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Sec. 144 Safe Harbor and Interested Director Transactions

During the 19th century, transactions between the corporation and its directors were commonplace. Such transactions often worked to the advantage of the interested director at the expense of the stockholder. The pernicious effect of such transactions caused legislatures to strictly regulate relationships between corporations and their directors. Through the early 20th century, transactions between a corporation and a director were considered void. Over the years, policy with respect to interested director transactions has loosened, but such transactions are still, rightly, looked at with suspicion.

Such transactions are no longer void per se. Section 144 provides for a statutory safe harbor for interested director transactions. Interested director transactions that comply with the requirements of Section 144 will not be considered void or voidable.  

Compliance with the requirements of Section 144 provides a board with a safe harbor only against attacks for voidability. Interested director transactions are still subject to attack for potential violations of the duty of loyalty. So, while the challenged transaction might not be void, it could still be unfair and boards may be required to defend the transaction for violations of the duty of loyalty. 

The procedures for insulating interested director transactions from attack for purposes of Section 144 provide a partial roadmap for the related doctrine of stockholder ratification. Interested director transactions that comply with the requirements of stockholder ratification doctrine will not be subject to attack for potential violations of the duty of loyalty and will receive the benefit of the business judgment presumption.

  • 1 DGCL Sec. 144 - Interested director transactions

    The following provision of the statute provides a safe harbor for interested director transactions. If the requirements of the safe harbor are complied with then an interested director transaction will not be void or voidable because of the participation of the director. It may still, however, be subject to attack as a violation of the duty of loyalty and the interested director may be required to prove the entire fairness of the transaction. 

    1
    TITLE 8
    2
    Corporations
    3
    CHAPTER 1. GENERAL CORPORATION LAW
    4 5 6

    (a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director's or officer's votes are counted for such purpose, if:

    7

    (1) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or

    8

    (2) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or

    9

    (3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the stockholders.

    10

    (b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction.

    11

    8 Del. C. 1953, § 144; 56 Del. Laws, c. 5056 Del. Laws, c. 186, § 557 Del. Laws, c. 148, § 771 Del. Laws, c. 339, §§ 15-1777 Del. Laws, c. 253, §§ 13, 14.;

  • 2 Benihana of Tokyo Inc. v. Benihana Inc.

    Section 144(a)(1) provides that when a board member's interest is disclosed to or is known by disinterested directors and a majority of the disinterested directors approve the challenged transaction, the board's decision to enter into the transaction will receive the benefit of the §144 safe harbor protection from challenges for voidness and voidability.

    Benihana raises a couple of important issues. First, does the disclosure of the director's interest need to be accomplished formally? Or, is it sufficient that the director's interest be common knowledge to the disinterested directors? Second, to the extent a majority of disinterested directors approve the transaction does such an approval provide the interested director and the transaction any additional protection beyond merely protection against the transaction being deemed void or voidable? If a transaction is approved by a majority of disinterested directors who are fully informed about the transaction should that transaction get the protection of the business judgment presumption? 

    1
    906 A.2d 114 (2006)
    2
    BENIHANA OF TOKYO, INC., individually and on behalf of Benihana, Inc., Plaintiff Below-Appellant,
    v.
    BENIHANA, INC., John E. Abdo, Norman Becker, Darwin Dornbush, Max Pine, Yoshihiro Sano, Joel Schwartz, Robert B. Sturges, Takanori Yoshimoto, and BFC Financial Corporation, Defendants Below-Appellees.
    3
    No. 36, 2006.
    4

    Supreme Court of Delaware.

    5
    Submitted: June 14, 2006.
    6
    Decided: August 24, 2006.
    7

    C. Barr Flinn, Elena C. Norman and D. Fon Muttamara-Walker of Young Conaway Stargatt & Taylor, L.L.P., Wilmington, DE; Jonathan Rosenberg (argued) and Alexandra A. Lewis of O'Melveny & Myers, L.L.P., New York City, of counsel, for appellant.

    8

    Gregory V. Varallo (argued), Lisa Zwally Brown and Geoffrey G. Grivner of Richards, Layton & Finger, P.A., Wilmington, [116] DE; Jeffrey A. Tew, and Dennis Nowak of Tew Cardenas, L.L.P., Miami, FL, of counsel, for appellees Benihana, Inc., Norman Becker, Darwin Dornbush, Max Pine, Yoshihiro Sano, Joel Schwartz, Robert B. Sturges and Takamori Yoshimoto.

    9

    John G. Harris of Reed Smith, L.L.P., Wilmington, DE; Alan H. Fein (argued) of Stearns Weaver Miller Weissler Alhadeff & Sitterson, P.A., Miami, FL, of counsel, for appellees BFC Financial Corporation and John E. Abdo.

    10

    Before STEELE, Chief Justice, HOLLAND and BERGER, Justices.

    11
    [115] BERGER, Justice:
    12

    In this appeal, we consider whether Benihana, Inc. was authorized to issue $20 million in preferred stock and whether Benihana's board of directors acted properly in approving the transaction. We conclude that the Court of Chancery's factual findings are supported by the record and that it correctly applied settled law in holding that the stock issuance was lawful and that the directors did not breach their fiduciary duties. Accordingly, we affirm.

