Pogostin v. Rice
| Decision Date | 09 January 1984 |
| Citation | 480 A.2d 619 |
| Parties | Bernard POGOSTIN, Ann Brown and Irwin J. Newman, Plaintiffs Below, Appellants, v. W. Thomas RICE, Eliot H. Stein, Fred Sullivan, A. Lightfoot Walker, Arthur C. Babson, Francis L. Cappaert, Edwin I. Hatch, Peter C. Huang, George T. Scharfenberger, Joe E. Lonning, Daniel E. Lyons, Stephen E. O'Neil, Eben W. Pyne, John H. Washburn and City Investing Company, Defendants Below, Appellees. . Submitted: |
| Court | Supreme Court of Delaware |
Upon appeal from the Court of Chancery. Affirmed.
Victor F. Battaglia, Samuel R. Russell, Biggs & Battaglia, Wilmington; Mordecai Rosenfeld (argued) Mordecai Rosenfeld, P.C., New York City, for appellants.
R. Franklin Balotti, Richards, Layton & Finger, Wilmington; Max S. Schulman, (argued) Cravath, Swaine & Moore, New York City, for individual appellees.
H. Murray Sawyer, Jr., H. Murray Sawyer, Jr., P.A., Wilmington, for appellee City Investing Company.
Before McNEILLY, MOORE and CHRISTIE, JJ.
This stockholder derivative suit, brought on behalf of City Investing Company ("City"), was dismissed by the Court of Chancery for plaintiffs' failure either to make a demand upon City's board of directors for appropriate corrective action, or to allege with particularity that demand was futile, pursuant to Del.Ch.Ct.R. 23.1. 1 The defendants are City and its board of directors, consisting of four company officers and ten outsiders. Plaintiffs charge that City's board wrongfully rejected a tender offer for its shares, resulting in the alleged loss by its stockholders of a substantial premium over market. It also is contended that the increase in the market price for City's shares, created by the tender offer, resulted in excessive payments to the four officer-directors under a pre-existing compensation plan keyed to the market price.
Upon the defendants' motion to dismiss, the Vice Chancellor found plaintiffs' allegations to be conclusory and lacking the particularity mandated by Chancery Rule 23.1. We agree with that result based on the principles stated by us in Aronson v. Lewis, Del.Supr., 473 A.2d 805 (1984). Under the Aronson test we are satisfied that the allegations in the complaint fail to create a reasonable doubt that the outside directors of City were entitled to the protections of the business judgment rule. We therefore affirm.
Our analysis begins with the allegations of the complaint, taking all well pleaded averments as true. Aronson v. Lewis, 473 A.2d at 815.
The issues evolve from a tender offer, totaling $1.1 billion, made for City's stock in June 1980 by Tamco Enterprises, Inc. (Tamco) at $32.50 per share. Just before Tamco's offer City's stock traded at $20 on the New York Stock Exchange. The company has approximately 40,900 shareholders.
The Tamco tender offer was rejected by City's board on July 23, 1980. Immediately thereafter the price of City's stock, which had been selling in the high 20's, declined. It is alleged that the board acted imprudently and improperly in rejecting the offer without any proper business purpose, thereby breaching the fiduciary duty owed the stockholders and denying them the substantial premium offered. More specifically, it is claimed that the defendants wrongfully refused to negotiate with Tamco for the improper reason that the four inside directors wanted to "retain control of the company, and continue to receive their substantial benefits." However, plaintiffs advise us that this claim is of secondary import to their other cause of action relating directly to the payment of executive bonuses.
As to the latter, it is alleged that in 1971, nine years prior to the tender offer, City, with stockholder approval, had adopted an arrangement for executive compensation, called the Share Unit Plan (the Plan), under which bonuses were awarded in cash, stock, or a combination thereof, to designated employees. The sum ultimately to be paid is based on a pre-existing timetable relative to the market price of City stock. The theory of the plan is that the stock market will reflect successful managerial performance. Thus, when share units are awarded, their value, and the amount ultimately to be paid, are keyed to the price of City's stock as of a later time. Each unit is equivalent to one share of common stock. One-fifth of the units vest in each of the five years after the grant date, and on the fifth anniversary of the grant date, when all units vest, the grantee has the right to receive a cash payment equalling the increase in the market value of the stock from the grant date, plus the assumed reinvestment of non-common stock dividends declared during that five-year period. This reinvestment figure is the market value of the number of common shares represented by the value of the dividends paid over the market value of a share of common stock.
