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were enjoined and two in which management was enjoined, will serve to illustrate the Delaware court's approach.“

In Empire Southern Gas Co. v. Gray, the corporation sought to enjoin a dissident faction of officers from soliciting proxies by a statement which appeared to have, but had not, come by authority of the directors. The Court placed "the burden of candor" on the solicitor of proxies and enjoined the use of the misleading material. The Court's statement of the law is as valid today as it was then:

Would a stockholder reading the notice, the proxy statement and the proxy be likely to obtain the impression that the proxy was being solicited by authority of the board of directors of the complainant company? I believe that he would so conclude, unless it is to be implied that the law will assume each stockholder will read and examine the various documents through the eyes of one who is placed on guard as to the possible existence of misleading statements. To expect or to require such a procedure of stockholders would remove the law beyond reason or reality. The accepted and desirable tendency has been to place the burden of candor upon those who would communicate with stockholders rather than to require the stockholders to be eternally vigilant.24 In Gerlach v. Gillam," certain stockholders of United Printers and Publishers, Inc., sought to enjoin the consummation of transactions which would have personally benefitted the corporation's dominant director. The stockholders having ratified the transaction, management argued that the claim for injunctive relief was precluded. The Court disagreed, finding that ratification had been based on a false and misleading proxy statement which had failed to disclose the dates of the challenged contracts, how they were negotiated, and the dominant director's role in their negotiation. The Court let its previous interlocutory injunction stand.

In Campbell v. Locv's, Inc., > Loew's president had solicited proxies which he sought to use to remove certain directors for cause. The proxy materials had presented only the case for removal and the directors under attack had been denied a stockholders' list to use in reply. Finding that stockholders had been deprived of the opportunity to hear both sides, the Chancellor ruled the proxies invalid for use on the removal question. However, following a detailed review of the specific and cumulative effect of a number of claimed misrepresentations together with the "whole impact ... the proxy material conveyed to the average reader," the Court declined to invalidate the proxies for other purposes.

Delaware courts are barred by federal law from taking jurisdiction over violations of federal proxy rules. The substantial result, however, is less than meets the eye. Twenty years ago, in the context of an election review, Vice Chancellor Seitz pointed out that violations of the securities acts were often independent violations of state law as well. The court wrote:

24 There is a heavy equitable flavor to Delaware cases in this area, as well. In In re Seminole Oil Gas Corp., 150 A. 2d 20 (Del. Ch. 1959), for example, the Court found that both management and dissidents were guilty of material misstatements; the misrepresentations were offsetting and the court declined to impose the economic burden of resolicitation on a small corporation.

246 A. 2d 741 (Del. Ch. 1948). The Empire Southern case turned aside an argument that a review of the corporate election thus tainted was the sole remedy for proxy fraud. Both remedies exist side by side.

28 46 A. 20 at 746. Equally instructive are the cases which, after carefully weighing all the evidence including the motives of the parties, have found no material misrepresentation to require that the proxy materials be condemned, e.g., Saxe v. Brady, 184 A, 20 602 (Del. Ch. 1962); Lynch v. Vickers Energy Corp., 351 A. 570 (Del. Ch. 1976); American Hardware Corp v. Savage Arms Corp., 135 A. 2d 725, (Del. Ch.) af'd 136 A. 2d 690 (Supr. Ct. 1957). 27 139 A. 2d 591 (Ch. 1958). 28 134 A, 2d 852 (Ch. 1957).

23 134 A. 2d at 865. A proxy procured to commit a fraud concealed from shareholders is of no effect. Chief Justice Southerland in Dolese Bro8. Co. y. Brown, 157 A. 20 784, 788 (Del. Supr. 1960), wrote: Defendant argues that when a meeting of stockholders has been held, and corporate action authorized by the use of general proxies permitting the exercise of unlimited discretion by the proxy holder, and that action is duly taken, the stockholder ordinarily cannot later repudiate the action of his agent. As a general proposition, this is correct (citation omitted). But that rule has no application to a case such as this, in which the dominating director is charged with using the proxies to commit a fraud concealed from the stockholders whose vote is necessary to accomplish it, and in which no rights of third persons are affected.