    13
    Factual and Procedural Background
    14

    Rocky Aoki founded Benihana of Tokyo, Inc. (BOT), and its subsidiary, Benihana, which own and operate Benihana restaurants in the United States and other countries. Aoki owned 100% of BOT until 1998, when he pled guilty to insider trading charges. In order to avoid licensing problems created by his status as a convicted felon, Aoki transferred his stock to the Benihana Protective Trust. The trustees of the Trust were Aoki's three children (Kana Aoki Nootenboom, Kyle Aoki and Kevin Aoki) and Darwin Dornbush (who was then the family's attorney, a Benihana director, and, effectively, the company's general counsel).

    15

    Benihana, a Delaware corporation, has two classes of common stock. There are approximately 6 million shares of Class A common stock outstanding. Each share has 1/10 vote and the holders of Class A common are entitled to elect 25% of the directors. There are approximately 3 million shares of Common stock outstanding. Each share of Common has one vote and the holders of Common stock are entitled to elect the remaining 75% of Benihana's directors. Before the transaction at issue, BOT owned 50.9% of the Common stock and 2% of the Class A stock. The nine member board of directors is classified and the directors serve three-year terms.[1]

    16

    In 2003, shortly after Aoki married Keiko Aoki, conflicts arose between Aoki and his children. In August, the children were upset to learn that Aoki had changed his will to give Keiko control over BOT. Joel Schwartz, Benihana's president and chief executive officer, also was concerned about this change in control. He discussed the situation with Dornbush, and they briefly considered various options, including the issuance of sufficient Class A stock to trigger a provision in the certificate of incorporation that would allow the Common and Class A to vote together for 75% of the directors.[2]

    17

    [117] The Aoki family's turmoil came at a time when Benihana also was facing challenges. Many of its restaurants were old and outmoded. Benihana hired WD Partners to evaluate its facilities and to plan and design appropriate renovations. The resulting Construction and Renovation Plan anticipated that the project would take at least five years and cost $56 million or more. Wachovia offered to provide Benihana a $60 million line of credit for the Construction and Renovation Plan, but the restrictions Wachovia imposed made it unlikely that Benihana would be able to borrow the full amount.[3] Because the Wachovia line of credit did not assure that Benihana would have the capital it needed, the company retained Morgan Joseph & Co. to develop other financing options.

    18

    On January 9, 2004, after evaluating Benihana's financial situation and needs, Fred Joseph, of Morgan Joseph, met with Schwartz, Dornbush and John E. Abdo, the board's executive committee. Joseph expressed concern that Benihana would not have sufficient available capital to complete the Construction and Renovation Plan and pursue appropriate acquisitions. Benihana was conservatively leveraged, and Joseph discussed various financing alternatives, including bank debt, high yield debt, convertible debt or preferred stock, equity and sale/leaseback options.

    19

    The full board met with Joseph on January 29, 2004. He reviewed all the financing alternatives that he had discussed with the executive committee, and recommended that Benihana issue convertible preferred stock.[4] Joseph explained that the preferred stock would provide the funds needed for the Construction and Renovation Plan and also put the company in a better negotiating position if it sought additional financing from Wachovia.

    20

    Joseph gave the directors a board book, marked "Confidential," containing an analysis of the proposed stock issuance (the Transaction). The book included, among others, the following anticipated terms: (i) issuance of $20,000,000 of preferred stock, convertible into Common stock; (ii) dividend of 6% +/- 0.5%; (iii) conversion premium of 20% +/- 2.5%; (iv) buyer's approval required for material corporate transactions; and (v) one to two board seats to the buyer. At trial, Joseph testified that the terms had been chosen by looking at comparable stock issuances and analyzing the Morgan Joseph proposal under a theoretical model.

    21

    The board met again on February 17, 2004, to review the terms of the Transaction. The directors discussed Benihana's preferences and Joseph predicted what a buyer likely would expect or require. For example, Schwartz asked Joseph to try to negotiate a minimum on the dollar value for transactions that would be deemed "material corporation transactions" and subject to the buyer's approval. Schwartz wanted to give the buyer only one board seat, but Joseph said that Benihana might have to give up two. Joseph told the board that he was not sure that a buyer would agree to an issuance in two tranches, and that it would be difficult to make the second tranche non-mandatory. As the Court of Chancery found, the board understood that the preferred terms were akin to a "wish list."

    22

    [118] Shortly after the February meeting, Abdo contacted Joseph and told him that BFC Financial Corporation was interested in buying the new convertible stock.[5] In April 2005, Joseph sent BFC a private placement memorandum. Abdo negotiated with Joseph for several weeks.[6] They agreed to the Transaction on the following basic terms: (i) $20 million issuance in two tranches of $10 million each, with the second tranche to be issued one to three years after the first; (ii) BFC obtained one seat on the board, and one additional seat if Benihana failed to pay dividends for two consecutive quarters; (iii) BFC obtained preemptive rights on any new voting securities; (iv) 5% dividend; (v) 15% conversion premium; (vi) BFC had the right to force Benihana to redeem the preferred stock in full after ten years; and (vii) the stock would have immediate "as if converted" voting rights. Joseph testified that he was satisfied with the negotiations, as he had obtained what he wanted with respect to the most important points.

