Corporations Flashcards
Summary
The sale of the tower is subject to judicial scrutiny as a “director’s conflicting interest transaction” because it was a transaction between the corporation and an entity in which the corporation’s directors had a material financial interest. The business judgment rule does not protect the board’s authorization of the sale because all the directors who authorized the transaction had a material financial interest in the sale, by virtue of their interest in LLC. Nor was there any shareholder approval.
The directors likely breached their duty of loyalty. Because this was a self-dealing transaction, the directors bear the burden of demonstrating that the sale was substantively and procedurally fair to the corporation. It is unlikely that they can demonstrate substantive fairness because nothing in the facts presented would support a finding that the price of the tower at the time of the sale was fair. It is also unlikely that the directors can demonstrate procedural fairness given their failure to obtain an up-to-date independent appraisal or to undertake another “market test” of the property’s value.
The directors also likely breached their duty of care by failing to diligently and adequately consider the transaction’s fairness to the corporation. The directors exhibited gross negligence in not inquiring about the continuing validity of the dated appraisal and by not considering other means to ensure the fairness of the transaction to the corporation.
[NOTE: The analysis of this question tracks the analysis specified by Subchapter F of the Model Business Corporation Act (MBCA).
Was the corporation’s sale of the tower a “director’s conflicting interest transaction”?
The sale of the tower was a “director’s conflicting interest transaction” (or director self-dealing) because the directors of the corporation had adverse financial interests as owners of LLC.
Rule and Application
The corporation’s directors were on both sides of the transaction, both authorizing it for the corporation and standing to gain from it as owners of LLC. The MBCA defines a “director’s conflicting interest transaction” as one effected by the corporation respecting which …the director had knowledge and a material financial interest. The sale of the tower meets this definition of director self-dealing and is subject to special scrutiny.
The directors’ financial interest in the transaction is clearly “material.” Each director’s one-fourth ownership of LLC is likely to have impaired his or her objectivity in considering the transaction. In addition, all the directors were aware that the transaction was with their LLC.
In a jurisdiction with an “interested director” statute, the sale of the tower would qualify as a “director’s conflicting interest transaction” given that it was a transaction with the corporation and one in which the directors had a direct or indirect interest. See former MBCA § 8.31; Del. GCL § 144 (“transaction between a corporation . . . and any other corporation . . . in which one or more of its directors . . . have a financial interest”). The conflict of interest is indirect because the directors of the corporation have a “material financial interest” in the other party, here the new LLC. See MBCA § 8.31(a).
Was the board’s authorization of the sale of the tower protected by the business judgment rule?
The board’s authorization of the sale of the tower is not protected by the business judgment rule because the transaction was not authorized by a majority of informed, disinterested directors
Rule
A “director’s conflicting interest transaction” (that is, a director self-dealing transaction) is not absolutely prohibited. Instead, modern corporate law permits such transactions—with the consequence that the business judgment rule applies if, after full disclosure of all relevant facts, qualified directors authorized the transaction. See MBCA § 8.61(b) (safe harbor); Del. GCL § 144.See also Benihana of Tokyo, Inc. v. Benihana, Inc., 906 A.2d 114 (Del. 2006) (holding that §144 creates safe harbor for interested director transactions, resulting in application of business judgment rule, provided material facts are disclosed or known to board, and majority of disinterested directors in good faith authorize transaction). If, however, the self-dealing transaction is not shown to have been properly authorized, the business judgment rule does not apply and the transaction must be shown to have been fair to the corporation.
Application
Here, the MBCA safe harbor for proper board authorization does not apply. There was no authorization of the sale of the tower by qualified directors—that is, by directors who did not have an interest in the transaction. See MBCA § 1.43(a)(3)(i) (defining “qualified director” for purposes of director-authorization safe harbor as not including “director as to whom the transaction is a director’s conflicting interest transaction”). As elaborated in Point One, the only directors who authorized the transaction were those who had a conflict of interest. Thus, the presumption of the business judgment rule that the directors were informed and acted in good faith is not available because each of the directors had a material conflicting interest in the sale of the tower. See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (presumption that in making business decisions, the directors acted on informed basis, in good faith, and in best interests of corporation not available to interested directors).
Did the corporation’s directors breach their fiduciary duty of loyalty by authorizing the sale?
Thedirectorslikelybreachedtheir dutyofloyaltybecauseitis unlikelytheycouldshowthatthe transaction wassubstantivelyand procedurallyfairtothecorporation.
Rule
Evenifthe saleofthetower was not properlyauthorized,thedirectors cansatisfytheirfiduciary dutyofloyaltybyshowingthat “thetransaction,judgedaccordingtothecircumstancesatthe relevant time, wasfairtothecorporation.” See MBCA§8.61(b)(3);see also Marciano v. Nakash, 535A.2d 400, 405 n.3(Del. 1987).