* $ 27 of the Securities Exchange Act of 1934, 15 U.S.C. $ 78aa, provides, in part: The district courts of the United States . . . shall have exclusive jurisdiction of violations of this chapter or the rules and regulations thereunder, and of all sults in equity and actions at law brought to enforce any liability or duty created by this chapter or rules and regulations thereunder...

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However, I think it should be made clear that some acts which constitute violations of the Securities Exchange Act and the rules and regulations formulated thereunder may also be cognizable in a Section 31 proceeding as independent wrongs for which this court would grant a remedy, even if

the Securities Exchange Act had never been passed. Somewhat later, Judge Rodney in the federal district court recognized that evidence that would establish proxy fraud under federal law would condemn a proxy statement in the state court. Any securities practitioner knows that securities fraud cases, like most other kinds of cases, are controlled by their peculiar facts. Thus, where we do not have the luxury of identity, as in Kaufman, comparisons between Delaware and federal proxy cases are difficult to make. Materiality, as it relates to misrepresentations, is a slippery concept even in the most deft of judicial hands. Nevertheless, Delaware Courts have come to respectable grips with the concepts involved in the deception of shareholders. The Court in Gerlach v. Gillam, for example, required "complete candor" and held inadequate proxy material that by omission of "essential information" made it impossible for stockholders to “make an objective evaluation of the proposed transaction." Vice Chancellor Marvel, in a tender offer case, held that the offeror:

... had a duty to exercise complete candor in its approach to the minority stockholders of Transocean for a tender of their shares, namely a duty to make a full disclosure of all of the facts and circumstances surrounding the offer for tenders, including the consequence of acceptance and that of refusal and, insofar as the price offered is concerned that it not be one which would induce the acceptance of an unconscionable bid by an unwary stockholder at a price below the market or otherwise unreasonable under the facts and circumstances attending such offer for tenders of stock.” [Emphasis sup

plied] ” Delaware courts look to the entire effect of the information presented. Specific candor will not suffice if the totality of the information tends to mislead; and, conversely, isolated errors when placed in the larger context may not mislead at all. Thus, in Campbell v. Loew's, Inc., supra., the court looked not only to the accuracy of various factual representations but also to the cumulative effect of the factual presentation to determine what “the whole impact of the proxy material conveyed to the average reader.”

III. MANAGEMENT RESPONSIBILITY

A. FIDUCIARY CAPACITY AND THE LIMITATIONS ON THE BUSINESS JUDGMENT RULE

The Delaware statute provides : “The business and affairs of every corporation * * * shall be managed by or under the direction of a board of directors * * who may be removed by a majority of the stockholders at any time.” 38

Overshadowing specific duties, a long and unchallenged line of Delaware cases makes clear that the primary duty of a director is, as a fiduciary, to deal fairly and justly with the entrusted assets in pursuit of the business objectives of the corporation. Vice Chancellor Marvel quoted the following language from an earlier case.

31 Investment Associates, Inc. v. Standard Power & Light Corp., 48 A. 2d 501, 510 (Del. Ch. 1946), af'd 51 A, 2d 572 (Del. Supr. 1947).

32 Kaufman v. Shoenberg, 154 F. Supp. 64 (D. Del. 1954). The same proxy materials had previously been attacked in the Delaware Chancery Court, where they had been cleared. Kaufman v. Shoenberg, 91 A. 20 786 (Del. Ch. 1952). The Federal court dismissed as res judicata a complaint containing the same allegations of misrepresentation and omission as had been made in the State court. The Court said: An examination of the two complaints reveals that the same affirmative allegations of misrepresentation and omission are included verbatim in the present case es were made the State court action. These allegations in both suits are directed toward the same proxy statement which was submitted by defendant to its stockholders in June, 1951. Clearly, the judgment sought in this action, which is identical with that sought in the Chancery suit, is inconsistent with the final adjudication of the Chancellor. It is also clear to me that the evidence necessary to enable plaintis to prevail herein would have been sufficient to authorize a recovery by her in the State court. (Emphasis supplied] 154 F. Supp. at 66, 67.

33 139 A. 2d at 594. Compare Empire Southern Gas Co. v. Gray, supra note 25.

34 Lynch v. Vickers Energy Corp., 351 A. 20 570 (Del. Ch. 1976). The plaintiff, Lynch, was a minority stockholder of Trans-Ocean. Vickers owned the majority of the TransOcean stock and wanted, by buying up the minority, to take Transocean private.

