Analysis of the Contract Effected between Ewing Oil Inc and Ewing Directors - Assignment Example

Question 1 A. The factual basis underlying this case can be developed such that a contract / transaction was effected between the corporation (Ewing Oil Inc.) and Ewing directors, who were the 60% controller of the stock with the remaining 40% being with the Barnes family. By the reason of Ewing director’s domination / majority as well as their directorship, it is clear that they owed a fiduciary duty towards Ewing Inc. and its shareholders. The transaction is not void or voidable solely because the interested directors are present at or participate in the meeting of the board or that because their votes have been counted for such purpose. This is so full B. because: An extensive revelation of all the material facts was made to the board as well as to the shareholders The transaction was ratified by the majority of the board of directors and the shareholders The votes of the directors and shareholders were made in good faith However, although the material facts as to the relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors; it is seen that no affirmative votes could be established of a majority of the disinterested directors. The standard of review to be applied by the court owing to the fiduciary relationship between directors and the corporation imposes a fundamental limitation on the extent to which a director may benefit from dealings with the corporation he serves. The court will emphasize that the interested transactions should be subject to scrutiny. Now, due to the Ewing director’s fiduciary duty and control over Ewing Inc., its relationship with Ewing Inc. must meet the test of intrinsic fairness and interested director transactions would be deemed voidable only after examination of the fairness of a particular transaction vis-à-vis the non-participating shareholders. The intrinsic fairness test will furnish the substantive standard against which the evidential burden of the interested directors is applied. Since the Ewing directors were on both sides of the business deal. They have to display maximum good faith and the most meticulously intrinsic fairness of the deal. The necessity of fairness is unwavering in its demand that where Ewing directors are standing on both sides of the business deal, they have the burden of ascertaining its complete fairness, adequate to pass the test of vigilant scrutiny by the courts. even if the eventual burden of proof is on the majority shareholder to show by a prevalence of the substantiation that the transaction is fair, it is first the burden of the plaintiff (Barnes directors) attacking the loan transaction to display some base for summoning the fairness compulsion. In this case, it can be well established that in arranging for the loan, the interested directors were not depriving Ewing Inc. of a business opportunity but were instead providing a benefit for the corporation which was unavailable elsewhere. It is quite evident that the loans were made by the Ewing Inc. with the bona fide intention of assisting Ewing Inc.’s efforts to remain in business. Directors who advance funds to a corporation in such circumstances do not forfeit their claims as creditors merely because of relationship1. Also a full disclosure as made by the Ewing directors to the board of directors as well as the shareholders which constitute the corporate body is an absolute condition which has been met precedent to the validity of any forthcoming rejection as well as to the availability to the director of the defence of fairness2. Therefore, it is appropriate that Ewing directors entered into the transaction with Ewing Inc. because they had disclosed their interest in the transaction and had secured ratification by a majority of the shareholders. C. If the lender was not Ewing directors, but a relative of their’s (for example their mother, a direct case of the transaction between the director and the corporation, Ewing Oil would not have been effected. Also, the board of directors would not be divided into a class of interested and disinterested directors. However, since the Ewing directors would be indirectly related to the transaction, and the transaction can be contested to have been carried out at an arms length; a breach of fiduciary duties could still be claimed by the Barnes Family. In that case however, the context would be weak since there is no direct involvement of the board of directors. Also, the voting of the majority of the board as well as the shareholders, who would then hold the burden of proof of the intrinsic fairness of the ratification of the transaction to be carried out. Here the equitable considerations existing previous to, at the time of, and subsequent to the transaction would be scrutinised. Since, this transaction would not be a direct one, it cannot be contested that the corporate fiduciary served both the corporate and personal interests at the same time as it is required that their whole duty is owed to their corporation3. Question 2 Montgomery Enterprises Inc.(ME) is a close corporation substantially by the way of its features as a company with less number of shareholders (less than 30 shareholders), substantial majority stockholder participation (with the majority shareholder being the Chairman as well as CEO of ME) and that its shares are not available for the public market in general. 4 Also, it has a set of special governance rules. The controlling shareholder in this case is Mr. Montgomery and the concerned minority shareholder being Dharma. It is now to be analysed whether the termination of Dharma can be justified as being for a legitimate business reason and whether a claim of violation of fiduciary duty can be made by Dharma. First, it is to be contested whether the act of sudden termination of Dharma was oppressive. A number of courts have defined oppression in terms of the fairness of the action taken by the majority, using phrases such as “burdensome, harsh and wrongful conduct… ‘a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a corporation is entitled to rely’.” 