California Corporations Code: Is Rescission Ever Legal?
Tuesday, July 26, 2016

Yesterday’s post concerned when a corporation’s rescission of the issuance of shares does not constitute a “distribution to its shareholders” as defined in Section 166 of the California Corporations Code.  I noted that one of the three conditions is that “it is reasonably likely that the holder or holders of the shares in question could legally enforce a claim for rescission”.  Upon reflection, I find this condition to be silly and wrong.

The statute is silly because “reasonably likely” has no fixed meaning.  Whether something is likely is a question of probability.  Whether something is reasonable depends upon the circumstances.   A one in a million probability of success may seem unreasonably small when betting on a horse race.  However, someone facing a terminal illness with no known cure may find it entirely reasonable to try an experimental drug with the same probability of success.  Further, it places the board of directors in a difficult position.  Suppose, for example, the board determines to rescind a share issuance because of a possible violation of the Corporate Securities Law of 1968 and that a creditor takes issue with that determination.  The creditor will argue that there was no violation of the CSL or that it wasn’t reasonably likely that the holders of the shares would prevail.  The board of directors would then be placed in the awkward position of arguing that the corporation had violated the CSL or that it was reasonably likely that the holders would prevail.  Does a board of directors really want to approve a resolution reflecting its determination that there a claim for rescission is “reasonably likely”?

The legislature also seems to have forgotten the difference between law and equity.  As many California courts have observed, rescission is an equitable, not legal, remedy.  See, e.g., Gill v. Rich, 128 Cal. App. 4th 1254, 1264 ( 2005) (“Rescission is an equitable remedy.”).  Although Section 166 does not refer specifically to the securities laws, two provisions of the CSL authorize rescission – Sections 25501 and 25501.5.  In addition, California Civil Code Section 1689(b) specifies the circumstances when a contract may be rescinded.

 

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