    23

    On April 22, 2004, Abdo sent a memorandum to Dornbush, Schwartz and Joseph, listing the agreed terms of the Transaction. He did not send the memorandum to any other members of the Benihana board. Schwartz did tell Becker, Sturges, Sano, and possibly Pine that BFC was the potential buyer. At its next meeting, held on May 6, 2004, the entire board was officially informed of BFC's involvement in the Transaction. Abdo made a presentation on behalf of BFC and then left the meeting. Joseph distributed an updated board book, which explained that Abdo had approached Morgan Joseph on behalf of BFC, and included the negotiated terms. The trial court found that the board was not informed that Abdo had negotiated the deal on behalf of BFC. But the board did know that Abdo was a principal of BFC. After discussion, the board reviewed and approved the Transaction, subject to the receipt of a fairness opinion.

    24

    On May 18, 2004, after he learned that Morgan Joseph was providing a fairness opinion, Schwartz publicly announced the stock issuance. Two days later, Aoki's counsel sent a letter asking the board to abandon the Transaction and pursue other, more favorable, financing alternatives. The letter expressed concern about the directors' conflicts, the dilutive effect of the stock issuance, and its "questionable legality." Schwartz gave copies of the letter to the directors at the May 20 board meeting, and Dornbush advised that he did not believe that Aoki's concerns had merit. Joseph and another Morgan Joseph representative then joined the meeting by telephone and opined that the Transaction was fair from a financial point of view. The board then approved the Transaction.

    25

    During the following two weeks, Benihana received three alternative financing proposals. Schwartz asked Becker, Pine and Sturges to act as an independent committee and review the first offer. The committee decided that the offer was inferior and not worth pursuing. Morgan Joseph agreed with that assessment. Schwartz referred the next two proposals to Morgan Joseph, with the same result.

    26

    On June 8, 2004, Benihana and BFC executed the Stock Purchase Agreement. On June 11, 2004, the board met and approved resolutions ratifying the execution of the Stock Purchase Agreement and authorizing the stock issuance. Schwartz [119] then reported on the three alternative proposals that had been rejected by the ad hoc committee and Morgan Joseph. On July 2, 2004, BOT filed this action against all of Benihana's directors, except Kevin Aoki, alleging breaches of fiduciary duties; and against BFC, alleging that it aided and abetted the fiduciary violations. Three months later, as the parties were filing their pre-trial briefs, the board again reviewed the Transaction. After considering the allegations in the amended complaint, the board voted once more to approve it. The Court of Chancery held a four day trial in November 2004. In December 2005, after post-trial briefing and argument, the trial court issued an opinion holding that Benihana was authorized to issue the preferred stock with preemptive rights, and that the board's approval of the Transaction was a valid exercise of business judgement. This appeal followed.

    27
    Discussion
    28

    Before addressing the directors' conduct and motivation, we must decide whether Benihana's certificate of incorporation authorized the board to issue preferred stock with preemptive rights. Article 4, ¶ 2 of the certificate provides that, "[n]o stockholder shall have any preemptive right to subscribe to or purchase any issue of stock. . . of the corporation. . . ." Article 4(b) authorizes the board to issue:

    29
    Preferred Stock of any series and to state in the resolution or resolutions providing for the issuance of shares of any series the voting powers, if any, designations, preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions of such series to the full extent now or hereafter permitted by the law of the State of Delaware. . . .
    30

    BOT contends that Article 4, ¶ 2 clearly and unambiguously prohibits preemptive rights. BOT acknowledges that Article 4(b) gives the board so-called "blank check" authority to designate the rights and preferences of Benihana's preferred stock. Reading the two provisions together, BOT argues that they give the board blank check authority to designate rights and preferences as to all enumerated matters except preemptive rights.

    31

    The trial court reviewed the history of 8 Del. C. § 102, and decided that the boilerplate language in Article 4, ¶ 2 merely confirms that no stockholder has preemptive rights under common law. As a result, the seemingly absolute language in ¶ 2 has no bearing on the availability of contractually created preemptive rights. The trial court explained:

    32
    Before the 1967 amendments, § 102(b)(3) provided that a certificate of incorporation may contain provisions "limiting or denying to the stockholders the preemptive rights to subscribe to any or all additional issues of stock of the corporation." As a result, a common law rule developed that shareholders possess preemptive rights unless the certificate of incorporation provided otherwise. In 1967 the Delaware Legislature reversed this presumption. Section 102(b)(3) was amended to provide in relevant part: "No stockholder shall have any preemptive right ... unless, and except to the extent that, such right is expressly granted to him in the certificate of incorporation."
    33
    Thereafter, companies began including boilerplate language in their charters to clarify that no shareholder possessed preemptive rights under common law.
    34
    The blank check provision in Benihana's Certificate of Incorporation suggests that the certificate was never intended to limit Benihana's ability to issue preemptive rights by contract to purchasers of preferred stock. Therefore, [120] I do not read Article 4 of the charter as doing anything more than confirming that the common law presumption does not apply and that the Certificate of Incorporation itself does not grant any preemptive rights.[7]
    35

    It is settled law that certificates of incorporation are contracts, subject to the general rules of contract and statutory construction.[8] Thus, if the charter language is clear and unambiguous, it must be given its plain meaning.[9] If there is ambiguity, however, the language must be construed in a manner that will harmonize the apparent conflicts and give effect to the intent of the drafters.[10] The Court of Chancery properly applied these principles, and we agree with its conclusion that the Benihana certificate does not prohibit the issuance of preferred stock with preemptive rights.