5 A fiduciary duty does indeed exist between the majority and minority shareholders and a disappointment of the minority’s reasonable expectations is oppression. Donahue v. Rodd Electrotype Co. has laid down exceptional rules of fiduciary duty pertinent to close corporations like ME. As already established, that ME bears all the traditional characteristics of a close corporation, we place a fiduciary duty on controlling shareholders as applicable under these facts. The courts have equitable powers to fashion appropriate remedies where the majority shareholders have breached their fiduciary duty to the minority by engaging in oppressive conduct.6 We may now argue that the termination of Dharma amounted to a wrongful freeze out of her stock interest where the Delaware Supreme Court has yet to consider whether a controlling shareholder is liable for actions taken with the purpose and effect of freezing out another shareholder. Also, the Delaware Supreme Court has certified that the majority stockholders are not liable for violation of a fiduciary duty to an employee under contract for issues involving that employment. However, the case of Dharma is different because she is not only an employee but also a shareholder of ME. Second, convinced of the existence of fiduciary duty between shareholders in a close corporation, we turn to the scope of that duty and examine whether Mr. Montgomery breached his duty in the case at bar. The Massachusetts court reiterated that, under Donahue, shareholders in a close corporation owe each other a duty of utmost good faith and loyalty. However, if the majority shareholder acted pursuant to a legitimate business purpose, there is no breach of Donahue’s equal opportunity rule. Such a rule was necessary in order to avoid hampering management’s effectiveness in operating the corporation and in order to preserve management’s discretion in declaring dividends, negotiating mergers, establishing salaries of officers, dismissing directors, and hiring and firing of employees. Consequently, when a legitimate business purpose exists, the minority shareholder must be given an opportunity to demonstrate that the purpose could have been achieved through means less disruptive to its shareholder interests. Therefore it follows, that if Dharma can prove that her termination was not for a legitimate business reason, a claim on violation of fiduciary duty by the majority controller Mr. Montgomery can definitely be made. Otherwise also, in case the termination can be shown on legitimate business grounds, Dharma will get an opportunity to prove that the same could have been achieved through less disruptive means to her shareholder interests. Evidently, Mr. Montgomery (the controlling shareholder) cannot, consistent with his fiduciary duty, effectively deprive Dharma (a minority shareholder) of her interest as a shareholder by terminating latter’s employment or salary. Finally, the minority shareholder’s interest is not injured, however, if the corporation redeems at a fair price or a price determined by prior contract or the shareholder is otherwise able to obtain a fair price. Therefore, in lieu of the fiduciary duty in the close corporation (ME), the context of protection of the shareholder’s investment indicates that since Dharma has been offered a fair valuation for repurchase of her stocks by ME and also all her wages equitably settled, her minority shareholder interest is not injured to that extent. Question 3 A. In this case where Diane objects to the board’s approval of the merger between Cheers and Chez Cosmo, Inc. even in case of a properly notified and long drawn out protracted meeting, seems unjustified. However, another aspect to be considered is that only three out six shareholders were present at the meeting and that does not constitute the majority of the board when counted as quorum for voting, out of which also, one of the directors on board (Diane) had dissented. It is to be well noted that no electronic or physical communication of non-attendance of meeting and hence authorization to carry on with the meeting in their absence was made. Secondly, Diane would be entitled to an Appraisal by the court of Chancery of the fair value of Diane’s shares of stock under the circumstances that Diane has neither voted in favour of the merger / consolidation nor consented thereto in writing. These appraisal rights shall be available for the shares of any class or series of stock of the constituent corporation in this merger or consolidation. In this regard, she shall have to deliver to the corporation, before taking of the vote of shareholders on the merger, a written demand for appraisal of such stockholder’s shares in order to demand the appraisal of the stockholder’s shares. B. Here, the board decision of the directors Cheers in favour of the sale of its restaurant business has been brought under the purview of a derivative action for breach of fiduciary duty against the directors who voted in its favour and the liability of the directors thereon. Whether, the directors have failed to act in good faith and that they may have consciously disregarded their fiduciary duties has to be analysed. It has been held that the corporate directors owe to their stockholders a fiduciary duty to disclose all facts germane (important to consider selling or retention of stock). To the transaction at issue in an atmosphere of complete candour.7 Applying these standard, the terms which go against the approving vote of directors are: The speed with which the transaction was consummated (one sitting) No market appraisal or valuation of the restaurant business was done and neither did they seriously press Colcord for a better price. The directors made no apparent effort to arm themselves with specific knowledge about the present value of the company. Thus, the directors failed to obtain the best available price in selling the company and defaulted on its fiduciary duty in service of a specific objective to maximise the sale price of the