Fresno Lawyer – Randolf Krbechek

Water supplies for West Side agriculture have been major news items in the past few years.  Many residents, including this writer, are proud of our agricultural heritage and bounty, and have questioned decisions that threaten water supplies for agriculture.

Journalist and attorney Lloyd Carter has penned a provocative article that probes the financial integrity of Westside agriculture.

Mr. Carter’s thesis is that, “While Westlands . . . has produced an undisputable bounty of cotton and field crops over the decades in western Fresno and Kings counties, irrigation of this mineral-laden desert has also created huge environmental problems, and the wealth generated has not trickled down to farmworkers or the surrounding poverty-stricken communities.”

Early West Side Farming

Mr. Carter admirably recites the history of West Side farming.  “In 1900, the West Side of the Valley remained an inhospitable desert with no surface water and only intermittent flow from small seasonal creeks . . . The first wells in western Fresno County were sunk a few years after the start of the twentieth century by a few hardy pioneers.  Deep wells were drilled during World War I by large landholders in order to plant cotton, a salt-tolerant crop in demand by the military.”

Take a look at this remarkable photograph, which shows researcher Dr. Joseph F. Poland standing at the location of maximum land subsidence identified in the Central Valley.  The signs on the pole show the approximate altitude of the surface of the land  in 1925, 1955, and 1977.  The site is in the San Joaquin Valley southwest of Mendota, California.

The level of the earth subsided by more than 28 feet at this location near benchmark S661 southwest of Mendota, due to the pumping of groundwater.

More information can be obtained from the U.S. Geological Survey.

And from this article:
“Land Subsidence in the United States,” by  Devin Galloway, David R. Jones, and S.E. Ingebritsen

In 1942, West Side growers, who were running out of groundwater, formed the Westside Landowners Association to gain support for federal assistance in delivering Northern California river water to their region.

In 1952, pursuant to the California Water Code, the growers formed the Westlands Water District, which would grow to become the nation’s largest federal irrigation district, with over 600,000 acres.

Bernie Sisk’s False Promises

Carter continues.  ”In 1959, Representative Bernard F. Sisk (D-Fresno), who represented the Westlands area, pushed for congressional approval of a U.S. Bureau of Reclamation project to deliver Northern California water to Westlands.”

In 1960, Congress approved the San Luis Unit.  Water deliveries to Westlands began in 1968.

Now, if you live in Fresno County, you will be astonished that Rep. Sisk made the following representations to secure Congressional approval for the water project.  Here’s what he promised:

• “If San Luis is built, according to careful studies, the present population of the area will almost quadruple.  There will be 27,000 farm residents, 30,700 rural nonfarm residents, and 29,800 city dwellers; in all, 87,500 people sharing the productivity and the bounty of fertile lands blossoming with an ample supply of San Luis water.”

• “Recent surveys show that the land proposed to be irrigated is now in 1,050 ownerships. These studies show that with San Luis built, there will be 6,100 farms, nearly a sixfold increase.  And in the breaking up of farms to family-size units, anti-speculation and other provisions of the reclamation laws will assure fair prices.”

We can all pause here.  Westlands was built on a false premise.  Nothing close to this has occurred in the past half century.

Where Are We?

“This Article shows how a long American tradition of helping small farmers has, in the past few decades, morphed into a massive government aid program for large industrialized agribusiness operations-a program that not only drives small farmers off the land but also perpetuates rural poverty because agribusiness requires huge numbers of low-paid, seasonal harvest workers”

Part 2 – Continued next week.

Lloyd G. Carter, Reaping Riches in a Wretched Region: Subsidized Industrial Farming and its Link to Perpetual Poverty, in 3 Golden Gate U. Envtl. L.J. (2009) page 5.

The issue this week concerns the appropriate remedy when controlling shareholder(s) breach the fiduciary duties they owe to the other shareholders.  An article by attorney William S. Monnin-Browder discusses whether courts should apply a minority interest discount in a forced sale.