    36

    Even if the Benihana board had the power to issue the disputed stock, BOT maintains that the trial court erred in finding that it acted properly in approving the Transaction. Specifically, BOT argues that the Court of Chancery erred: (1) by applying 8 Del. C. § 144(a)(1), because the board did not know all material facts before it approved the Transaction; (2) by applying the business judgment rule, because Abdo breached his fiduciary duties; and (3) by finding that the board's primary purpose in approving the Transaction was not to dilute BOT's voting power.

    37
    A. Section 144(a)(1) Approval
    38

    Section 144 of the Delaware General Corporation Law provides a safe harbor for interested transactions, like this one, if "[t]he material facts as to the director's. . . relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors ... and the board . . . in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors. . . ."[11] After approval by disinterested directors, courts review the interested transaction under the business judgment rule,[12] which "is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company."[13]

    39

    BOT argues that § 144(a)(1) is inapplicable because, when they approved the Transaction, the disinterested directors did not know that Abdo had negotiated the terms for BFC.[14] Abdo's role as negotiator is material, according to BOT, because Abdo had been given the confidential term sheet prepared by Joseph and knew which of those terms Benihana was prepared to give up during negotiations. We agree that the board needed to know about Abdo's involvement in order to make an informed decision. The record clearly [121] establishes, however, that the board possessed that material information when it approved the Transaction on May 6, 2004 and May 20, 2004.

    40

    Shortly before the May 6 meeting, Schwartz told Becker, Sturges and Sano that BFC was the proposed buyer. Then, at the meeting, Abdo made the presentation on behalf of BFC. Joseph's board book also explained that Abdo had made the initial contact that precipitated the negotiations. The board members knew that Abdo is a director, vice-chairman, and one of two people who control BFC. Thus, although no one ever said, "Abdo negotiated this deal for BFC," the directors understood that he was BFC's representative in the Transaction. As Pine testified, "whoever actually did the negotiating, [Abdo] as a principal would have to agree to it. So whether he sat in the room and negotiated it or he sat somewhere else and was brought the results of someone else's negotiation, he was the ultimate decision-maker."[15] Accordingly, we conclude that the disinterested directors possessed all the material information on Abdo's interest in the Transaction, and their approval at the May 6 and May 20 board meetings satisfies § 144(a)(1).[16]

    41
    B. Abdo's alleged fiduciary violation
    42

    BOT next argues that the Court of Chancery should have reviewed the Transaction under an entire fairness standard because Abdo breached his duty of loyalty when he used Benihana's confidential information to negotiate on behalf of BFC. This argument starts with a flawed premise. The record does not support BOT's contention that Abdo used any confidential information against Benihana. Even without Joseph's comments at the February 17 board meeting, Abdo knew the terms a buyer could expect to obtain in a deal like this. Moreover, as the trial court found, "the negotiations involved give and take on a number of points" and Benihana "ended up where [it] wanted to be" for the most important terms.[17] Abdo did not set the terms of the deal; he did not deceive the board; and he did not dominate or control the other directors' approval of the Transaction. In short, the record does not support the claim that Abdo breached his duty of loyalty.[18]

    43
    C. Dilution of BOT's voting power
    44

    Finally, BOT argues that the board's primary purpose in approving the Transaction was to dilute BOT's voting control. BOT points out that Schwartz was concerned about BOT's control in 2003 and even discussed with Dornbush the possibility of issuing a huge number of Class A shares. Then, despite the availability of other financing options, the board decided on a stock issuance, and agreed to give BFC "as if converted" voting rights. According to BOT, the trial court overlooked this powerful evidence of the board's improper purpose.

    45

    It is settled law that, "corporate action . . . may not be taken for the sole or [122] primary purpose of entrenchment."[19] Here, however, the trial court found that "the primary purpose of the . . . Transaction was to provide what the directors subjectively believed to be the best financing vehicle available for securing the necessary funds to pursue the agreed upon Construction and Renovation Plan for the Benihana restaurants."[20] That factual determination has ample record support, especially in light of the trial court's credibility determinations. Accordingly, we defer to the Court of Chancery's conclusion that the board's approval of the Transaction was a valid exercise of its business judgment, for a proper corporate purpose.

    46
    Conclusion
    47

    Based on the foregoing, the judgment of the Court of Chancery is affirmed.

    48

    [1] The directors at the time of the challenged transaction were: Dornbush, John E. Abdo, Norman Becker, Max Pine, Yoshihiro Sano, Joel Schwartz, Robert B. Sturges, Takanori Yoshimoto, and Kevin Aoki.

    49

    [2] Before this time, Schwartz and Dornbush had discussed transactions that could lead to BOT's loss of its voting control. Schwartz testified that, under pressure from Wall Street, he was looking at ways to improve Benihana's stock liquidity, and the elimination of the two-tiered voting structure would have helped. As part of his effort to improve liquidity, Schwartz regularly asked Dornbush whether the Trust was interested in selling the shares held by BOT.