enterprise. No assistance of financial or legal advisor Majority’s comedy of errors where the majority erroneously assessed the director’s knowledge of the affairs of the corporation and their combined ability to act in this situation under the protection of the business judgement rule Therefore, it can be established that the board failed to reach an informed business judgement in approving the sale and that the director’s failed to negotiate better terms and superior deals. The approving director’s evidently did not exercise due care and thus breached their fiduciary duties of care, loyalty and candour. In this case, the burden falls on defendants (approving board of directors) who claim ratification based on shareholder vote to establish that the shareholder approval resulted from a fully informed electorate. When the court examines good faith, three different categories of fiduciary behaviour may be analysed for bad faith pejorative label. Firstly no subjective bad faith can be established as there was no intent to harm. Secondly, fiduciary action can also not be taken on context of gross negligence. However, am existence of mere interest to speedily sell off an entity based on lack of interest of Sam in the restaurant business owed a fiduciary conduct in between the above two extreme categories. This however, cannot be conclusively proven that the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for duties. C. A claim that Cheers board members have a directorial liability in this case with regards to the alleged food poisoning due to which Cheer’s customers were falling ill is to be evaluated here. The directorial liability of Cheers’ board is predicted upon ignorance of liability creating activities within the corporation…only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists-will establish the lack of good faith which would necessarily bring upon them the condition to liability. It has been seen to a certain extent that the above can be authenticated by way of the facts that (a)When cheers considered franchising its restaurant operation, the recommendation of a consultant for internal controls was never addressed; (b) Cheers never established any monitor compliance with internal controls and procedures as done by others in the industry; (c) Two years ago, no action was taken on a consultant’s report outlining serious health risks resulting from lax procedures and he had recommended a comprehensive audit and review of food storage and preparation procedures; (d) A junior manager who reported a similar lack of internal controls was terminated. All these point out to a sustained and determined disregard for oversight and hence demands liability due to lack of bad faith. Here the directors have utterly failed to implement any sort of statutorily required monitoring, reporting or information controls that would have enabled them to learn of problems requiring their attention. The directors in this case should have known that violations of law were occurring. The standard for assessing a director’s potential liability is failing to act in good faith in discharging his or her responsibilities. The director’s potential personal liability including a monetary liability for breach of duty of care, but not for conduct however depends upon whether or not their conduct was in good faith or if there was a breach of loyalty. It is expected that the Cheers’ directors should have known of the illegal conduct by corporation’s employees as seen in the bribing case of its food operations senior manager. Although, in absent cause for suspicion, no duty is upon the directors to suspect that some wrongdoings exist. Also that non existing ground to construe deception, neither board members nor officers can be charged only because the honesty and integrity of dealings may be wrong. But, in case of Cheers’ it is evident that the board is lenient and negligent in their concern for taking precautions. Their “if it ain’t broke, let’s not fix it” attitude points the same exactly. Their emphasis in compliance to economic results and profit contributing aspects of business further validates this proposition. It follows thus that the directors have breached their fiduciary duty by letting the circumstances so develop that it exposed the corporation to vast legal obligations and thus violated a duty to be a committed supervisor of corporate performance. Since the board members of Cheers did not consider it important to out in place internal checks and controls, they did not satisfy their obligation to be reasonably informed as far as their corporation is concerned. Now, a failure to act in good faith will be more serious than a mere violation of fiduciary duty. It has been established that the Cheers’ board failed to exercise their oversight which draws heavily upon their failure to act in good faith. Question 4 A. The tender offer, while not an unknown device, is not used here including such methods as two-tier “front-end” loaded offers with their coercive effects. The stock acquisition followed by a proxy contest is a much favoured attack because it evolved as an alternative to other defensive tactics, which provided no benefit whatever to the raider. Thus, the use of corporate funds by management to counter a proxy battle was approved.9 Specifically because hostile tender bids tend to amount to coercive action on the part of shareholders, provide a ground to the board to insist that they acted under pressure. For that very reason, a tactical measure of issuing proxy or consent solicitation of a takeover proposal is a more diplomatic and legally hassle free mode of action. B. In this case, the claim of SMC on Paulaski and the incumbent board members of Amore Inc. of an intentional interference and impediment created in way of the efforts of shareholders to effectively exercise their voting rights in a contested election for directors is to be evaluated. The factual background of the case is that SMC had attempted, by way of a proxy solicitation and a takeover proposal including the expansion of the size of