Buzz

LBO: Fiduciary Duties of Controlling Persons

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP


According to a celebrated authority, "fiduciary duty" means a duty, implied in law, of "the finest loyalty" to another party in certain business relationships.[1] Judge Cardozo's opinion in the landmark case, Meinhard v. Salmon, set forth two general themes of fiduciary analysis: (1) fiduciary duty is a moral principle of the highest order,[2] and (2) the duty is strict, with few exceptions.[3]

However, Cardozo's opinion, while quoted ad nauseam, has not become the universal standard in the world of corporations and their directors and shareholders. Justice Frankfurter aptly presented the other side: "[t]o say that a man is a fiduciary only begins the analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respect has he failed to discharge these obligations? And what are the consequences of his deviation from duty?"[4] Frankfurter's casuistic counterpoint to Cardozo's categorical imperative is driven by the fact that the term "fiduciary" is not a natural inhabitant of the world of corporate finance. It was borrowed from the law of trusts where it refers to the duty the trustee owes the beneficiary of his trust-including rigorous duties of loyalty and of care.

Of course, when confined to the four corners of express trusts, the concept of fiduciary duty has been tailored and refined over the years to meet the needs of private trustees and beneficiaries. But, it is important to note that the original context contemplates a planned relationship usually governed by a trust instrument that carefully defines the compensation, power and duties of the trustee. The trustee accepts the trust at least presumably with a working knowledge of his responsibilities. His compensation is calculated to take into account potential liability. In this context, the concept of a fiduciary "works" in that it governs the relationship of the parties for the most part without surprise, litigation, avoidable ambiguity and uncertainty-all the enemies of profitable commercial relationships and family peace.

Cardozo's natural law explanation would import the term and its attendant meaning, unscathed, into at least the law of partnerships. And, for some theorists and judges, the task of migrating Cardozo's hard-line position from the context of partners in a commercial partnership to proprietors in a general business corporation has not been intellectually strenuous-a fiduciary is a fiduciary is a fiduciary.

The opposite view, exemplified in Frankfurter's skeptical paragraph and shaded towards positivist theories of jurisprudence, views the pedigree of the phrase as potentially mischievous. As Frankfurter might have phrased the argument, the law business often suffers from ancestor worship when it comes to picking its language generally and its shorthand phrases in particular. Any phrase which carries with it an apparent majesty, suggesting a meaning which transcends time, place and circumstances, violates the rule announced by Humpty Dumpty in Through the Looking Glass: the user of the word, not the word itself, should be master.[5] Contrast a pedestrian phrase like "reasonable care" -- few courts would assume an intrinsic, natural law meaning; few courts would or do end their inquiry when the phrase drops into the discussion.[6]

The second, and complementary, weakness of the phrase is that it is, in fact, borrowed.

The tendency to assume that word which appears in two or more legal rules, and so in connection with more than one purpose, has and should have precisely the same scope in all of them runs all through legal discussions. It has all the tenacity of original sin and must constantly be guarded against.[7]

The short of the matter, as per the Frankfurter view, is that relationships between inside directors, outside directors, stockholders, officers, tippers, tippees (and so on) can be far more varied in economic reality than the hornbook relation of a paid trustee and the trust's beneficiary in the context of a planned text. If a court's reasoning consists solely in determining whether the case under consideration looks like earlier cases in which fiduciary duty was the tool of the plaintiff's recovery, then fiduciary duty[8] does have a fixed meaning (but not one necessarily consistent with changing economic realities), i.e., recovery for the plaintiff.[9]

Whether one leans towards Cardozo's natural law or Frankfurter's positivism, the issue is further complicated by prior questions of status. Who is a fiduciary in the first instance? A general business corporation is controlled de jure by its board of directors, and the board, without more, is elected by a majority of the voting shares. However, it is clear that a corporation can be controlled de facto by a person or persons who own substantially less than 51 percent of the stock, or even, as in the case of a dominant lender, an entity with no stock at all.[10]

[1]-The Incorporated Partnership Theory

In an often cited Massachusetts case, Donahue v. Rodd Electrotype Co.,[11] the corporation purchased shares held by a controlling shareholder without according minority shareholders the opportunity to redeem at the same price. The Supreme Judicial Court stated:

Because of the fundamental resemblance of the close corporation to the partnership, the trust and confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in the close corporation, we hold that stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe one another.[12]

In reaching an "incorporated partnership" conclusion, the court emphasized the illiquidity of the shareholders' investment and the vulnerability of minority shareholders to abuse through measures that on the surface may appear neutral or harmless.[13]

The incorporated partnership theme recalls the strict good-faith standard set out by Judge Cardozo in Meinhard, which in fact did involve partners. Donahue does not, however, go so far as to hold that any unequal distribution of corporate stock is inconsistent with fiduciary duty, nor does the case define allowable circumstances where the controlling party may act unequally without being "disloyal."

