Katzowitz v. Sidler, 24 N.Y.2d 512 (1969)

In close corporations, directors breach their fiduciary duty when they issue new stock at prices far below fair value without a valid business justification, especially when it dilutes a minority shareholder’s interest.

Summary

Katzowitz, Sidler, and Lasker were equal shareholders and directors of Sulburn Holding Corp., a close corporation. After a falling out, Sidler and Lasker orchestrated a stock issuance at 1/18th the book value, which Katzowitz declined to purchase, resulting in the dilution of his equity. The court held that this action breached the directors’ fiduciary duty because there was no valid business justification for the underpriced issuance and it unfairly prejudiced Katzowitz. The court emphasized the heightened duty of fairness in close corporations where market remedies are ineffective.

Facts

Sulburn Holding Corp. was formed by Katzowitz, Sidler, and Lasker, each holding an equal number of shares.
Disagreements arose, and Sidler and Lasker sought to exclude Katzowitz from management.
Despite a prior stipulation to maintain equal stock interests, Sidler and Lasker called a board meeting to issue additional shares at $100 each, while the book value was $1,800 per share.
Katzowitz declined to purchase the additional shares, and Sidler and Lasker bought them, diluting Katzowitz’s ownership.
Upon dissolution, Katzowitz received significantly less than Sidler and Lasker due to the dilution.

Procedural History

Katzowitz sued for a declaratory judgment to restore his proportional interest.
Special Term ruled against Katzowitz, finding he waived his rights by not exercising his preemptive rights.
The Appellate Division affirmed, holding that disparity in price alone was insufficient to prove fraud.
The New York Court of Appeals reversed the Appellate Division’s order, ruling in favor of Katzowitz.

Issue(s)

1. Whether directors of a close corporation breach their fiduciary duty to a minority shareholder by issuing stock at a price far below its fair value without a valid business justification, thereby diluting the minority shareholder’s equity.

Holding

1. Yes, because directors in a close corporation have a fiduciary duty to treat all stockholders fairly when issuing new stock, and issuing stock at a significantly undervalued price without a valid business justification constitutes a breach of that duty, particularly when it serves to dilute the equity of a dissenting shareholder.

Court’s Reasoning

The court reasoned that directors owe a fiduciary duty to all stockholders, especially in close corporations where the usual protections of a public market do not exist. The court stated that “directors, being fiduciaries of the corporation, must, in issuing new stock, treat existing shareholders fairly.” The court found that the stock issuance at a price significantly below book value ($100 vs. $1,800) lacked a valid business justification and was designed to pressure Katzowitz into investing additional funds or suffer dilution. The court emphasized that preemptive rights offer illusory protection in close corporations due to the limited market for shares. It was not enough to offer Katzowitz the right to purchase; the price itself was unfair and coercive. The court noted, “The corollary of a stockholder’s right to maintain his proportionate equity in a corporation by purchasing additional shares is the right not to purchase additional shares without being confronted with dilution of his existing equity if no valid business justification exists for the dilution.” The court concluded that Sidler and Lasker should not benefit from their conduct and ordered that Katzowitz receive his aliquot share of the assets upon dissolution, less the amount invested by Sidler and Lasker in the unfairly issued stock. Chief Judge Fuld dissented without opinion.