Corporations & LLC's Flashcards
Summary
Controlling shareholders (including parent corporations) generally owe fiduciary duties to their partially owned subsidiaries and may not use their power to benefit themselves at the expense of
the subsidiary and its minority shareholders. Here, Parent likely did not violate its fiduciary duties of loyalty and care by causing its subsidiary, HomeSolar, to adopt a no-dividend policy,
given that the policy applied equally to all shareholders of HomeSolar and had the purpose of ensuring funding for HomeSolar’s research and development budget.
Business dealings by parent corporations with partially owned subsidiaries can be set aside as self-dealing transactions unless approved by a majority of disinterested directors or shareholders
or unless, in the absence of such approval, they are judicially determined to be fair. Here, Parent breached its fiduciary duty of loyalty by causing HomeSolar to enter into a long-term contract
with SolarMaterials, a wholly owned subsidiary of Parent, at prices significantly higher than current market prices under similar long-term contracts for the minerals. Because Parent selected the entire board of HomeSolar, there are no disinterested directors to approve the transaction.
Furthermore, there are no facts to suggest that the minority shareholders of HomeSolar approved the transaction. And, because HomeSolar paid higher than market prices, the transaction cannot
satisfy the fairness test. The presumption of the business judgment rule does not apply to this conflict-of-interest transaction. There are no facts indicating that Parent or the directors of HomeSolar breached a duty of care. Parent did not violate its fiduciary duties by allocating the opportunity to apply for the government grant to its wholly owned subsidiary IndustrialSolar and not to its partially owned subsidiary HomeSolar, given that the grant was for development of industrial solar projects and thus beyond the existing residential business of HomeSolar.
Did Parent breach any duties to HomeSolar with respect to HomeSolar’s no-dividend policy?
Parent likely did not violate its fiduciary duties of loyalty and care by causing HomeSolar to institute a no-dividend policy, given that the policy applied equally to all shareholders of HomeSolar and had the purpose of ensuring funding for the company’s research and
development budget.
Rule
The MBCA does not specify the duties of controlling shareholders to a controlled corporation or its minority shareholders. Instead, the duties of controlling shareholders generally arise as a matter of the court’s “inherent equity power” to fashion fiduciary duties owed by majority shareholders to minority shareholders. See Official Comment, MBCA § 10.01 (stating that actions by majority shareholders “may be reviewable by a court under its inherent equity power to review transactions for good faith and fair dealing to minority shareholders”), citing McNulty v. W. & J. Sloane, 54 N.Y.S.2d 253 (Sup. Ct. 1945). Generally, courts have examined business dealings between a controlling shareholder (such as a
parent corporation) and the controlled corporation using a fairness test. See Sterling v. Mayflower Hotel Corp., 93 A.2d 107, 109–110 (Del. 1952). But when the transaction does not involve self-dealing (as is the case with respect to dividends payable to all shareholders of the controlled corporation), then the “business judgment” standard applies. See Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971); see also Wolfensohn v. Madison Fund, Inc., 253 A.2d 72, 76
(Del. 1969) (holding that overreaching must be shown in a suit against a parent of a subsidiary). That is, the fairness test applies to parent-subsidiary dealings only where the “parent . . . causes
the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders . . . .” Sinclair, 280 A.2d at 720; see
generally Lewis H. Lazarus & Brett M. McCartney, Standards of Review in Conflict Transactions on Motions to Dismiss: Lessons Learned in the Past Decade, 36 Del. J. Corp. L. 967, 998–1003 (2011) (concluding that the business judgment rule is standard under Delaware law unless rebutted)
Application
Here, the shareholder challenges the no-dividend policy of HomeSolar instituted by Parent. The no-dividend policy affects the shareholder and all other HomeSolar shareholders (including Parent) equally and thus is not a self-dealing transaction in which Parent receives something to the exclusion of other shareholders.
Parent did not breach any duty of care. Under a “business judgment” standard, it is sufficient if Parent can offer a rational business justification for the no-dividend policy, which it has by
explaining that the no-dividend policy is meant to provide funds for HomeSolar’s research and development budget as the subsidiary seeks to develop new products for the residential solar
power market. See Note on Business Judgment Rule, MBCA § 8.31 (decisions subject to the business judgment standard “will not be disturbed (by a court substituting its own notions of
what is or is not sound business judgment) if they can be attributed to any rational business purpose”), citing Sinclair, 280 A.2d at 720; see also Auerbach v. Bennett, 393 N.E.2d 994, 1000
(N.Y. 1979) (business judgment rule “bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes”).
Did Parent breach any duties to HomeSolar with respect to HomeSolar’s contract with SolarMaterials for the purchase of rare earth minerals?
