ADKINS, J.
These appeals involve two lawsuits, which include a derivative claim and a direct shareholder action, both arising from a series of stock transactions in a family business owned primarily by eight siblings. Out of those siblings, three brothers served as directors and officers of two family corporations, while the other five siblings were not actively involved in their management. After the death of one of the sisters, the corporations attempted to repurchase her stock pursuant to the terms of a Stock Purchase Agreement. The sister's estate refused on the grounds that the Agreement grossly undervalued the estate's shares. The corporations filed a declaratory judgment action, seeking enforcement of the Stock Purchase Agreement, and named the other, non-director
Meanwhile, the non-director siblings had learned of an earlier stock transaction in which the three directors had acquired additional corporate stock for themselves. Aggrieved by this transaction, two of the non-director siblings sent a demand for litigation to the corporation, and shortly thereafter filed a derivative action in the Circuit Court for Montgomery County, alleging self-dealing and a breach of fiduciary duty.
In response, the corporations appointed a special litigation committee ("SLC"), consisting of two newly hired "independent directors," to examine the claims. After an extended study, the SLC issued a report concluding that the stock transactions were legitimate and that the Stock Purchase Agreement was enforceable. The Circuit Court, deferring to the judgment of the SLC, granted summary judgment in favor of the corporations on the derivative action. In the declaratory judgment proceeding, the Circuit Court, relying on res judicata, dismissed the cross-claims and granted summary judgment to the corporation.
On appeal in the derivative action, the Court of Special Appeals upheld the Circuit Court's grant of summary judgment, agreeing that the SLC's report resolved that matter. The two non-director siblings sought certiorari from this Court, which we granted. See 417 Md. 500, 10 A.3d 1180 (2010). At the same time, we granted certiorari in the declaratory judgment action, which had been pending in the Court of Special Appeals. The questions presented for review in these two cases are as follows, rephrased for brevity and clarity:
In the derivative action (Circuit Court Case # 282138-V, Appellate No. 123), we shall reject the Petitioners' suggestion that Maryland courts should apply their "independent business judgment" and review the SLC's substantive conclusions. Instead, we shall adhere to the business judgment rule as applied in Auerbach and limit the judicial investigation of an SLC report to the issues of whether the SLC was independent, acted in good faith based on facts, and followed reasonable procedures. Even under this more limited inquiry, however, we shall reverse the Circuit Court, as the court made an inadequate inquiry into the SLC's independence and the reasonableness of its procedures.
In the declaratory judgment action, (Circuit Court Case #273284-V; Appellate No. 123) we shall affirm the Circuit Court's grant of summary judgment to the Respondents on the contract issue, because we agree that the Stock Purchase Agreement in this case was supported by adequate consideration and was enforceable. We shall, however, reverse the Circuit Court's grant of summary judgment with regard to Petitioners' cross-claims (the direct action). The court based its summary judgment solely on the grounds that the Petitioner's cross-claims were barred by the doctrine of res judicata because of its resolution in the derivative action. As we explain below, the resolution of a derivative claim is not necessarily a factual resolution of the merits of the claim, and the Petitioners stated a separate, individual cause of action regarding allegedly oppressive actions by the majority shareholders.
In the early 1960s, Louis Boland Sr., the patriarch of the Boland family, entered into a franchise agreement with the Trane Company to be its exclusive sales agent in the greater Washington, D.C., market. Boland established Boland Trane Associates ("BTA"), to sell and distribute Trane's heating, ventilation, and air conditioning equipment, and Boland Trane Services, Inc. ("BTS"), to handle services and repairs.
During the 1960s, Boland
Under the new management, BTS and BTA continued to be profitable. In 2004, the corporations issued almost $5 million in dividends to the shareholders, and in 2005, the dividends increased to almost $6 million.
The dispute centers on a series of stock transactions, the first of which was a corporate repurchase of Mrs. Boland's stock. After Mr. Boland's death, Mrs. Boland owned a 20 percent share in BTS. Seeking to reduce her eventual estate for tax purposes, and to secure a more stable source of income, Mrs. Boland negotiated with BTS to exchange her stock in return for the purchase of an annuity. On June 25, 2004, she sold her holdings in BTS back to the corporation, and the corporation purchased her an annuity which provided a monthly payment of $28,544.70 for life.
