New Developments

Delaware Court of Chancery on books and records inspection

The Delaware Court of Chancery has denied stockholder inspection of three letters on the grounds that the stockholder does not have a proper purpose and that, even if the purpose were proper, the letters are confidential and the harm from disclosure would outweigh the benefits. In Pershing Square, L.P. v. Ceridian Corp., Pershing Square, Ceridian’s largest stockholder, learned that Mr. Krow, the president of one of Ceridian’s two operating units, had sold a significant amount of stock and intended to quit because he disagreed with the business plan of Ceridian’s CEO, Ms. Marinello. Ms. Marinello confirmed those business plans in a meeting with Pershing Square and other significant stockholders. Pershing Square then met with Krow who disclosed the existence of some letters to the board that, inter alia, hinted at mismanagement by the prior CEO and hinted that the board had been lax in its oversight. Pershing Square then announced its intention to run an opposition slate of directors at the Ceridian annual meeting. All these events occurred within two weeks.

A month later, Pershing Square made a books and records demand under DGCL § 220 seeking the letters and a few other items. Ceridian allowed inspection of the other items but denied inspection of the letters. Pershing Square filed suit and a trial ensued.

Chancellor Chandler denied inspection. He held that Pershing Square’s ostensible purposes, to communicate with stockholders for the purpose of soliciting proxies and to investigate the suitability of directors, were not its actual purpose. Pershing Square’s actual purpose was legally to make public the information in the letters, which it could not otherwise publicize without acknowledging that it had obtained that information improperly. Chancellor Chandler also held that the letters were confidential, that their confidentiality had been maintained, and that the harm of disclosure would outweigh the benefits.

Chancellor Chandler is absolutely right here and the case is pedagogically interesting on at least three levels. First, the Chancellor sets out in wonderfully clear and concise language the Delaware rules for books and records disclosure. That is, that the burden is on the stockholder to assert a proper purpose, to prove that it has evidence warranting further investigation, and to prove that the information is necessary and essential to its stated purpose. The corporation may defeat inspection by showing that the stockholder’s ostensible purpose is not a proper purpose or, if it is proper, that it is not the stockholder’s actual, improper, purpose. A stockholder may inspect for a proper purpose even if the stockholder’s additional purposes are improper. Books and records inspection is commonly coupled with a confidentiality order.

Second, it makes a nice contrast with Seinfeld v. Verizon Communications Inc., (Casebook Supplement), which is replacing Compaq Computer Corp. v. Horton, casebook page 567. This case could be inserted at page 571. The two cases taken together would make a nice class discussion of the contours for stockholder inspection.

Finally, and perhaps most importantly, there are distinct fiduciary and professional responsibility aspects to this case. Pershing Square’s counsel and Mr. Krow’s personal counsel attended the meeting between Pershing Square and Mr. Krow. Chancellor Chandler, in his understated way, lays out the problems:

While Krow was a Ceridian fiduciary, but contemplating resignation, he formed an alliance with his employer’s largest stockholder to achieve one common goal—the replacement of the current board with a board that would spin-off Comdata and retain Krow as CEO. To further this goal, Krow participated in two secret meetings with Pershing Square. In the first, he discussed Ceridian’s strategic plans, aligned himself with Pershing Square, and schemed to unseat Ceridian’s current management and board. In the second meeting, held on one day’s notice in an airport, Krow reassured Pershing Square that he was adverse to the current board and at least allied with, if not loyal to, Pershing Square. Krow advised Pershing Square of Ceridian stockholders who were loyal to Krow and would likely support Pershing Square’s opposition slate. He also advised Pershing Square on the suitability of at least one of its nominees. Further, he disclosed confidential information written not only by himself, but also by another Ceridian executive officer.

Notably, Pershing Square and Krow were both represented by counsel, who informed them that Krow might face legal issues if he joined Pershing Square’s slate. Yet, neither party seemed concerned that Ceridian, the company that employed Krow, was not represented at this meeting. Both participants ignored all duties that Krow owed to Ceridian, including Krow’s duty to report to management elected by and responsible to all stockholders. It appears that self-interest, not the best interest of the corporation or its stockholders, drove Krow’s actions, and Pershing Square stood to benefit from Krow’s self-interested actions.

Law professors who teach this case can and should raise questions about Mr. Krow’s behavior under Agency and Corporate law, Pershing Square’s ethics, and counsel for Pershing Square and for Mr. Krow’s professional responsibility.

Francis Pileggi has a very nice discussion of this opinion here.