the board. SMC was thus exploring the feasibility of obtaining control of Amore, including instituting a takeover through proxy solicitation and hence seeking “appropriate” representation on the Amore board of directors. In this regard, Amore board had taken the following steps: Postponed annual meeting Amended bylaws to board size from five to seven and nominated two independent directors on board SMC here challenges the validity of Amore board’s action to add two new member’s to Amore board of directors. In a concern for corporate democracy, the following issues can be identified in the context of this case: Whether Amore board acts consistently with its fiduciary duty when it acts in good faith and with appropriate care, for primary purpose of preventing or impeding an unaffiliated majority of shareholders (in case SMC got to elect its two nominees on board) from expanding the board and electing a new majority. Also, Amore board has set or moved the annual meeting date upon a finding that such action was intended to thwart the shareholder group of SMC from effectively mounting an election campaign. Now, Delaware courts have long exercised a most sensitive and protective regard for the free and effective exercise of voting rights. 8 Amore board has viewed the proxy solicitation as an attempt by SMC to take control of the company. The point of the emergency meeting of Amore board was to act on their conclusion or to seek to have the board act on their conclusion that they should add two directors on the board. The Amore board may have acted on their view of the corporation’s interest and not selfishly, but the action constituted an offence to the relationship between corporate directors and shareholders that has traditionally been protected in courts of equity. The principal motivation behind increasing the size of Amore board by two and filling new created positions, the members of Amore board realised that they were thereby precluding the holders of a majority of the Company’s shares from placing a majority of new directors on the board through SMC’s proxy solicitation, should they want to do so. To prevent or delay the shareholders from possibly placing a majority of new members on the board, the board was thus motivated in this direction. As a consequence, the action taken by board may be invalid. If the board was in fact not so motivated, but rather had taken action completely independently of the proxy solicitation, which merely had an incidental impact upon the possible step Effectuation of any action authorised by the shareholders, it is very unlikely that such action would be subject to judicial nullification. Clearly, the induction of these experienced men (independent directors) would, under other situations, be undoubtedly appropriate as an independent move, such a move in fact taken in order to obstruct or prohibit a majority of the shareholders from efficiently assuming the course recommended by SMC makes it questionable. Since the board was improperly motivated by selfish concern to maintain collective control over the company, there were no strategy differences or issues that in actuality motivated this action, but that affirmed policy disputes were excuses for embedding of selfish reasons would tantamount the action taken by the board as a beach of duty. 10 Here, it needs to be evaluated carefully whether the motivation behind Amore board’s action was a result of good faith belief that the shareholder action would be self damaging and that the shareholders need to be guarded from their own judgement. Amore board’s action was indeed in a good faith effort to guard its incumbency, not self-interestedly, but in order to impede implementation of recapitalisation that it was anxious about, reasonably, would cause great injury to the Company as also pointed out by Mr. Paulaski in an interview about the fear of SMC spoiling Amore’s brand image. It is seen that an action attempting to interfere with the smooth carryout of a vote inevitably brings in a conflict between the board and a shareholder majority. 11 Amore board members can effectively argue that the restructuring proposal by Amore is very unrealistic and would lead to injury to the corporation and its shareholders if pursued. It thus deemed fit to take certain steps, held in good faith, to escape the potential risks it perceived. However, even if finding that the action taken was in good faith, it constituted an unintentional violation of duty of loyalty that board owed to shareholders. Moreover, in case of Amore, it can be well maintained that power was exercised by its board for the primary purpose of foreclosing an effectual shareholder action. A majority of shareholders could have viewed the matter in a very different manner than did the Amore’s board. The context majorly changed when the SMC proposal contained a indication towards poor incumbent board at Amore and might have created the platform for the rejection of the initial offer for merger between Amore and SMC. However, it has also been seen that the consultation of an investment banker was indeed sought while deciding the fate of the offer and therefore, the decision may not be biased in its entirety. 1 New York Stock Exchange v. Pickard & Co., Inc., Del. Ch., 296 A. 2d 143, 149 (1972) 2 Klinicki v. Lundgren, 298 Or. 662, 695 P.2d 906 (1985) 3 Camden Land Co .v .Lewis, 10 1Me. 78, 97, 63 A. 523, 531 (1905) 4 Donahue v.Rodd Electrotype Co., 367 Mass. 578, 328 N. E. 2d 505 (1975) 5. Skierka v. Skierka Bros., Inc., 192 Mont. 505, 629 P. 2d 214, 221 (1981) 6 Masinter v. WEBCO. 164 W. Va. 241, 262 S. E. 2d 433 (1980); Alska Plastics, Inc. v. Coppock, 621 P. 2d 270 (Alska 1980) 7 Schreiber v. Pennzoil Corp., del. Ch., 419 A. 2d 952 (1980) 8 In re Anderson Clayton Shareholders’ Litigation, Del. Ch., 519 A. 2d 858 (1985) 9 Hall v. Trans-Lux Daylight Picture Screen Corp., Del. Supr., 171 A. 226 (1934) 10 Schnell v. Chris Craft Industries, Del Supr., 285 A. 2d 437 (1971) 11 Canada Southern Oils, Ltd. V. Manabi Exploration Co., Del. Ch., 96 A. 2d 810 (1953) Read More