After the repurchase of Mrs. Boland's stock, the director siblings designed a series of stock purchases that would give them an increased share in BTA and BTS. First, in January 2005, BTS approved a sale of 75,075 shares to Sean's son, Sean Jr., and 151,150 shares to James, all at the price of $2.16 per share.
After these transactions, the Directors and Sean Jr. all had an increased ownership in the corporations. Sean Jr., who previously owned no stock in either corporation, now held just under 2 percent in each company. James increased his share of BTS by approximately 3 percent, and his share in BTA by 14 percent. Louis Jr. and Lawrence Cain each increased their share in BTA by approximately 7 percent. The boards approved the stock sales, retroactively,
The Board's stated purpose in approving these transactions was to compensate the corporations' directors and to increase their management share to a level comparable to similar corporations. The Board recognized a "need for management incentives for both short-term financial results as well as long-term growth of shareholder value[,]" and "acknowledged [that] it was most desirable to continue the employment of the [Directors] and adequately compensate them for their efforts and reward them for their accomplishments." In order to accomplish these goals, "the Board agreed it was critical that the compensation plan include an appropriate ownership interest in the Corporation's stock."
The Boards structured the payments for these stocks in a way that required no money up front. Instead, in exchange for the stocks, the recipients gave promissory notes with nine-year terms and a set interest rate. At the rate the corporations were issuing dividends, these newly issued stocks would eventually pay for themselves.
The directors' stock purchases came to the attention of the non-director siblings, specifically John and Kevin, in June 2005.
Colleen died on June 7, 2006, and the corporations sent notice of their intention to repurchase the stocks on June 16, 2006. The valuation of her stock, pursuant to the stock purchase agreement, was significantly lower than some estimations of its market value. Upset at the low valuation of the stock, Colleen's personal representative resisted the corporations' attempts.
On July 19, 2006, the Respondents filed a complaint for declaratory judgment, seeking to enforce the repurchase provisions in Colleen's SPA, naming all the Boland siblings as defendants/interested parties.
Ten months later, on May 1, 2007, John and Kevin responded on two fronts. First, they filed a cross-claim in the corporation's
Maryland courts have distinguished between direct and derivative claims by looking at the nature of the right claimed to be violated, and the remedy sought. In Shenker v. Laureate Educ., Inc., 411 Md. 317, 983 A.2d 408 (2009), for example, the shareholders brought claims after the corporation approved a cash-out merger, alleging that the directors "violated the fiduciary duties of candor and maximization of value" resulting in "a lesser value that shareholders received for their shares in the cash-out merger[.]" Id. at 346, 983 A.2d at 425. We held that claim to be direct, as the fiduciary claims were "based on a breach owed directly to the shareholder[,]" and the injury was "suffered solely by the shareholders and not by [the] corporate entity. . . . A higher or lower price received by shareholders for their shares in the cash-out merger in no way implicated [the corporation's] interests and causes no harm to the corporation." Id., 411 Md. at 346-47, 983 A.2d at 425.
More generally, we have recognized the fundamental differences between a direct claim and a derivative claim. The derivative suit involves a corporate right, a distinction underlying many of the derivative action's peculiar procedures and standards of review. See, e.g., Werbowsky v. Collomb, 362 Md. 581, 600, 766 A.2d 123, 133 (2001) ("The fact that the action is on behalf of the corporation, rather than the shareholder, has significant implications, not the least of which is the extent to which the corporation can control the litigation after it is filed."); see also Shenker, 411 Md. at 344, 983 A.2d at 424 ("In a derivative action, any recovery belongs to the corporation, not the plaintiff shareholder."); 12B William Meade Fletcher, et al, Cyclopedia of the Law of Private Corporations § 5921 (2009 Rev. Vol.) ("A shareholder may sue as an individual where the act complained of creates not only a cause of action in favor of a corporation but also creates a cause of action in favor of the shareholder as an individual . . . and under certain circumstances, even if the shareholders are unable to get relief on behalf of
One advantage a derivative action has for the shareholder is that the expenses of the litigation, if successful, may be borne by the corporation, not the shareholder: "In direct, as opposed to derivative actions, each side will normally be responsible for its own legal expenses. Costs and expenses of bringing a successful derivative action are usually available for the plaintiff-shareholder, and some jurisdictions may provide by statute for the recovery of attorney's fees in derivative actions." Fletcher, supra, at § 5938. In Maryland, recovery of attorney's fees is permitted under the "common fund" doctrine. See, e.g., Hess Constr. Co. v. Board of Educ., 341 Md. 155, 168, 669 A.2d 1352, 1358 (1996) (observing that the common fund theory, allowing reasonable recovery of fees for a successful plaintiff, is allowed "where a stockholder's derivative action benefitted all of the shareholders") (citing Davis v. Gemmell, 73 Md. 530, 21 A. 712 (1891)).