Background

As explained in many published opinions, “stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another . . . They may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other stockholders and to the corporation.”  Donahue v. Rodd Electrotype Co., 328 N.E.2d 505, 515 (Mass. 1975)

Wrongful Conduct by the Controlling Shareholder

Mr. Monnin-Browder explains that, “There are a number of ways that majority shareholders can usurp the interest of the minority.  For instance, the terms ‘freeze-out’ and ‘squeezeout’ are often used, synonymously, to describe a situation where the majority uses its controlling position to exclude a minority shareholder from participation in the business.”

By the wrongful acts of the majority, “minority shareholders can be prevented from gaining a return if they are fired, which a majority-controlled board can freely do . . . One common form of the squeeze-out occurs when a majority shareholder prevents a minority from receiving a return on her investment, and then attempts to buy the minority’s shares when the value of the stock is compromised . . . The lack of a ready market for shares in a close corporation prevents a minority shareholder from selling shares as a means of escape.”

The Remedy

“Once a court determines that majority shareholders have breached their fiduciary duty, the court is forced to find an appropriate remedy.  Remedies for breach of fiduciary duty are equitable in nature . . . Common remedies for breach of fiduciary duty in a close corporation include dissolution, reversal of an offending decision, or buyout of the minority shareholder’s shares by the corporation.”

However, “the most common remedy employed by courts today [ ] is buyout . . . Courts view buyout as a less harsh remedy than dissolution because it compensates the aggrieved shareholder, while allowing the corporate entity to survive.  It is also often the most practical remedy.  A court order to rehire or return the shares sold, for example, may not be a viable option.”

Marketability Discount

But to do so, the court must establish the value of the victim’s interest in the entity.  “Valuing a share in a close corporation usually begins with an analysis of the value of the corporation as a whole.  To do this, courts often look to three major approaches: market value, net asset value, and earnings value.  These factors are weighed differently, according to the specific factual circumstances.”

Two general forms of discount are commonly applied in valuing interests in a closely-held corporation.  The first is a marketability discount.  As explained, “The marketability discount compensates for the absence of a market for shares of a close corporation.  Investors will pay less for these shares, compared to more liquid shares, because they prefer shares that are easily sold and/or transferred.  Marketability discounts can be substantial, averaging from approximately 35 to 50% of the value of the stock. “

Minority Interest Discount

The second principal discount is the minority interest discount.  “The minority discount compensates for the fact that the shares constitute a minority interest in the corporation that is not controlling, so long as there is no shareholder agreement to the contrary.  Investors prefer stock that has the accompanying voting power to influence the operations of the corporation.  Therefore, investors will pay less for those shares than shares in the majority interest.  Like marketability discounts, minority discounts can have a substantial impact on the value of the shares, reducing the price as much as 33%.”

Thus, the combined discount based on minority interest and lack of marketability can exceed 50% of the value of the stock.  Such discounts are commonly used in the estate planning context.

Should a Court Apply the Discount?

The judicial trend is not to apply the discount in the context of a forced buyout of a minority interest.  “Some courts state that the context and purpose of the legislation suggest that no discount should apply.  In Swope v. Siegel Robert, Inc., for example, the Eighth Circuit Court of Appeals applied Missouri law to reject the application of both a marketability and minority discount.”

In this way, “The typical freeze-out situation arises when a minority shareholder has no other choice but to sell their shares to the majority shareholder at less than their fair value.  From a policy standpoint, it would be illogical to discount the value of the shares because doing so would reward an oppressive majority shareholder and injure the party who is relatively blameless.”

That analysis is sound, because the “buyout does not occur on an open market.  Therefore, courts argue that they should not apply discounts that account for irrelevant market conditions.  As Professor Moll writes, ‘the forced-sale nature of buyout proceeding and the identity of the purchasers involved weigh heavily against the application of discounts.’”