New Hampshire Supreme Court on dissolution

The Supreme Court of New Hampshire has held that a court has the equitable power to set aside a shareholder’s election to buy out the shareholder who petitioned for dissolution, even where the electing shareholder does not seek to revoke the election. In Bendetson v. Killarney, Inc. (watch oral argument here and note the wonderful courtroom), Bendetson and Buonato, the two equal shareholders of Killarney, Inc., had a falling out. Killarney served as the sole general partner of a limited partnership that Bendetson and Buonato also owned equally. Bendetson petitioned for dissolution of Killarney on the ground of deadlock and petitioned for dissolution of the limited partnership on the ground that it was not reasonably practical to carry on the limited partnership given Killarney’s deadlock.

Buonato filed an election to purchase Bendetson’s Killarney shares at fair value, pursuant to MBCA § 14.34(a). The trial court stayed dissolution and, when the parties could not agree on value, held a valuation hearing. At the hearing the court noted that the limited partnership dissolution was pending and that, after Buonato purchased Bendetson’s Killarney shares he would also control the limited partnership. The court set aside Buonato’s election and later ordered dissolution of Killarney. Buanato appealed, arguing that the court was without power to set aside his election in the absence of his request to revoke.

Chief Justice Broderick held that the court has the power to set aside a shareholder’s election. The relevant language of § 14.34(a) reads,

An election pursuant to this section shall be irrevocable, unless the court determines that it is equitable to set aside or modify the election.

The Chief Justice acknowledged that the word “irrevocable” ordinarily has reference to a withdrawal only by the original actor (i.e. Buanato) but held that the Official Comments, the statutory scheme, the statute’s purpose and the legislative intent were all consonant with judicial discretion even in the absence of the electing shareholder’s request to revoke.

This result seems correct and the court’s analysis is rather thorough and nuanced.

Massachusetts court on buyout remedy and shareholder fiduciary duty

The Massachusetts Supreme Judicial Court has held that buyout is not within a court’s equitable power to impose as a remedy for violation of a shareholder’s fiduciary duty. In Brodie v. Jordan, (watch the oral argument here) the plaintiff inherited from her husband one-third of the shares of a closely held corporation. The two defendants owned the remaining shares. Plaintiff’s husband and the other shareholders had a falling out in the early 1990s. Plaintiff’s husband died in 1997. The corporation has paid no money to plaintiff or her husband since 1995. The defendants have not provided financial or operational information to plaintiff, they have not performed a valuation of the company, nor has the corporation held an annual meeting for five years. The Superior Court found that the defendants violated their fiduciary duty of utmost good faith and loyalty, required under Donahue and Wilkes, “by excluding her from corporate decision-making, denying her access to company information, and hindering her ability to sell her shares in the open market.” The Appeals Court affirmed and defendants did not seek further review of the liability issue. The Superior Court judge ordered the defendants to buy out the plaintiff at a price to be determined by a court-appointed expert. No corporate document requires a shareholder to sell or buy shares.

Justice Cowin, speaking for the court, made a subtle but potentially far reaching assertion. After quoting various examples of freeze-outs from Donahue, she concludes, “What these examples have in common is that, in each, the majority frustrates the minority’s reasonable expectations of benefit from their ownership of shares. We have previously analyzed freeze-outs in terms of shareholders’ ‘reasonable expectations’ both explicitly and implicitly.” She cites two Massachusetts cases (including Wilkes) then cites the standard New Jersey, New York, and North Carolina cases that use the reasonable expectations test to determine oppression.

As near as I can tell, Justice Cowin’s description of Massachusetts law is incorrect. I’ve found no appellate case that analyzes the Donahue/Wilkes fiduciary duty in terms of the minority’s reasonable expectations. In a footnote Justice Cowin notes that Massachusetts is different from those other states in that no Massachusetts statute permits a claim for relief for oppression. However, says she, the standards for determining a breach of fiduciary duty and finding oppression are often the same. That’s probably an accurate description of the law in other states, but not (until now) in Massachusetts.

No matter. Justice Cowin then holds that the goal in a freeze-out case is to restore the minority to the position it would have been in had there been no freeze-out. Here, because no corporate document permits or requires a buyout and no market for the corporation’s shares exists, ordering a buyout provides a different and more favorable remedy than plaintiff would have had if defendants had not violated their fiduciary duties. Justice Cowin then makes a slippery slope argument that buyout would be appropriate in every freeze-out case. Finally, she drops a footnote that distinguishes cases from other states that permit forced buyouts. She correctly notes that those states have statutes that permit involuntary dissolution and, by inference, the courts in those states have arrogated the power to order a buyout. In Massachusetts, by contrast, dissolution is only permitted for deadlock.

