626 A.2d 1366
In 1928 E.C. Barton formed E.C. Barton & Co.1 The corporation is a non-public closely-held Delaware corporation headquartered in Arkansas.2 It is engaged in the business of selling wholesale and retail lumber in the Mississippi Delta.3 The corporation issued two classes of common stock consisting of Class A voting shares and Class B non-voting shares.4
Substantially all of the corporation's stock was held by Mr. Barton at the time of his death in 1967.5 Mr. Barton was survived by his second wife Martha K. Barton who died in 1985 and by his daughter and granddaughter from his first marriage.6 Pursuant to Mr. Barton's testamentary plan 49 percent of the Class A voting stock was bequeathed outright to eight of his loyal employees.7 The remaining 51 percent of Class A along with 14 percent of Class B was placed into an independently managed 15-year trust for the same eight people.8 Sixty-one percent of the Class B non-voting stock was bequeathed outright to Mrs. Barton.9 Mr. Barton's daughter and granddaughter received 21 percent of the Class B stock in trust.10 The non-voting Class B shares Mr. Barton bequeathed to his family represented 75 percent of the corporation's total equity.11
Mrs. Barton gave certain shares of Class B non-voting stock to her three children Guy C. Blackwell Owen G. Blackwell and Martha G. Hestand.12 In 1973 the corporation purchased all of the Class B stock held in trust for Mr. Barton's daughter and granddaughter at a price of $45 per share.13 Mrs. Barton sold the remainder of her Class B shares to the corporation in January 1975 at a price of $45 per share.14 These transactions left Mrs. Barton's three children collectively with 30 percent of the outstanding Class B non-voting stock.15 The children have no voting rights despite their substantial equity interest in the corporation.16 The children are also the only non-employee Class B stockholders.17
The corporation made repeated self-tender offers to repurchase the children's Class B shares. The corporation first offered to repurchase the children's stock at $45 per share shortly after they acquired it from Mrs. Barton.18 The children rejected the offer and the stock subsequently split 25-for-1 in 1976.19 A second unsuccessful repurchase offer was made in 1977 at $8.22 per share.20 In 1979 the corporation again approached the children and offered to repurchase their stock at a price of $15 per share.21 Martha Hestand accepted the offer and tendered her shares to the corporation.22 Guy and Owen Blackwell however refused to sell their shares at that price.23 The corporation made no further repurchase offers until May 1985 when the ESOP undertook a tender offer to repurchase 48,000 shares of Class B stock concurrently with a tender offer by the corporation for 39,000 Class A and 100,000 Class B shares at a price of $25 per share.24 The book value of the Class A stock and the Class B stock at that time was $38.39 and $26.35 respectively.25 The remaining children and the other plaintiffs in the present action refused to sell.26
In November 1975 the corporation established an ESOP designed to hold Class B non-voting stock for the benefit of eligible employees of the corporation.27 The ESOP is a tax-qualified profit-sharing plan whereby employees of the corporation are allocated a share of the assets held by the plan in proportion to their annual compensation subject to certain vesting requirements.28 The ESOP is funded by annual cash contributions from the corporation.29 Under the plan terminating and retiring employees are entitled to receive their interest in the ESOP by taking Class B stock or cash in lieu of stock.30 It appears from the record that most terminating employees and retirees elect to receive cash in lieu of stock.31 The corporation commissions an annual appraisal of the corporation to determine the value of its stock for ESOP purposes.32 Thus the ESOP provides employee Class B stockholders with a substantial measure of liquidity not available to non-employee stockholders.33
Beginning in 1982 the corporation purchased additional key man life insurance policies in connection with agreements entered into between the corporation and nine key officers and directors.34 In 1985 the corporation purchased eight $300,000 keyman life insurance policies.35 In the five-year period 1985 to 1989 the corporation paid approximately $450,000 in net key man premiums.36 The premiums exceeded the corporation's declared dividends in 1986 and 1989 even after the earnings on the policies were deducted.37
Plaintiffs are 14 minority stockholders of Class B non-voting stock of the corporation.38 The individual defendants are the members of the board of directors.39 The corporation is also a defendant.40 Plaintiffs collectively own only Class B stock and own no Class A stock.41 Their total holdings comprise approximately 25 percent of all the common stock outstanding as of the end of fiscal year 1989.42 At all relevant times the board consisted of ten individuals who either are currently employed or were once employed by the corporation.43 At the time this suit was filed these directors collectively owned approximately 47.5 percent of all the outstanding Class A shares.44
After a five-day trial that included live witness testimony, depositions, and documents, the Vice Chancellor held that the corporation's low-dividend policy was within the bounds of business judgment.45 The Vice Chancellor also held that the executive compensation levels were not excessive.46 The Vice Chancellor ruled in favor of defendants on these issues.47 The Vice Chancellor further held, however, that the defendant directors had breached their fiduciary duties to the minority.48 The basis for this ruling was that it was inherently unfair for the defendants to establish the ESOP.49 The basis for this ruling was also that it was inherently unfair for the defendants to purchase key man life insurance to provide liquidity for themselves while providing no comparable method by which the non-employee Class B stockholders may liquidate their stock at fair value.50 The trial court entered judgment requiring use of all key man premiums plus interest to repurchase Class B stock from non-employee holders at an independent appraisal price.51 The judgment also included a requirement that future repurchases offer equal terms to those stockholders.52
The Supreme Court of Delaware reviewed the decision of the Court of Chancery.53
Whether the Court of Chancery applied erroneous legal standards in holding that the defendant directors breached their fiduciary duties to the plaintiffs?54