An Extreme Result

One court went the opposite direction.  “Rather than force the oppressor shareholder to purchase the oppressed shareholder’s stock, the trial court chose a different remedy, holding that the oppressed shareholder was entitled to buyout the shares of the oppressor.  The court [then] applied discounts.”  Balsamides v. Protameen Chemicals, Inc., 734 A.2d 721, 734 (N.J. 1999).

We could certainly ask – Isn’t sauce for the goose also sauce for the gander?  The court put a real hurt to the wrongdoer by forcing a sale and also applying  a judicially-created discount.

A Point of Dispute

Mr. Monnin-Browder posits that “a heightened fiduciary duty exists among shareholders of a close corporation,” explaining that, “In the wake of the Massachusetts ruling, courts in many other states adopted the fiduciary duty rationale of Donahue, thereby recognizing heightened fiduciary duties among shareholders in close corporations and creating a common-law cause of action.”

That is not a careful use of terms.  Fiduciary duties are, by definition, “heightened duties,” filling gaps in the relationship between the parties.  It does not make a great deal of sense to speak in terms of a “heightened fiduciary duty.”

William S. Monnin-Browder, Are Discounts Appropriate?: Valuing Shares in Close Corporations for the Purpose of Remedying Breach of Fiduciary Duty under Massachusetts Law, in 40 Suffolk Univ. Law Review, Vol. 3 (2007) page 723.

This posting continues the question of whether fault should be considered in evaluating a claim for breach of contract, specifically, whether the courts should weigh the “fault” of the non-breaching party.

When would such “fault” by the non-breaching party arise?  It would seem that three time frames could be considered:

• Before (i.e., during the formation of contract)
• During performance
• After breach

The bigger question is, Are we better off as a society if we disregard all fault by the non-breaching party when we assess liability for breach of contract?

Here are several hypotheticals from Prof. Porat, and my comments regarding them.

Before performance:

“Ann, a contractor, and Bob, the owner of a certain piece of land, enter a contract for the performance of construction work.  Due to geological difficulties, there is a delay in performance that causes Bob substantial losses.  It becomes evident, however, that Bob knew about these obstacles at an early stage (although not prior to entering into the contract with Ann).  Had he revealed this to Ann in due time, the delay could have been prevented.”

Response:  This is a thorny issue for contract purists, who would insist that Ann had the obligation to review the situation fully before entering into the contract.  Yet, Bob had the power to prevent some of the losses, and, indeed, could probably help reduce the overall cost of performance.  The law should impose a duty on Bob to cooperate and assist in the performance of the contract.

During performance:

“In the course of a construction project, Charles makes demand for an installment payment.  In fact, Charles is not entitled to any payment, because she failed to meet an additional condition stipulated by the contract.  Charles is not aware of this additional condition because of an oversight on her part.  Debbie refuses to pay, stating that he is not obliged to do so under the contract, but Debbie provides no other explanation.  Charles then stops her work, causing loss to Debbie.  Only after a month, during which Debbie stubbornly refuses to meet with Charles, does Debbie explain to Charles why he was not entitled to payment.”

Response:  The law should encourage efficiency.  Debbie should not be rewarded for her failure to act in a commercially reasonable manner, and the damages should be reduced accordingly.

During performance:

“Edward undertakes to construct a building for Fay.  During the last stage of performance, Fay gives Edward’s employees confusing instructions on the construction work required.  In the end, there is a delay in the completion of performance; moreover, some of the construction work is found to be defective.  Had Fay refrained from instructing Edward’s employees, the contract would have been adequately performed.”

Response:  In this hypothetical, the contributing fault of Fay, the non-breaching party, should be considered to reduce liability.  Fay caused part of the harm, and Edward should not bear all of the losses.

Comment:  The hypothetical is not complete, as we need to know the nature of the losses suffered by Fay.