To the extent that a controlling stockholder or other stockholder, in violation of his fiduciary duty, causes the corporation to issue stock in order to expand his holdings or to dilute the holdings of other stockholders, the other stockholders will have a right to relief in Court.[14] There are grounds for relief in the event of breach of fiduciary duty, but there is no explanation or assistance as to just when such a breach occurs. Thus, while Donahue seems primarily concerned with enforcing traditional ethical principles, the approach the court selects offers little analytical help. The court simply replaces one inexact and ambiguous set of principles-fiduciary duty of controlling shareholders-with another-fiduciary duty of partners. Donahue is, nonetheless, viewed as a throwback to Meinhard,[15] asserting that the conduct of controlling shareholders be held to a high standard. Were there a spectrum of fiduciary duty results in this context, Donahue (or at least the language thereof) would be located somewhere close to the left-hand edge.

The situation in Massachusetts has been complicated by the Supreme Judicial Court's decision in Blank v. Chelmsford OB/Gyn P.C.[16] In that case, the court, while repeating that the stockholders have "a high fiduciary duty owed to one another in all their mutual dealings," nonetheless held that "questions of good faith and loyalty with respect to rights on termination of stock purchase do not arise when all the stockholders in advance enter into agreement concerning" those subjects. There are a variety of interpretations of the precise holding, a few commentators restricting it to situations in which all the stockholders agree on the specific terms upon the company's organization while the broader view is that fiduciary duty only steps in when the parties have not formalized their expectations.[17]

[2]-The Balancing Approach: Business Purpose versus Reasonable Expectations

The following year, the Massachusetts Supreme Judicial Court, by its own admission, initiated a general retreat from the broad rule of Donahue. The court in Wilkes v. Springside Nursing Home affirmed that majority shareholders in a close corporation owe a fiduciary duty to the minority, but asserted that the majority had forty-six certain rights to what has been termed "selfish ownership."[18] Although the court applied a strict fiduciary standard to the actions of the majority, it expressed concern that the unlimited application of such a strict standard might discourage controlling shareholders from taking legitimate actions for fear of being held in violation of a fiduciary duty.

In light of its concern, the court enunciated a balancing test, weighing the majority's right of self-interest against the fiduciary duty owed to the minority in light of the following factors: (1) whether the majority could demonstrate a legitimate business purpose for its action, (2) whether the minority had been denied its justifiable expectations by the action of the majority, and (3) whether an alternative course of action was less harmful to the minority's interests. Using the balancing approach, the Wilkes court concluded that the proper method would be to place the initial burden on the majority shareholder to show a legitimate business purpose for the actions taken. Upon such a showing, the burden would then shift to the minority or burdened party to demonstrate that the same legitimate objective could have been achieved through an alternative course of action less harmful to the minority's interests.

[a]-Business Purpose

If Massachusetts and New York[19] jurisprudence admit business purpose to the analysis, such is not consonant with the weight of authority. Thus, the Delaware courts have stated that an inquiry into the business purpose of the actions taken by controlling shareholders is basically conclusory in nature.[20] After a long flirtation with business purpose as an appropriate normative constraint, the Delaware Supreme Court in Weinberger[21] discarded the label, noting "we do not believe that any meaningful protection is afforded minority shareholders by the business purpose requirement."

[b]-Reasonable Expectations

The importance of Wilkes[22] is that the court introduced the expectations of the minority shareholders when they entered upon the corporate venture. It is important to note, however, that the court did not examine the reasonableness of the minority's expectations; indeed, it may be difficult in a particular case to say just what expectations of the minority are justifiable. Giving validity to erroneous or romantic assumptions of the minority could unduly hamper the venture's operations and lead to the handcuffing of majority action or further investment-the precise concern expressed in Wilkes.[23] Nonetheless, the reasonable expectations approach has been followed in some jurisdictions and has support from commentators who have called, for example, for legislation ordering courts to protect the reasonable expectations of close corporation shareholders.[24] He would have the primary emphasis be on the reasonable expectations as they existed at the inception of the participants' original business bargain, but would allow fallback in some cases where there is a showing of concurrence by all shareholders that a change in expectations developed through subsequent dealings.[25]

[c]-Less Harmful Means

Under Wilkes, the minority may attempt to establish that the majority could have achieved the legitimate business purpose through an alternate course of action less harmful to the minority's interest.[26]

[d]-Focus On Wrongful Conduct

At least one commentator posits that, in the context of close corporations, courts have quietly abandoned principles of fiduciary duty and replaced them with remedial approaches that focus solely on the putative fiduciary's wrongful conduct.[27]

