Opinion ID: 1478250
Heading Depth: 1
Heading Rank: 5

Heading: applicable principles of substantive law

Text: Defendants contend that the trial court erred in not applying the business judgment rule. Since the defendants benefited from the ESOP and could have benefited from the key man life insurance beyond that which benefited other stockholders generally, the defendants are on both sides of the transaction. For that reason, we agree with the trial court that the entire fairness test applies to this aspect of the case. Accordingly, defendants have the burden of showing the entire fairness of those transactions. Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717 (1971) ( Levien ); Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701 (1983) ( Weinberger ). When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.... The requirement of fairness is unflinching in its demand that where one stands on both sides of a transaction, he has the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts. Weinberger, 457 A.2d at 710. Weinberger explains further the two aspects of entire fairness, fair price and fair dealing: The concept of fairness has two basic aspects: fair dealing and fair price. The former 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. The latter aspect of fairness 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.... All aspects of the issue must be examined as a whole since the question is one of entire fairness. Id. at 711. The case before us involves only the issue of fair dealing. It is often of critical importance whether a particular decision is one to which the business judgment rule applies or the entire fairness rule applies. It is sometimes thought that the decision whether to apply the business judgment rule or the entire fairness test can be outcome-determinative. [B]ecause the effect of the proper invocation of the business judgment rule is so powerful and the standard of entire fairness so exacting, the determination of the appropriate standard of judicial review frequently is determinative of the outcome of derivative litigation. Mills Acquisition Co. v. MacMillan, Inc., Del.Supr., 559 A.2d 1261, 1279 (1988) ( MacMillan ) (quoting AC Acquisitions v. Anderson, Clayton & Co., Del.Ch., 519 A.2d 103, 111 (1986) ( Anderson, Clayton )). Application of the entire fairness rule does not, however, always implicate liability of the conflicted corporate decisionmaker, nor does it necessarily render the decision void. [6] The entire fairness analysis essentially requires judicial scrutiny. Weinberger, 457 A.2d at 710. In business judgment rule cases, an essential element is the fact that there has been a business decision made by a disinterested and independent corporate decisionmaker. Aronson v. Lewis, Del.Supr., 473 A.2d 805, 812 (1984); Smith v. Van Gorkom, Del.Supr., 488 A.2d 858, 872-73 (1985). When there is no independent corporate decisionmaker, [7] the court may become the objective arbiter. Marciano, 535 A.2d at 404. The trial court in this case, however, appears to have adopted the novel legal principle that Class B stockholders had a right to liquidity equal to that which the court found to be available to the defendants. It is well established in our jurisprudence that stockholders need not always be treated equally for all purposes. See Unocal Corp. v. Mesa Petroleum Co., Del.Supr., 493 A.2d 946, 957 (1985) ( Unocal ) (discriminatory exchange offer held valid); and Cheff v. Mathes, Del.Supr., 199 A.2d 548, 554-56 (1964) (selective stock repurchase held valid). To hold that fairness necessarily requires precise equality is to beg the question: Many scholars, though few courts, conclude that one aspect of fiduciary duty is the equal treatment of investors. Their argument takes the following form: fiduciary principles require fair conduct; equal treatment is fair conduct; hence, fiduciary principles require equal treatment. The conclusion does not follow. The argument depends on an equivalence between equal and fair treatment. To say that fiduciary principles require equal treatment is to beg the question whether investors would contract for equal or even equivalent treatment. Frank H. Easterbrook and Daniel R. Fischel, The Economic Structure of Corporate Law 110 (1991) (emphasis in original). This holding of the trial court overlooks the significant facts that the minority stockholders were not: (a) employees of the Corporation; (b) entitled to share in an ESOP; (c) qualified for key man insurance; or (d) protected by specific provisions in the certificate of incorporation, by-laws, or a stockholders' agreement. There is support in this record for the fact that the ESOP is a corporate benefit and was established, at least in part, to benefit the Corporation. [8] Generally speaking, the creation of ESOPs is a normal corporate practice and is generally thought to benefit the corporation. [9] The same is true generally with respect to key man insurance programs. [10] If such corporate practices were necessarily