Hypo: board service? | Holger Spamann | December 07, 2017


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Hypo: board service?

Therein of Meinhard v. Salmon (NY 1928).

Imagine you are the in-house lawyer for a real estate developer, Rosalind Franklin Broes. Broes is doing business through RFB Condominiums Inc. ("RFBC"), a Delaware corporation. Broes is RFBC’s sole shareholder and president. You are technically an employee of RFBC. RFBC develops and administers condo complexes in the Midwestern United States, mainly in Michigan.

Broes now wants your opinion on the following issue. One of RFBC’s bankers, John Cash of Big Bank, has asked Broes to join the board of another real estate developer, CIS Inc., also a Delaware corporation. CIS is an erstwhile competitor of RFBC. It has been in chapter 11 for the last two years, however, and lost or sold most of its properties and contracts during that time. When it emerges from bankruptcy next month, it will only have interests in Texas. Cash sits on CIS’s creditor committee on behalf of Big Bank, a major creditor of CIS. Cash would like to get Broes’s experience onto CIS’s board.

Broes is concerned that service on CIS’s board will expose her to conflicts of interest. She has shared these concerns with Cash. In Cash’s view, the concerns are unfounded. After all, he, Cash, also has access to much confidential information from both CIS and RFBC in his role as their banker. Besides, he argues, CIS and RFBC will no longer be operating in the same areas. Lastly, even if CIS wanted to expand back into the Midwest, Cash points out that CIS would find it very difficult to do so under the restrictive post-bankruptcy loan covenants that prohibit most acquisitions or additional financing.

Broes is still worried though. She looked around the internet, and what she found did not reassure her. The most famous description of the duty of loyalty sounds rather ominous to her. It was penned by Judge Benjamin Cardozo, then Chief Judge of the New York Court of Appeals, in Meinhard v. Salmon, 249 N.Y. 458 (1928):

“Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of 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.”

Broes says she definitely does not want to sink to the “level . . . trodden by the crowd,” but she isn’t quite sure what “the punctilio of an honor the most sensitive” demands of her. Can she or can she not serve on CIS’s board without getting into trouble? What would you advise Broes to do?


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December 07, 2017

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