Management Chapter 20 Holmes Originally Brought The Deal The Directors

Chapter Twenty

Directors, Officers, and Controlling

Shareholders

A MANAGER’S DILEMMA: PUTTING IT INTO PRACTICE

Should Mickey Pay Greenmail?

Issue Presented: Was a controlling shareholder who induced the board of directors to pay

greenmail liable as an aider and abettor of the board’s breach of its duty to the company?

Was it a breach of fiduciary duty for the shareholder to agree to abandon a derivative suit it

had brought against the company as part of the greenmail transaction?

The California Court of Appeal ruled in Heckman v. Ahmanson, 214 Cal. Rptr. 177 (Cal.

App. 1985), that the plaintiffs had demonstrated reasonable probability of success at trial and

upheld the trial court’s imposition of a constructive trust on Steinberg’s profits. If the plaintiffs

The court further found that the Steinberg group could be held liable as an aider and

abettor of the board’s alleged breach of fiduciary duty. The court noted that the Steinberg

group knew it was reselling its stock at a price considerably above the market value to enable

the Disney directors to retain control of the corporation. It also knew or should have known

Second, the court found that the plaintiff shareholders had adequately demonstrated a

breach of fiduciary duty owed directly by the Steinberg group to the Disney shareholders.

QUESTIONS AND CASE PROBLEMS

Question 1

Issues Presented: Do defensive measures intended to reduce the power of a minority

shareholder that started a competing business violate the directors’ fiduciary duties to that

shareholder?

The Delaware Court of Chancery in eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1

(Del. Ch. 2010), first addressed the rights plan adopted by the two remaining stockholders:

Enhanced scrutiny has been applied universally when stockholders challenge a

board’s use of a rights plan as a defensive device. In the typical scenario, the

decision to deploy a rights plan will fall within the range of reasonableness if the

Like any strong medicine, however, a pill can be misused. The Delaware

Supreme Court understood from the outset that a rights plan can be

deployed inappropriately to benefit incumbent managers and directors at the

stockholders’ expense. Therefore when deploying a rights plan, “directors must

Here, the two remaining stockholders were not dispersed, disempowered, or vulnerable

stockholders. Instead, they were the majority, and were thus not using the rights plan to

preclude Craigslist stockholders from considering and opting for a value-maximizing

transaction. As such, the court continued its analysis under the Unocal framework: the directors

must “(1) identify the proper corporate objectives served by their actions; and (2) justify their

actions as reasonable in relationship to those objectives.”

stockholder value to support the indefinite implementation of a poison pill.”

The court next turned to the legality of the staggered board amendments. The proper

standard of analysis, explained the court, was to determine whether the staggered board

amendments “further any rational business purpose.” The court concluded that the

amendments indeed furthered a rational business purpose:

Throughout this dispute, Jim and Craig have argued that they designed the

Staggered Board Amendments to keep eBay, a business competitor, from

unilaterally being able to place a director on craigslist’s board. Jim and Craig

by eBay not to use his or her board seat to access confidential information and

then surreptitiously pass it on to eBay. Implementing a staggered board was one

way to accomplish this. It does not matter that there were (and are) other

alternatives available to Jim and Craig because the Staggered Board

Amendments were sufficiently rational to satisfy business judgment review.

The “price” of receiving an additional craigslist share under the [scheme] was the

granting of a right of first refusal over five shares. This same deal (a 5:1 ratio)

was offered to each craigslist stockholder. Jim and Craig argue that the

[scheme] was fair to craigslist stockholders because all stockholders were offered

the same deal. Superficially, this appears to be true. Deeper reflection, however,

reveals that it actually costs eBay more to grant a right of first refusal over five of

its craigslist shares than it costs Jim or Craig to do the same. When eBay engaged

in Competitive Activity by launching Kijiji, Jim and Craig had to decide whether

to issue a Notice of Competitive Activity. If they chose to do so and if eBay failed

Craig’s craigslist shares remained encumbered. Thus, the price Jim and Craig had

to pay for a new share under the [scheme] was their granting a right of refusal to

craigslist on five already-encumbered shares. The price eBay had to pay for a

new share under the [scheme] was its granting a right of first refusal to craigslist

on five freely transferable shares. Although each craigslist stockholder had to

Question 2

Issue Presented: Is it a breach of fiduciary duty for a director of a real estate investment trust

(REIT) negotiating a joint venture on behalf of the REIT with another director for the

development of a portfolio of the REIT’s properties to indicate a desire to co-invest in buying

an interest in the properties without disclosing the possibility to the REIT?