The "direct" claim alleged by John and Kevin is that the majority shareholders oppressed them and threatened to squeeze them out of the company. In Edenbaum v. Schwarcz-Osztreicherne, 165 Md.App. 233, 885 A.2d 365 (2005), Judge Krauser described a similar claim of oppression:
Id. at 255-56, 885 A.2d at 377-78. The "direct" suit, alleging oppression, requested dissolution of the corporations, and any recovery would have run directly to John and Kevin.
The derivative suit, on the other hand, alleged injury to the corporation. At oral argument, the Petitioners asserted that, because of the stock purchases by the
The two cases were consolidated by the Circuit Court on June 6, 2007.
The corporations appointed two outside, independent directors to the Special Litigation Committee, at a May 2007 meeting of the Boards of Directors. These new directors had no business relationship with the corporations. Each had significant experience in corporate matters.
The SLC investigated the issues presented in the derivative complaint, as well as an issue it apparently raised on its own: whether John and Kevin were "adequate shareholder representatives." The Court of Special Appeals summarized the SLC's investigation as follows:
Boland v. Boland, 194 Md.App. 477, 512-13, 5 A.3d 106, 127 (2010).
After this investigation, the SLC concluded that "none of the derivative claims have merit and the actions on behalf of the corporations should be terminated." The SLC first found that "each individual's salary is commensurate with his education, experience, position, and tenure with the company." The SLC also approved of the stock sales to the directors, stating as follows:
Then the SLC moved on to the issue of "adequate representation." The SLC concluded that John and Kevin were not adequate representatives of the shareholders:
The SLC concluded as follows:
The SLC submitted this report to the Circuit Court on February 1, 2008.
After the submission for the SLC's report, the Circuit Court severed the derivative action from the declaratory judgment action. In the severed derivative action,
On September 5, 2008, the Circuit Court denied the motion to dismiss.
Reviewing the SLC's procedure under this standard, the Circuit Court concluded that the SLC was independent, performed its duties in good faith, and made a reasonable investigation. Turning to the third step, the court analyzed whether the SLC made reasonable findings and conclusions on each individual count. The Circuit Court determined that the SLC's conclusion on the executive compensation was reasonable.
The corporations filed a motion for reconsideration, arguing that the Circuit Court erred in applying an "entire fairness" test, and that the court should instead adhere to the business judgment rule. Without a hearing, the Circuit Court issued (1) an order granting the motion for reconsideration, and (2) a memorandum opinion granting summary judgment.
The Circuit Court thus granted summary judgment on all counts.
After judgments against the plaintiffs in the derivative action, all that remained in the Circuit Court was the corporations' action for declaratory judgment, and John and Kevin's cross-claims and counterclaims, in Case # 273284-V.
The Court later agreed:
The Court concluded at the hearing that res judicata could apply and dismissed all of John and Kevin's "direct" claims, but it granted them leave to amend their complaints one final time to demonstrate an individual cause of action separate from the derivative claims.
After John and Kevin filed an amended Counter-Claim on May 12, 2009, the court held a hearing on July 30, 2009, to consider whether any could survive res judicata. The court again concluded that John and Kevin had failed to present distinct claims from the derivative action:
Having dismissed the direct claims of John and Kevin, the court finally turned to the dispute over the enforceability of the Stock Purchase Agreements. After a hearing, the court granted the Respondents' motion for summary judgment. Finding the SPAs to be "plain and unambiguous[,]" supported by consideration, and still valid despite Louis Sr.'s death, the court ordered Colleen's estate to abide by the redemption clause.