    50

    [3] Benihana would only be able to borrow 1.5 times its earnings before interest, taxes, depreciation and amortization (EBITDA). In 2003, Benihana's EBITDA was far below the $40 million required to access the full credit limit.

    51

    [4] Joseph testified that: "the oldest rule in our business is you raise equity when you can, not when you need it. And Benihana's stock had been doing okay. The markets were okay. We thought we could do an equity placement."

    52

    [5] BFC, a publicly traded Florida corporation, is a holding company for several investments. Abdo is a director and vice chairman. He owns 30% of BFC's stock.

    53

    [6] At the outset of the negotiations, Joseph agreed not to shop the Transaction to any other potential investor for a limited period of time.

    54

    [7] Benihana of Tokyo, Inc. v. Benihana, Inc., 891 A.2d 150, 172 (Del.Ch.2005) (Citation omitted).

    55

    [8] Staar Surgical Co. v. Waggoner, 588 A.2d 1130, 1136 (Del.1991); Lawson v. Household Finance Corporation, 152 A. 723, 726 (Del. 1930).

    56

    [9] Northwestern National Ins. Co. v. Esmark, Inc., 672 A.2d 41, 43 (Del.1996).

    57

    [10] Anchor Motor Freight v. Ciabattoni, 716 A.2d 154 (Del.1998).

    58

    [11] 8 Del. C. § 144(a)(1).

    59

    [12] See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 366 n. 34 (Del.1993); Marciano v. Nakash, 535 A.2d 400, 405 n. 3 (Del.1987).

    60

    [13] Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

    61

    [14] BOT argued to the trial court that the directors who voted on the Transaction were not disinterested or independent. BOT is not pressing that claim on appeal.

    62

    [15] Appellant's Appendix, A 135.

    63

    [16] The Court of Chancery also decided that the Benihana directors' ratifying votes on June 11 and October 27, 2004 provide independent grounds to uphold their decision under § 144. 891 A.2d at 181 n. 190. Assuming that the board's initial decision was not an informed one, we question how a vote taken after the June 8 closing could ratify the earlier approval. See: Smith v. Van Gorkom, 488 A.2d 858, 885-888 (Del.1985). We need not reach this question, however, as we find that the board was adequately informed of all material facts before voting at the May 6 and May 20 meetings.

    64

    [17] Benihana of Tokyo, Inc. v. Benihana, Inc., 891 A.2d at 181 (Internal quotations omitted.).

    65

    [18] Cf. Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1170 (Del.1995).

    66

    [19] Williams v. Geier, 671 A.2d 1368, 1381 n. 28 (Del.1996).

    67

    [20] 891 A.2d at 190.

  • 3 Fliegler v. Lawrence

    Section 144 provides alternate methods to insulate interested director transactions from attack for voidness. In addition to seeking the approval of a majority of the disinterested directors, a board can seek the approval of the stockholders. Notice that the statute requires only that the challenged transaction is approved by a majority of the stockholders in order to gain the protection of the statutory safe harbor and not necessarily a majority of disinterested stockholders.

    Remember the protections of §144 extend only to the question of void or voidability of an interested director transaction and not further.  One can see how there would be many situations where one might not want stockholder approval of an interested director transaction to do much more than simply rescue a transaction from voidness. Where a controlling stockholder approves a transaction with itself (as a director) we may be okay with that transaction not being void, but we might still want the interested director/stockholder to be required to prove the transaction is nevertheless entirely fair to the corporation.    

    The court in the following case, Fliegler, recognizes this problem and makes it clear that for directors who are seeking the additional protection of the business judgment presumption, they would have to do more than just comply with §144(a)(2).  For those directors, they will have to take the additonal step of complying with the requirements of common law stockholder ratification doctrine and seek informed approval of a majority of disinterested stockholders.  

    1
    361 A.2d 218 (1976)
    2
    Irving FLIEGLER, Plaintiff below, Appellant,
    v.
    John C. LAWRENCE et al., Defendants below, Appellees.
    3

    Supreme Court of Delaware.

    4
    Submitted October 15, 1975.
    5
    Decided June 28, 1976.
    6

    Steven D. Goldberg of Theisen, Lank & Mulford, Wilmington, and Barry H. Singer of Pollack & Singer, New York City, of counsel, for plaintiff below, appellant.

    7

    R. Franklin Balotti and Stephen E. Herrmann of Richards, Layton & Finger, Wilmington, and Warren M. Weggeland, Salt Lake City, Utah, of counsel for defendants below, appellees, John C. Lawrence and Fred H. Tresher.

    8

    Edward B. Maxwell of Young, Conaway, Stargatt & Taylor, Wilmington, for defendant below, Agau Mines, Inc.

    9

    Before DUFFY and McNEILLY, JJ., and CHRISTIE, Judge.

    10
    [219] McNEILLY, Justice:
    11

    In this shareholder derivative action brought on behalf of Agau Mines, Inc., a Delaware corporation, (Agau) against its officers and directors and United States Antimony Corporation, a Montana corporation (USAC), we are asked to decide whether the individual defendants, in their capacity as directors and officers of both corporations, wrongfully usurped a corporate opportunity belonging to Agau, and whether all defendants wrongfully profited by causing Agau to exercise an option to purchase that opportunity. The Court of Chancery found in favor of the defendants on both issues. (1974). Reference is made to that opinion for a full statement of the facts; what follows here is but a brief resume of the events giving rise to this litigation.