35 134 A. 2d at 865 ; compare In re Seminole Gas Corp., supra note 24.

38 8 Del. C. $ 141—Directors have numerous specific statutory powers which complement the general power. There is a specific enumeration in E. Folk, The Delaware General Corporation Law, Appendix II, Statutory Powers of Directors Corporation, p. 611.

It is fundamental that directors stand in a fiduciary relation to the corporation and its shareholders, and that their primary duty is to deal fairly and justly. It is a breach of this duty, wholly apart from any consideration of pre-emptive rights, for directors to make use of the issuance of shares to accomplish an improper purpose, such as to enable a particular person or group to maintain or obtain voting control, against the objection of share

holders from whom control is thereby wrested.* Not only directors, but officers as well, are treated as fiduciaries for the benefit of the corporation, its shareholders and creditors. The much cited business judgment rule serves to protect the acts of both directors and officers in those cases where their expertise is greater than the court's. Such protection only obtains, however, if the officials have paid informed attention to their duties. Chancellor (now Justice) Duffy in Kaplan v. Centea Corporation * in finding a substantial judgment for the plaintiff in a derivative suit explained this crucial limitation on the protection of the rule:

Application of the (business judgment) rule depends upon a showing that informed directors did, in fact, make a business judgment authorizing the transaction under review. And, as plaintiff argues, the difficulty here is that evidence does not show that this was done. There were director-committeeofficer references to the realignment but none of these, singly or cumulatively, show that director judgment was brought to bear with specificity on the

transactions. (Emphasis supplied.) Of course, the business judgment rule is wholly inapplicable if the transaction in question is not "at arms-length”.40

It is said that the business judgment rule, when applicable, creates a presumption of good faith and requires a showing of bad faith or abuse of discretion to mount a successful challenge." This presumption, however, can either be rebutted altogether; as in a situation of self dealing, or where the directors have passed "an unintelligent or unadvised judgment”. “ The rule can lose a portion of its force if, for example, the questioned transaction was done in haste. In a situation where full director attention is questionable, the court may carefully scrutinize the questioned transaction though granting some quantum of weight to the presumption of sound business judgment.

There are, of course, other substantial limitations on officers of the corporation. Officers' powers and duties arise from the corporation law, the charter, the bylaws, and board resolution. By-laws and resolutions must not be contrary to the certificate of incorporation or a clear statutory or common law policy.“ Very little authority or power in corporate officers is presumed. However, when dealing with the rights of third parties, the ordinary principles of agency and equity law frequently hold the corporation to transactions which were not in fact authorized in advance.

B. USE OF INSIDER INFORMATION Directors who purchase their corporation's stock from outside minority shareholders are held to the standards of a fiduciary. Delaware courts have expressly held that an insider, possessed of special knowledge of future plans or secret resources of his corporation, owes a fiduciary duty to a stockholder who is ignorant

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37 Condec v. Lunkenheimer, 230 A. 20 769, 775 (Del. Ch. 1967), quoting from Yasik v. Wachtel, 17 A. 20 309, 313 (Del. Ch. 1941).

39 Bovay v. H. M. Byllesby & Co., 38 A. 20 808, 813 (Del. Supr. 1944). 9 284 A. 2d 117, 124 (Del. Ch. 1971). See also Mitchell v. Highland-Western Glass Co., 167 A. 831, 833 (Del. Ch. 1933).

40 David' J. Greene & Co. v. Dunhill International, Inc., 249A. 20 427, 430 (Del. Ch. 1968); Sterling v. Mayflower Hotel Corp., 93 A. 2d 107 (Del. Supr. 1952) ; Sinclair Oil Corp. v. Levien, 280 A. 20 717 (Sup. Ct. 1971). See p. 19 infra.

It is said that the business judgment rule, when applicable, creates a presumption of good faith and requires a showing of bad faith or abuse of discretion to mount a successful challenge." This presumption, however, can either be rebutted

11 Warshaw v. Calhoun, 221 A. 20 487, 493 (Del. Supr. 1966); Parges v. Vadsco Sales Corp., 32 A. 20 148. 151-2, (Del. Ch. 1943) ; Sinclair v. Levien, 280 A. 20 717 (Del. Supr. 1971); Getty Oil Co. v. Skelly Oil Co., 267 A. 20 883 (Del. Supr. 1970); Meyerson v. El Paso Natural Gas Co., 246 A. 20 789 (Del. Ch. 1967).