John and Kevin filed an appeal to the Court of Special Appeals, and while that action was pending we granted a writ of certiorari.
The first issue before the Court is the Circuit Court's grant of summary judgment
The common law tailored the derivative action to be a "justifiable, but limited, intrusion upon the general authority of the directors to manage the business affairs of the corporation." Werbowsky, 362 Md. at 602, 766 A.2d at 135. As an exception to the general rule that "the business and affairs of a corporation are managed under the direction of its board of directors[,]" the derivative action is an "extraordinary equitable device to enable shareholders to enforce a corporate right" in certain circumstances. Id. at 598-99, 766 A.2d at 133. "The purpose of the derivative action is to place in the hands of the individual shareholder a means to protect the interests of the corporation from the misfeasance and malfeasance of faithless directors and managers." Shenker, 411 Md. at 342, 983 A.2d at 423 (quotation marks and citations omitted). Despite the role given the shareholder, the "corporation is the real party in interest and . . . [t]he substantive claim belongs to the corporation[.]" Werbowsky, 362 Md. at 599-600, 766 A.2d at 133 (quoting 13 William Meade Fletcher, et al, Cyclopedia of the Law of Private Corporations, § 5941.10 (1995 Rev. Vol.)). The derivative suit thus balances the interests of the shareholders with those of the corporation and its directors.
The main levers with which the courts maintain this balance are varying levels of judicial scrutiny of corporate decisions. The default standard is the deferential business judgment rule, which insulates "the business decisions made by the director from judicial review[.]" Shenker, 411 Md. at 344, 983 A.2d at 424. The Delaware Supreme Court, in a popular formulation of the rule, described it as follows:
Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citations omitted), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del.2000); see also Della Ratta v. Larkin, 382 Md. 553, 579, 856 A.2d 643, 659 (2004) ("[T]he business judgment rule requires that the decision maker act in good faith and on an informed basis."). This standard recognizes that the "conduct of the corporation's affairs are placed in the hands of the board of directors and if the majority of the board properly exercises its business judgment, the directors are not ordinarily liable." Devereux v. Berger, 264 Md. 20, 31-32, 284 A.2d 605, 612 (1971) (quoting Parish v. Md. & Va. Milk Producers Ass'n, 250 Md. 24, 74, 242 A.2d 512, 540 (1968)).
This approach, where courts defer to corporate decisions generally, but inquire into the method, process, and self-interest of the decision makers, applies "to all decisions regarding the corporation's management." Shenker, 411 Md. at 344, 983 A.2d at 424 (citing NAACP v. Golding, 342 Md. 663, 673, 679 A.2d 554, 559 (1996)). In a derivative lawsuit, this includes a corporate decision on whether the case should proceed, as "any exercise of the corporate power to institute litigation and the control of any litigation to which the corporation becomes a party rests with the directors[.]" Werbowsky, 362 Md. at 599, 766 A.2d at 133. Thus, the common law developed a requirement that the derivative plaintiff, at the outset, seek a corporate decision on whether to maintain a lawsuit, a prerequisite known as the "demand requirement." See Waller v. Waller, 187 Md. 185, 192, 49 A.2d 449, 453 (1946) (observing that a stockholder must "allege and prove he requested the directors to institute suit in the name of the corporation, and they refused"); Shenker, 411 Md. at 343-44, 983 A.2d at 423 (describing demand requirement as one of "a number of procedural hurdles [the derivative plaintiff must overcome to] demonstrate that he or she, rather than the corporation itself, should control the litigation"). See generally Werbowsky, 362 Md. 581, 766 A.2d 123 (discussing changes in the demand requirement and the futility exception).
Shenker, 411 Md. at 344, 983 A.2d at 423-24.
Judicial review of a demand refusal is subject to the business judgment rule, and the court considering a demand refused action limits its review to whether the board acted independently, in good faith, and within "the realm of sound business judgment." See George Wasserman & Janice Wasserman Goldsten Family LLC v. Kay, 197 Md.App. 586, 611, 14 A.3d 1193, 1208 (2011) (citing Bender, 172 Md.
