Gries Sports Enterprises, Inc. v. Cleveland Browns Football Co., Inc.

Citation26 OBR 12,26 Ohio St.3d 15,496 N.E.2d 959
Decision Date20 August 1986
Docket NumberNo. 85-704,85-704
Parties, 55 USLW 2235, 26 O.B.R. 12 GRIES SPORTS ENTERPRISES, INC. et al., Appellants, v. CLEVELAND BROWNS FOOTBALL CO., INC. et al., Appellees.
CourtUnited States State Supreme Court of Ohio

Syllabus by the Court

1. Under Delaware law, the business judgment rule is a presumption that the directors of a corporation, in keeping with their fiduciary obligation to the corporation and its shareholders, acted on an informed basis, in good faith and with the honest belief that the action taken was in the best interests of the company.

2. In a stockholders' derivative action challenging the fairness of a transaction approved by a majority of directors of a corporation, a director must be (1) disinterested, (2) independent and (3) informed in order to claim the benefit of the business judgment rule. (Delaware law applied.)

3. Where the evidence supports the conclusion that the challenged transaction was not approved by a majority of disinterested and independent directors, the transaction is not protected by the business judgment rule, and under Delaware law the directors have the burden of showing that the transaction was intrinsically fair to the minority shareholders.

This shareholders' derivative action was brought by Robert Gries ("Gries") and Gries Sports Enterprises, Inc. ("GSE"), plaintiffs-appellants herein, against the Cleveland Browns Football Company, Inc. ("Browns"), Arthur B. Modell ("Modell"), Patricia B. Modell, James N. Bailey ("Bailey"), James H. Berick ("Berick"), Richard S. Cole ("Cole") and Nate Wallack ("Wallack"), defendants-appellees herein, challenging the fairness of a transaction wherein the board of directors of the Browns on March 16, 1982, purchased all of the stock of Cleveland Stadium Corporation ("CSC") for $6,000,000.

GSE and Gries own forty-three percent of the outstanding stock of the Browns, a Delaware corporation which has its principal place of business in Cleveland, Ohio. Gries is also a director and officer of the Browns. Modell owns fifty-three percent of the stock of the Browns and is president, chief executive officer and director of the Browns. In addition to Modell and Gries, on March 16, 1982, the board of directors of the Browns was comprised of Modell's wife, Patricia Modell; Bailey, who was general counsel for and a full-time employee of the Browns; Berick, outside legal counsel for the Browns; Cole; and Wallack, another full-time employee of the Browns who died in January 1984.

Other than Modell and Gries, the only director who then owned any shares in the Browns was Berick, whose stock represented only about one percent of the total outstanding shares.

In 1973, Modell, along with others not involved in this action, formed Cleveland Stadium Corporation. CSC leased the Cleveland Municipal Stadium from the city of Cleveland for a period of twenty-five years and entered into sublease agreements with the Browns and with the Cleveland Indians baseball team. As of 1981, Modell owned eighty percent of the stock of CSC, with the remaining twenty percent owned by various individuals including Berick, Bailey, Cole, Wallack and Gries (and GSE). Modell was president of CSC, and Bailey was secretary and general counsel for CSC.

In December 1975, Modell sold to CSC approximately one hundred ninety acres of vacant land located in Strongsville, Ohio ("the Strongsville land") for $4,000,000. The Strongsville land had originally been acquired in parcels by Modell in 1972 and 1973 for approximately $800,000. Of the $4,000,000 purchase price, $3,000,000 was paid to Modell in cash in late 1975 and 1976. Modell was given a promissory note for the remaining $1,000,000 which note was to be payable out of the net cash flow derived from any development and subsequent sale of the Strongsville land by CSC. 1

In order to make the $3,000,000 cash payment to Modell, CSC borrowed that sum from Central National Bank and, as part of the security for that borrowing, gave Central National Bank a mortgage on the Strongsville land. By March 1982, the principal amount owed by CSC with respect to that land indebtedness was approximately $2,600,000.

In March 1982, CSC owned a two-sevenths interest in a certain promissory note that had been given to Public Square Hotel Co., LTD. As a result of that interest, CSC, as of March 1982, had an additional outstanding loan indebtedness in excess of $1,400,000.

On or about May 1, 1981, Modell asked McDonald & Company, a brokerage and investment banking firm located in Cleveland, Ohio, to make a valuation of CSC. On August 12, 1981, McDonald & Company reported to Modell that CSC had a net value of between $5,200,000 and $5,900,000. Modell and Bailey then asked McDonald & Company to determine if CSC might have additional value if it were acquired by the Browns. On October 8, 1981, McDonald & Company informed Modell and Bailey that CSC's acquisition by the Browns would increase its value by $1,000,000.

