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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 48 simply misconstrued Delaware law when it held to the contrary.co

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

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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.,54 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

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

48 269 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.

69 70 A. 20 5 (Del, Ch. 1949).
61 24 N.Y. 2d 494 (1969).
52 2 A, 2d 904 (Del. Supr. 1938).
63 2 A, 2d 904. 908.
84 5 A. 20 503 (Del. Supr. 1939).
65 5 A. 2d 503, 510.

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

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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 :

[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. Grcene, 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 succinctly stated in the Johnston v. Grecne. 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.60

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".02

D. RECLASSIFICATION OF SHARES

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Reclassification of shares is an essential tool of capital flexibility. Although abuses can occur through improper use of this device, Delaware law forbids such inipropriety. 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 dividends, 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 :

... å 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. 2d 660 (Del. Supr. 1952). 58 121 A. 20 919, 925; see also Gottlieb v. Hayden Chemical Corp., supra note 58. 80 121 A. 2d 919, 925.

#1 e.g., 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. fied 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.

ti Professor Cary. Federalism Article at 677. 678, naintains 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.

64 8 Del. C. $ 242.
658 Del. o. $ 242(a) (4); cf. Keller v. Wilson & Co., 190 A. 115 (Del. Supr. 1936).
63 2 A. 20 114, 119 (Del. Ch. 1938).
07 Barrett v. Denver Tramway Corp., 146 F. 2d 701, 706 (3rd Cir. 1944).
Qs Porges v. Vadsco Sales Corp., 32 A. 2d 148, 151 (Del. Ch. 1943).

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conscious disregard of the interests of the corporation and the rights of its stockholders.”

Reclassification, of course, can be accomplished by a merger or consolidation. Mergers, like charter amendments, are subject to safeguards which protect the interests of minority shareholders.

Where there is a thin market, a stockholder dissenting from a merger has a right to an appraisal of his stock." The stockholder must object in writing to the merger and demand payment for the value of his shares. If he and the surviving corporation do not reach agreement, he or the corporation may begin an appraisal proceeding.

The Delaware courts have identified various factors which are to be considered and weighed in arriving at a valuation for stock in an appraisal proceeding.

... [T]he actual or true value of the stock is to be determined by considering the various factors of value including earnings, dividends, market price, assets, and the other factors deemed relevant in a stock evaluation problem arising under the Delaware Corporation Merger Statute, 8 Del, C.

$ 262." Furthermore, the over-riding consideration is that all factors relevant to a determination of fair price in a particular situation are to be examined and weighed as appropriate to the circumstances of the particular corporation and merger. The courts recognize that the determination of fair price necessitates much bal. ancing and judgment.

Thus, for example, in Sterling v. Mayflower Hotel Corp.," the Supreme Court accorded less weight to net assets value than market value.

... But the requirement that consideration be given to all relevant factors entering into the determination of value does not mean that any one factor is in every case important or that it must be given a definite weight in the evaluation. ... The relevant importance of several tests of value depends on the circumstances. Thus, in some cases net asset value may be quite important. . . . But in the case at bar it is of much less importance than the factors analysed in the [investment banker's] report. We are dealing here with corporations engaged in the hotel business, whose capital is inrested largely in fixed assets. The shares of such corporations are worth, from the viewpoint of an investor, what they can earn and pay. A comparison of net asset values may have some weight, but it is of much less importance than demonstrated capacity of the corporation to earn money and

pay dividends. In appraisal proceedings, as elsewhere, the courts of Delaware look to the circumstances of the particular case in applying statutory and common law as the equities require.

Much of the recent criticism of appraisal had to do with its complexity and cost."* Two recent developments show that such criticism is baseless or outdated. The Delaware Supreme Court in Raab v. Villager * recently reaffirmed that: “The requirements of 262 (6) are to be liberally construed for the protection of objecting stockholders, within the boundaries of orderly corporate procedure and the purpose of the requirement.” 10 [Emphasis supplied) Perhaps, more importantly, Chief Justice Herrman on that occasion announced a prospective policy-make sure that their stockholders were fully informed of their rights under Section 262:

A Delaware corporation, engaged in 8 262 proceedings, henceforth shall have an obligation to issue specific instructions to its stockholders as to the correct manner of executing and filing a valid objection or demand for payment under the Statute, as construed by Delaware courts, including: (1) the general rule that all such papers should be executed by or for the stock

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* Bodell v. General Gas & Electric Corp., 140 A. 264 (Supr. Ct. 1927). 70 8 Del. C. $ 262.

