proper consideration are void. (Kellerman v. Maier (1897) 116 Cal.416, 423-424 [applying former Civil Code Section 359, which provided, “No corporation shall issue stock or bonds except for money paid, labor done, or property actually received.]”) See also, 9 Witkin, Summary of California Law, 10th Ed. (2005) Corporations § 186, p. 958 (the established rule in California that stock issued without consideration is void, and consequently gives no rights to the shareholder, does not appear to be affected by the consideration requirements of Corporations Code §409(a); citing J.F. Lucey Co. v. McMullen (1918) 178 Cal. 425, 429 [also holding that shares issued without consideration are void and provide no shareholder rights].) The available remedy may include cancellation of stock that has been issued without consideration. (James v P. B. Steifer Mining Co. (1918) 35 Cal.App. 778.) The corporation may also reclaim the shares issued in a wrongful transaction. (Topanga Corp. v. Gentile (1967) 249 Cal.App.2d 681.)
Mr. Dinsmore presented a compelling case that Defendant did not provide any money or property for the shares and was therefore required to return all shares to the corporation. As a director and purported majority shareholder, Defendant had a fiduciary duty to Plaintiff and the corporation. (Brown v. Halbert (1969) 271 Cal.App.2d 252, 266-267; Jones v. H.F. Ahmanson & Co. (1969) 1 Cal.3d 93, 108.) The burden of proof is shifted to a director or majority shareholder to prove that they provided adequate consideration for shares of stock. The “burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein.” (Brown, supra, at 266-267.)
The money Defendant claimed to have paid for the shares was actually paid to third parties for ordinary business expenses. These payments were made over a period of 18 months after Defendant transferred the shares to himself. Evidence showed these payments were properly characterized as loans, not payments for shares. Every claimed payment except the first one (a $10 filing fee) was made after the shares were issued to Defendant. However, the law provides that the full agreed consideration for shares must be paid prior to or concurrently with the issuance of the shares. (Corporations Code § 410(b).)
Defendant also claimed that he provided “expertise and knowledge,” “business relationships” and “customers” for the shares. Plaintiff took the position that none of these contributions amounted to legally sufficient consideration. Rather, they were simply services rendered after the shares were issued. Such future services cannot serve as consideration. (Corporations Code §409(a)(1).) Furthermore, the board of the corporation never determined, as required by law, the amount to be paid for the shares issued to Defendant, or the monetary value of any consideration other than money. (Corporations Code §409(e).)
Defendant countered that the non-monetary contributions qualified as consideration in the form of “tangible or intangible property actually received.” (Corporations Code §409(a)(1).) However, “intangible property” is generally defined as “such property as has no intrinsic and marketable value, but is merely the representative or evidence of value, such as certificates of stock, bonds, promissory notes, and franchises.” (Black’s Law Dictionary, 4th Ed.) Plaintiff asserted that there are no property rights in “expertise and knowledge,” “business relationships” or “customers.” These items had no inherent value and could not be transferred. There was no tangible property of any type that Defendant contributed, such as a purchase order, patent, trade secret, or anything similar that was pledged to the corporation.
Statute of Limitations Defense:
Defendant made a motion for summary judgment on the grounds that Plaintiff’s claims were barred by the statute of limitations. The court denied the motion, finding that the statute of limitations on a claim for stock ownership does not commence to run until the stockholder has knowledge or notice that his rights are denied or that his status is repudiated or controverted by the corporation. (Bennett v. Hibernia Bank (1956) 47 Cal.2d. 540, 559.) The underlying theory is that a corporation holds its property in trust for the benefit of its shareholders and occupies a fiduciary position with respect to them. (Ibid.) A shareholder “has the right to believe that the corporation would not assert a claim adverse to his rights until he had notice of some unequivocal act that his rights are being disputed.” (Schneider v. Union Oil Co. (1970) 6 Cal.App.3d 987, 994.) Mr. Dinsmore showed that that Plaintiff never received notice that his stock rights were repudiated. As such, the court agreed that the statute of limitations did not bar Plaintiff’s claims to ownership of the shares, or any rights to profits which derived from such ownership.
The case of Maguire v. Hibernia S. & L. Soc. (1944) 23 Cal.2d 719 was instructive on this point. In Maguire, the California Supreme Court held that the plaintiffs’ rights as successors in interest to membership rights in a savings and loan corporation were not barred by the statute of limitations or laches, even 70 years after their predecessor’s membership rights extinguished. These rights were preserved because no notice was given by the corporation that the membership rights were denied. The defendant society was organized in 1859 to conduct a banking business. Plaintiffs were successors of original members, and in 1864 the society was incorporated and adopted bylaws purporting to deprive existing members of their rights. The plaintiffs filed an action for declaratory relief in 1934 to determine their membership rights. The defendants argued that a remedy was available, and the claims therefore accrued (the statute of limitations began to run), when plaintiffs’ predecessors were excluded from membership in 1864. The Court rejected this contention, noting that there was no showing that plaintiffs or their predecessors were deprived of the right to attend meetings, vote, or otherwise participate in the society’s affairs, or that they had knowledge of the passage of the exclusionary bylaws. The court relied on cases holding that the statute does not run against a stockholder until knowledge that his or her rights are denied or that his or her status is controverted by the corporation.
Mr. Dinsmore presented additional authority, which was also adopted by the court, supporting Plaintiff’s position that the breach of contract claim for damages was not barred by the statute of limitations. The statute of limitations on a breach of contract claim does not run until there is a breach. Plaintiff alleged that the contract was breached on dates continuing to the present. Plaintiff also alleged that the complaint filed in the lawsuit constituted the operative demand for Defendant to perform the contract and that failure to comply with that demand amounted to a breach. Furthermore, “the debt a declared dividend creates on the part of a corporation is payable only on demand, and hence not subject to limitation until there has been a demand and a refusal to pay.” (Schneider v. Union Oil Co., supra, 6 Cal.App.3d. 987, 994.)
Plaintiff also defeated the statute of limitations defense on his claim for conversion of stock shares and dividends. Because a fiduciary has a duty to make full disclosure of facts, any act of conversion by a fiduciary of trust property is akin to fraudulent concealment. (Bennett, supra, at p. 561) When a fiduciary duty exists, a plaintiff does not have a duty to inquire, and therefore does not have to disprove that an earlier discovery could have been made upon diligent inquiry. (Id. at p. 563.) A claim for conversion normally accrues as soon as the act of conversion is committed. However, such a claim does not accrue until discovery in a case where there has been fraudulent concealment. (Id. at p. 561.)
This case provides a good example that even very old claims, which appear almost certainly to be dead, may in fact have life. A thorough examination of all of the facts and law are required to make the proper diagnosis.