When directors stand on both sides of a transaction the entire fairness test applies.55 The test requires demonstration of utmost good faith together with scrupulous inherent fairness in both fair dealing and fair price.56 Stockholders of a Delaware corporation need not be treated equally for all purposes.57 No special judicially created rules protect minority stockholders of closely held corporations that have not elected statutory close corporation status under Subchapter XIV of the Delaware General Corporation Law.58
Yes. The Vice Chancellor adopted the novel legal principle that Class B stockholders possessed a right to liquidity equal to that available to defendants through the ESOP and key man insurance.59 This principle overlooks the significant facts that the minority stockholders were not employees of the corporation.60 The minority stockholders were not entitled to share in an ESOP.61
The minority stockholders were not qualified for key man insurance.62 The minority stockholders were not protected by specific provisions in the certificate of incorporation by-laws or a stockholders agreement.63 The trial court failed to evaluate and articulate whether corporate benefits flowed from the ESOP and key man insurance.64 The trial court failed to evaluate and articulate whether those plans constituted novel or routine business practices.65
The trial court failed to evaluate and articulate whether Mr. Barton's plan for employee management and benefits should be honored.66 The trial court failed to evaluate and articulate whether the self-tenders demonstrated willingness to provide an exit opportunity for the plaintiffs.67
The Court of Chancery applied erroneous legal standards in holding that the defendant directors breached their fiduciary duties.68
Whether the factual findings of the Court of Chancery were supported by the record and were the product of an orderly and logical deductive reasoning process?69
This Court reviews the entire record and the sufficiency of evidence to test the propriety of those findings.70 This Court will review the factual findings of the trial court to determine if they are sufficiently supported by the record and are the product of an orderly and logical deductive process.71
No. The findings of fact by the trial court regarding the motivation for the key man insurance were not the product of an orderly and deductive reasoning process.72 The Vice Chancellor expressed suspicions about the motivation for the key man insurance.73 The Vice Chancellor used the vague phrase makes one wonder whether the decisions to accumulate large amounts of cash and pay low dividends were not also at least partially motivated by self-interest.74 The court had already ruled that the dividend policy was not per se actionable.75
The opinion did not crisply and clearly set forth findings of fact in a form entitled to deference.76 The opinion failed to delineate and articulate findings of fact and conclusions of law so that the reviewing court could fathom the bases for the decision without undue difficulty.77
The factual findings of the Court of Chancery were not supported by the record and were not the product of an orderly and logical deductive reasoning process.78
Whether the defendant directors of the closely-held corporation breached their fiduciary duties by establishing an ESOP and purchasing key man life insurance policies that provided liquidity to employee stockholders but not to non-employee Class B stockholders?79
When directors are on both sides of a transaction they bear the burden of establishing entire fairness.80 Application of the entire fairness test is not outcome-determinative.81 The entire fairness test does not necessarily require equality.82 The entire fairness analysis requires judicial scrutiny through a principled and disciplined examination of whether corporate benefits flowed from the challenged practices and whether those practices are consistent with the founder's plan for employee management and ownership.83
No. The directors followed a consistent policy originally established by Mr. Barton.84 Mr. Barton's 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.85 Mr. Barton himself established the practice of purchasing key man life insurance to retain valuable employees by assuring them that the corporation would have liquid assets to repurchase shares that might otherwise constitute an illiquid asset of an estate.86 Another purpose was 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.87
An ESOP is normally established for employees.88 There is no inequity in limiting ESOP benefits to employee stockholders.89 The board made continuing efforts to buy back the Class B stock through self-tender offers.90 The Class B stockholders benefited from multiple increases in the value of their shares.91 On this record the defendants met their burden of establishing the entire fairness of their dealings with the non-employee Class B stockholders.92
The defendant directors of the closely-held corporation did not breach their fiduciary duties by establishing an ESOP and purchasing key man life insurance policies that provided liquidity to employee stockholders but not to non-employee Class B stockholders.93
Whether special judicially-created rules should protect minority stockholders of closely-held Delaware corporations that have not elected statutory close corporation status under Subchapter XIV?94
Subchapter XIV applies only to corporations that elect close corporation status in the certificate of incorporation.95 Subchapter XIV requires fulfillment of the statutory requirements of a limitation to thirty stockholders transfer restrictions on all classes of stock and no public offering.96 Unless a corporation elects close corporation status it remains subject in all respects to the General Corporation Law.97 The tools of good corporate practice permit a purchasing minority stockholder to bargain for protection through charter provisions by-laws or stockholder agreements before parting with consideration.98
No. The corporation in this case is not a close corporation under Subchapter XIV because it never elected that status.99 One cannot read into the situation any special relief for minority stockholders in a closely held but not statutory close corporation because the provisions of Subchapter XIV preempt the field.100 It would run counter to the spirit of the doctrine of independent legal significance.101
It would constitute inappropriate judicial legislation for the court to fashion a special judicially created rule for minority investors when the entity does not fall within those statutes or when there are no negotiated special provisions in the certificate of incorporation by-laws or stockholder agreements.102 The entire fairness test correctly applied and articulated remains the proper judicial approach.103
Special judicially-created rules should not protect minority stockholders of closely-held Delaware corporations that have not elected statutory close corporation status under Subchapter XIV.104