42 E.g., Sinclair Oil Corp v. Levien, 280 A. 20 717 (Sup. Ct. 1971).
13 Mitchell v. Highland-Western Glass Co., 167 A. 831, 833 (Del. Ch. 1933).

14 E.g., Gimhel v. Signal C08. Inc., 316 A. 2d 599, 615 (Del. Ch.), aff'd, 316 A. 2d 619 (Del, Supr. 1974).

45 Burr v. Burr Corporation, 291 A. 20 409, 410 (Del. Ch. 1972); Prickett v. American Steel and Pump Corp., 253 A. 20 86, 88 (Del. Ch. 1969); Kerbs v. California Eastern Airways. 90 A. 20 652. 659 (Del. Supr. 1952).

40 Folk, op cit, pp. 71-72.

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of such facts when negotiating for the purchase of his shares." These standards of disclosure are set out above at p. 10. The Fifth Circuit in Mansfield Hardware Co. v. Johnson " simply misconstrued Delaware law when it held to the contrary.

If a director or officer is undeterred by the prospect of damages for misrepresentation, an additional deterrent to taking advantage of inside information is found in Brophy v. Cities Service Co. There, an insider, privy to secret information that his corporation was planning open market purchases of its own shares, made his own purchase before hand and then sold out at a substantial profit. The Chancellor had no difficulty holding that the director took these gains as a trustee and that the corporation, as beneficiary, was entitled to them. Diamond v. Oreamuno 61 was hailed as a significant advance of the law when the New York Court of Appeals decided it. Diamond not only expressly followed Brophy's holding, but followed Brophy chronologically by twenty years.

C. INTERESTED DIRECTOR TRANSACTIONS AND CONTROLLED MERGERS

Since the Delaware courts viewed a director as a fiduciary, it follows that he may not profit from his position of trust. When challenged, he must prove, that transactions in which he has an interest are fair.

Several nationally celebrated Delaware cases serve to illustrate this proposition.

In Keenan v. Eshleman," the plaintiff stockholders of Sanitary Corporation of America sought an accounting from three of their directors who, as principals of Consolidated Management Association, had provided “management consultation" to Sanitary. Of the directors the court said :

The appellants were in absolute control of both corporations. As directors, they were trustees for the stockholders, and the utmost good faith and fair dealing was exacted of them, especially where their individual interests were

concerned." The accounting was granted.

Guth v. Loft, Inc.,oh which condemned the usurpation of a corporate opportunity by a director, is still a leading decision on a director's fiduciary duties.

Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. While technically not trustees, they stand in a fiduciary relation to the corporation and its stockholders. A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer, preemptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it, or to enable it to make in the reasonable and lawful exercise of its powers. The rule that requires an undivided and unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest. The occasions for the determination of honesty, good faith and loyal conduct are many and varied, and no hard and fast rule can be formulated. The

standard of loyalty is measured by no fixed scale." More recent decisions, far from lowering the standards, have served to reinforce the principles found in Keenan and Guth.

Burden of proof is significant here, as well. Not only are directors held to a rigid standard of conduct, but the allegation of self-dealing shifts the burden of establishing the entire fairness of the challenged transaction to the defendant director. In Keenan, upon noting that the defendants were on both sides of the transaction which resulted in their being paid handsome consulting fees, the court declared :

47 Lank v. Steiner, 224 A. 20 242 (Del. Supr. 1966); Kors v. Carey, 158 A. 20 136 (Del. Ch. 1969).

48 268 F. 2d 317 (5th Cir.), cert. den., 361 U.S. 885 (1959).

49 Professor Cary, without analysis of Delaware law, blindly followed the Fifth Circuit in its error. Cary, Federalism Article, at 663.

50 70 A. 20 5 (Del. Ch. 1949).
61 24 N.Y. 20 494 (1969).
59 2 A. 20 904 (Del. Supr. 1938).
53 2 A. 2d 904. 908.
645 A. 20 503 (Del. Supr. 1939).
65 5 A. 2d 503, 510.

