Jacobs, Norman I

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Corporations—Protection of Incumbent Management by the Corporate Purchase of Its Own Stock—Business Judgment Rule.—Bennett v. Propp

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Boston College Law ReviewVolume 5 | Issue 1 Article 1810-1-1963Corporations—Protection of IncumbentManagement by the Corporate Purchase of ItsOwn Stock—Business Judgment Rule.—Bennettv. ProppNorman I. JacobsFollow this and additional works at: http://lawdigitalcommons.bc.edu/bclrPart of the Business Organizations Law CommonsThis Casenotes is brought to you for free and open access by the Law Journals at Digital Commons @ Boston College Law School. It has been acceptedfor inclusion in Boston College Law Review by an authorized administrator of Digital Commons @ Boston College Law School. For more information,please contact nick.szydlowski@bc.edu.Recommended CitationNorman I. Jacobs, Corporations—Protection of Incumbent Management by the Corporate Purchase of ItsOwn Stock—Business Judgment Rule.—Bennett v. Propp, 5 B.C.L. Rev. 190 (1963),http://lawdigitalcommons.bc.edu/bclr/vol5/iss1/18BOSTON COLLEGE INDUSTRIAL AND COMMERCIAL LAW REVIEWthese agreements are, henceforth per se illegal." The Snap-On Tools Corp.decision will, in such an eventuality, be meaningless as precedent and, ineffect, overruled.PAUL E. D'HEDOUV1LLECorporations—Protection of Incumbent Management by the CorporatePurchase of Its Own Stock—Business Judgment Rule.—Bennett v.Propp.1—Plaintiff-appellee brought a minority shareholders' derivative suitfor an accounting, by the chairman and the board of directors of Noma Lites,Inc., and also for any damages proximately resulting from the allegedlyimproper expenditure of corporate funds in the purchase of the company'sown capital stock. The chairman, without authority, had negotiated purchasesof nearly two hundred thousand shares of Noma common stock in responseto a letter, marked "personal and confidential," from Royal Little, theexecutive head of Textron, Inc. Therein was requested a list of Nomashareholders; it was further indicated that Little desired to obtain a con-trolling interest in Noma. Textron had previously been unsuccessful in itsbid to garner a control interest in American Screw Company, a corporationin which Noma held 51 per cent of the outstanding stock, and it appeared thatLittle might now attempt to succeed by gaining control of Noma itself.Learning of the stock purchases only one business day before payment wasdue, Noma's board ratified the purchases although the financial instabilityof the corporation forced them to effect a loan, at one per cent interest permonth, to meet the two million dollar purchase price. The Vice-Chancellorfound the purchases to have been essentially motivated by the chairman'sdesire to further personal interests and preserve favored position; he refusedto apply the business judgment rule to the board's resolution in view of the"precipitate and impulsive manner" in which they reached their decision.2On appeal to the Supreme Court of Delaware, it was HELD • the boardwas confronted with a fait accompli, which, if left unratified, might wellresult in serious financial embarrassment to the corporation. The urgency ofthe situation and the nature of the emergency justified the apparent hastewith which the board meeting was conducted as well as the failure toconsider possible alternate avenues of action. The court affirmed thefinding of personal liability as to the chairman!'The instant case is significant for the insight it may offer into the steps40 Justice Clark characterized the decision thusly:Today the Court does a futile act in remanding this case for trial. In my viewappellant cannot plead nor prove an issue upon which a successful defense . . .can be predicated. Certainly the decision has no precedential value in substantiveanti-trust law.Supra note 1, at 282-83.I — Del. —, 187 A.2d 405 (1962).2 Propp v. Sadacca, — Del. 	 175 A.2d 33 (Del. Ch. 1961).3 The court renumerated the accepted Delaware position that the board's resolutioncould not legalize the unlawful purchases of the chairman so as to exonerate him fromliability. It only served to "take up the stock to save the corporation from financialdifficulty." Supra note 1, at 411.190CASE NOTESmanagement may properly take to protect themselves from the so-calledcorporate "raider," although more specifically, the narrow holding concernsthe validity of spending corporate funds for the purchase of its own out-standing stock. It is an oft commented-upon fact that serious abuses mayresult from the improper exercise of such a power, 4 the most relevant andobvious being that an incumbent management may utilize this authority toinsulate itself, as it were, from potentially insurgent shareholders. 