## Facts

- Alfred S. Johnson, Inc. was formed to process color photographs for printed reproduction; Alfred S. Johnson originally owned all 100 shares.
- Johnson sold 20 shares to James DeBaun and 10 shares to Walter H. Stephens; Johnson retained 70 shares.
- After Johnson became ill and later died (Jan. 15, 1965), First Western Bank and Trust Co. became executor and trustee of Johnson’s testamentary trust and held the 70-share controlling block.
- The Bank, through trust administration, attended and participated in corporate governance and voted the controlling shares through a nominee.
- The Bank decided (Oct. 27, 1966) to sell the trust’s controlling shares and chose not to inform corporate insiders until a sale was firm; it retained an investment firm to find a buyer.
- Buyer Raymond J. Mattison, using the name “S.O.F. Fund,” made offers to purchase the 70-share block; the Bank obtained a Dun & Bradstreet report showing adverse information, including litigation, bankruptcies, tax liens, and doubt about the Fund’s existence.
- Deal terms evolved so that, instead of Mattison providing adequate outside security, the corporation’s own assets would secure the unpaid purchase price, and restrictions on dividends from pre-sale retained earnings would be removed.
- Despite the adverse report and the proposed use of corporate assets to secure the purchase, the Bank did not conduct additional readily available investigation (including public records checks) into Mattison’s financial and litigation history.
- After acquiring control, Mattison and associates caused transactions that used corporate funds and assets to finance the purchase and diverted corporate value, severely harming the company.
- The Bank later joined DeBaun and Stephens in removing the Mattison group from control, but substantial losses had already occurred.
- DeBaun and Stephens brought a derivative action on behalf of the corporation alleging the Bank, as controlling shareholder, breached duties in selling control to a looter without reasonable investigation; the trial court found liability and awarded damages, and the Bank appealed.

## Issues

1. Whether a controlling shareholder selling a controlling block owes the corporation a duty of reasonable investigation and due care when the seller has facts indicating a reasonable likelihood the buyer will loot the corporation.
2. Whether the Bank breached that duty by proceeding with the sale despite warning signs about the buyer and transaction structure.
3. Whether the buyer’s looting was a foreseeable result of the Bank’s conduct such that the Bank’s breach was a proximate cause of corporate losses.
4. What damages were recoverable for injury to the corporation resulting from the transfer of control.

## Decision

- The Court of Appeal affirmed liability against the Bank (with limited modification not central to the governing rule).
- The court held that a controlling shareholder must act in good faith and fairness in transferring control and, when possessed of facts showing a reasonable likelihood of looting, owes the corporation a duty of reasonable investigation and due care.
- The Bank breached that duty by failing to make a reasonable investigation into Mattison in light of the adverse credit information and deal terms suggesting use of corporate assets to fund the acquisition.
- The Bank’s breach was a proximate cause of the corporation’s losses because the subsequent looting was the risk that made further investigation necessary; the buyer’s wrongdoing did not break causation.

## Legal Principles

- A controlling shareholder may be liable for corporate harm caused by a sale of control to a buyer likely to misuse control when the seller knows, or should know based on available facts, that looting is reasonably likely.
- The duty to investigate arises when warning signs create a reasonable likelihood the purchaser will loot the corporation; it is not an automatic duty to investigate every purchaser.
- Red flags can include credible adverse financial and litigation information about the purchaser and transaction terms that permit the purchaser to use corporate assets or retained earnings to pay for the control block.
- When the foreseeable risk is that the purchaser will loot the corporation, the purchaser’s later misconduct generally does not constitute a superseding cause that relieves the control seller of liability.

## Conclusion

The court held that a controlling shareholder transferring control must reasonably investigate a prospective buyer when facts indicate a reasonable likelihood of corporate looting, and it affirmed liability where the seller ignored significant warning signs and facilitated a control transfer that foreseeably enabled the corporation’s subsequent stripping of assets.


DeBaun v. First W. Bank & Tr. Co., 46 Cal. App. 3d 686 (Cal. Ct. App. 1975)