Plaintiffs contend that after the Tamco offer was received and rejected, bonuses were calculated under the Plan at $26 per share, the average market price from June to September 1980. This resulted in abnormally large payments to the four inside directors, based on artificially inflated stock prices caused by heavy trading during the tender offer.
It is claimed that the large payments made to the four officer-directors were not a reward for successful managerial performance, but solely the result of market fluctuations unrelated to the Plan's purpose. The relief sought includes assessment of damages against all directors. The complaint states that demand on the City board was excused as futile because "[e]ach of the directors participated in the wrongs alleged, and each is liable therefor" and "[t]he directors could not and would not sue themselves."
To the claim that the defendants wrongfully rejected the Tamco offer, the defendants reply that the City board appointed a special committee of outside directors to consider the tender offer. None of these outside directors were eligible to participate in the Plan, and there are no allegations that they had a financial stake in opposing the tender offer. The committee, in turn, hired two investment banking firms, Blyth, Eastman, Paine, Webber, Inc. and the First Boston Corporation, to prepare valuation studies of City. These firms spent nearly one month analyzing City and the offer. City's officer-directors were not on the special committee, and they did not participate in the valuation decisions of the investment bankers.
At a board meeting held on July 23, 1980, the special committee reported its conclusions that the Tamco price was too low, that the market had undervalued City's assets, and that City stock was actually worth approximately $48 per share. Committee members and other directors not on the committee then discussed the tender offer. It appears that the majority of the board had no personal financial interest under the Plan and plaintiffs do not question the independence of these directors. Ultimately, the board voted unanimously to reject the Tamco offer as not in the best interests of City and its shareholders.
As to the Plan, defendants argue that such compensation arrangements are matters of business judgment. They also note that the Plan was approved by City shareholders in 1971, nine years before the Tamco tender offer.
Defendants contend that demand was not excused, because the plaintiffs' claims of futility are facially insufficient. The defendants argue that bare allegations of director participation in the wrongdoing do not meet the particularity requirement of Rule 23.1, as no facts are alleged indicating bias, self-interest, or other impropriety by City's board. According to defendants, an allegation of futility, based on a claim of director reluctance to bring suit against themselves, has no merit because it would entirely circumvent the demand requirement of Rule 23.1. Finally, the defendants argue that the naked allegation of board liability for rejecting the tender offer does not excuse demand, because no particularized facts are alleged which suggest any reasonable basis upon which City's board might be subject to personal liability.
The bedrock of the General Corporation Law of the State of Delaware is the rule that the business and affairs of a corporation are managed by and under the direction of its board. See 8 Del.C. § 141(a). It follows that the existence and exercise of this power carries with it certain fundamental fiduciary obligations to the corporation and its shareholders. Aronson v. Lewis, 473 A.2d at 811 [citing Loft, Inc. v. Guth, Del.Ch., 2 A.2d 225 (1938), aff'd, Del.Supr., 5 A.2d 503 (1939) ]. Balanced against the managerial power of directors is the derivative action enabling shareholders to sue on behalf of the corporation where those in control of the enterprise refuse to assert a claim belonging to it. The derivative action is one method by which shareholders may obtain redress for the misuse of managerial power.
However, because the derivative action impinges on the managerial freedom of directors, the law imposes certain prerequisites to the exercise of this remedy. Thus, the requirement of Chancery Court Rule 23.1 exists at the threshold to prevent abuse and to promote intracorporate dispute resolution. Inextricably bound to threshold questions of demand futility are issues of business judgment, and the standards by which director action is measured. Aronson, 473 A.2d at 812-816.
The test for determining demand futility reflects the interrelationship of business judgment, director independence and interest. It requires a bifurcated factual analysis based upon a reasonable doubt standard. Under the demand futility test, the facts alleged in the complaint are examined to determine whether they create a reasonable doubt that: (1) the directors are disinterested and independent and (2) the challenged transaction otherwise was the product of a valid exercise of business judgment. Id. at 814. As to the first Aronson...
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