## Facts

- Reynolds Investing Company, Inc., an investment-trust type corporation, held over $5 million in readily saleable securities.
- Clarence K. Reynolds and William F. Woodward (with other family members) controlled a majority of the voting common stock and served as officers/directors.
- The common stock traded at about $0.06 per share, but the Reynolds group agreed to sell approximately 1.035–1.055 million shares at $2 per share to a purchasing group associated with Franklin Mayer and Prentice (of Prentice & Brady).
- The sellers received the purchase funds through Granberry & Co., which guaranteed performance and handled disbursement of proceeds.
- As part of the transfer of control, the sellers resigned and caused the buyer’s nominees to be elected as directors and officers, without notice to other security holders.
- The sellers made only a cursory inquiry into the buyers’ resources and background; a more careful inquiry would have indicated weak finances and associations with similar asset-diversion transactions.
- After the buyers obtained control, the new management diverted and mismanaged corporate assets, using the securities portfolio for improper purposes, leading to insolvency and bankruptcy.
- The bankruptcy trustee, Gerdes, pursued claims against the selling controllers, the purchasing group, and intermediaries who facilitated the transfer.

## Issues

1. Whether controlling shareholders who are also directors/officers breach fiduciary duties by selling control at a substantial premium and transferring managerial power to purchasers under circumstances indicating a foreseeable risk of looting a corporation with highly liquid assets.
2. Whether intermediaries that guarantee and facilitate the control transfer and disbursement of proceeds can share liability for the resulting corporate losses.
3. What level of investigation and care is required of insider-sellers before installing a purchaser’s nominees in control of a corporation susceptible to asset diversion.

## Decision

- The court held that the Reynolds selling group could be liable for breach of fiduciary duty arising from the manner of the sale of control and the delivery of corporate power to the purchasers.
- The court concluded that the sellers knew or should have known the corporation’s liquid asset structure made it a tempting target for diversion and that their limited investigation was inadequate under the circumstances.
- The court allowed claims to proceed against certain intermediaries, including Granberry & Co., to the extent they knowingly facilitated the transaction and transfer of control in a way that enabled the later diversion of assets.
- The case proceeded with liability and damages to be determined based on further proof.

## Legal Principles

- Directors and controlling shareholders owe fiduciary duties to the corporation and may not dispose of control in a way that foreseeably exposes the corporate treasury to diversion.
- A control premium is not per se improper, but liability may arise when the premium and surrounding circumstances indicate the buyer is paying for access to corporate assets and looting is a foreseeable consequence.
- When selling control of a corporation holding substantial liquid assets, insider-sellers have a duty to make a reasonable inquiry into the purchaser’s integrity and financial responsibility; superficial assurances and reputational signals may be insufficient in the presence of warning signs.
- Parties who substantially assist in effectuating an improper transfer of control, with knowledge of circumstances indicating a high risk of asset diversion, may be held jointly responsible for resulting corporate losses.
- Claims for fiduciary breach must be supported by specific factual allegations describing the misconduct and causal connection to corporate harm, not merely general assertions of wrongdoing.

## Conclusion

The court recognized a fiduciary-duty limitation on the sale of corporate control: controlling directors/officers may be liable when they transfer control of a liquid-asset corporation to buyers without reasonable investigation despite warning signs, and the buyers then loot the corporation; intermediaries who knowingly facilitate such a transfer may also face liability.


Gerdes v. Reynolds, 28 N.Y.S.2d 622 (N.Y. Sup. Ct. 1941)