On October 13, 1981, Modell and Bailey informed Union Commerce Bank (with whom Modell had outstanding personal loans totalling, at that time, $4,000,000) that they contemplated the Browns would acquire CSC in the first quarter of 1982, and as a result of this acquisition, Modell would net approximately $5,000,000 which would enable him to extinguish his loan indebtedness with that bank.

On November 24, 1981, Modell, Bailey, Berick and Michael Poplar, chief financial officer of CSC, met with Gries and his then brother-in-law, Cole, at which time Modell informed Gries and Cole for the first time that "[w]e have decided that [the] Browns would be a logical buyer for the Stadium Corporation" and that the price would be $6,000,000, which sum would be borrowed from local banks. Modell gave Gries copies of the August 12, 1981 McDonald & Company report and the October 8, 1981 McDonald & Company letter. Gries responded that he would "get back" to Modell after he had had an opportunity to study the McDonald & Company report and evaluate the proposed acquisition.

The $6,000,000 price had been determined by Bailey, an officer of and general counsel for both CSC and the Browns, Poplar, and Modell, the principal shareholder and president of both companies. No arm's-length negotiation as to price, terms, the elements to be included (or not to be included), or any other aspect of the proposed acquisition ever took place between the Browns and CSC.

The initial plan was for the Browns to directly purchase from CSC shareholders all of that corporation's 50,000 outstanding shares for $6,000,000, i.e., $120 a share. When it was learned that such a procedure might prevent the minority stockholders of CSC from treating the proceeds as a capital gain, Berick and Bailey devised a new plan whereby CSC, on March 2, 1982, redeemed for $120 a share the twenty percent of its outstanding stock that was owned by persons or entities other than Modell. Each of the minority shareholders had held an option to sell his shares back to the corporation for the sum of $32 a share. Among the minority shareholders who received the increased $120 a share were Berick, Bailey, Wallack, Cole and Gries (and GSE), all of whom were directors of the Browns at the time of the acquisition of CSC. In order to accomplish the March 2 redemption, CSC paid a total of $1,200,000 which was borrowed from Central National Bank and guaranteed by the Browns. The next step of the two-step procedure that had been devised by Bailey and Berick provided that the Browns would borrow $6,000,000 from the Central National Bank, pay $4,800,000 to Modell for his 40,000 shares of stock in CSC, and distribute $1,200,000 to CSC, so that CSC could repay the $1,200,000 that it had borrowed from Central National in order to fund the redemption of the 10,000 shares owned by the minority shareholders.

At the meeting of the board of directors on March 16, 1982, Gries voiced his objection to the proposed acquisition and discussed the reports he had obtained from various persons showing major differences in valuation from those contained in the McDonald & Company report. Modell then made a presentation as to why the board should approve the transaction. By a vote of four to one--Gries casting the sole no vote; Bailey, Berick, Cole and Wallack voting yes; the Modells abstaining--the board adopted (a) a resolution approving the purchase by the Browns from Modell of all of the outstanding stock of CSC for the sum of $4,800,000; (b) a resolution authorizing the payment of $1,200,000 to CSC as a contribution to capital, to be used to repay the $1,200,000 that CSC borrowed in order to redeem the shares of CSC's minority shareholders; (c) a resolution authorizing the borrowing by the Browns of $6,000,000 from Central National Bank in order to finance the acquisition; and (d) various other resolutions further implementing the transaction.

On March 17, 1982, as threatened, GSE and Gries filed this shareholders' derivative action, seeking the rescission of the CSC acquisition. Plaintiffs contended that the purchase of CSC by the Browns was not "intrinsically fair"--that (1) when the Browns paid $6,000,000 for CSC, they overvalued the price by $4,000,000; (2) the price paid for CSC was overvalued so that the Browns' majority owner, Modell, would make a profit that was large enough to retire outstanding debts that he owed to several banks; and (3) the Browns' directors who approved the sale either had been shareholders of both CSC and the Browns and had received a benefit on the sale of their CSC stock or they were "dominated" by Modell.

The Browns contended that the board's decision was protected by the "business judgment rule" as propounded by the Delaware courts and, as a result, the board's judgment could not be inquired into as to its fairness by the trial court.

After a four-week trial in 1984, the Court of Common Pleas of Cuyahoga County determined that the Browns' directors were not entitled to...

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