Shifting the inquiry from the beneficiary's personal interests to a more limited focus on the fiduciary's malfeasance provides, presumably, greater leeway for corporate fiduciaries to pursue their own interests and diminish the law's power to enforce higher business ethics. For example, in a 1989 decision,[28] a New York state court held that no duty of loyalty and good faith as between partners and joint ventures arises between shareholders; but the court specifically pointed out that a shareholder could still bring an action for dissolution under the New York oppression statute. It is argued that the case stands for the proposition that shareholders in New York are not bound by fiduciary duties, and that oppression actions are the appropriate remedy with which to address harm to minority shareholders.[29]

[e]-Statutory Relief Against Wrongful Conduct: Oppression Statutes

Virtually every state has enacted statutory provisions enabling a court to order dissolution on grounds involving misconduct by those in control.[30] The corporate statutes of most states follow the position of the revised Model Business Corporation Act, which focuses on the "illegal, oppressive, or fraudulent" actions of the majority shareholders.[31] The inclusion of "oppression" as a basis for involuntary dissolution or alternative remedies has opened up an avenue of relief for minority shareholders caught in a close corporation marred with dissension.[32] Predictably, however, a reliable definition of "oppression" has proved elusive and has inspired both narrowly and broadly phrased descriptions that are usually tailored to the specific factual setting.[33]

The standards for obtaining relief vary widely but are generally quite demanding.[34] Prospective plaintiffs rarely know if the often cryptic statutory language will apply to their situation. As a rule, the statutes are usually construed narrowly, and relief, particularly for minority interests, is neither frequent nor predictable.

[f]-Specific Corporate Wrongs: "Watered" Stock

An ancient doctrine in the law, no longer of much currency in light of flexible corporation laws and the lessening emphasis on par value as creditor protection, entails the proposition that stock cannot be given away. Strictly speaking, watered stock occurs when a corporation issues shares for overvalued property or services, so that the true value of the consideration given is less than the share's par value.[35] Over time, different jurisdictions have adopted several rules or theories to deal with liabilities of shareholders when a corporation issues watered stock.[36] Prohibitions against watered stock and share repurchases were based on the theory that the firm's capital represented a "trust fund" for the benefit of creditors. Thus, a shareholder not making valid payment for shares purchased could be liable to creditors for taking from this "trust."[37] Other jurisdictions have developed a "constructive fraud" theory; the defendant corporation must show that the creditor actually knew of the watered shares being distributed and was, therefore, not defrauded.[38]

In Delaware, holders of watered stock are liable to the corporation's creditors on grounds that the corporation incurred a "statutory obligation" to give consideration at least equal to the stock's par value.[39] The issuance of stock without consideration does not render the issue void, though an attempt to exempt the issuee from liability to pay lawful consideration is void.[40] Statutes permitting no par value stock were designed to eliminate the problem of watered stock by making it after to issue stock for property of uncertain or speculative value. But, many of the statutes, such as Delaware's,[41] require the directors to determine or state the value of the consideration received for no-par shares as stated capital. If the assets received for no-par shares are worth less than the stated value, the problem of watered stock may reemerge.[42]

[3]-Duty to Negotiate with Controlling Party[43]

[a]-Louisiana Municipal Police Employees' Retirement System v. Fertitta

A decision by the Delaware Court of Chancery reinforces the responsibility of a board of directors to assertively defend the interests of the noncontrolling stockholders when negotiating with a controlling stockholder in order to satisfy the board's duty of loyalty.

In Louisiana Municipal Police Employees' Retirement System v. Fertitta,[44] the court refused to dismiss claims against the board and the CEO of Landry's Restaurants, Inc. alleging breach of their duty of loyalty and waste of corporate assets in connection with a failed leveraged buyout of the company by the CEO. The court's decision hinged on three key factual aspects alleged in the complaint:

• the CEO's role in negotiating a financing agreement on behalf of the company as part of the buyout financing, and the board's acquiescence to that role;

• the board's "apparent and inexplicable impotence" in dealing with a creeping takeover by the CEO during the buyout negotiations; and

• the board's termination of the merger agreement, which eliminated the CEO's reverse termination fee obligations.

In reaching its decision, the court distinguished Lyondell Chemical Co. v. Ryan,[45] in which the Delaware Supreme Court held that an accelerated process for sale of the company did not constitute a bad faith breach of the board's Revlon duties.

[b]-Key Facts in the Fertitta Case

[i]-Fertitta Offers Management Buyout

Landry's owned approximately 180 restaurants in twenty-eight states, the Golden Nugget Hotel and Casino in Las Vegas and other properties. Tilman Fertitta, the CEO of Landry's, owned 39% of its outstanding common stock. Fertitta proposed a management buyout at $23.50 per share in January 2008-at a 41% premium. Landry's board set up a special committee of independent directors to evaluate the merger proposal and in June 2008, agreed to a merger at $21 per share. The merger agreement built in a 45-day "go-shop" period, contained a relatively standard right to terminate in the event of a material adverse effect, and specified that a $24 million reverse termination fee would be paid to Landry's, personally guaranteed by Fertitta, if the buyers failed to close. Fertitta entered into a commitment letter with lending banks to finance the buyout.