    12
    I
    13

    In November, 1969, defendant, John C. Lawrence (then president of Agau, a publicly held corporation engaged in a dual-phased gold and silver exploratory venture) in his individual capacity, acquired certain antimony properties under a lease-option for $60,000.[1] Lawrence offered to [220] transfer the properties, which were then "a raw prospect", to Agau, but after consulting with other members of Agau's board of directors, he and they agreed that the corporation's legal and financial position would not permit acquisition and development of the properties at that time. Thus, it was decided to transfer the properties to USAC, (a closely held corporation formed just for this purpose and a majority of whose stock was owned by the individual defendants) where capital necessary for development of the properties could be raised without risk to Agau through the sale of USAC stock; it was also decided to grant Agau a long-term option to acquire USAC if the properties proved to be of commercial value.

    14

    In January, 1970, the option agreement was executed by Agau and USAC. Upon its exercise and approval by Agau shareholders, Agau was to deliver 800,000 shares of its restricted investment stock for all authorized and issued shares of USAC. The exchange was calculated on the basis of reimbursement to USAC and its shareholders for their costs in developing the properties to a point where it could be ascertained if they had commercial value. Such costs were anticipated to range from $250,000. to $500,000. At the time the plan was conceived, Agau shares traded over-the-counter, bid at $5/8 to $¾ and asked at $1 to $1¼. Applying to these quotations a 50% discount for the investment restrictions, the parties agreed that 800,000 Agau shares would reflect the range of anticipated costs in developing USAC and, accordingly, that figure was adopted.

    15

    In July, 1970, the Agau board resolved to exercise the option, an action which was approved by majority vote of the shareholders in October, 1970. Subsequently, plaintiff instituted this suit on behalf of Agau to recover the 800,000 shares and for an accounting.

    16
    II
    17

    The Vice-Chancellor determined that the chance to acquire the antimony claims was a corporate opportunity which should have been (and was) offered to Agau, but because the corporation was not in a position, either financially or legally, to accept the opportunity at that time, the individual defendants were entitled to acquire it for themselves after Agau rejected it.

    18

    We agree with these conclusions for the reasons stated by the Vice-Chancellor, which are based on settled Delaware law. Equity Corp. v. Milton, Del.Supr., 221 A.2d 494 (1966); Guth v. Loft, Inc., Del.Supr., 23 Del.Ch. 255, 5 A.2d 503 (1939); also see Wolfensohn v. Madison Fund, Inc., Del.Supr., 253 A.2d 72 (1969). Accordingly, Agau was not entitled to the properties without consideration.

    19
    III
    20

    Plaintiff contends that because the individual defendants personally profited through the use of Agau's resources, viz., personnel (primarily Lawrence) to develop the USAC properties and stock purchase warrants to secure a $300,000. indebtedness (incurred by USAC because it could not raise sufficient capital through sale of stock), they must be compelled to account to Agau for that profit. This argument pre-supposes that defendants did in fact so misuse corporate assets; however, the record reveals substantial evidence to support the Vice-Chancellor's conclusion that there was no misuse of either Agau personnel or warrants. Issuance of the warrants in fact enhanced the value of Agau's option at a time when there was reason to believe that USAC's antimony properties had a "considerable potential", and plaintiff did not prove that alleged use of Agau's personnel and equipment was detrimental to the corporation.

    21

    [221] Nevertheless, our inquiry cannot stop here, for it is clear that the individual defendants stood on both sides of the transaction in implementing and fixing the terms of the option agreement. Accordingly, the burden is upon them to demonstrate its intrinsic fairness Johnston v. Greene, Del.Supr., 35 Del.Ch. 479, 121 A.2d 919 (1956); Sterling v. Mayflower Hotel Corp., Del.Supr., 33 Del.Ch. 293, 93 A.2d 107 (1952); Gottlieb v. Heyden Chemical Corp., Del.Supr., 33 Del.Ch. 82, 90 A.2d 660 (1952); David J. Greene & Co., v. Dunhill International, Inc., Del.Ch., 249 A. 2d 427 (1968). We agree with the Vice-Chancellor that the record reveals no bad faith on the part of the individual defendants. But that is not determinative. The issue is where the 800,000 restricted investment shares of Agau stock, objectively, was a fair price for Agau to pay for USAC as a wholly-owned subsidiary.[2]

    22
    A.
    23

    Preliminarily, defendants argue that they have been relieved of the burden of proving fairness by reason of shareholder ratification of the Board's decision to exercise the option. They rely on 8 Del.C. § 144(a)(2) and Gottlieb v. Heyden Chemical Corp., Del.Supr., 33 Del.Ch. 177, 91 A. 2d 57 (1952).

