## Facts

- Phillip J. Gentile and other promoters, including Ernest Breault and Henry Luft, formed Topanga Corporation to acquire and operate a dump site known as Topanga Ranch.
- Gentile represented that Topanga Ranch would be purchased for $210,000: $70,000 value credited for Gentile’s Fresno ranch, $30,000 cash, and a $110,000 note secured by Topanga Ranch.
- The actual purchase price was $150,000, and Gentile’s Fresno ranch was treated in the transaction at only $10,000, with $30,000 cash and the same $110,000 note.
- Corporate documents reflected the inflated $210,000 price and treated Gentile as having contributed $70,000, resulting in his receiving roughly a one-third ownership interest.
- About a year after the acquisition, the board learned the Fresno ranch was worth far less than represented and sought to reduce Gentile’s interest; the corporation issued a rescission notice offering to reissue shares reflecting a reduced contribution.
- Litigation followed, seeking declaratory and equitable relief, including cancellation and reissuance of shares, and punitive damages for fraud.
- After an earlier appeal rejecting a res judicata bar and remanding for trial on the merits, the trial court found fraud, ordered cancellation of outstanding shares held in escrow, and directed issuance of new shares proportionate to actual contributions, treating Gentile’s contribution as $10,000.
- The trial court denied punitive damages on the ground it lacked authority to award them.
- The Gentiles appealed the cancellation/reallocation judgment, and the corporation cross-appealed the denial of punitive damages.

## Issues

1. Whether substantial evidence supported findings that the promoters defrauded the corporation in connection with stock issuance, warranting cancellation and reissuance of shares according to actual contributions.
2. Whether the trial court had authority to award punitive (exemplary) damages to a corporation for promoters’ fraud in an action granting equitable stock-adjustment relief.

## Decision

- The Court of Appeal affirmed the judgment cancelling the original stock and ordering reissuance based on the actual value of contributions.
- The Court of Appeal held the evidence supported fraud by the Gentiles through misrepresentation of the purchase price and overstatement of the value credited for Gentile’s contributed property.
- The Court of Appeal reversed the denial of punitive damages, holding the trial court had authority to award exemplary damages under California Civil Code § 3294 upon a showing of fraud and actual damages.
- The case was remanded solely to determine whether punitive damages should be awarded and, if so, the amount.

## Legal Principles

- Corporate promoters and controlling insiders owe fiduciary duties of full disclosure and fair dealing to the corporation and incoming shareholders.
- A promoter may not obtain an undisclosed, secret profit from transactions in which the corporation issues shares based on the promoter’s misrepresented contribution.
- When shares are issued on the basis of fraud, a court in equity may cancel the affected shares and order reissuance in proportion to the actual contributions to restore the parties to their rightful positions.
- California Civil Code § 3294 permits exemplary damages “in addition to actual damages” for fraud, and a corporation may recover such damages when defrauded by its promoters; equitable relief does not categorically bar punitive damages where actual damage is shown.

## Conclusion

The court upheld cancellation and proportional reissuance of stock as a proper remedy for promoters’ fraudulent overvaluation of contributed property, and it held that the trial court had power to consider punitive damages for that fraud, remanding only to decide whether to award exemplary damages and in what amount.


Topanga Corp. v. Gentile, 249 Cal. App. 2d 681, 58 Cal. Rptr. 713 (Ct. App. 1967)