On September 13, 2008, Hurricane Ike damaged Landry's restaurants in three Texas cities. The company's press release reassured the market that the losses were insured and forecasted minimal, if any, negative long-term effect. Nevertheless, Fertitta informed the special committee that he believed the lending banks would claim that a material adverse effect had occurred under the debt commitment letter, which would allow Fertitta to terminate the merger agreement. Fertitta suggested the merger consideration be reduced to $17 per share to persuade the lending banks not to assert a material adverse effect. The company had $400 million in debt coming due in February 2009 in an increasingly tumultuous credit market, and faced a bankruptcy filing if it could not refinance the debt, putting additional pressure on the board.

[ii]-Fertitta Renegotiates Merger Agreement and Debt Commitment Letter

After three weeks of negotiations with Fertitta, on October 7, 2008 Landry's announced publicly that the merger might not proceed. Landry's stock dropped to $8.44 per share. Then, on October 17, 2008, the company and Fertitta amended the merger agreement, agreeing to a new price of $13.50 per share, reducing the reverse termination fee to $15 million and providing that Fertitta would not assert a material adverse effect for the hurricane-related events.

Concurrently with renegotiating the merger agreement amendment, Fertitta negotiated an amendment to the commitment letter with the lending banks in which the banks also agreed not to assert a material adverse effect for any event through the date of the amendment. As part of that agreement, Fertitta also negotiated, on Landry's behalf, a commitment to refinance the $400 million of Landry's debt that was coming due, if the merger was not consummated.

[iii]-Fertitta Engages in Creeping Takeover

From mid-September through early December 2008, Fertitta purchased approximately 2.6 million shares of Landry's common stock on the open market, raising his ownership stake to 56.7% and obtaining control without paying a control premium. Although the amended merger agreement provided that any newly acquired shares were not eligible to vote on approval of the merger agreement, the Landry board did nothing further to protect the minority stockholders from the impact of Fertitta's purchases of shares.

[iv]-Landry's Terminates Merger and Fertitta Avoids Paying reverse termination Fee

In late 2008, the SEC asked Landry's to make routine disclosures in its merger proxy statement relating to the financing of the deal. When the lending banks objected, Landry's terminated the merger agreement. In a January 2009 press release, Landry's explained that providing the SEC-requested disclosure over the lending banks' objections would violate the terms of the commitment letter, which would jeopardize both the buyout financing and the debt refinancing. By terminating the merger agreement, Landry's maintained the lending banks' obligation to fund the $400 million refinancing, but doing so also eliminated Fertitta's obligation to pay the $15 million reverse termination fee.

[c]-Court of Chancery of Delaware Denies Motion to Dismiss Claims for Breach of the Duty of Loyalty and for Waste

The Court of Chancery found that the allegations of the complaint, if taken as true, raised a reasonable inference that defendants breached their fiduciary duty of loyalty and engaged in corporate waste.

[d]-Controlling Stockholder Owes Fiduciary Duties to Noncontrolling Stockholders: Court May Review Entire Fairness of Board's Decision

A nonmajority stockholder in a Delaware corporation has fiduciary duties as a controlling stockholder if the stockholder's relationship with the corporation allows him to dominate the corporation through actual control over its actions. Fertitta did not have control of Landry's through majority ownership until December 2008, but he served as its Chairman and CEO, and he was also a 39% stockholder. In the court's view, these facts, in addition to his actions on behalf of Landry's in negotiating the debt refinancing, suggest that he was the controlling stockholder during those negotiations.

Combining the refinancing and buyout commitments in a single agreement so that a breach under the buyout commitment would allow the lending banks to terminate the debt refinancing commitment provided Fertitta with additional leverage in negotiating with Landry's. Fertitta's direct role in negotiating the agreement created a reasonable inference that either he used his position as CEO or his influence as a controlling stockholder for his personal benefit to the detriment of the corporation and the noncontrolling stockholders.

Once he acquired 56.7% of the common stock, Fertitta clearly controlled the corporation but argued that he should not have been treated as the majority stockholder, even then, because the merger agreement prohibited him from voting his newly acquired shares to approve the merger. The sterilization of Fertitta's new shares for such a limited purpose was not sufficient, in the court's view, to keep him from controlling Landry's at that point. Consequently, the Landry's board's decision to terminate the merger agreement after Fertitta obtained majority control is subject to entire fairness review.

[e]-Court Found Directors' Response to Creeping Tender Offer May Breach Fiduciary Duty of Loyalty

The Landry's directors argued that plaintiffs' allegations amounted only to a breach of the duty of care and that Landry's charter exculpated directors from monetary damages for a breach of the duty of care. Therefore, the directors could not be held liable for monetary damages for such a breach unless, as the Delaware Supreme Court held in Lyondell, the breach was so egregious as to constitute bad faith. The court found that Lyondell was not applicable because it presented only allegations of gross failure of process by the Lyondell board. By contrast, plaintiffs here asserted a straightforward breach of the duty of loyalty, namely, that "the board knowingly preferred the interests of the majority stockholder to those of the corporation or the minority."[46] A breach of the duty of loyalty cannot be exculpated under Delaware law.

