Duty of Loyalty Flashcards
Duty of Loyalty restricts what exactly?
• Corporate Actions where Directors or Controlling S/H have a financial interest (CONFLICTED TRANSXS)
o Self-Dealing Transactions b/t Co & Directors7
o Compensation of Officers & Directors
o Controlling S/H relationship w Minority S/Hs
• Corp Actions considered Integral to Continued Existence or Identity of Corp (STRUCTURAL CHANGES)
o Corporate Mergers
o Dissolutions
o Sales of Substantially all Assets
Transaction Cleansing: disclosure requirement
• BOD may approve transxs b/t Corp & interested Directors/Officers ONLY if transx is FAIR; AND
• INTERESTED Director must FULLY DISCLOSE all MATERIAL facts to Corp’s S/H & DISINTERESTED Directors
to deal w the Co on terms that are INTRINSICALLY FAIR in all respects.
Transaction Cleansing: Hayes Oyster Co. v. Keypoint Oyster (Wash 1964)
Hayes Oyster Co. v. Keypoint Oyster (Wash 1964)
Facts: Coast BOD sued Hayes (Director/Officer) who, as a part of BOD approved sale of Coast Assets to Keypoint (Hayes 25% ownership of Keypoint). On both sides of transx. Did not disclose. π claims he acquired secret profit & personal advantage, violation of duty, must disgorge
Rule: Non-Disclosure by an interested Director or Officer is, in itself, unfair, even if he had no intent to defraud AND no unfairness (injury) to Corp can be shown…IN WASHINGTON
NOTE: Remedy is similar to to Meinhard (punctilio) – reverse transx and put parties back to where they were before. Here he can’t use fairness as a defense for loyalty breach bc he did NOT disclose.
Transaction Cleansing: GF REQ:
Facts: Derivative suit. Closely held Corp. Majority S/H sued by Minority S/Hs due to self dealing. Herring making sweetheart deals, standing on both sides of transx, S/H not receiving dividends. BOD aware of Herring’s dual ownership and approved transxs.
Rule: When disinterested directors approve transx involving interested director, safe harbor – except additional requirement from the C/L gives Director BOP to show GF, honesty, Fairness controlling S/H
NOTE: This decision is a little funky. The Ct reads into the statute the C/L GF requirement. The self interested director can’t indicate to the BOP they need to approve the transx. Here, w controlling S/H a board isn’t really disinterested. While this Ct stresses the GF requirement and fair process & price, more often than not Fair Price will overcome unfair process. So if you are in Iowa, satisfy GF.
Remember! Lack of GF is NOT on its own an independent duty! (See: Loyalty Flow Chart, thx Chao)
Transaction Cleansing Director Approval: Cooke v. Oolie (DE 2000)
Facts: Derivative suit. S/H sue two directors who were not technically conflicted bc not standing on both sides but were creditors – their interests differed from S/Hs & favored a transx beneficial to them. Ct here applies traditional loyalty analysis regarDLess.
Rule: Actions by Disinterested Directors who are not majority S/H are protected by BJR if interest is fully disclosed & majority of disinterested directors ratify.
Reasoning: Ct here said bc transx was ratified ALSO by non-interested board members, safe harbor applies. Also, relies on profitability to show GF, honesty & fair dealing (i.e., he charged a premium for premium services…)
NOTE: This is a weird case bc they are creditors…normally loyalty analysis doesn’t happen w.o conflict. Ct ended up granting SumJ.
Transaction Cleansing Shareholder Ratification: Lewis v. Vogelstein (Del Ch 1997)
Rule: A S/H ratification (by a majority) can be ineffectual when the transx ratified amounts to waste. You need a unanimous vote to ratify waste.
Reasoning: A transx that constitutes waste can also be a gift, but always need un-coerced unanimous ratification when Corp. directors have material conflict of interest. A Biz can’t just give stuff away for free.
NOTE: If it’s a conflicted transx. its duty of loyalty. If not, its probably duty of care, but likely immunized by 102(b)(7).
Shareholder ratification: Limitations
Two Main Limits to S/H Ratification:
1. Waste Doctrine limits S/H power to ratify self-dealing transxs need unanimous vote
o Waste is when no reasonable person would think it is a fair trade
2. Controlling S/H power to bind disinclined minority of S/H to ratify a self-dealing transx subject to fairness review
Transaction Cleansing: Controlling Shareholder: Wheelabrator Tech [duty of Care (not informed) and duty of loyalty case]
Facts: BOD & S/H approved merger agmt. Then S/H brought suit saying BOD breached loyalty. Transx involved Controlling S/H. Rule: If Controlling S/H, board can never be fully independent. So even if disinterested board approves, you still are subject to fairness standard (BOP π). BUT, if in addition to board approval, a MAJ of the MIN S/H APPROVE, then its BJR.
Fairness Standard for Controlling S/H
If a Corp enters into a transx w a Controlling S/H POTENTIAL CONFLICT ALERT
• Care Claim: If claim is that directors failed to exercise due care to adequately inform themselves before committing the corporation to a transaction, so long as a Maj of Min S/H approve the transx BJR protection
• Loyalty Claim: Here is the catch – the Controlling S/H might be on both sides of the transx, but to be self dealing, we have to do a Benefit to Detriment Test to then determine if there is any loyalty conflict
Benefit to Detriment Test
Did the Controlling S/H receive any benefit to the EXCLUSION (and detriment) of the Minority S/H?
o If YES: There is a loyalty conflict Fairness review (see Weinberger v. UOP)
o If NO: There is no conflict BJR (see Sinclair Oil)
Transaction Cleansing Controlling Shareholder: Sinclair Oil v. Levin (Del 1971) [Transx w.o conflict]
Facts: Sinclair Controlling S/H of subsidiary Sinvin. Minority S/H Sinvin claimed Sinclair forced improper payment of dividends & denied Sinven improperly a Corp. Opp.
Hold: No Conflict. Dividends distributed pro rata. No benefit to detriment.
Rule: Benefit to detriment is when the Parent Benefits at the Detriment to other S/H. If no benefit to detriment, no conflict (for COMMON transx).
Transaction Cleansing Controlling Shareholder: Weinberger v. UOP (Del 1983) [Transx w conflict]
Facts: S/H (49.5%) Signal (50.5%). Signal wants to buy the S/H out. Signal offers Merger ($21/share). Mkt Price was $14.50. Only 56% of minority S/H VOTE on merger, and 51% vote in favor of it. Signal was willing to pay up to $24. Lehman bros (future client of Signal) made exclusive report for them saying $21 was a fair price.
Rule: Fairness is not a bifurcated test. A really fair price can overcome unfair process.
Reasoning: The court wanted to see some kind of arms length bargaining, but that didn’t really happen. Should have set up an independent negotiating committee.
