June 23rd, 2014
The case of Harris v. Leikin Group Inc. provides another illustration of the messy, and costly, fallout that can occur when there is a dispute within a successful family business.
The Leikin Group was founded by Harry Leikin (now deceased), the grandfather of the protagonists in the Harris litigation. Harry Leikin had 11 grandchildren, each of whom received an equal amount of common shares in the family company. As time went on, discord grew among the grandchildren – little trust or cooperation existed among the group. A group of 8 grandchildren wished to sell their shares. The remaining 3 grandchildren wished to carry on and grow the business. Negotiations ensued for the 8 grandchildren to be bought out.
Negotiations between the parties was characterized by bitterness and distrust. Ultimately the parties determined that College Square would be valued at $60 million. This figure was negotiated between the parties and not based on any appraisal or other determination of fair market value.
During the course of negotiations, the selling shareholders were aware that the non-selling shareholders might subsequently cause the company to sell a stake in College Square in order to help finance the cost of the share redemption. The selling shareholders were concerned that such a sale might be based on a valuation of College Square in excess of $60 million. The selling shareholders asked that they be granted tag-along rights as part of the share redemption deal so that they would be allowed to participate in any upside, should such a sale occur above a $60 million valuation. The non-selling shareholders refused. The selling shareholders accepted this refusal and proceeded with the share redemption based on a valuation of $60 million for College Square.
Some time after the parties came to terms on the share redemption, the non-selling shareholders sold a 50% equity stake in College Square to a third party based on a valuation of $78.8 million.
After finding out about the third-party College Square transaction, six of the eight selling shareholders commenced a lawsuit against a multitude of parties connected to the Leikin Group, including the three non-selling shareholders and various professional advisors to the three non-selling shareholders. The central claim was that the non-selling shareholders and their advisors knew several months before the share redemption agreement closed that the third party was willing to buy a share of College Square based on a valuation of at least $70 million. The primary legal theory was that the non-selling shareholders breached a fiduciary duty owed to the selling shareholders.
The trial judge held, and the Court of Appeal agreed, that the non-selling shareholders did not owe a fiduciary duty to the selling shareholders.
Generally speaking, a fiduciary duty is a duty of good faith, trust, confidence, and candor. Fiduciary duties generally arise in situations where there is a relationship of vulnerability where the fiduciary has undertaken to act in the best interests of the beneficiary.
In upholding the trial judge’s refusal to find the existence of a fiduciary duty, the Court of Appeal noted the explicitly adversarial nature of the negotiation process, and the fact that the selling shareholders entered into a share redemption agreement in spite of the non-selling shareholders’ refusal to grant them tag-along rights. On the evidence, the selling shareholders were not expecting the non-selling shareholders to protect their interests in the negotiations. In these circumstances, the Court of Appeal held, the trial judge quite properly rejected the claims of breach of fiduciary duty.
The Court of Appeal also upheld the trial judge’s finding of fact that there was no evidence that there was a “bought deal” with the equity investor during the time the share redemption transaction was being negotiated in any event – a key plank of the selling shareholders’ case. However, even if there had been a bought deal in place, it is certainly open to debate whether this could have grounded a fiduciary duty given the findings made by the trial judge and the Court of Appeal as to the nature of the relationship and the tenor of the negotiations between the parties.
The selling shareholders’ claim against the various professional advisors also failed. These claims sounded in knowing assistance of a breach of fiduciary duty. Since there was no underlying breach of fiduciary duty, these claims could not succeed.
The selling shareholders were ordered to pay the various defendants $2.5 million for the costs of the trial, and $235,000 for the costs of the appeal.