Although Delaware courts have never required a board of directors to implement a poison pill, the court found that the failure to do so in the face of a clear threat to Landry's minority stockholders and the corporation, "together with other suspect conduct,"[47] supported a reasonable inference that the board breached its duty of loyalty.

[f]-Court Found Directors' Failure to Require Reverse Termination Fee Payment May Constitute Corporate Waste

Plaintiffs alleged that the Landry's board committed waste by failing to require Fertitta to pay the reverse termination fee in connection with the termination of the merger agreement.[48] In decisions such as In re Citigroup Inc. Shareholder Derivative Litigation,[49] Delaware courts have set a high bar to prevail on a claim of corporate waste, namely, that "the board's decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation's best interest."[50]

The board announced that it had terminated the merger agreement to prevent a breach of the debt commitment letter, which breach would have given the lending banks the option to deny both the buyout financing and the debt refinancing. The board argued that this was the only rational alternative open to it because the company faced bankruptcy without the financing. The court was skeptical, wondering why the board and special committee did not challenge the lending banks on whether the SEC-requested disclosure would actually result in a breach of the debt commitment letter, and questioned whether terminating the merger agreement in order to preserve the debt financing commitment was necessary to prevent the company's bankruptcy. The court clearly felt that the board had not negotiated hard enough with Fertitta; the board could have turned the threat of bankruptcy into a bargaining chip to force Fertitta to terminate the merger agreement, leaving Landry's with the debt refinancing commitment intact and the reverse termination fee of $15 million in hand. In the court's view, the special committee did not thoroughly consider that Fertitta (at that point, the majority stockholder) might have terminated the merger agreement to protect his existing $78 million to $119 million investment in Landry's. The court found that the complaint raised a reasonable inference that the special committee's decision to terminate the merger agreement and forego the reverse termination fee did not constitute the "rational exercise of business judgment."[51]

[g]-Sometimes Substance of Board's Decisions Trumps Good Board Process

The Fertitta court's decision to deny the motion to dismiss is a reminder of the difficult duty of loyalty issues that can face a board of directors in negotiating with a controlling stockholder, especially one who is also the CEO. When Fertitta made his initial offer, the Landry's board did the right thing procedurally: it formed a special committee that hired its own legal and financial advisors, negotiated for six months before reaching a merger agreement that provided a premium to Landry's stockholders and contained a go-shop clause and a reverse termination fee favorable to the company, negotiated actively with Fertitta for a month before agreeing to a revised merger agreement, and decided to terminate the merger agreement in the midst of an unprecedented financial crisis in the U.S. credit markets in order to preserve the company's debt refinancing commitment.

Nevertheless, the court faulted the special committee and the board for, among other things, failing to adopt a rights plan to protect against a creeping takeover and failing to play a game of high-stakes chicken with its controlling stockholder regarding who would terminate the merger agreement. A standstill agreement or adoption of a rights plan would have protected the status quo, but had to be negotiated at the outset. It is not clear whether the board asked for these terms but were refused, or failed even to ask. Without these protections, the board found itself without leverage when it came time to renegotiate the merger agreement. Many of the asserted errors of the board could also be characterized as errors of process rather than evidence that the board favored the controlling stockholder.

The case is a reminder that, if a board is negotiating with a controlling stockholder, its actions will be seen through the prism of possible dominance by that stockholder, and even good faith errors of process may appear to be driven by an improper intent to benefit the controlling stockholder.

[h]-Practical Tips

[i]-Identify and Use All Possible Leverage When Negotiating With a Controlling Stockholder

The court may change its view on a more complete record, but the current decision underscores one primary lesson in negotiating with a controlling stockholder: however little leverage the board thinks it has, it must test its assumptions about what terms the controlling stockholder (or other parties, such as the buyout lenders) will accept. With the help of sophisticated legal and financial advisors, the board must use any available leverage to negotiate the best terms possible for the noncontrolling stockholders.

[ii]-Oversee a Controlling Stockholder Who Is Also the Chief Executive Officer

Allowing Fertitta to negotiate refinancing of the company's debt on behalf of the company put him in a position to insert terms that increased his leverage in the buyout transaction. When an executive officer who would normally negotiate on the company's behalf has interests on both sides of the transaction, the board should replace that person with a disinterested party, such as an independent board member.


[1] Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545, 546 (1928).

[2] "Joint adventurers . . . owe to one another, while the enterprise continues, the duty of the finest loyalty-[n]ot honesty alone, but the punctilio of an honor the most sensitive, is then the standard or behavior." Meinhard v. Salmon, 249 N.Y. at 463-464.