71 Poole v. N. v. Deli Maatschappij, 243 A. 2d 67, 69 (Del. Supr. 1968). (These factors are customarily grouned under the three principal headings of market value, earnings value and net asset value.)

72 Supra note 61.

73 93 A. 20 at 115, 116. See also Universal City Studios, Inc. v. Francis I. duPont & Co., 334 A. 20 216. 218 (Del. Supr. 1975); Gibbong v. Schenley Industries, Inc., 339 A. 2d 460 (Del. Ch. 1975). A. 21

(Del. Supr. 1976), C.A. Nos. 5, 56, 73, and 99, 1975 (Del. Supr., filed April 12, 1976).

78 Compare salt Dome Oil Corp. v. Schenck, 41 A. 20 583 (Del. Supr. 1945) and Carl M. Loeb, Rhoades & Co. v. Hilton Hotels Corp., 222 A. 2d 789 (Del. Supr. 1966).

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holder of record, fully and correctly, as named in the notice to the stockholder; and (2) the manner in which one may purport to act for a stockholder of record, such as a joint owner, a partnership, a corporation, a trustee, or a guardian.

Fairness to stockholders require such reasonably specific instructions in § 262 proceedings. As a general rule in the future, failure by the corporation to furnish such instructions will result in the resolution in favor of the stockholder of all doubt as to the sufficiency, for corporate purposes, of the

objection or demand.” Second, effective July 1, 1976, the General Corporation Law has been amended by the Delaware General Assembly to permit reimbursement of attorney's fees and simplification of procedures. The official commentary sets out the purposes sought to be attained :

The present statute contains circuitous and arbitrary provisions governing the time limits for an appraisal so that an appraisal action may be filed up to four months and 50 days following the effective date of the merger. Under the proposal to 8 262 (c), this period would be changed to 120 days and provision made for the filing of an appraisal action immediately following the effective date of the merger. However, the stockholder has been afforded the opportunity to change his mind nd withdraw the appraisal action during the first 60 days of the 120 day period.

The proposed revisions to 8 262(h) are intended to provide a more equi. table means of sharing the cost of an appraisal. Under the present practice, each stockholder bears his own expenses in the appraisal so that if one stockholder hires an attorney and expert witnesses, he must bear all of the expenses while all of the other stockholders receive the benefit of the attorney's representation and the testimony of the expert witnesses. This has resulted in unfairness to the stockholder who has neither the money nor a sufficient stock interest in the corporation to hire attorneys and experts. Also, the stockholder who does hire attorneys and experts is unfairly taxed with all of the cost. Under the proposed revisions of 262(h), all of the stockholders would share the expenses of the attorneys and ex

perts who have achieved a benefit for them." There, of course, are well recognized circumstances under which a stockholder need not choose between appraisal and accepting the merger."" Where unfairness amounts to fraud, actual or constructive, the stockholder may enjoin the merger.So if a constituent corporation is "on both sides" of the transaction, the burden of proving the intrinsic fairness of the transaction, under the careful scrutiny of the court, is shifted to the defendant.

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E. INDEMNIFICATION Indemnification of directors against losses suffered from good faith performance of duty seems desirable, if not necessary, to enable corporations to attract qualified independent directors. Some have faulted the indemnification provisions of the General Corporation Law for allowing corporations to pay insurance premiums for directors' and officers' liability insurance policies. This analysis is faulty.

No responsible insurer will make coverage available to protect directors against liability for defalcations or breaches of trust. Even a tentative inquiry into the subject of available coverage makes this plain. As does lawyers' and doctors' malpractice insurance, director and officer liability insurance serves both to protect the insured against consequences of negligent behavior and to benefit the victims of that behavior by providing a fund to compensate them.

A. 2d at

(Del. Supr. 1976). supra note 75. 78 Official Commentary to $8.253 and 262 (Appraisal Rights); House Bill #906, 128th General Assembly, Second Session 1976.

70 As an additional problem with reclassifications, Professor Cary has said that the Delaware courts have avoided looking through form to substance. Federalism Article, at 677. In support of this, he cited, alternatively, Kcller v. Wilson & Co., supra note 65 and Federal United Corporation v. Havender, infra note 80. Since. 8 Del. 0. $ 242(a) (4) now permits elimination of dividend accruals by charter amendment, Cary is wrestling with a dead issue.