Thedirectorshavethe burdentoshowthatthetransactionasawhole wasfairintermsof“fair price”and“fairdealing.”Thismeanscourts willinquireinto(1)whetherthetransactionprice wascomparabletowhatmighthavebeen obtainedin anarm’s-lengthtransaction,giventhe considerationreceivedbythecorporation,and(2)whetherthe processfollowedbythedirectors inreachingtheirdecision wasappropriate. See OfficialComment6toMBCA§8.60.Abreach ofthedirectors’dutytodealfairlywiththecorporation canresultinpersonalliability. See MBCA§8.31(a)(2)(v)(receiptoffinancialbenefittowhichdirector notentitledunder applicablelaw).
Application
Here,thedirectors mayarguethatthe $12millionpricepaidby LLC forthetowermadethe transactionsubstantivelyfairbecausetheprice waswithintherangeof offers($8to$13million) receivedbythecorporationwhenthetower wasofferedfor saletwoyearsbefore. SeeHMG/ CourtlandProperties Inc. v.Gray,749A.2d94(Del.Ch.1999)(pricewithinrangeof offersis fair).Thedirectorsmaypointoutthatthe salespricewasalsowithintherangeofvaluesofthe appraisal($12to$15million).Additionally,thedirectorsmayarguethatevenifthe sale wasnot atthehighestvaluationreceivedbythecorporationforthetower,the salegavethecorporation non-economicadvantagesbyenablingitto“have timetorelocatetoanewheadquarters.” Finally,thedirectorsmayarguethatthetransaction wasprocedurallyfairbecauseinformation aboutthevalueofthetower wasalready knowntothemandthere wasnoreasontomake further inquiries.
Itisunlikely,however,thatthedirectors’argumentswouldmeettheir burdentoshowthe transaction’sfairness.Astosubstantivefairness,the offersandappraisalreliedonbythe directorsoccurredtwoyearsbeforethesaletoLLC,andthe$12million salespriceislessthan the$13 millionofferthattheCEOhadrejectedasinsufficient.Astoproceduralfairness,the directorsdidnotconductanewmarkettestor seekotherpurchasers.Theprocessoftheboard’s decision wasflawed:themeeting wasconductedin10minutes,there wasnodiscussionof whethermarketcircumstanceshadchangedsincethetwo-year-oldappraisalorwhetherto seek anotherappraisal,andthere wasnoconsiderationoflookingforotherpurchasersorconducting anothermarkettest.Finally,thedirectorsdidnotconsiderwhetheranotherbuyerotherthanLLC wouldbewillingtoaccommodatethecorporation’sneedfor timetolocateandmovetonew headquarters.
Did the corporation’s directors breach their fiduciary duty of care in the waytheyauthorizedthe sale?
Thedirectorslikelybreachedtheirfiduciarydutyofcareinauthorizingthe saleofthetower becausetheydidnotbecomeadequatelyinformedpriortotheirdecision
Rule
Under the MBCA, a director is called on to exercise “the care that a person in a like position would reasonably believe appropriate under similar circumstances” in “becoming informed in connection with their decision-making function.” MBCA § 8.30(b). A director may be liable for harm to the corporation from a board decision where it is proven that the director was “not informed to an extent the director reasonably believed appropriate in the circumstances.” MBCA § 8.31(a)(2)(ii)(B); see also Smith v. Van Gorkom, 488 A.2d 858, 873 (Del. 1985) (directors breach duty of care when grossly negligent in informing themselves about board decision).
Application
Normally, “the party attacking a board decision as uninformed must rebut the presumptionthat its businessjudgment was aninformedone.” Smithv.VanGorkom,488A.2dat 872; see also MBCA§8.31(a)(2)(ii)(to similareffect).Butherethepresumptionofthebusinessjudgment ruledoesnotapply,giventhatthedirectorswere eachfinanciallyinterestedinthetransaction (see PointTwo).
A strong case can be made that the directors were grossly negligent in informing themselves about the sale of the tower to LLC, and thus that they breached their fiduciary duty of care. As discussed in Point Three, the directors decided to sell the tower at a board meeting that lasted 10 minutes; the only document they reviewed was a two-year-old appraisal; they did not discuss whether market circumstances had changed since the appraisal; they did not seek another appraisal; they did not consider looking for other purchasers, including an accommodating purchaser, or conducting another market test; and they did not discuss how the CEO had conducted the earlier market test. See Smith v. Van Gorkom, 488 A.2d 858 (finding directors were grossly negligent for authorizing cash-out merger in reliance on 20-minute oral presentation by corporation’s chief executive officer without written summary of merger terms or documentation to support price adequacy).
