Sutherland v. Sutherland, C.A. No. 2399-VCN (Del. Ch. May 3, 2010), read opinion here.
This is the latest installment in a long-running internecine battle among siblings in a large, closely-held business based in the Pacific Northwest. The eight (8) prior decisions of the Delaware Court of Chancery in this matter have been highlighted on this blog and are available here.
The latest iteration of this family feud involves a motion for partial summary judgment which was granted in part and denied in part. There are many examples in Delaware opinions of lengthy battles among shareholders in large closely-held, family-owned companies that over the span of many years resulted in multiple decisions from the Court of Chancery in the same case. This case deserves a place "on the podium as one of the top three finalists" among such hotly contested disputes.
The first complaint that was filed in this matter was a Section 220 claim filed in 2004. The decision in that case is captioned Sutherland v. Dardanelle Timber Co., 2006 WL 1451531 (Del. Ch. May 16, 2006). The Court allowed documents to be inspected based on credible evidence of possible management entrenchment, as well as possible waste and other breaches of fiduciary duty.
In 2006, the same plaintiff filed a complaint against the same company (and its directors) based on breach of fiduciary duty claims. The company appointed a special litigation committee (“SLC”) which recommended that the company not pursue the derivative claims. However, the Court denied the motion to dismiss based on that SLC report, finding that the investigation by the SLC was lacking in good faith and reasonableness, and that the SLC failed to investigate adequately all of the claims. See Sutherland v. Sutherland, 958 A.2d 235, 242-45 (Del. Ch. 2008).
The primary claims addressed in the instant motion for summary judgment include the following: (1) The defendant directors breached their fiduciary duty of loyalty by allowing the company to pay for certain accounting expenses incurred for the benefit of one or more of the directors personally; (2) The purchase and continued use of a company jet was challenged based on the argument that the personal use was a breach of the duty of loyalty, and the decision regarding the jet was allegedly made on an uninformed basis such that it was a breach of the duty of care, and that the purchase and continuing ownership of the jet was not for a rational business purpose; (3) The third claim was based on the argument that the expenditure by the company of $750,000 in legal fees merely to defend the Section 220 action unsuccessfully, was a waste of corporate assets and was the result of self-dealing and bad faith; (4) The fourth argument was that an amendment to the charter after the litigation commenced to include a Section 102(b)(7) provision to protect the directors with self-dealing; (5) The last primary argument was that an accounting should be provided to establish that the company did not pay for personal expenses of the individual directors.
The first claim addressed by the Court is based on the premise that a director may be held liable for receiving some personal benefit that is not shared by other shareholders generally and that was the result of the director’s actions. See footnote 20. However, the Court rejected the argument that simply by appointing the Special Litigation Committee the directors conceded self-dealing. The appointment of an SLC pursuant to Zapata Corp. v. Maldonado, 430 A.2d 779, 786 (Del.1981), may allow for the inference at the initial pleadings stage that a claim for self-dealing was alleged, but it does not concede self-dealing as a substantive matter for purposes of trial or other merits-based decisions by the Court. See footnotes 21 to 26.
In sum, the Court concluded on this particular point that it was a factual issue for purposes of summary judgment, and that the Court could not conclude on the present record that the directors received no material benefit from tax and accounting services that they received personally. Moreover, the Court found that the absence of documentation to support the inference that at least one director received a disproportionate benefit for personal expenses that were paid for him is a problem for the defendants who could not account for the funds paid at this stage of the proceedings.
The second claim concerning the argument that a private jet was not necessary to purchase or to continue to own, was rejected for several reasons. First, it was barred by the statute of limitations, but more importantly, the claims failed to rebut the presumptions of the business judgment rule. The familiar formulation of the business judgment rule was reiterated by the Court. See footnote 71. Moreover, the Court observed that conduct may rebut the presumption upon the showing that the board breached either its fiduciary duty of care, or fiduciary duty of loyalty, but that the decision of the board will be upheld unless it cannot be attributed to any rational business purpose. See footnote 72 and 73.
The duty of due care of directors includes the need to act on an informed basis, although in order to be adequately informed “the board need not know every fact, but is instead responsible only for considering material facts that are reasonably available.” See footnote 76. Moreover, the standard for determining whether the decision of the board was informed is one of gross negligence which is conduct that “constitutes reckless indifference or actions that are without the bounds of reason.” See footnotes 78 and 79. Importantly, the Court emphasized that in connection with analyzing this duty, there is “no prescribed procedure, or a special method that must be followed to satisfy the duty of due care.” See footnotes 80 and 81. See generally DGCL Section 102(b)(7).
The Court also reasoned that the purchase of the aircraft and continued ownership of it clearly had a rational business purpose and was protected by the business judgment rule since it was not otherwise the product of self-dealing.
The argument was also made that because the company incurred approximately $750,000 in legal fees merely to defend the Section 220 action (unsuccessfully), that expense was allegedly an example of the breach of the duty of loyalty because it was merely for self interest that the Section 220 litigation was defended.
The Court observed that it is customary, especially in a closely-held corporation, for the corporation to pay the legal costs to oppose a Section 220 or a Section 225 claim even though there may be some personal benefit to incumbent management by doing so. See footnotes 103. The controlling question, rather, is whether the defendants acted in bad faith by refusing the request for books and records and by contesting the Section 220 action. The Court distinguished the Technicorp and Carlson cases in which the Court had found that there was a bad faith opposition of Section 220 actions that resulted in fee shifting, but those cases were distinguishable from the facts of the instant matter. See footnotes 103 through 106.
The Court also cited to prior Delaware decisions to reject the argument that adopting a Section 102(b)(7) provision (during the litigation) to protect the directors from personal liability was self-dealing. Those arguments had been rejected in prior decisions by the Court of Chancery.
The Court also discussed the Technicorp and Carlson cases in connection with the truism that fiduciaries have a burden to maintain and produce records to explain expenses paid for by the company, but an accounting is only required where improper expenses, or expenses that are unaccounted for, would warrant the Court to require an accounting.
Lastly, the Court acknowledged that because some of the more excessive provisions of the compensation package in the employment agreements of the top executives of the company were changed and made “less generous” as a result of the lawsuit, the Court ruled that some fee shifting would be allowed but that those details would be addressed in a separate proceeding.