5 Eachjurisdiction, manifesting a cognizance of these dangers, imposes its ownequitable limitations on the exercise of this power,° implicitly recognizing,however, that the fact that a power may be abused is not in itself a compellingargument for the complete prohibition of its exercise?It is fundamental that directors of a corporation are in a fiduciary rela-tionship to said corporation, and, as such, are bound to act with reasonablecare and intelligence in the conduct of its affairs, although they are notresponsible for mere errors of judgments It is noteworthy that in the caseat bar there was no finding of fraud by the directors; the court made nodefinite finding as to the allegation of misconduct, although "statementsmade by the court . . . compel the conclusion that the charge of misconductwas implicitly rejected."s Thus, it is significant that in partly reversing thelower court, the board was absolved from liability only because of thepotentially destructive effect on the corporation's credit and general financialposition if they had refused to ratify.To be sure, the corporate purchase of its own shares "is not ordinarilyan essential corporate function," although, in Delaware, it is not per seinvalid." Little light is shed on this perplexing area by attacking a particularexercise of this power merely because it achieves a perpetuation of a group'spositions and salaries." Indeed, this is a necessary concomitant of anydecision to purchase which is successful in its actual operation. A similarfact situation was presented in the case of Kors v. Carey, 12 where the stockpurchases were sustained because the evidence "clearly showed" that theinsurgents, if successful, would attempt to force a business policy upon the4 Ballantine, Law of Corporations § 257 (rev. ed. 1940) ; 1 Hornstein, CorporateLaw & Practice § 491 (1959) ; 62 Colum. L. Rev. 1096 (1962) ; Comment, 70 Yale L.J.308 (1960).5 See Comment, 70 Yale L.J. 308 (1.960).6 Del. Code Ann. tit. 8, § 160 (1953) provides that a corporation organized under therelevant chapter of the Delaware laws "may purchase, hold, sell and transfer sharesof its own capital stock; but no such corporation shall use its funds or property forthe purchase of its own shares of capital stock when such use would cause any impair-ment of the capital of the corporation." See generally Model Bus. Corp. Act Ann. § 5,¶ 2.02 (1960).7 Noteworthy in this context is the British position that no company may purchaseits own shares for any purpose. Trever v. Whitworth, 12 App. Cas. 409 (1887).8 Albert E. Touchet, Inc. v. Touchet, 264 Mass. 499, 163 N.E. 184 (1928); Henn,Handbook of the Law of Corporations § 233 (1961).9 3 B.C. Ind. & Coln. L. Rev. 531, 532 (1962) ; Propp v. Sadacca, supra note 2, at38.10 Martin v. American Potash & Chem. Corp., 33 Del. Ch. 234, 92 A.2d 295 (1952) ;Brophy v. Cities Serv. Co., 31 Del. Ch. 258, 70 A.2d 5 (1949).11 See 62 Colum. L. Rev. 1096, 1100 (1962).12 	 Del. —, 158 A.2d 136 (Del. Ch. 1960).191BOSTON COLLEGE INDUSTRIAL AND COMMERCIAL LAW REVIEWcorporation which defendants, on "manifestly reasonable" grounds, deter-mined would be detrimental to the best interests of their corporation.While there was no explicit finding in Kors that the corporation wouldhave been damaged if the insurgents gained control, the court stated thatplaintiff's proof failed to establish fraud or misconduct such as would compela finding of breach of fiduciary duty. 13The lower court in the present case found that Textron posed noimmediate threat to Noma, special emphasis was given to the fact thatLittle had not, as yet, obtained any stock in the corporation. It is un-fortunate that this proved determinative for the court in distinguishing thiscase from the principles enunciated in Kors. There was at no time anevaluation of the character of Royal Little or the interests and intentionshe represented. While the lower court was reversed on its distinguishing Korsbecause of the "extensive consideration" the board gave to the decisionto purchase,14 its dismissal of Little's letter as not constituting an immediatethreat to Noma was accepted.It is arguable that the board was faced with a situation which reasonablyappeared to preface a serious attempt at stock purchase by Textron. TheChancellor's characterization of the letter as no more than a "thinly-veiledattempt to induce Sadacca and his fellow stockholder-directors to sell out toLittle,"15 is open to question. More important, however, are the disturbingimplications suggested by this decision. The acknowledged advantages ac-cruing to management when engaged in a proxy contest,m and the potentialabuses of the power to purchase corporation stock with corporate funds by agroup determined to preserve its position are surely relevant considerationsin analyzing the inadequacies of modern corporate structure and practices.A purely objective decision by a board which is in danger of being oustedfrom power is not always to be expected." Nevertheless, an equally "realistic"approach would suggest that