Gaillard v. Natomas Co.

• Decision Date: 23 March 1989
• Docket Number: No. A040647,A040647
• Citation: 256 Cal.Rptr. 702,208 Cal.App.3d 1250
• Court: California Court of Appeals Court of Appeals
• Parties: , 57 USLW 2610, Fed. Sec. L. Rep. P 94,369 Tilly GAILLARD, Plaintiff and Appellant, v. NATOMAS COMPANY et al., Defendants and Respondents. Vincent J. ASHTON, Plaintiff and Appellant, v. Dorman L. COMMONS et al., Defendants and Respondents.

Page 702

256 Cal.Rptr. 702

208 Cal.App.3d 1250, 57 USLW 2610, Fed. Sec. L. Rep. P 94,369

Tilly GAILLARD, Plaintiff and Appellant, v. NATOMAS COMPANY et al., Defendants and Respondents.

Vincent J. ASHTON, Plaintiff and Appellant, v. Dorman L. COMMONS et al., Defendants and Respondents.

No. A040647.

Court of Appeal, First District, Division 3, California.

March 23, 1989.

Review Denied June 1, 1989.

David B. Gold, Paul F. Bennett, Solomon B. Cera, San Francisco, Lowey, Dannenberg & Knapp, Stephen Lowey, Henry A. Brachtl, New York City, for plaintiff and appellant.

David G. Robertson, Paul Flum, Neal S. Berinhout, Morrison & Foerster, Pillsbury, Madison & Sutro, William I. Edlund, John F. McLean, Kevin M. Fong, San Francisco, Skadden, Arps, Slate, Meagher & Flom, James E. Lyons, Harriet S. Posner, Jeffrey T. Makoff, Los Angeles, for defendants and respondents.

STRANKMAN, Associate Justice.

I Statement of the Case

These shareholder derivative actions ¹ arise from the merger of Natomas Company (Natomas) into Diamond Shamrock Corporation (Diamond), effective August 31, 1983. By their complaints, appellant Tilly Gaillard, a common stockholder of Natomas, and appellant Vincent J. Ashton, a common stockholder of Diamond, challenge the purported "golden parachute" agreements ² and other benefits provided for five inside directors of Natomas as part of the merger. ³

Golden parachutes are special termination agreements that shelter executives from the effects of a corporate takeover. Their emergence has been attributed to the dramatic increase in the size of corporate takeovers and the volume of hostile takeovers. (See Note, Golden Parachutes: Untangling the Ripcords (1987) 39 Stan.L.Rev. 955, 957-958, fn. 14 (hereafter Ripcords ); Note, Golden Parachutes: Executive Employment Contracts (1983) 40 Wash. & Lee L.Rev. 1117, fn. 1.) Typically, golden parachutes provide senior executives who are dismissed or who, under certain circumstances, resign as a result of a takeover with either continued compensation for a specified period following the executives' departure or with a lump-sum payment. The legality and desirability of this form of executive compensation, which some view as a form of corporate looting, have been the subject of increasing controversy faced by courts and addressed by legal commentators. (Note, Ripcords, op. cit. supra, 39 Stan.L.Rev. 955; Note, Golden Parachutes and the Business Judgment Rule: Toward a Proper Standard of Review (1985) 94 Yale L.J. 909 (hereafter Golden Parachutes ); Note, Golden Parachutes--Executive Compensation or Executive Overreaching? (1984) 9 J.Corp.L. 346; Comment, Golden Parachutes: A Perk That Boards Should Scrutinize Carefully (1984) 67 Marq.L.Rev. 293.)

Defendants and respondents, who consist of the five inside directors and the twelve outside directors of Natomas at the time of the merger, ⁴ contend that the golden parachute agreements and other benefits here are protected by California's "business judgment rule," codified in Corporations Code section 309. ⁵ The trial court agreed with respondents, granted summary judgment in their favor (Code Civ.Proc., § 437c), and dismissed the actions.

We conclude that the business judgment rule does not apply to a judicial review of the conduct of the inside directors, and reverse as to these respondents. We further conclude that, while the business judgment rule applies to the outside directors, there are triable issues of fact as to whether the adoption of the golden parachute agreements constituted a proper exercise of these respondents' "business judgment," and reverse.

II Facts

The following facts are derived from the extensive record on appeal, including the copies of transcripts of deposition testimony, deposition exhibits, and corporate minutes of directors' meetings. We consider not only this evidence but also all inferences reasonably deducible from such evidence. (Code Civ.Proc., § 437c, subd. (c).)