So it seems that Massachusetts is now using one of the standards for oppression as its test for determining whether the Donahue/Wilkes fiduciary duty has been violated. Where this leaves the rather elaborate weighing process in Wilkes is unclear. Could it be that Massachusetts is finally ready to abandon the notion that close corporation shareholders owe one another the same duties partners owe one another?

Further, of course, this raises one of the more problematic issues of the reasonable expectations test. That is, when the complaining shareholder did not purchase shares from the corporation, to what extent should the corporation and other shareholders be required to honor that shareholder’s reasonable expectations? A stark example is a shareholder who obtains shares from a parent. The parent and child may have very different, and reasonable, expectations about the optimal investment horizon. Whose expectations should be other shareholders respect?

Delaware Court of Chancery on shareholder fiduciary duties

The Delaware Court of Chancery has held that a 44% shareholder that exercises a contractual right is not a “controlling shareholder” and thus does not owe fiduciary duties to the other shareholders. In Superior Vision Services, Inc. v. ReliaStar Life Ins. Co., ReliaStar owned 44% of Superior. Pursuant to stock purchase agreements, Superior agreed not to pay any dividends, a prohibition that could be waived by owners of two-thirds of the shares. Superior’s board voted to pay dividends but ReliaStar refused to consent.

Vice Chancellor Noble noted that the prior cases have focused on power over the board. Here, obviously, ReliaStar did not control the board, at least not sufficiently to prevent the board’s approval of dividends. Instead, ReliaStar’s power came from arm’s length contractual rights. The Vice Chancellor held that contract rights would be limited if parties were subject to fiduciary duties in the exercise of those rights. He did, however, leave open the possibility that a substantial shareholder, with contract rights, “other factors” might have fiduciary duties as a controlling shareholder, particularly where the contract rights are used to effect board actions. What those other factors are, he does not speculate.

Montana Supreme Court on Corporate Dissolution

The Supreme Court of Montana has held that dissolution of a corporation is an appropriate remedy even where the innocent shareholder will be economically harmed. In Sartori v. S & S Trucking, Inc., Stacy and Sartori formed a corporation, S & S Trucking, Inc. (Gee, how did they think of THAT name??), to purchase a hauling business. Sartori and Stacy each owned half of the corporation. A bank loaned Sartori, but not Stacy, $78,000 to purchase to business. The loan was secured by property owned by Sartori and property owned by Stacy. Within weeks the parties’ relationship deteriorated and Sartori took several actions that effectively undermined the corporation. Sartori then had the audacity to sue Stacy for breach of fiduciary duties and sought dissolution; Stacy counterclaimed and asked that the corporation not be dissolved.

The Supreme Court, per Leaphart, J., affirmed that the trial court had the power to order dissolution under MBCA §14.30 because the corporation could no longer be conducted to the advantage of the shareholders because of deadlock. The court also affirmed the trial court’s removal of Sartori as a shareholder and a director and denial to Sartori of any compensation for his ownership interest (presumably because Sartori’s damage to the corporation was larger than the value of his ownership) under a non-MBCA provision allowing a court to,

[M]ake any order to grant the relief other than dissolution as, in its discretion, it considers appropriate, including, without limitation, an order:

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    (d) providing for the purchase at fair value of shares of any shareholder, either by the corporation or by other shareholders.

(2) Relief … may be granted as an alternative to … dissolution or may be granted whenever, under the circumstances of the case, relief but not dissolution would be appropriate.

The court also remanded for a calculation of damages owed by Sartori.

Stacy’s objection was that the loan would have to be repaid or refinanced in some way, which I presume would entail the sale of the business for cash. He argued that an appropriate remedy would be to leave the loan in place and simply remove Sartori as a shareholder, director, and officer.

It strikes me that Stacy’s victory is a hollow one indeed. The opinion is silent as to whether the loan can likely be refinanced on comparable terms or whether sale of the business is likely to generate sufficient money to satisfy the loan. Presumably Stacy’s collateral is subject to seizure if necessary to satisfy the bank. Further, it is unclear what assets Sartori has that could be used to satisfy a judgment of damages against him for harm to the corporation. I would think the fairer result is the one Stacy seeks: remove Sartori, render him liable for damages caused to the corporation, and allow Stacy to own and operate the corporation by himself.

Nevada case on power to order buy-out

The Supreme Court of Nevada has held, in a matter of first impression, that the courts have a common law power to order a buy-out, but only where the court finds that the statutory grounds for dissolution or the appointment of a receiver have been met. In Bedore v. Familian, 125 P.3d 1168, (Nev. 2006), in a stunning example of bootstrapping, the court based its decision on a Fifth Circuit diversity case that held that the federal District Court was not clearly erroneous in guessing that the Nevada Supreme Court would some day hold that a buy-out is a permissible remedy even in the absence of a statutory grant of authority.