    24

    In Gottlieb, this Court stated that shareholder ratification of an "interested transaction", although less than unanimous, shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or waste of corporate assets. Also see Saxe v. Brady, 40 Del.Ch. 474, 184 A.2d 602 (1962). The Court explained:

    25
    "[T]he entire atmosphere is freshened and a new set of rules invoked where formal approval has been given by a majority of independent, fully informed [share]holders." 91 A.2d at 59.
    26

    The purported ratification by the Agau shareholders would not affect the burden of proof in this case because the majority of shares voted in favor of exercising the option were cast by defendants in their capacity as Agau shareholders. Only about one-third of the "disinterested" shareholders voted, and we cannot assume that such non-voting shareholders either approved or disapproved. Under these circumstances, we cannot say that "the entire atmosphere has been freshened" and that departure from the objective fairness test is permissible. Compare Schiff v. R. K. O. Pictures Corp., 37 Del.Ch. 21, 104 A.2d 267 (1954), with David J. Greene & Co. v. Dunhill International, Inc., supra, and Abelow v. Symonds, 40 Del.Ch. 462, 184 A.2d 173 (1962). In short, defendants have not established factually a basis for applying Gottlieb.

    27

    Nor do we believe the Legislature intended a contrary policy and rule to prevail by enacting 8 Del.C. § 144, which provides, in part:

    28
    (a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors [222] or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if:
    29
    (1) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board of committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or
    30
    (2) The material facts as his relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or
    31
    (3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee, or the shareholders.
    32

    Defendants argue that the transaction here in question is protected by § 144(a)(2)[3] which, they contend, does not require that ratifying shareholders be "disinterested" or "independent"; nor, they argue, is there warrant for reading such a requirement into the statute. See Folk, The Delaware General Corporation Law — A Commentary and Analysis (1972), pp. 85-86. We do not read the statute as providing the broad immunity for which defendants contend. It merely removes an "interested director" cloud when its terms are met and provides against invalidation of an agreement "solely" because such a director or officer is involved. Nothing in the statute sanctions unfairness to Agau or removes the transaction from judicial scrutiny.

    33
    B.
    34

    Turning to the transaction itself, we note at the outset that from the time the option arrangement was conceived until the time it was implemented, there occurred marked changes in several of the factors which formed the basis for the terms of the exchange. As of the critical date, the market value of Agau shares had risen and shares were being traded at about $3.00 per share; thus, while initially the maximum discounted market value of the 800,000 was considered to be $500,000, by the time in question it was $1.2 million. Development expenses, originally anticipated to range from $250,000.-$500,000., but as actually incurred, were towards the lower end of that scale. Further, while only equity investment was anticipated as the means of raising the capital to finance exploration and development, an original subscriber for 1,500 shares for $250,000. cancelled his subscription and USAC found itself unable to obtain sufficient capital through sale of stock; thus it was forced to borrow $300,000., the debt being secured by USAC property as well as by Agau stock purchase warrants.[4] It also appears that only $83,000. in cash was actually received through sales of stock.

    35

    [223] On the basis of these changed conditions and in light of the fact that the exchange price was originally calculated simply to reimburse the USAC shareholders for their costs, plaintiff argues that the issuance of 800,000 shares of Agau stock, having a market value of at least 1.2 million dollars, to acquire a corporation in which only $83,000 in cash had been invested, and whose property was subject to loans of $300,000, is patently unfair.

    36

    The difficulty with this argument for purposes of the fairness test is that it impermissibly attempts to equate and compare two different standards of value (if indeed USAC's debt/equity ratio is a standard of value) in order to demonstrate the inadequacy of the consideration Agau received. See Sterling v. Mayflower Hotel Corp., supra. In fact, a reference to market sales of the stock involved, might support a finding of fairness. It appears that, although USAC was closely held, there was one arms-length sale of 75 USAC shares to non-affiliated investors for $160. per share. At this rate, the value of the 10,000 USAC shares would be 1.6 million, $400,000. more than the value of the shares given up by USAC. Furthermore, the market value of Agau's stock, even discounted, is an unrealistic indicator of the true value of what Agau gave up as it was clearly inflated due to Agau's possession of the option to acquire USAC whose properties were increasing in value largely as a result of the time and efforts expended by the individual defendants. As stated by the Vice-Chancellor:

    37
    "Thus, I think it is without question that if Lawrence and the other defendant shareholders of USAC had not granted the option to Agau, the value of the consideration originally established would not have risen. In other words, the very fact that Agau had the option increased the value of the consideration it was committed to give in the event it chose to exercise it, and this, in turn, was due to the fact that as USAC continued its efforts it became increasingly obvious that it had something that Agau would want to acquire."
    38

    The book value of 800,000 Agau shares reinforces this conclusion. Saleable assets (at cost less depreciation) less liabilities (excluding accrued salary due Lawrence) yielded an equity totaling about $113,000. On this basis, the 800,000 shares, which when issued represented a 28.6% interest in the corporation,[5] thus had a value of about $32,000. In this sense, Agau paid little; but, USAC's book position was no better, with assets and liabilities about equal. This comparison, however, is likewise unrealistic for it ignores the true value of USAC's most valuable asset, the antimony properties themselves. While the properties were carried on the books at cost ($60,000.), the record indicates their value was considerably higher. In late 1969 or early 1970, when the properties were still considered to be a "raw prospect", USAC received two offers (subsequently confirmed in writing) of $200,000. for a 50% interest in the properties and their future development and yield. Further, Lawrence, a qualified expert, testified that in his opinion, the properties had a net value of between 3.5-70 million dollars as of August 31, 1970.

