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A Pennsylvania common pleas court judge has taken steps to define more clearly a majority shareholder’s duty to minority shareholders when selling control of the corporation to an outsider. The question before the court in Pitterich v. Styling Technology Corp., PICS Case No. 00-1326 (C.P. Allegheny June 27, 2000), was whether majority shareholders who are officers and directors of a closely held corporation violate a fiduciary duty to minority shareholders by bargaining for the sale of only their shares at a premium instead of bargaining for the sale of the shares of the entire corporation at a lower price. This is an issue that has not been directly addressed by the Pennsylvania appellate courts, Allegheny County Judge R. Stanton Wettick said, turning to other states’ decisions for guidance. “With few exceptions, courts throughout the country have adopted the rule that a majority shareholder who is also a director and an officer may sell his or her property to whomever the shareholder wishes,” Wettick said. However, there are exceptions to this general rule. The majority shareholders cannot mislead a minority shareholder regarding the transaction and cannot sell control of the corporation to an outsider who will mismanage or loot the corporation, the judge said. Because Michael Pitterich’s complaint alleging breach of fiduciary duty by the majority shareholders of Fort Pitt Acquisition Inc. “may bring plaintiff’s claim within the exception covering the situation in which the shareholders sold control of the corporation when it was apparent from the circumstances that the buyer would not protect the interests of the minority shareholders,” Wettick refused to grant the defendants’ preliminary objection. THE NEGOTIATIONS According to the opinion, Pitterich owned at least four percent of the outstanding shares of common stock of Fort Pitt, which was in the business of making and marketing hair-care and related products to professional beauty and barber salons. Defendants Dennis M. Katawczik, Kevin T. Weir and Carol M. Weir owned or controlled 58.6 percent of the shares of common stock of the corporation. In April 1998, Graham Webb International Limited Partnership approached Katawczik and Kevin Weir to discuss purchasing the assets of Fort Pitt. Pitterich alleges that after negotiations, in June or July 1998, the majority shareholders orally agreed to sell to Graham Webb all the stock of Fort Pitt for $45 million. But at some later time, the defendants repudiated the Graham Webb agreement and instead negotiated a stock-purchase agreement with another company, Styling Technology Corp. The latter agreement benefited only the defendants, since under its terms, Styling Technology purchased only the controlling stock owned by defendants for $30 million. Pitterich filed suit against the two corporations and the majority shareholders. Against Katawczik and the other individual defendants, Pitterich alleges a breach of fiduciary duty. According to the opinion, Pitterich alleges “they breached this obligation by repudiating the Graham Webb agreement and negotiating and accepting, instead, the Styling Technology agreement which benefited only themselves as majority shareholders.” Wettick first concluded, over the objection of the defendants, that Pitterich could maintain an individual action in his own right against the majority shareholders without filing a derivative claim. “A minority shareholder – rather than the corporation – is the proper party to bring a lawsuit based on the breach of [the majority shareholder's fiduciary duty to the minority shareholders],” the judge said. Wettick then turned to the issue of whether the majority shareholders breached their duty to Pitterich under these circumstances. “Defendant states that the law should allow majority shareholders to select any option [for selling their shares] because under settled law an owner of property (i) cannot be compelled to sell his or her property and (ii) is permitted to sell his or her property on whatever terms he or she wishes,” according to the opinion. Plaintiff countered that control of the corporation should not be recognized as property of any individual shareholders, because it is an asset that belongs to all of the shareholders. Generally speaking, Wettick said, a majority shareholder has a right to sell his or her stock to third persons on such terms as the shareholder selects. But there are two exceptions to this rule, both of which arise from tort law. “First, the majority shareholder cannot mislead the minority shareholder,” the judge wrote. “Second, the majority shareholder cannot sell control of the corporation to an outsider who will mismanage or loot the corporation.” This second exception “covers the situation in which it should be apparent to the controlling shareholders from the circumstances surrounding the transaction that the purchasing shareholders are going to violate their obligations to the minority shareholders following the acquisition of the stock.” Wettick concluded that Pitterich’s complaint contains allegations that would satisfy this exception. Pitterich made the following claims regarding the circumstances at the time of the stock purchase: * Styling Technology’s financial health was rapidly deteriorating and it had issued false and/or misleading financial statements. * Circumstances existed that would have alerted the defendants that an investigation of Styling Technology should have been made in order to protect the best interests of Fort Pitt and its shareholders. * The defendants failed to conduct an adequate investigation into Styling Technology in order to prevent the dramatic diminution in value of Fort Pitt shares or the complete destruction of Fort Pitt’s financial well-being. * The shares of the minority shareholders, including Pitterich, were effectively rendered worthless by the transaction. * Styling Technology was carrying substantial debt and was experiencing financial difficulties. These allegations could satisfy the requirement that Pitterich claim that the majority shareholders sold control of the corporation when it was apparent from the circumstances that the buyer would not protect the interests of the minority shareholders, Wettick said. However, Wettick dismissed Pitterich’s claim seeking recovery for intentional interference with contractual relations. “A shareholder is free to sell his or her stock to whomever the shareholder wishes; consequently, the controlling shareholders were entitled to further their own separate interests by selling their stock through a transaction more favorable to the controlling shareholders,” Wettick wrote.

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