A. Tender offer and merger negotiations. In 1983, Natomas was a publicly held California corporation engaged in petroleum and geothermal exploration and production, domestic coal mining, shipping, and real estate. The bulk of its 1982 operating income derived from its Indonesia operations. Natomas's total gross revenues in 1982 were approximately $1.7 billion with assets valued at approximately $2.8 billion. Net income in 1982 was approximately $44 million.

At that time, the Natomas board of directors consisted of the twelve outside directors and Natomas's five principal officers (see fn. 4, ante.) The five officers were respondent Commons, the chairman of the board and chief executive officer; respondent Lee, a vice-president; respondent Reed, the vice-chairman; respondent Seidl, a vice-president and president of Natomas's domestic oil production subsidiary; and respondent Seaton, president and chief operating officer.

Each of the 12 outside directors had a business career independent of Natomas. Most of them had served as a president, vice-president, director, or some similar position for corporate and banking institutions in the past, and many continued to hold such positions. ⁶ In total, they owned or held an interest in approximately 15 percent of the Natomas common stock.

In May 1983, Diamond initiated a hostile tender offer to acquire 51 percent of Natomas's common stock at $23 per share. Diamond stated in the tender offer that it intended to acquire the remaining shares of Natomas common stock in a later merger in which Natomas stock would be converted into the stock of New Diamond Corporation (the holding company formed for the purpose of merger). After considering various alternative responses to the tender offer, Natomas representatives agreed to meet with Diamond representatives on May 29, 1983.

Prior to the meeting, Commons directed the Natomas compensation committee to meet on May 30 to review proposed amendments to executive employment agreements for key executives. At this time, Commons and Reed already were entitled to golden parachute benefits in the event of a takeover. For example, Commons's employment agreement provided that in the event of his termination by Natomas for any reason other than cause, he was entitled to payment of his annual salary of $450,000 for a three-year period. Reed's employment agreement provided that in the event of merger or takeover, he was entitled to payment of his base annual salary for the remainder of the three-year term of the agreement through December 31, 1985. ⁷ As discussed infra, that these officers already were protected by golden parachutes in the event of a takeover is significant in relation to respondents' contention that the golden parachute agreements under attack here were necessary to facilitate the merger.

At the group meeting on May 29, Commons, on behalf of Natomas, led a team that included Natomas's outside counsel, Joseph H. Flom, who specialized in corporate takeovers and mergers, and Natomas's investment bankers. The Diamond team was led by William H. Bricker, its chairman and chief executive officer. Following the group meeting, Commons and Bricker met alone for further negotiations and reached agreement on the terms of a friendly merger which would result in the withdrawal of the tender offer and the execution of a plan of reorganization. The agreement included certain significant changes from the terms of the original tender offer: (1) the transaction would be changed from part cash to all stock; (2) Natomas's real estate and shipping subsidiaries, including American President Lines (APL), would be spun off as a separate public company, American President Companies (APC); (3) Natomas's shareholders would receive 1.05 New Diamond Corporation shares for each Natomas share instead of the previously offered .92.

Following this meeting between Bricker and Commons, Commons met with the Natomas group, including Flom, to discuss executive employment agreements. Commons suggested that he propose to Bricker severance arrangements for all employees, and the amendment of employment agreements for 17 key executives to include golden parachute provisions comparable to those provided to Diamond executives. Commons testified that he thereafter met with Bricker and discussed severance payments and the amendment of employment agreements. The minutes of a subsequent board of directors meeting state that "Natomas' management was extremely careful not to discuss any of these arrangements until the terms of the merger were developed and the consideration to be exchanged was fixed." Commons testified that Bricker consented to the proposed agreements on May 29.

In deposition, Bricker testified that he did not recall discussing employment agreements for Natomas senior management on May 29. He recalled Commons advised him on May 30 that the compensation committee was reviewing amended employment agreements for key executives, and Bricker stated he would be amenable to them, recognizing "the need for everyone to be enthusiastic and highly supportive of the deal."

Commons then returned to the Natomas group and instructed Flom to draft agreements with new golden parachute provisions for his review prior to the meeting of the compensation committee the following morning.

B. Golden parachutes. The following morning, Flom reviewed with Commons drafts of the employment agreements he had prepared. As to golden parachutes, the amended agreements ultimately provided that Commons and Reed could terminate their employment within six months following the merger "for Good Reason," or for any reason following the six-month period, and thereupon receive a lump-sum payment equal to five times their total annual compensation. The lump-sum payment would be reduced proportionate to the length of time they remained employees of Natomas following the six-month period.

Lee's agreement was similar to those of Commons and Reed, except that he was entitled to a lump-sum...