Given that Parent caused HomeSolar to enter into a contract for the purchase of minerals with Parent’s wholly owned subsidiary SolarMaterials at significantly higher prices than current market prices under similar long-term contracts for the same minerals, Parent engaged in unfair self-dealing and thus breached its duty of loyalty to HomeSolar. The business judgment rule does not apply to this conflict-of interest transaction.
Rule and Application
As described above, business dealings between a parent corporation (or its wholly owned subsidiary) and a partially owned subsidiary can involve self-dealing and a breach of the duty of loyalty when the parent causes the partially owned subsidiary to enter into a transaction that prefers the parent (or its wholly owned subsidiary) at the expense of the partially owned subsidiary and its minority shareholders. This breach cannot be cured here because there are no disinterested directors to approve the transaction, as Parent appointed all the directors of HomeSolar, and there is no evidence that the minority shareholders of the partially owned subsidiary approved the transaction. This means that liability can be avoided only if the transaction is judicially determined to be fair.
Generally, the person seeking to justify a self-dealing transaction has the burden of proving its fairness to the corporation. The MBCA has described “fairness,” in connection with directors’ conflicting-interest transactions, to include not only “the market fairness of the terms of the deal —whether it is comparable to what might have been obtainable in an arm’s-length transaction—but also . . . whether the transaction was one that was reasonably likely to yield favorable results (or reduce detrimental results)” for the corporation. Official Comment to MBCA § 8.61 (Comment 6, Fair to the Corporation). Thus, contractual dealings by a partially owned subsidiary
(here HomeSolar) with a wholly owned subsidiary (here SolarMaterials) in a corporate group must not only be shown to reflect the terms obtainable in comparable market transactions but
must also be shown to be beneficial to the partially owned subsidiary. Here, given that the prices set in the contract between HomeSolar and SolarMaterials were significantly higher than current
market prices under similar long-term contracts for the same minerals, Parent cannot establish the fairness of the contract. Thus, Parent breached its fiduciary duty of loyalty to HomeSolar.
Lastly, there are no facts to indicate that Parent or the directors of HomeSolar breached a duty of care. First, there are no facts indicating that Parent caused the HomeSolar directors to act with a
faulty decision-making process. Second, there are no facts indicating that the above-market transaction was “wasteful,” meaning that no reasonable person would have paid those higher prices. There could be any number of reasons why HomeSolar agreed to pay higher prices, and there are no facts indicating that the deliberation processes were faulty.
Did Parent breach any duties to HomeSolar by denying HomeSolar the opportunity to apply for the government grant?
Parent likely did not violate its fiduciary duties by allocating the opportunity to apply for the government grant to its wholly owned subsidiary IndustrialSolar rather than its partially owned
subsidiary HomeSolar, given that the grant was for development of industrial solar projects and thus beyond the residential business of HomeSolar.
Rule and Application
The MBCA does not address the duties of controlling shareholders to not usurp corporate opportunities of partially owned corporations. Nonetheless, an official comment to the MBCA explains the corporate opportunity doctrine in connection with the duties of directors: The corporate opportunity doctrine [applicable to directors] is anchored in a significant body of case law clustering around the core question whether the corporation has a
legitimate interest in a business opportunity, either because of the nature of the opportunity or the way in which the opportunity came to the director, of such a nature that the corporation should be afforded prior access to the opportunity before it is pursued
(or, to use the case law’s phrase, “usurped”) by a director.
MBCA, Introductory Comment to Subchapter F (Comment 4, Non-Transactional Situations Involving Interest Conflicts – Corporate Opportunity). In a similar vein, the American Law Institute (ALI) Principles of Corporate Governance define a corporate opportunity, for purposes of directors and senior executives, generally as a business opportunity where either “the person offering the opportunity expects it to be offered to the corporation,” the opportunity “would be of interest to the corporation,” or the opportunity is “closely related to a business in which the
corporation is engaged or expects to engage.” ALI Principles of Corporate Governance § 505(b); see also Northeast Harbor Golf Club, Inc. v. Harris, 661 A.2d 1146 (Me. 1995) (adopting the ALI Principles approach to corporate opportunities as consistent with the MBCA). For business opportunities allocated within a corporate group, courts have accepted that the parent should have some leeway in allocating business opportunities within the group. See
Sinclair, supra; see also In re Synthes, Inc. S’holder Litig., 50 A.3d 1022, 1040–41 (Del. Ch. 2012) (“the duty to put the best interest of [a partially owned subsidiary] above any interest . . . does not mean that the controller has to subrogate his own interests so that the minority stockholders can get the deal that they want”) (internal quotations omitted).
Here, although HomeSolar might have wanted to receive the government grant, there is no indication that HomeSolar was capable of using the grant to pursue industrial solar projects;
instead, the facts indicate that HomeSolar’s line of business is developing residential solar projects. Finally, it is unclear that the government would have given the grant to HomeSolar, as
opposed to the wholly owned subsidiary IndustrialSolar.
