SCHIFF et al.
RKO PICTURES CORP. et al.
Stockholders' class action to enjoin corporate defendant from accepting an offer of a single stockholder to purchase its assets. The Court of Chancery, Seitz, Chancellor, held, inter alia, that evidence of stockholders was insufficient to show that the proposed sale of assets was tainted with bad faith, or that the purchase price was grossly inadequate.
Judgment for defendant.
No service of process
was made on the other defendants.
[34 Del.Ch. 330] Herbert L. Cobin, Wilmington, Harry. J. Halperin, Samuel L. Scholer, and Edmund B. Hennefeld (of Halperin, Natanson, Shivitz & Scholer), New York City, and Bernard Buchwald (of Hoffman, Bondi, Buchwald & Hoffman), New York City, for plaintiffs.
Russell J. Willard (of Hastings, Stockly & Walz), Wilmington, Israel Beckhardt and Louis C. Fieland, New York City, for Sidney Schwartz, intervening plaintiff.
William S. Potter and Richard F. Corroon (of Berl, Potter & Anderson), Wilmington, Ralston R. Irvine, Roy W. McDonald and Thomas K. Fisher (of Donovan, Leisure, Newton, Lumbard & Irvine), New York City, for defendant RKO Pictures Corp.
Robert C. Barab, Wilmington, and Nemerov & Shapiro, New York City, for Milton Friedman, intervening defendant.
[34 Del.Ch. 331] SEITZ, Chancellor.
This is a stockholders' class action to enjoin the corporate defendant from accepting an offer to purchase its assets, and also for the appointment of a receiver. The court was so pressed for a quick decision that it did not have time to write a short opinion.
By letter, dated February 7, 1954, Howard R. Hughes, chairman of the board of RKO Pictures Corporation (hereafter called ‘ RKO’ ), offered to purchase all of RKO's assets of every kind including claims and causes of action against any person including Hughes for the sum of $23,489,478. Actually RKO is a holding company but since it operates through wholly owned subsidiaries, all parties agree that we should consider the assets as though they were all held by RKO.
The more important terms and conditions of the offer must be here stated. It had to be accepted by the directors on or before February 15, 1954, approved by the affirmative vote of a majority of the stock, other than that owned by Hughes, not later than March 31, 1954, and also approved by a majority of all of the outstanding stock. The transfer of the assets was to be consummated not later than 10 a. m. on April 2, 1954. In his letter, Hughes as the owner of 1,262,120 shares of RKO stock, out of 3,914,913 shares outstanding, agreed to vote his stock to approve the acceptance of the offer and he further promised that at such stockholders' meeting he would vote his stock to reduce RKO's capital by paying $6 in cash per share for all shares other than his own tendered for redemption during the 60 day period following the adoption of the resolution or such longer period as the company's attorneys considered desirable. Hughes also proposed to undertake to protect the stockholders against any liability for corporate debts and he represented that there was no offer outstanding to him for the assets he offered to purchase.
Some of the history of RKO is appropriate background for the determination of this lawsuit. For many years prior to 1948, Radio-Keith-Orpheum Corporation was a successful producer, distributor and exhibitor of motion pictures. In that year the defendant Hughes acquired approximately 30% of the outstanding stock. In 1950, as a result of Federal Anti-Trust action, Radio-Keith-Orpheum was split into two corporations:
[34 Del.Ch. 332] 1. The defendant RKO, which retained the production and distribution end of the business, and
2. RKO Theatre Corporation, which acquired the exhibition end.
In 1948-the year Hughes became a 30% stockholder-Radio-Keith-Orpheum commenced losing money and lost over $5,000,000 a year for the three following years. After the division in 1950, RKO operations resulted in losses of $600,000 in 1951, about $10,000,000 in 1952, and about $4,500,000 for 1953. The experience so far in 1954 demonstrates a probable loss for this year of between $6,000,000 and $7,000,000. Indeed, the credible testimony is that other future losses are probable.