[3] "As to this [duty] there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of the courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion' of particular exceptions. . . . Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court." Id., 249 N.Y. at 464.

[4] Securities and Exchange Commission v. Chenery Corp., 318 U.S. 80, 85-86, 63 S.Ct. 454, 87 L.Ed. 626 (1943).

[5] C. Dodgson, The Complete Works of Lewis Carroll, 214 (Vintage Books ed. 1976).

[6] The error of supposing the terms have a transcendental meaning has been aptly illustrated by Felix Cohen:

The Supreme Court argued, "A labor union can be sued because it is, in essential aspects, a person, a quasi-corporation." The realist will say, "A labor union is a person or quasicorporation because it can be sued; to call something a person in law, is merely to state, in metaphorical language, that it can be sued."

There is a significant difference between these two ways of describing the situation. If we say that a court acts in a certain way "because a labor union is a person," we appear to justify the Court's action, and to justify this action, moreover, in transcendental terms, by asserting something that sounds like a proposition but which cannot be confirmed or refuted by positive evidence or by ethical argument. If, on the other hand, we say that a labor union is a person "because the courts allow it to be sued," we recognize that the action of the courts has not been justified at all and that the question of whether action of the courts is justifiable calls for an answer in non-legal terms. To justify or criticize legal rules in purely legal terms is always to argue in a vicious circle."

Cohen, "Transcendental Nonsense and the Functional Approach,"36 Colum. L. Rev. 809, 815 (1935).

[7] Cook, The Logical and Legal Bases of the Conflict of Laws, 159 (1942).

[8] 1n recent years, flexible standards like "fiduciary" have appealed to those styling themselves as liberals because, among other things, the alternative is said to be "Social Darwinism." See Kennedy, "Form and Substance in Private Law Adjudication,"89 Harv. L. Rev. 1685 1744-1745 (1976). See also, Ellinghaus, "In Defense of Unconscionability," 78 Yale L.J. 757, 759-761, 768-772 (1969). Such an underdog type of mentality fails in a variety of commercial contexts, as, for example, competitive tender offers, wherein the target company's typical defensive tactics include an appeal to altruism, portraying itself as the victim of a rapacious monopolist. Note the remarks (unpublished) of Judge Wyzanski:

This Court is not so naive as to suppose that this is really an antitrust case. It really comes in that form because that is the way powerful interests seeking to control in their own interest the managerial prerogatives of USMC [the target company] have found a handle to get here. A court would be blind if it thought that USMC and its officers were disinterested champions of the antitrust laws. They know what they are, codottieri, and so does the Court."

Emhart Corp. v. USM Corp., 527 F.2d 177 (1st Cir. 1975).

[9] Bartlett, A Tired Monopoly, 138 (1978).

[10] See 8 Del. C. § 228 (1983); Gilson, The Law and Finance of Corporate Acquisitions, 506 (1986); N.Y. Bus. Corp. Law § 903(2) (McKinney).

[11] Donahue v. Rodd Electrotype Co., 367 Mass. 578, 328 N.E.2d 505 (1975).

[12] Id., 328 N.E.2d at 515.

[13] Id., 328 N.E.2d at 514-515. The "incorporated partnership" principle was articulated by Judge Fuld (dissenting) in Kruger v. Gerth: The enterprise before us is a "close corporation" in the strictest sense, that is, one in which, regardless of the distribution of the shareholdings, "management and ownership are substantially identical.". . . In such a case, it seems almost self-evident, the fiduciary obligation of the majority to the minority extends considerably beyond what would be its reach in the context of a larger or less closely held enterprise. Here the relationship between the shareholders is very much akin to that which exists between partners or joint venturers. 16 N.Y.2d 802, 806, 210 N.E.2d 355, 263 N.Y.S.2d 1, 4 (1965). (Citation omitted.) See also:

Circuit Courts:

D.C. Circuit: Helms v. Puckworth, 249 F.2d 482, 486 (D.C. Cir. 1957).

State Courts:

Indiana: Crosy v. Shannon Continental Corp., 378 N.E.2d 941 (Ind. App. 1978).

Massachusetts: Hallahan v. Haltom Corp., 385 N.E.2d 1033, 1034 (Mass. App. 1979).

New Jersey: 68th St. Apartments, Inc. v. Lauricella, 362 A.2d 78 (N.J. Super. 1976).

New York: In re T.J. Ronan Paint Corp., 98 A.D.2d 413, 421, 469 N.YS.2d 931, 936 (N.Y. App. Div. 1984); In re Thines v. Gene Barry One Hour Photo Process, Inc., 123 Misc.2d 529, 538, 474 N.Y.S.2d 362, 368 (N.Y. Sup. 1983), aff'd 108 A.D.2d 630, 486 N.Y.S.2d 699, appeal dismissed 66 N.Y.2d 757, 497 N.Y.S.2d 367 (1985); Weiss v. Gordon, 32 A.D.2d 279, 281, 301 N.YS.2d 839, 842 (1969).

