Reinforcing Corporate Bylaws through Shareholder Fiduciary Duties: Le v. Pham

In Le v. Pham, 180 Cal. App. 4th 1201 (Cal. Ct. App. 2010), the Les (Tien Le and his wife Dieu-Hoa Le)  sued Lieu Pham, seeking to affirm the validity of a stock transaction to a third party.  Pham filed a cross complaint arguing that Le breached a shareholder’s fiduciary duty in conducting the transaction.  The court concluded that the sale violated a corporate bylaw and that this violation also constituted a breach of the shareholder's fiduciary duties. 

This case arose from Le’s sale of his 50% share of stock in Newland Pharmacy.  Such a sale implicated the California Pharmacy Law (“CPL”).  Notably, the CPL severely restricted those who could own stock in a pharmacy corporation and provided for compulsory winding down of a pharmacy corporation in the event of violations. 

In addition, the corporation’s bylaws required Le to give Pham, the other 50% shareholder, written notice of any intent to sell or transfer, as well as a right of first refusal.  The shares could not be transferred to a third party at a lower price or on terms more favorable than those stated in the notice of intent to sell or transfer.  A transfer that failed to meet these conditions would be null and void.      

On July 18, 2006, in accordance with the CPL, Pham notified the California State Board of Pharmacy that he would like to buy Le’s 50% stake in Pharmacy Corporation.  On July 20, Le notified Pham of his intent to sell his 50% share to a third party for $70,000, cash at transfer.  Pham responded with a letter accepting the purchase price.

Despite receiving the letter, Le sold his shares to the third party, Paul Hoang.  The sale price was $24,000, a considerable discount from the price provided to Pham.  In addition, the sale was not a cash sale.  The third party was allowed to make installment payments.  Because Hoang did not file a change of ownership form with the California Board of Pharmacy, the Board issued a "cease and desist” order and closed the pharmacy down for about three months. 

Pham filed a shareholder derivative suit alleging, in part, that Le violated the company's bylaws and breached his fiduciary obligations in selling the shares.  The trial court agreed that the bylaw had been violated but declined to find a breach of fiduciary duties.

The appellate court found otherwise, concluding that "the Les had a fiduciary duty to Pham not to violate the bylaws in regard to the right of first refusal."  The determination turned upon the highly regulated nature of the business at issue. 

The court initially found a public policy favoring the “strict enforcement of the corporate bylaws of pharmacy corporations restricting transfers of shares [to licensed pharmacists] in such corporations.”  The policy arose from the terms of the CPL that sought to regulate those allowed to operate a pharmacy.  Given that a pharmacy was in the business of “selling drugs and poisons,” ownership was more carefully regulated.  As the court noted, the policy sought “a reasonably snug fit between the ownership of pharmacies and their control by licensed pharmacists.”       

After concluding that public policy favored placing the control of pharmacies in the hands of licensed pharmacists, the court turned to corporate common law.  Specifically, corporate common law protected  vulnerable stockholders from other stockholders who had the power, by merely selling their shares, to affect negatively the conduct of the corporation.  As the court noted:

• This is a case where the very attempt to transfer shares of stock itself precipitated the regulatory closure of the corporation‟s business because that business was a pharmacy business. Hence, it is clear that a fiduciary duty was violated by that attempted transfer, based on mutual vulnerability in which the stockholders found themselves. By unilaterally -- and this was the trial court‟s word -- selling to the Hoangs and effectively excluding Pham from the process, the Les jeopardized the “proper conduct” of the business and unilaterally deprived Pham of an important right given her by the corporate bylaws: the right to control who were her “partners” in a regulated professional corporation.

 To bolster its position, the court turned to the Delaware Supreme Court, which has noted that the exercise of control “over the business affairs of the corporation” establishes a fiduciary duty on the part of a shareholder.  Kahn v. Lynch Communications Systems, Inc., 638 A.2d 1110, 1113-14 (Del. 1994).  When public policy mixes with established corporate law, a fiduciary duty emerges for shareholders of pharmacy corporations to abide by the corporate bylaws relating to the sale of stock.  Le breached this fiduciary duty by attempting to sell his shares of the corporation in violation of the corporate bylaws.

The primary materials for this case may be found on the DU Corporate Governance Website.