After Hughes bought his substantial stock interest in 1948, he became responsible for the production end of the business. In 1952, Hughes contracted to sell his stock to a Chicago syndicate. He received a down payment and the Board resigned and the syndicate took over and new directors were appointed. For reasons not here important the syndicate did not complete the transaction and forfeited the down payment to Hughes. The new Board resigned and the previous board was then reelected.
Shortly thereafter, certain stockholders of RKO commenced actions against Hughes and the other directors seeking to recover the money realized by Hughes on the syndicate transaction and seeking an accounting for waste and mismanagement. Certain of the plaintiffs in such actions were the Castlemans who commenced actions in New York, California and Nevada. Hughes and the other directors of the corporation all voluntarily appeared in the Nevada action. They were not served nor did they appear in the other cases.
In August 1953, the present plaintiffs commenced a derivative action in New York against RKO, Hughes and the other directors for waste and mismanagement, claiming damages of $38,500,000. The defendant Hughes was never served in the New York action. The defendant RKO sought a stay of the trial of the New York action because the Nevada trial of similar issues was about to commence. But plaintiffs opposed the stay on the ground that the [34 Del.Ch. 333] Nevada action was not being prosecuted in good faith. The Appellate Division of the New York Supreme Court on January 27, 1954, denied the stay without passing on the merits of the grounds relied upon by the parties.
Then on February 7 came the Hughes' offer. On February 11, Hughes moved in the Nevada Court for dismissal of that action with prejudice on the ground that he, by purchasing RKO's assets, would acquire the cause of action against him and the other defendants. It may be noted that this motion was made prior to the date when the directors met to act on the Hughes' offer.
The Board of Directors of RKO met in Atlanta, Georgia, to act on the Hughes' offer. It convened on February 12, and directors Walker and Simpson resigned. Immediately thereafter, Clark, Van Wagner, Boasberg and Walton were elected directors. These men were all officers and employees of RKO. The remaining directors at the time were Dietrich, Grainger, and Hughes. Dietrich and Hughes were not present and Grainger retired from the meeting before they considered the offer. The personnel changes in the board were made at the suggestion of RKO's counsel to get a majority who were not defendants in any then pending actions. These meetings lasted on the 12th from 2:30 until 6 p. m. and from 8:30 until about 11 p. m. and continued on February 13, from 9 a. m. to final adjournment about 11 a. m. The directors present concluded that the
Hughes' offer was fair and should be accepted and recommenced to the stockholders.
The stockholders met on March 18 and voted on the question of the acceptance or rejection of the Hughes' offer. 3,358,116 shares were voted out of a total of 3,891,526 shares outstanding and entitled to vote. There were 3,914,913 shares outstanding. With the Hughes' shares included there were 3,284,889 shares voted for and 73,227 shares against the acceptance of the offer. Excluding the Hughes shares, 2,022,769 shares were voted for and 73,227 against the offer. It thus appears that a majority of all of the outstanding stock voted in favor of accepting the Hughes' offer even when we exclude the shares voted by Hughes.
[34 Del.Ch. 334] On February 16 this action was commenced against RKO and the board members including the two who resigned at the Atlanta meeting. Only RKO was served with process and the case was tried between March 8 and 11, with the record left open to receive the result of the stockholders' vote at the meeting called for March 18.
Plaintiffs' contentions may be outlined as follows:
1. Hughes dominated and controlled the board of directors that approved the acceptance of his offer; RKO therefore has the burden of showing the fairness of the transaction and this burden is not shifted because of the approval of the acceptance by the holders of a majority of the shares outstanding, without counting the Hughes' shares.
2. Whether RKO has the burden or whether plaintiffs have the burden, the offer is so grossly inadequate as to justify a finding of constructive fraud.
3. The proxy statement contains such false and fraudulent matters that stockholder action induced thereby should be considered meaningless.
4. The sale of assets is tainted with bad faith.
At the conclusion of the trial the intervening plaintiff joined with the corporate defendant and the intervening defendant in urging that the offer was fair by any standard and that no bad faith was shown.