to require equal treatment for non-employee stockholders, that would be a matter for legislative determination in Delaware. There is no such legislation to that effect. If we were to adopt such a rule, our decision would border on judicial legislation. See Providence & Worcester Co. v. Baker, Del.Supr., 378 A.2d 121, 124 (1977). Accordingly, we hold that the Vice Chancellor erred as a matter of law in concluding that the liquidity afforded to the employee stockholders by the ESOP and the key man insurance required substantially equal treatment for the non-employee stockholders. Moreover, the Vice Chancellor failed to evaluate and articulate, for example, whether or not and to what extent (a) corporate benefits flowed from the ESOP and the key man insurance; (b) the ESOP and key man insurance plans are novel, extraordinary, or relatively routine business practices; (c) the dividend policy was even relevant; [11] (d) Mr. Barton's plan for employee management and benefits should be honored; [12] and (e) the self-tenders showed defendants' willingness to provide an exit opportunity for the plaintiffs. [13] In a case where the court is scrutinizing the fairness of a self-interested corporate transaction the court should articulate the standards which it is applying in its scrutiny of the transactions. These standards are not carved in stone for all cases because a court of equity must necessarily have the flexibility to deal with varying circumstances and issues. Yet, the standards must be reasonable, articulable, and articulated. While the court is not expected to substitute its business judgment for that of the directors in areas where particular business expertise is an ingredient of the decision, [14] the reasonableness of the business judgment of the conflicted directors' decision must be examined searchingly through a principled and disciplined analysis. The decision of the trial court did not plainly delineate and articulate findings of fact and conclusions of law so that this Court, as the reviewing court, could fathom without undue difficulty the bases for the trial court's decision. [15] The court's decision should not be the product solely of subjective, reflexive impressions based primarily on suspicion [16] or what has sometimes been called the smell test. [17] We hold on this record that defendants have met their burden of establishing the entire fairness of their dealings with the non-employee Class B stockholders, and are entitled to judgment. The record is sufficient to conclude that plaintiffs' claim that the defendant directors have maintained a discriminatory policy of favoring Class A employee stockholders over Class B non-employee stockholders is without merit. The directors have followed a consistent policy originally established by Mr. Barton, the founder of the Corporation, whose intent from the formation of the Corporation was to use the Class A stock as the vehicle for the Corporation's continuity through employee management and ownership. Mr. Barton established the Corporation in 1928 by creating two classes of stock, not one, and by holding 100 percent of the Class A stock and 82 percent of the Class B stock. Mr. Barton himself established the practice of purchasing key man life insurance with funds of the Corporation to retain in the employ of the Corporation valuable employees by assuring them that, following their retirement or death, the Corporation will have liquid assets which could be used to repurchase the shares acquired by the employee, which shares may otherwise constitute an illiquid and unsalable asset of his or her estate. Another rational purpose is to prevent the stock from passing out of the control of the employees of the Corporation into the hands of family or descendants of the employee. The directors' actions following Mr. Barton's death are consistent with Mr. Barton's plan. An ESOP, for example, is normally established for employees. Accordingly, there is no inequity in limiting ESOP benefits to the employee stockholders. Indeed, it makes no sense to include non-employees in ESOP benefits. The fact that the Class B stock represented 75 percent of the Corporation's total equity is irrelevant to the issue of fair dealing. The Class B stock was given no voting rights because those stockholders were not intended to have a direct voice in the management and operation of the Corporation. They were simply passive investors  entitled to be treated fairly but not necessarily to be treated equally. The fortunes of the Corporation rested with the Class A employee stockholders and the Class B stockholders benefited from the multiple increases in value of their Class B stock. Moreover, the Board made continuing efforts to buy back the Class B stock. We hold that paragraphs 4 and 5 of the March 10, 1992 order of the trial court and the order of May 20, 1992, awarding fees and costs to plaintiffs, are reversed and remanded with instructions to conform the judgment to the findings and conclusions in this opinion.