Of course, the reality is that many business dealings are approved by directors
A more disputed question is how rigorously a court should review that recommendation. One approach, commonly referred to as the Auerbach approach, after the case Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 393 N.E.2d 994 (1979), treats the SLC's decision like other corporate decisions, and engages in limited review under the business judgment rule. Another approach, known as the Zapata approach, after the Delaware case Zapata Corp. v. Maldonado, 430 A.2d 779 (Del.Supr.1980), provides an additional layer of scrutiny. In this appeal, Petitioners have criticized the Auerbach approach and requested this Court to adopt the Zapata approach instead. We discuss these two divergent approaches before considering the Petitioners' specific claims.
In Auerbach, shareholders of a corporation brought a derivative action regarding certain illegal foreign payments made by the corporation. See Auerbach, 419 N.Y.S.2d 920, 393 N.E.2d at 997. In response, the corporation appointed an SLC to consider the claims.
On appeal, the appellate court concluded that the SLC's decision fell under the business judgment rule, explaining that the "ultimate substantive decision . . . not to pursue the claims advanced in the shareholders' derivative actions . . . falls squarely within the embrace of the business judgment doctrine . . . [and] is outside the scope of our review." Id., 419 N.Y.S.2d 920,
Id., 419 N.Y.S.2d 920, 393 N.E.2d 994 at 1000. A more limited inquiry into methodologies and procedures, the court observed, was well within the domain of the judicial system:
Id., 419 N.Y.S.2d 920, 393 N.E.2d 994 at 1002. The Auerbach rule, like the business judgment rule generally, carves out a limited role of judicial review, and allows a "tainted" board of directors to reclaim the protection of the business judgment rule through the appointment of an SLC.
One year later, Delaware emerged with an alternative standard in the landmark Zapata case. As in Auerbach, the Zapata court considered the appropriate standard of review of an SLC's conclusion that a derivative lawsuit should be dismissed.
Id. at 788-89. In embracing involvement by the courts, the Zapata court "recognize[d] the danger of judicial overreaching" but further concluded that this independent review provided "the essential key in striking the balance between legitimate corporate claims as expressed in a derivative stockholder suit and a corporation's best interests as expressed by an independent investigating committee." Id. at 788-89. It further reasoned that review under the strict business judgment rule "would in the name of practicality and judicial economy foreclose a judicial decision on the merits," a result it found unnecessary and undesirable. Id. at 788.
In the aftermath of Zapata and Auerbach, courts reviewing motions to dismiss or for summary judgment were presented with two alternatives: Auerbach's adherence to the business judgment rule or Zapata's belief that the SLC process should be independently examined, on the merits, by the courts.
Many courts hewed to the business judgment rule, adopting a standard like that in Auerbach. See Roberts v. Alabama Power Co., 404 So.2d 629, 632, 636 (Ala. 1981) (rejecting Zapata
The Pennsylvania Supreme Court, in Cuker v. Mikalauskas, 547 Pa. 600, 692 A.2d 1042 (1997), strongly rejected Zapata, warning that allowing a court to apply "its own business judgment" was a "defect which could eviscerate the business judgment rule[.]" Id. at 1049. Instead, the Pennsylvania court adopted a standard in which, similar to the standard of Auerbach, courts avoided reviewing the substance of the SLC decision, and focused on the process:
Id. at 1048.
In contrast, some states have agreed with Delaware that the traditional business judgment rule does not suffice when reviewing a motion to dismiss a derivative complaint based on an SLC's report. North Carolina, for example, after temporarily adopting Auerbach's inquiry, changed course and endorsed the Zapata approach. Compare Alford v. Shaw, 318 N.C. 289, 349 S.E.2d 41, 52, 56 (1986) (adopting Auerbach approach), with Alford v. Shaw, 320 N.C. 465, 358 S.E.2d 323, 324 (1987) (withdrawing earlier opinion). In the later iteration of Alford, the court was swayed by concerns over the inadequacy of SLC investigations:
Id. at 326.