This trend was noted by Professor Israels when he remarked that "[t]he objective of the participants in a close corporation is to equate the scheme of governance of their enterprise to that of a partnership." Israels, "The Close Corporation and the Law,"33 Cornell L.Q. 488, 491 (1948). See also, Davidian, "Corporate Dissolution in New York: Liberalizing the Rights of Minority Shareholders,"56 St. John's L. Rev. 24, 29 (1981). See also: DiLuglio v. Providence Auto Body, Inc., 755 A.2d 757 (R.I. 2000); Taylor v. Taylor, 1997 Mass. Super. LEXIS 137 (Mass. Super. Feb. 19, 1997).

[14] Donahue v. Rodd Electrotype Co., 367 Mass. 578, 328 N.E.2d 505, 519 n.25. (1975). (Emphasis added.)

[15] See Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545 (1928).

[16] Blank v. Chelmsford OB/GYN P.C., 420 Mass. 404, 649 N.E.2d 1102 (1995).

[17] See Sullivan & Rooney, "Chelmsford OB/Gyn, P.C.: Further Developments in the Rights of Employee/Shareholders of Close Corporations," Boston Bar J. 16 (Jan./Feb. 1996).

[18] Wilkes v. Springside Nursing Home, 370 Mass. 842, 850-851, 353 N.E.2d 657 (1976).

[19] The business purpose test has been adopted, as well, in New York. Schwartz v. Marien, 37 N.Y.2d 487, 335 N.E.2d 334, 373 N.Y.S.2d 122 (1975).

[20] Singer v. Magnavox Co., 380 A.2d 969, 974 (Del. 1977); Comment, "The Strict Good Faith Standard-Fiduciary Duties to Minority Shareholders in Close Corporations," 33 Mercer L. Rev. 595, 605 (1982). A business purpose test would presumably only control the outcome of egregious cases of oppression, such as in Wilkes or Donahue. In most cases, a plausible business purpose would not be difficult to show. Peeples, "The Use and Misuse of the Business Judgment Rule in the Close Corporation," 60 Notre Dame L. Rev. 456, 499 (1985), (citing FH O'Neal & R. Thompson, O'Neal's Oppression of Minority Shareholders, § 3.05 (2d ed. 1985)).

[21] Weinberger v. UOP, Inc., 457 A.2d 701, 715 (Del. 1983).

[22] By finding a breach of fiduciary duty in Wilkes, the Massachusetts court again displayed its willingness to break with the traditional reluctance of courts to substitute their judgment for that of management in decisions concerning the internal affairs of the corporation. Melton, "Close Corporations: Strict Good Faith Fiduciary Duty Applied to Controlling Stockholders,"38 La. L. Rev. 214, 222(1977).

[23] The North Carolina Supreme Court offers guidance in this area. In Meiselman v. Meiselman, 309 N.C. 279, 307 S.E.2d 551 (1983), the court elucidated the concept of reasonable expectations: "Privately held expectations which are not made known to the other participants are not ‘reasonable.' Only expectations embodied in understandings, express or implied, among the participants should be recognized by the court." 307 S.E.2d at 563. Under Meiselman, a court would determine the shareholder's reasonable expectations through a case-by-case examination of the entire history of the shareholder's relationship with the corporation. This history may include the shareholder's expectation that he will participate in the management of the business. Wilkes v. Springside Nursing Home, 370 Mass. 842, 353 N.E.2d 657, 663 (1976). The North Carolina court advises that these reasonable expectations be set forth in a well-drafted written agreement, but since minority shareholders may not have the appropriate power or knowledge, the court allows an implied understanding among the participants. McLean, "Minority Shareholders' Rights in the Close Corporation under the New North Carolina Business Corporations Act," 68 N.C. L. Rev. 1109, 1116 (Sept. 1990).

[24] O'Neal, "Close Corporations: Existing Legislation and Recommended Reform," 33 Bus. Law. 873, 885 (1978). But Peeples notes that no court has adopted the reasonable expectations test without the assistance of a statute, even though the test does not require such a restriction. Peeples, "The Use and Misuse of the Business Judgment Rule in the Close Corporation,"60 Notre Dame L. Rev. 456, 505 (1985).

[25] Professor Hillman claims this approach improperly ignores the expectations of parties other than the dissatisfied shareholder. Two tasks of a court using an expectations based analysis are thus to define circumstances under which dissatisfied shareholders would be entitled to relief and to carefully structure the type of relief. Hillman modifies the idea of reasonable expectations to supplement relief now provided by statute for such matters as oppression, deadlock, mismanagement, and failure of corporate purposes. Hillman, "The Dissatisfied Participant in the Solvent Business Venture: A Consideration of the Relevant Permanence of Partnerships and Close Corporations,"67 Minn. L. Rev. 1, 75-78 (1982).