In HMG/Courtland Properties, Inc. v. Gray, 749 A.2d 94 (Del. Ch. 1999), the Delaware

Court of Chancery held that both directors violated their duty of loyalty to the REIT. The court

characterized Gray’s undisclosed, buy-side interest in the transactions as a classic case of self–

dealing. Proof of such undisclosed self-dealing, in itself, was sufficient to rebut the

presumption of the business judgment rule and invoke entire fairness review.

Gray’s interest was clearly material. Since Gray anticipated taking a buy-side interest in

the transactions at least as early as February 1986 and was HMG’s lead negotiator in the

transactions, a reasonable director would have certainly wanted to know abut his buy-side

position in the Transactions.

The concept of entire fairness has two components: fair dealing and fair price. Fair

dealing “embraces questions of when the transaction was timed, how it was initiated,

structured, negotiated, disclosed to the directors, and how the approvals of the directors and

the stockholders were obtained.” Fair price “relates to the economic and financial

considerations of the proposed merger, including all relevant factors: assets, market value,

earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a

company’s stock.”

HMG did not receive a shockingly low price in the transactions. But the court held that

proof that the prices paid were within the low end of the range of possible prices that might

have been paid in negotiated arm’s–length details would not necessarily satisfy defendants’

burden under the entire fairness standard. A contract price might be fair in the sense that it

corresponds to market price, and yet the corporation might have refused to make the contract if

a given material fact had been disclosed. In short, the defendants failed to persuade the court

that HMG would not have gotten a materially higher value for the properties had Gray and

Fieber come clean about Gray’s interest.

The court ruled that HMG was entitled to receive as damages the difference between

what Fieber paid for an interest in the properties and the amount the court concluded was what

HMG would have received if Gray had not negotiated the deal. The court also ordered Gray to

Question 3

Issue Presented: Did the directors violate their fiduciary duty by selling corporate control

through their directorships?

A personal trustee, corporate officer or director, or other person standing in a fiduciary

relationship with another may not sell or transfer such office for personal gain. The reason for

the rule is plain: A fiduciary endeavoring to influence the selection of a successor must do so

with an eye single to the best interests of the beneficiaries.

Question 4

Issues Presented: When has an officer wrongfully taken a corporate opportunity that belongs

to his corporation?

The shareholder will argue that Holmes has stolen a corporate opportunity that belongs

to After School. As an officer of After School, Holmes owes the corporation the same duty of

loyalty that is owed by directors. In Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939), the Delaware

Supreme Court stated that officers cannot use their position within the company to further their

personal interests. In spite of the fact that Holmes originally brought the deal to the directors

Question 5

Issue Presented: (a) When must a board redeem a poison pill? (b) How is the adequacy of an

offer for stock determined? (c) Should a director consider constituencies other than the

shareholders when making corporate decisions?

(a) Under the corporate law of Delaware, it is very probable that the board of Engulf

would not be required to redeem the poison pill at this time. The key question is whether the

directors have the authority to use the pill as a barrier that makes it more difficult for

shareholders to directly accept offers by outsiders to tender their shares. As Delaware case law

has stated, directors must be able to articulate a valid corporate reason for keeping the pill in

place.

The directors also considered the information over a fourteen-hour meeting, which

demonstrates their concern for acting in an informed manner. Furthermore, the directors have a

genuine concern that Megaclout would adversely change the company’s corporate culture. The

Delaware court has upheld this rationale as a valid concern of directors and a reason for

resisting a takeover.