    39

    Viewing the two corporations as going concerns from the standpoint of their current and potential operational status presents a clearer and more realistic picture not only of what Agau gave up, but of what it received.

    40

    Agau was organized solely for the purpose of developing and exploring certain properties for potentially mineable gold and silver ore. The bulk of its cash, raised through a public offering, had been expended [224] in "Phase I" exploration of the properties which failed to establish a commercial ore body, although it did reveal "interesting" zones of mineralization which indicated to Lawrence that "Phase II" development and exploration might eventually be desirable. However, plans for further development had been temporarily abandoned as being economically unfeasible due to Agau's lack of sufficient funds to adequately explore the properties, as well as to the falling market price of silver. It further appears that other than a few outstanding unexercised stock purchase warrants, Agau did not have any ready sources of capital. Thus, as the Vice-Chancellor found, had the option not been exercised, Agau might well have gone out of business.

    41

    By comparison, the record shows that USAC, while still considered to be in the exploratory and development stage, could reasonably be expected to produce substantial profits. At the time in question, the corporation had established a sizeable commercial ore body, had proven markets for its product, and was in the midst of constructing a major ore separation facility expected to produce a high grade ore concentrate for market.

    42

    An admittedly "conservative" report submitted in June, 1970, by Pennebaker, an independent geologist retained by USAC, confirmed the presence of a sizeable ore body and projected for the corporation a three-year net pre-tax profit of $660,000. after deducting all costs from ground to market including property payments, a complete return of the capitalized construction costs of the ore separation facility and $120,000 per year for further exploration and development.[6] Without allowing for capital return and exploration and development costs, he projected a three-year profit of $1,357,500. He noted further that his projections were based on only 50% recovery by the proposed separation facility; the remaining 50% not thereby recovered would be recoverable at a later date by another facility planned to be constructed for this purpose. Likewise a metallurgy report by defendant Snyder, projected a sizeable positive cash flow once production got underway.

    43

    The record does suggest that if the properties were to be immediately profitable, the market value for antimony would have to remain relatively high; however, Pennebaker, after noting this potential problem, stated that he was encouraged by the long-term purchaser offers USAC had already received and accordingly concluded that USAC should proceed with the plant construction as planned. Further, Lawrence stated that any mining venture is by its very nature speculative in that its success or failure largely depends upon the whims and vagaries of the metals market. It appears that at the time in question, consumption and demand for domestic antimony were rising.

    44

    The only evidence offered by plaintiffs on the fairness question consisted of Agau's annual reports for the years 1971 and 1972, and a 1973 proxy statement. These documents are immaterial to the issue before us since we are concerned only with the situation as it existed at the time of the transaction. Johnston v. Greene, supra.

    45

    Considering all of the above factors, we conclude that defendants have proven the intrinsic fairness of the transaction. Agau received properties which by themselves were clearly of substantial value. But more importantly, it received a promising, potentially self-financing and [225] profit generating enterprise with proven markets and commercial capability which could well be expected to provide Agau at the very least with the cash it sorely needed to undertake further exploration and development of its own properties if not to stay in existence. For those reasons, we believe that the interest given to the USAC shareholders was a fair price to pay. Accordingly, we have no doubt but that this transaction was one which at that time would have commended itself to an independent corporation in Agau's position.

    46

    Affirmed.

    47

    [1] Antimony is a metallic element used in a wide variety of alloys, especially with lead in battery plates, and in the manufacture of flame-proofing compounds, paints, semiconductors and ceramic products.

    48

    [2] The date at which this transaction must be scrutinized for intrinsic fairness is critical to the resolution of this question. We agree with the Vice-Chancellor that as of January 28, 1970, when the option was formally executed, that the transaction was one which would have commended itself to an independent corporation in Agau's position. Johnston v. Greene, supra. However, we are not concerned so much with Agau's acquisition of the option, but rather with the exercise thereof and implementation of its terms. In other words, the focus must be on the actual exchange of Agau's stock for USAC's stock and the test is whether that which Agau received was a fair quid pro quo for that which it had to pay. Since that exchange did not and could not, in fact occur until shareholder approval had been given in October, 1970, we must examine the transaction as of that point in time.

    49

    [3] They also argue that since defendant-director Dawson was not "interested" and since he approved acquiring the option, the transaction falls under the protection of § 144(a)(1). However, Dawson, who was the only disinterested director, did not participate at the Board meeting in which it was resolved to exercise the option; and it is with that decision which we are now concerned.

    50

    [4] These warrants apparently were demanded by the lenders because of Agau's option rights in USAC and were issued after the Agau Board of Directors had resolved that the option be exercised.

    51

    [5] Prior to the exchange, there were approximately two million shares outstanding. Adding to that the 800,000 shares paid to defendants, their consequential share was 800,000/2,800,000, or 28.57%.

    52

    [6] We note here that while Agau did take USAC subject to a $3000,000 long-term debt, the loan proceeds were used in part to pay off the balance due on USAC's lease-option on the properties and to finance construction of the ore separation facility; and as indicated above, these expenditures were anticipated to be recovered through before-profit product sale receipts. In other words, it was apparently anticipated that the loans would be paid off from gross product income.

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