while the purest of motives behind a challengeto management is that a change would result in a sounder and moreprofitable organization, it remains that control has added value that followsregardless of the virtue of the individual shareholder. The emoluments ofoffice will similarly accrue to the insurgent shareholder or corporate raider ifhe is successful.15 Id. at 141 .14 Supra note 1, at 409.15 Ibid. The letter read essentially as follows:At the Textron directors' meeting Wednesday, November 26, I am going toask the Board to consider making an offer to purchase 472,143 shares (morethan 50%) of the stock of Noma.. .. Any such offer would be made on a basiswhere the first shares deposited would be taken up, not on a pro rata basis.I would like to have you let me know whether you would be willing tosupply . . . a stockholders' list for the purpose of making such an offer.We believe that through such an offer we can gain control of both NomaLites, Inc. and American Screw Company with a smaller total investment thanwe 'had planned to pay for American Screw Company alone.Since this matter is of a confidential nature, we naturally will not publicizeit until after we have received your reply.16 Aranow & Einhorn, Proxy Contests for Corporate Control (1957) ; Berle,"Control" in Corporate Law, 58 Colum. L. Rev. 1212 (1958).17 62 Colum. L. Rev. 1100 (1962).192CASE NOTESThe difficulties inherent in applying a test of motive—personal gainrather than policy considerations—is well documented in the context of theexpenditure of corporate funds in proxy contests.18 It would seem thatdirectors should be able "in the exercise of an honest business judgment" toadopt "a valid method of eliminating what appears to them a clear threatto the future of their business."9 This does not give the directors an "un-controllable" weapon against shareholder challenge, yet it achieves whatare here suggested to be desirable ends. The corporation will not be forced toengage in costly and most often wasteful proxy fights in the name offurthering corporate democracy; it would not, under the facts of the case atbar, have to wait until the raider obtained a foothold in the company and im-proved his bargaining position for the ultimate "sell-out"; it could eliminatea dissentient faction for valid business purposes. At the same time, the courtwould not have foreclosed the possibility of an independent inquiry into theactions of the incumbent management if plaintiff could show fraud, badfaith or misconduct.NORMAN I. JACOBSLabor Law—Collective Bargaining Agreements—Procedural Arbitra-tion.—Livingston v. John Wiley El Sons, Inc.'—District 65, Retail, Whole-sale, and Department Store Union, AFL-CIO, on the basis of a collectivebargaining agreement with Tnterscience Publishing, Inc., brought an actionto compel arbitration on disputes arising over seniority rights, pension plans,job security and severance and vacation pay, against John Wiley & Sons, asuccessor corporation of a consolidation between Interscience and Wiley. Itwas undisputed that no notice of any grievance was filed within the four-weekperiod required by the collective bargaining agreement, nor were any ofthe procedures established in the agreement followed.2 The district court,assuming that the consolidation did not terminate the agreement, deniedthe motion to arbitrate on the grounds that the agreement should be soconstrued as "to exclude from arbitration matters involving the entirecollective bargaining unit, as distinguished from the individuals comprisingit;" and that even if not so limited, the Union failed to avail itself of thegrievance procedure described in the agreement and thus abandoned anyrights it might have had to arbitrate the dispute The Court of Appeals12 See Steinberg v. Adams, 90 F.Delaware law); Hand v. Missouri-Kansas1944).12 McPhail v. L. S. Starrett Co., 257Gas & Elec. Co., 16 Del. Ch. 157, 142 Atl.10 Del. Ch. 358,92 Atl. 255 (1914).Supp, 604, 608 (S.D.N.Y. 1950) (applyingPipe Line Co., 54 F. Supp. 649, 651 (D. Del.F.2d 388 (1st Cir. 1958) ; Davis v. Louisville654 (1928); In re International Radiator Co.,   313 F.2d 52 (2d Cir. 1963), cert. granted, 373 U.S. 908 (1963).2 The collective bargaining agreement set forth "procedures, which shall beresorted to as the sole means of obtaining adjustment of the difference, grievance, ordispute" between Interscience and the Union. In another clause, the agreement statedthat "notice of any grievance must be filed with the Employer and with the UnionShop Steward within four (4) weeks after its occurrence or latest existence. The failureby either party to file the grievance within this time limitation shall be construed andbe deemed to be an abandonment of the grievance." Id, at 64.193

Corporations—Protection of Incumbent Management by the Corporate Purchase of Its Own Stock—Business Judgment Rule.—Bennett v. Propp

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