(b) Economists such as Gregg A. Jarrell might argue that the price at which Engulf is

currently trading results from a highly efficient market calculating the present value of the

However, Jarrell made his argument that the premium offered was clearly adequate in

the context of Paramount’s $200-a-share bid for Time when Time was trading at approximately

(c) Whether managers should be concerned with constituencies other than shareholders

is a hotly debated issue. Those against such considerations contend that a manager’s sole

concern should be toward maximizing shareholder value. To factor in the needs and well being

of any group besides shareholders is thought to be a violation of the contract between owners

Those who argue that managers should consider other constituencies take a broader

view of the corporation’s place in society. They argue that takeovers can have adverse effects on

employees or a local economy. It is seen as correct for corporate directors to think about those

Question 6

Issue Presented: Does the decision not to install lights at Wrigley Field, thereby preventing

the Chicago Cubs baseball team from playing home games at night, fall under the protection

of the business judgment rule?

As later articulated in the business judgment rule, courts have long vowed not to

question or interfere with the honest business judgment of the corporation’s directors unless

The plaintiff Schlensky alleged that Wrigley had made the decision not to install lights

for reasons unrelated to the financial interest and welfare of the corporation when he said that

baseball is a daytime sport and that he felt that night games would be bad for the

neighborhood. However, the court was not satisfied that Wrigley’s actions were not in the long–

term financial interest of the Cubs. For example, it noted that the long-run interest of the

corporation in its property value at Wrigley Field might demand all efforts to keep the

neighborhood from deteriorating. And although it stopped short of saying that Wrigley’s

decision was a correct one (precisely because it was not its place to do so), the court felt that the

decision was properly one to be handled by the directors.

Directors are elected for their business capabilities and judgment, and the courts cannot

require them to forego their judgment because of the decisions of directors of other companies.

Question 7

Issue Presented: Does Halbert, as dominant stockholder and chair of the board, have a

fiduciary duty to the shareholders? If so, did he violate that duty by selling a controlling

block of stock to outside purchasers at a price not made available to the minority group of

shareholders?

The minority shareholders alleged that Halbert was a triple fiduciary (majority

shareholder, director, and officer). As such, they argued, Halbert owed a duty to all

shareholders that existed when the majority stock was sold to an outsider, which was breached

Noting that the special facts doctrine recently has been limited to those cases in which

the directors or majority shareholders purchase the stock of the minority shareholders by

withholding information concerning the value of the stock, the California appellate court felt

that adoption of a new rule would be appropriate for the circumstances. The court stated: “The

rule we . . . adopt here simply is that the duty of the majority stockholder-director, when

contemplating the sale of the majority stock at a price not available to other stockholders and

Question 8: (a) Did the directors of a Delaware corporation breach their fiduciary duty when

they hired a president with a four-year employment contract that provided for what turned

out to be $130 million in termination compensation? (b) Did the president violate his

fiduciary duty when he accepted that compensation?

(a) The Delaware Court of Chancery dismissed all claims against the directors in In re

Walt Disney Co. Derivative Litigation, 906 A.2d 27 (Del. 2006), but was highly critical of their

actions:

As I will explain in painful detail hereafter, there are many aspects of defendants’

conduct that fell significantly short of the best practices of ideal corporate

Unlike ideals of corporate governance, a fiduciary’s duties do not change over

time. How we understand those duties may evolve and become refined, but the

duties themselves have not changed, except to the extent that fulfilling a

average medical practitioner be found inevitably derelict.

Fiduciaries are held by the common law to a high standard in fulfilling their

stewardship over the assets of others, a standard that (depending on the

circumstances) may not be the same as that contemplated by ideal corporate

governance. Yet therein lies perhaps the greatest strength of Delaware’s

. . .

Even where decision-makers act as faithful servants, however, their ability and

the wisdom of their judgments will vary. The redress for failures that arise from

faithful management must come from the markets, through the action of

shareholders and the free flow of capital, and not from this Court. Should the

Court apportion liability based on the ultimate outcome of decisions taken in

good faith by faithful directors or officers, those decision-makers would

(b) The court ruled that Ovitz did not breach his fiduciary duty of loyalty by receiving

the no-fault termination payments. Disney made the payments pursuant to a contract Ovitz had

negotiated at arms-length before becoming a fiduciary. Although he had fiduciary duties as a

director and officer when the decision was made to terminate him without cause, he played no

part in that decision. “Furthermore, Ovitz did not ‘engage’ in a transaction with the

corporation—rather, the corporation imposed an unwanted transaction upon him.” The court

continued:

No reasonably prudent fiduciary in Ovitz’s position would have unilaterally