56 e.g., David J. Greene & Co. v. Dunhill International, Inc., 249 A. 2d 427 (Del. Ch. 1968); Johnston v. Greene, 121 A. 2d 919 (Del. Supr. 1956); Bovay v. H. M. Bylesby & Co., 38 A. 20 808 (Del. Supr. 1944).

[D]ealing as they did with another corporation of which they were sole directors and officers, they assumed the burden of showing the entire fairness

of the transaction." A similar expression of the rule appears in Johnston v. Greene, a case that involved the offer of various patents to a corporation by its dominating director :

The refusal of the directors of Airfleets to buy the patents was, under the Chancellor's finding, a transaction between the dominating director and his corporation. It is therefore subject to strict scrutiny, and the defendants

have the burden of showing that it was fair.” (Emphasis supplied.) ** The utimate standard which the interested director inust establish he has met is succinetly stated in the Johnston v. Greene. If the court can be satisfied that a "wholly independent board of directors" would have reached the same decision on the transaction, given the information supplied by the interested director, then the transaction is fair and will be upheld.

Delaware applies the same shifting burden where, in a merger or other reorganization, one of the constituent corporations is on both sides of the transaction.“ Some of the most recent and colorful of such cases have been popularly termed "going private".69

D. RECLASSIFICATION OF SHARES Reclassification of shares is an essential tool of capital flexibility. Although abuses can occur through improper use of this device, Delaware law forbids such impropriety. Where a reclassification is effected by means of direct charter amendment," the holders of the outstanding shares of any class are entitled to a class vote if the amendment increases or decreases the aggregate number; increases or decreases the par value; or alters or changes the powers, preferences or special rights of their shares so as to have an adverse effect. For example, the direct elimination of dividend accruals is now permitted by charter amendment. If the amendment would eliminate the accrued preferred divi. dends, the majority of the preferred, as a separate class, must approve the proposal.

A further protection is provided by the inherent power of the Court of Chancery to enjoin or rescind a reclassification if it is unfair to a segment of stockholders. Topkis v. Delaware Hardware Co. held:

... a power conferred by statute upon a majority of the stockholders or upon directors, though conferred in terms that are absolute, is neverthe

less subject to restraint by a court of equity if it be inequitably exercised. Proof of constructive fraud will condemn a recapitalization as unfair. Constructive fraud has been defined as “(a) acts of bad faith, or a reckless indifference to the rights of others interested, rather than from an honest error of judgment" és or (b) "improper motive or personal gain or arbitrary action or

57 2 A. 20 904, 908. 68 supra note 56. at page 925 ; see also Gottlieb v. Hayden Chemical Corp., 90 A. 20 660 (Del. Supr. 1952). to 121 A. 20 919, 925; see also Gottlieb v. Hayden Chemical Corp., supra note 58. 80 121 A. 20 919, 925.

* e.9., Sterling v. Mayflower Hotel Corp., 93 A. 2d 107, (Del. Supr. 1952); David J. Greene & Co. V. Dunhill International, Inc., 249 A. 2d 427 (Del. Ch. 1968).

Compare two recent going private cases decided by Vice Chancellor Marvel: In Pennsylvania Mutual Fund, Inc. v. Todhunter International Inc., C. A. No. 4845, (Del. Ch. filed August 5, 1975), 1 Del. J. Corp. Law 229 (1976), the merger was restrained because "use of control to freeze out or to manipulate a corporation to the detriment of minority stockholders has always been frowned on by this court.' In Lynch v. Vickers, 351 A. 2d 570 (Del. Ch. 1976), by contrast, the court, after a trial on the merits, found adequacy of disclosure and price and repeated a challenge to an allegedly "coercive" tender offer by the majority.

# Professor Cary. Federalism Article at 677, 678, maintains that reclassifications and similar reorganizations are examples of how the Delaware courts will permit one class of shareholders to profit at the expense of another class. His criticism ignores the statutory and case law. GA 8 Del. C. $ 242. 65 8 Del. o. $ 242 (a) (4); cf. Keller v. Wilson d Co., 190 A. 115 (Del. Supr. 1936). 66 2 A. 2d 114, 119 (Del. Ch. 1938). 7 Barrett v. Denver Tramway Corp., 146 F. 2d 701, 706 (3rd Cir. 1944). 48 Porges v. Vadsco Sales Corp., 32 A. 2d 148, 151 (Del. Ch. 1943).

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