During performance:

“In a home remodeling contract, both George and Harold are aware that there could be delays in completion.  Even though Harold is well aware of this risk, he enters into a contract with a contractor to refurnish the house starting on the day set for delivery.  He also incurs expenses advertising the house for rent.  In the end, George breaches due to late delivery, and Harold suffers losses due to forfeiting the contractor’s deposit and his advertising expenses.  These losses would have been prevented had Harold waited to see whether the contract would be adequately performed.”

Response:  It would seem that Harold assumed the risk of loss.  However, assumption of the risk is not a traditional contract defense.  This is an uncomfortable fit for the law, as Harold caused some of his own losses, yet it appears that George is liable for late delivery.

After breach:

“Ike, a carrier, undertakes to ship a crank shaft from Jane’s mill for repair and to bring it back in one week’s time.  Ike instead brings the shaft back after two weeks, which results in high consequential losses to Jane, who could not find a substitute shaft.  At the time of contracting, the parties were aware of a small risk that a substitute shaft would not be available.  One week later it became clear to Jane, but not to Ike, that this risk had materialized.  Had Jane conveyed this information to Ike on time, Ike would have taken costly precautions to ensure that he would return the shaft on time, thus preventing the breach.”

Response:  Historically, the law has favored common carriers, in the sense that the public does not want to pay exorbitant rates for carriage.  It seems that the carrier could have take precautions to avoid the loss.  However, I want know whether the rate structure reflected the potential loss.

In other words, Did the price for shipping reflect a one-week delivery time?  Ike could have shopped for someone who would have guaranteed delivery.  Further, the additional loss was not due to any acts or omissions on the part of Ike, in that Jane simply could not locate the replacement part in a timely manner.

(Ariel Porat, A Comparative Fault Defense in Contract Law, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1397.)

This week’s posting considers whether culpability should be considered in a claim for breach of contract.  The traditional answer in the U.S. (traditional at least since 1900) is No.

As discussed in a recent symposium, “In terms of the Restatement of Contracts conception, then, contract law is strict liability without a contributory negligence defense . . . The core of contract law as applied in the courts is a no-fault regime.”

“Among the many debates about fault in contract law, one principle remains unchallenged: a promisor is strictly liable for defective performance or nonperformance despite her exercise of due care.”

“Even the most fervent adherents of fault in contract law concede that the law always applies this rule strictly.  Thus, the promisee does not have to prove that the promisor failed to take cost-effective precautions against breach.  Nor, for that matter, can the promisor escape liability by showing that the breach was caused by exogenous factors beyond her control.”

(Robert E. Scott, In (Partial) Defense of Strict Liability in Contract, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1381.)

Which means that contract law is applied as a binary system – either you perform the contract or you do not.  If you do not perform (i.e., if you breach), then you are liable for damages.

This system is effectively 180 degrees different from tort liability, in which culpability is always an issue.  Another commentator notes that,

“The main puzzle that emerges from the discussion is why contract law puts the burden on the wrongdoer to show that he was not at fault in order to avoid paying damages, while tort law puts the burden on the victim to show that the wrongdoer was at fault in order to obtain damages.”

(Eric A. Posner, Fault in Contract Law, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1431.)

Thus, one of the issues is whether society is better when contract law is treated as a binary system of liability, without consideration of fault by either party.  A third commentator considers whether the non-breaching party contributed to the loss.  Prof. Ariel Porat proposes that “the comparative fault defense should be available to a breaching party against an aggrieved party when the latter’s fault has contributed to his own losses.”

In this scenario, “the promisee should be considered ‘at fault,’ and should shoulder part of the loss, when he fails to meet a legal burden to reduce his potential losses by cooperating with the promisor or avoiding overreliance.”

Next week’s posting further examines comparative fault as a defense to a breach of contract claim.

(Ariel Porat, A Comparative Fault Defense in Contract Law, in Michigan Law Review (June 2009), Vol. 107, No. 8, p. 1397.)