[26] Wilkes v. Springside Nursing Home, 370 Mass. 842, 353 N.E.2d 657, 663 (1976).

[27] Mitchell, "The Death of Fiduciary Duty in Close Corporations,"138 U. Pa. L. Rev. 1675, 1676 (June 1990) [hereinafter Mitchell]. Mitchell explains the reason for the trend:

The classic statement of the fiduciary principle is that, within the scope of the relationship, the fiduciary is to act in a disinterested manner in the beneficiary's best interests. Conduct deviating from that standard results in liability, regardless of the fiduciary's motive or intent. The problem burdening fiduciary analysis in the law of close corporations is that those considered fiduciaries ... are not, in fact, disinterested.... Thus, the fiduciary shares with the beneficiary a legitimate claim to the "trust" property over which she has exclusive control.

Id. at 1677.

[28] Ingle v. Glamore Motor Sales, 73 N.Y.2d 183, 535 N.E.2d 1311, 538 N.Y.S.2d 771 (1989).

[29] Mitchell, N. 27 supra, at 1723-1724.

[30] See Thompson, "The Shareholder's Cause of Action for Oppression," 48 Bus. Law. 699, 708 (1993). If and as a close corporation is dissolved, the issue may arise whether one of the participants, by setting up a shop identical to the foreign entity, has wrongfully appropriated the goodwill associated with the former business. See Honig, “Escape From Corporate Bondage,"Boston Bar J., p. 9 (Sept.-Oct. 1992).

[31] O'Neal, Close Corporations, § 9.29, at 131 (1986).

[32] Statutes that do not include the term “oppression" are unlikely to give assistance to any but the strongest cases of abuse. Id.

[33] Peeples, “The Use and Misuse of the Business Judgment Rule," 60 Notre Dame L. Rev. 456, 501 (1985). A number of courts in the past defined “oppression" in terms of reasonable expectations of the parties, i.e., frustration of a party's reasonable expectations results in “oppression." See:

Second Circuit: O'Donnel v. Marine Repair Services, 530 F Supp. 1199, 1207 (S.D.N.Y 1982); In re Taines, 111 Misc.2d 559, 444 N.Y.S.2d 540, 543 (N.Y. Sup. 1981).

Third Circuit: Exadaktilos v. Cinnaminson Realty Co., 167 N.J. Super. 141, 400 A.2d 554, 561-562 (Law Div. 1979), aff ‘d 173 N.J. Super. 559, 414 A.2d 994, cert. denied 425 A.2d 273 (N.J. 1980).

Fifth Circuit: Capital Toyota v. Gerwin, 381 So.2d 1038, 1039 (Miss. 1980).

[34] For detailed explanation of such requirements, see: In re Topper, 433 N.YS.2d 359, 364 (Sup. Ct. 1980); Thompson, “The Shareholder Cause of Action for Oppression," 48 Bus. Law 699 (1993); O'Neal, Close Corporations, § 9.29 (1986); Note, “Involuntary Dissolution of Close Corporations for Mistreatment of Minority Shareholders," 60 Wash U. L.Q. 1119 (1982); Hetherington & Dooley, “Illiquidity and Exploitation: A Proposed Statutory Solution to the Close Corporation Problem," 63 Va. L. Rev. I (1977.

[35] The protections to creditors afforded by the par value concept have generally faded with the establishment of no-par and 1 cent par stock. See generally, Manning, Legal Capital (1980).

[36] Clark, Corporate Law, § 17. 1, at 710 (1986) [hereinafter Clark].

[37] Sawyer v. Hoag, 84 U.S. 610, 21 L.Ed. 731 (1873).

[38] Hospes v. Northwestern Manufacturing & Car Co., 48 Minn. 174, 50 N.W. 1117 (Minn. 1892).

[39] DuPont v. Ball, 106 A. 39 (Del. Ch. 1918).

[40] Highlights for Children v. Crown, 227 A.2d 118, 122 (Del. Ch. 1966) (citing DuPont v. Ball).

[41] Del. Code Ann. tit. 8, § 153(b).

[42] Clark, N. 36 supra, at 715. See generally, Hamilton, “Reflections of a Reporter," 63 Tex. L. Rev. 1455, 1469-1470 (1985).

[43] Courtesy of Evelyn Cruz Sroufe, Patrick Simpson, and Naomi Sheffield of Perkins Coie LLP.

[44] Louisiana Municipal Police Employees' Retirement System v. Fertitta, 2009 WL 2263406 (Del. Ch. July 28, 2009).

[45] Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009).

[46] Fertitta, 2009 WL 2263406 at *8.

[47] Id.

[48] Id., 2009 WL 2263406 at *6.

[49] In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Del. Ch. 2009).

[50] Id., 964 A.2d at 136.

[51] Fertitta, 2009 WL 2263406 at *8.

Joseph W. Bartlett, Special Counsel, JBartlett@McCarter.com

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