Debaun v. First West Bank & Trust Co.

Facts

Alfred S. Johnson Inc. was incorporated by Alfred S. Johnson to process color photographs in 1955. Johnson sold 20% of the outstanding shares to Debaun (P), the primary salesman of the corporation, and 10% to its production manager. Upon illness, Johnson transferred managerial control of the corporation to P and two others. After P died testate, First West Bank & Trust (D) was named trustee of the remaining 70% of the corporate shares. The business grew and was very successful under P's control, yet D sought to sell its shares for another investment opportunity. D also decided that no one connected with the Corporation should be made aware of its decision to sell until a sale was firm. An appraisal showed that the Corporation was worth at least $326,000. A competitor of Corporation showed P a letter indicating that Corporation was for sale. P was contacted by two potential buyers. P refused to sell. P even submitted an offer for the 70 shares held by D. The offer was rejected as inadequate. D then received several offers from Mattison, acting in the name of S.O.F. Fund. D ordered a Dun & Bradstreet report on Mattison and the fund. It noted pending litigation, bankruptcies, and tax liens against corporate entities in which Mattison had been a principal, and suggested that S.O.F. Fund no longer existed. A vice-president of D had personal knowledge that the Los Angeles Superior Court had entered a judgment against Mattison in favor of D's predecessor in interest for compensatory and punitive damages as the result of Mattison's fraudulent misrepresentations and a fraudulent financial statement to obtain a loan. That judgment remained unsatisfied in 1968 and was an asset of D acquired from its predecessor in an acquisition of 65 branch banks. Mattison submitted a third offer. D has reservations on the legality of the use of corporate assets to secure an obligation of a major shareholder. Mattison explained the bad D&B report from his practice to take over failing companies so that the existence of the litigation and tax liens noted in the Dun & Bradstreet report was not due to his fault. D requested more information and Mattison's attorney refused to divulge any but said that the information was publicly available. D did not pursue its investigation into the public records of Los Angeles County where a mass of derogatory information lay. There were 38 unsatisfied judgments against Mattison or his entities totaling $330,886.27, and 54 pending actions claiming a total of $373,588.67 from them. The record also contained 22 recorded abstracts of judgments against Mattison or his entities totaling $285,704.11, and 18 tax liens aggregating $20,327.97. Even so, D knew or should have known that the payment of the $200,000 balance of the purchase price would come from Corporation. D was aware that Corporation would not generate a sufficient after-tax cash flow to pay dividends in a sufficient amount to permit the payments of interest and principal on the $200,000 balance. D knew that Mattison could make those payments only by resorting to distribution of 'pre-sale' retained earnings and assets of Corporation. Mattison and D reached agreement. S.O.F. was required to retain a working capital of not less than $70,000, to refrain from intercompany transactions except in the ordinary course of business for adequate consideration, and to furnish monthly financial statements and a certified annual audit report to D. The stock will be held by D in pledge to secure the fund's obligation. There were provisions for acceleration of the unpaid balance on default and a security agreement to secure Mattison's obligation to D covering all 'furniture, fixtures and equipment of [Corporation].' Mattison agreed to do all Corporation banking at D. 

P and Stephens were told that the shares of Corporation owned by D had been sold on an installment basis to Mattison. They were informed that a security agreement had been signed to protect Corporation in the event of death or default of Mattison and that in such an event Bank would 'foreclose on the stock.' They did not get a copy of the security agreement nor were they informed that the deal hypothecated corporate assets as security for Mattison's debt to D. They voted for approval. Corporation had cash of $76,126.15 and other liquid assets of over $122,000. Its remaining assets were worth $60,000. Reserve for bad debts was $233,391.94, and its net worth about $220,000. Mattison implemented a systematic scheme to loot Corporation of its assets. He diverted $73,144 in corporate cash to himself and MICO, a shell company owned by Mattison. This, of course, was totally unsecured. Mattison caused Corporation assign to MICO all of Corporation's assets in exchange for a fictitious agreement for management services. He diverted all corporate mail to a post office box from which he took the mail, opened it, and extracted all incoming checks to the corporation before forwarding the mail on. He ceased paying trade creditors promptly, as had been Corporation's practice, delaying payment of trade creditors to the last possible moment and, to the extent he could, not paying some at all. He delayed shipments on new orders. To cover his activities, Mattison removed the corporate books and records. P quit because of Mattison's policy of not filling orders and because Mattison had drastically reduced P's compensation. He collected payments from employees to pay premiums on a voluntary health insurance plan although the policy covering the plan was terminated in September for failure to pay premiums. He issued payroll checks without sufficient funds and continued not to pay trade creditors. He did not supply the financial reports required by the exchange agreement. D learned of the misconduct in real time but took no action beyond seeking an oral explanation from Mattison. D eventually filed an action in the superior court seeking the appointment of a receiver. D pursued neither a receivership nor an ouster of the board until June when it shut down the operations of Corporation. Corporation was hopelessly insolvent. Corporation had no assets and owed $218,426 to creditors. Ps filed two related actions against D. One asserted their right to recover, as shareholders, for damage caused by D. The other was a stockholders' derivate action brought on behalf of Corporation. The trial court held for Ps, finding that D had breached duties it owed as a majority controlling shareholder to the corporation it controlled. It assessed monetary damages in the amount of $473,836, computed by adding to $220,000. This appeal followed. 

Issues

Rule of Law

Holding and Decision

Legal Analysis

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