THE BUSINESS LAW JOURNAL JOHN EDSON BRADY EDITOR UOI. XV THE BUSINESS LAW JOURNAL COMPANY 71-73 MURRAY STREET NEW YORK CITY JOHN EDSON BRADY, Editor VOL. 15 JANUARY, 1930 No. 1 Purchase of Stock by Officer of Corporation T HE president, or other officer or director, of a corporation has knowledge of an approaching event, such as a merger with another corporation which will enhance the value of the stock of his corporation. Without disclosing the information which he has he negotiates with one of the corporation's stockholders and purchases his stock at an agreed price. The event which the president had in mind occurs and the value of the stock is substantially increased. The stockholder, realizing that he has made a bad bargain, brings an action to have the contract set aside. Is he entitled to such relief? Or, will the courts permit the officer or director, as the case may be, to retain the stock and keep the profits which he has made on the transaction? In a recent case of this kind it was held that the stockholder was entitled to no relief, that the officer who purchased the stock was under no obligation to divulge his inside information, and that he was entitled to hold the profits of the transaction. The case in question is Connolly v. Shannon, 147 Atl. Rep. 234, decided by the Court of Chancery of New Jersey. The facts of this case showed that the plaintiff, Connolly, was a director of the Mercantile Trust Company of Jersey City, and owned sixty shares of the capital stock of that company. The defendant, Shannon, was president of the trust company. He was also a director and chairman of the executive committee of the board of directors. In his bill of complaint the plaintiff alleged that the defendant had knowledge that negotiations were on foot which were practically certain to result in a merger of the Mercantile Trust Company with the Commercial Trust Company on the basis of a value of at least $2,500 for each share of stock of the Mercantile Trust Company. Without informing the plaintiff of these facts, the defendant offered to purchase fifty shares of the plaintiff's stock at $1,400 per share and the plaintiff, being unaware of the intended merger, accepted the offer. The proposed merger was subsequently effected on a basis which gave to each stockholder of the Mercantile Trust Company for each share of stock held by him $1,397.73 in cash and eight shares of the stock of the Commercial Trust Company at a market value of $220 per share. In other words the defendant paid the plaintiff $70,000 for his fifty shares; he subsequently received $69,886.50 in cash and four hundred shares of the Commercial Trust Company having a market value of $88,000. The plaintiff brought this action to have the contract set aside, offering to repay the money which he had received from the defendant and asking that the defendant be directed to turn over to the plaintiff what he had received in exchange for the fifty shares. The defendant moved to strike out the bill of complaint on the ground that the facts set forth stated no cause of action. The defendant's contention was that, even if the plaintiff could prove the facts alleged in his complaint, he would not be entitled to a judgment against the defendant. The court held that the defendant's contention was correct and the suit was accordingly dismissed. The decisions on this question are not 'in accord, but the decision in the present case follows the majority rule. The following paragraphs are quoted from the court's opinion: My decision on this motion is controlled by the decision of the Court of Errors and Appeals in Crowell v. Jackson, 53 N. J. Law, 656, 23 A. 426, 427. It was there held: "A director or the treasurer of a corporation is not, because of his office, in duty bound to disclose to an individual stockholder, before purchasing his stock, that which he may know as to the real condition of the corporation affecting the value of that stock. He is, to some extent, trustee for the stockholders as a body in respect to the property and business of the corporation, but does not sustain that relation to individual stockholders with respect to their several holdings of stock, over which he has not control." There seem to be two distinct lines of authorities on the point involved in this motion; that is, whether or not an officer and director of a corporation occupies such a fiduciary relation toward individual stockholders as to make it the duty of such officer and director to disclose to an individual stockholder, before purchasing his stock, that which he may know as to the real conditions of the corporation affecting the value of that stock. The majority view, apparently, is that adopted by the Court of Errors and Appeals in Crowell v. Jackson, supra, which holds that he does not occupy such fiduciary relation. The minority view is that expressed in Oliver v. Oliver, 118 Ga. 362, 45 S. E. 232, cited by counsel for the complainant, and which holds that such fiduciary relation does exist. The following statement on this question is quoted from 14a Corpus Juris 128: The authorities agree that a director is not precluded by virtue of his position from purchasing or securing an option to purchase the shares of an individual stockholder; that the stockholder is not entitled to arbitrarily rescind the sale regardless of the facts and circumstances; and that where a dirctor or officer misrepresents material facts peculiarly within his knowledge as a corporate officer and the stockholder relies thereon, the contract may be rescinded, or damages for the fraud may be recovered. They are in conflict, however, as to whether the director or officer may deal as freely with the stockholder as a stranger might or whether he is subject to the rules governing persons occupying fiduciary positions. In some jurisdictions the rule that a director or officer is a trustee for the stockholders is deemed to be limited to the management of the general corporate affairs and not to extend to dealings with the individual share owner in respect to his shares of stock. In these jurisdictions a director or officer is free to purchase shares from a stockholder without divulging information which he may have affecting the value of the stock, unless special facts exist imposing the duty of disclosure. In other jurisdictions the relation of a director or officer to an individual stockholder in respect to his shares is deemed to be fiduciary so as to make it fraudulent for him to purchase from a stockholder without disclosing facts within his knowledge concerning the corporate affairs which affect the selling price of the stock. In jurisdictions where this rule obtains a purchase of shares by a managing officer from an individual stockholder is presumptively fraudulent and voidable, and the burden is cast on the 'officer to rebut the presumption by an affirmative showing that the purchase was fairly made for value, or, if for less, upon a full disclosure of all the facts bearing thereon which were known to the officer and unknown to the stockholder. The states in which an officer or director is permitted to retain the profits which he makes in a transaction of this kind are listed as follows in Corpus Juris: Arizona, Idaho, Illinois, Indiana, Louisiana, Michigan, Minnesota, New York, Tennessee, Utah and Washington. The states which hold to the contrary rule are Georgia, Iowa, Kansas, Nebraska and Wisconsin. The reason for the rule which denies the right of the director |