50 Porges v. Vadeco Sales Corporation, supra note 68. See also Federal United Corporation V. Havender, 11 A. 2d 331 (Del. Supr. 1940).

81 Sterling v. Mayflower Hotel Corp., supra pote 61; David J. Greene & Co. v. Dunhill International, Inc., supra note 61 ; and pages 22-25, supra.

8 Del. C. $$ 145 (f) and 145(g); Cary, Federalism Article at 669, 670.

IV. COMPETITION FOR CONTROL

A. AVAILABLE TOOLS

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When an outsider or a group of stockholders seeks to replace incumbent management, the structure of the corporation law receives a severe test. Perhaps it is in the corporation's best interest for the outsiders to succeed. As Professor Cary has written: "The raider may sometimes be a better manager than the 'raidee'".

Ilowever, as the word "sometimes" would suggest, the matter is not black and white. "Raiders" and others frequently use surprise and market forces, such as stampede and arbitrage; and foul play is not unknown. Financing for a takeover may make real or thinly veiled use of the target's own credit, Certain stockholders of well managed and conservatively financed businesses may be offered a quick profit to the disadvantage of other stockholders at a time of depressed market price. A good corporation law must deal in the context of its more permanent structure, with the abuses on all sides that arise in competitions for control, and strike a fair balance between the competing considerations.

In order to perform their duties properly when faced with a raid or attack believed contrary to the interests of the stockholders, the directors must have available to them as many legitimate tools as possible to defend those interests. The field is well developed. Capital structure may be flexible with power to buy or sell securities, whether common stock, preferred stock, convertible securities or warrants, together and the statutory and charter authorization to use them.“ To act promptly, a large board must be able to delegate decision-making to a smaller committee of its members.

Continuity of board membership can provide the stability that is particularly, but not exclusively, desirable when a company is engaged in a financial recovery or undergoing otherwise difficult times. Such a board prevents the wholesale replacement of all the knowledgeable members.7 Prohibition, in certain cases, of the removal without cause of board members by shareholders is as important an adjunct to the procedure as the ability to effect that removal may be in other circumstances. Mergers and other major corporate changes for many years required votes of substantially more than 51% of the stockholders. Normal business flexibility may require the lower majority vote, which is the general rule. Nevertheless, a higher vote, if adopted by the stockholders, may retard or inhibit takeover."

A corporation whose shares are selling at a depressed price may desperately need, but not attract, the best managers because of the hazards of short tenure. These hazards may also require the payment of undesirably high salaries. What the shareholders of such a corporation may need is not corporate war, but a corporate peace in which to develop or recover resources. In such cases, management's needs may not be “entrenchment" so much as “peace of mind". If such is the will of the stockholders, a proper statute should make the tools available; and the Delaware statute does.

On the other hand, the available tools are subject to abuse. Delaware courts have time and again condemned and proscribed that abuse. It was the context of a corporate takeover fight, that gave rise to that touchstone of Delaware corporate common law:

DO

8 Cary. A Proposed Federal Corporate Minimum Standards Act, 29 Bus. Law. 1101, 1105 (1974).

84 See Casey, Introduction to Aranow & Einhorn Tender Offer8 for Corporate Control, Columbia University Press. p. xvi-ii (1973), p. xvi-ii.

$5 8 Del C. $$ 122(4):123: 160.

80 & Del. o. $ 141(c) ; but see Folk, Corporation Lar Developments1969, 56 Va. L. Rev. 75.5, 790 (1970).

878 Del. c. 141(a): cf. Essential Enterprises Corp. v. Automatic steel Prod., 159 A. 24 288, 291 (Del. Ch. 1960).

58 Del. C. $ 141(k); cf. Dillon v. Berg, 326 F. Supp. 1214, 1224 (D. Del.), aff'd, 453 F. 20 876 (3rd Cir. 1971) ; Campbell v. Loero's Ino., 134 A. 2d 852, 857-58 (Del. Ch. 1957).

* Arsht and Stapleton, Analysis of the 1969 Amendments to the Delaware Corporation Law, Prentice-Hall. Inc., 1969.

20Dei. C. $8 102 (4) ; 242 (c) (4).

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