Before considering specific contentions of the plaintiffs, it is desirable to state certain general principles which I believe are here operative. This is a proposed sale of assets under 8 Del.C. § 271. While a part of the Hughes' offer was the expression of an intention to vote his shares to cause RKO to redeem shares for $6 per share (which resolution was also passed on March 18), to give particular weight to the contrast between this $6 per share and the market price of about $3 per share prior to the Hughes' offer, is to misconceive the issue. As noted and obviously approved by the Chancellor in his reasoning in Allied Chemical & Dye Corporation v. Steel & Tube Co. of America, 14 Del.Ch. 1, 120 A. 486, the market price on the [34 Del.Ch. 335] stock exchange is not a reliable criterion of the true value of corporate property. I consider RKO's market price to be of minor importance in resolving the issue here.
On the other hand, in connection with the valuation of assets for purpose of sale under the statute, the earning record made by the selling corporation and future prospects based on the use of such assets by the selling corporation and by prospective purchasers are pertinent and important factors. The Chancellor so held in his second opinion in Allied Chemical & Dye Corporation v. Steel & Tube Co. of America, 14 Del.Ch. 64, 122 A. 142. The various pertinent considerations are discussed in that opinion and in applying them, I shall only add that in the final analysis they require the appropriate officers to apply honest and intelligent business judgment standards in discharging their statutory duty.
Burden of Proof
Against this background I consider plaintiffs' first contention that the offeror
Hughes so dominated and controlled the board that the burden of showing the fairness of the transaction is upon the defendant RKO and did not shift back to the plaintiffs because of any stockholder approval.
A preliminary objection by plaintiffs must be considered. They say the court should not have held the case open to receive the stockholders' vote. I cannot agree. The stockholders' approval was part of the bargain and in fact, there would be no case without such vote. I think it proper evidence to await, to receive and to consider.
The transaction here attacked was approved by vote of a majority of all of the outstanding stock without counting the shares owned by the offeror Hughes. The pendency of this action was noted in the proxy statement and in fact the trial was completed a week prior to the stockholders' meeting with leave granted RKO to supplement the record by including the stockholders' vote. Also, plaintiffs were afforded the opportunity to introduce any further evidence they desired in connection with the stockholders' vote, but they chose not to do so.
[34 Del.Ch. 336] Passing by for the moment the objection that the stockholders were not fully informed, I therefore assume and conclude for present purposes that the Hughes offer was approved by a legally disinterested group of stockholders owning a majority of all of the outstanding shares. Thus sufficient shares were voted in favor of the offer to meet the statutory requirement without counting the Hughes' stock. This being so, it seems to me that even assuming that, otherwise, RKO would have the burden of showing the fairness of the transaction on the theory that the purchaser Hughes dominated and controlled the board of directors, nevertheless, the independent majority stockholder approval has the effect of shifting that burden back to the plaintiffs. The approach was announced by the Delaware Supreme Court in Gottlieb v. Heyden Chemical Corp., 91 A.2d 57, 58, in the following language:
‘ Where the directors have represented both themselves and the corporation, and where there was no ratification by stockholders, and the action is thereupon duly challenged, the court will usually have no choice but to employ its own judgment in deciding the perhaps very close and troublesome questions as to whether the evidence shows that the directors in fact used the utmost good faith and the most scrupulous fairness. Where there was stockholder ratification, however, the court will look into the transaction only far enough to see whether the terms are so unequal as to amount to waste, or whether, on the other hand, the question is such a close one as to call for the exercise of what is commonly called ‘ business judgment’ . In the former case the court will reverse the decision of the stockholders; in the latter it will not.'
For purpose of considering the Gottlieb principle, I shall assume that where it appears that the purchaser in fact dominates and controls the board of the selling corporation then those espousing the transaction would have the burden of showing its fairness absent independent stockholder approval. It is true that the Gottlieb case involved a stock option and that the Delaware statute authorizing options does not explicitly call for both director and stockholder approval, as does the sale of assets statute. However the stock option [34 Del.Ch. 337] plan in the Gottlieb case required both and so the principles announced by the court would seem equally applicable.
Because of the stockholder vote, I conclude that plaintiffs to be successful have the burden of showing that the disparity between the money received and the value of the assets sold is so great that the court will infer that those passing judgment are guilty ...