After Zapata, federal courts construing the state law of Connecticut, Georgia, Iowa, and Virginia applied a Zapata inquiry. See Joy v. North, 692 F.2d 880, 891 (2d Cir.1982) (concluding that Connecticut would adopt Zapata rule), superseded by statute, Conn. Gen.Stat. Ann. § 33-724; Peller v. Southern Co., 911 F.2d 1532, 1536, 1538 (11th Cir.1990) (concluding that Georgia would follow Delaware case law); Watts v. Des Moines Register & Tribune, 525 F.Supp. 1311, 1326 (S.D.Iowa 1981) ("[T]he Court is persuaded that the Iowa Supreme Court would apply the more stringent version of the deferential business judgment rule expounded by [Zapata]."); Abella v. Universal Leaf Tobacco Co., 546 F.Supp. 795, 797-800 (E.D.Va. 1982) ("The Court is persuaded that the Zapata approach adequately safeguards the competing interests at stake and that Virginia has no need for, nor would it follow, a more restrictive approach."). Maryland, however, has yet to definitively decide whether courts should follow Zapata or Auerbach.
Some courts have characterized the Auerbach standard as one of minimal scrutiny. For example, the Alford court characterized the Auerbach approach as a "slavish adherence to the business judgment rule" which necessarily requires "great deference" to the corporation. Alford, 358 S.E.2d at 326. In Abella, the court recognized the "relative ease with which a committee could construct a record of apparently diligent investigation after having predetermined the outcome of the investigation." Abella, 546 F.Supp. at 799. In Rosengarten v. Buckley, 613 F.Supp. 1493, 1500 (D.Md.1985), the district court, applying Maryland law, posited that the Auerbach approach "does not acknowledge the structural bias inherent in a system which allows directors to judge the actions of their fellow directors." Indeed, John and Kevin seemingly advance this view of the Auerbach approach, arguing that, without an independent Zapata inquiry, a court would "simply sign off on a litigation committee's decision," and warning that "legitimate complaints of minority shareholders will be subject to summary dismissal based upon reports from committees chosen by the accused without any reasonable judicial review." (Emphasis added).
Regarding the first prong of the Auerbach inquiry (the SLC's independence and good faith), judicial inquiry can involve an investigation of the SLC's composition and its members' relation to the director-defendants. Auerbach, 419 N.Y.S.2d 920, 393 N.E.2d at 1002-03 (stating that courts should examine the SLC's "disinterested independence" and "the adequacy and appropriateness of the committee's investigative procedures and methodologies"); Miller, 591 N.E.2d at 1343 (rejecting Zapata and limiting inquiry to whether "(1) the SLC is comprised of independent, disinterested trustees; (2) the SLC conducts its inquiry in good faith; and (3) the committee's recommendation is the product of a thorough investigation"); see also Hasan, 729 F.2d at 378 (describing that although Auerbach and Zapata "diverge on the issue of the judicial deference appropriate to the substantive business judgments of a special committee,
Examining cases that analyze an SLC's independence, we observe that the inquiry, although not substantive, can be rigorous. For example, in In re Oracle Corp. Derivative Litig., 824 A.2d 917 (Del. Ch.2003), the Delaware Court of Chancery
Id. at 938-41 (citations omitted).
Oracle exemplifies the "teeth" that the independence inquiry can have when there are significant questions regarding the SLC's relationship with the directors. The Oracle court, however, dealt with a particularly complex network of social influence and interaction. As a practical matter, we cannot expect as detailed and prolonged of a factual analysis from the trial court in every case.
Regarding the second prong of the Auerbach inquiry (the reasonableness of the SLC's methodology), the reviewing court inquires into the procedural aspects of the SLC's investigation:
Auerbach, 419 N.Y.S.2d 920, 393 N.E.2d at 1002-03.
Although this line of inquiry does not address the merits of the SLC decision, it can still set a high bar for the SLC. For example, in Peller v. S. Co.,
Peller, 707 F.Supp. at 529; see also Hasan, 729 F.2d at 380 (concluding that the investigation carried out by the SLC was "procedurally infirm" and thus not entitled to any deference).
As these cases demonstrate, courts applying a limited review of an SLC decision have been willing and able to find deficiencies in the SLC's process when appropriate. Accordingly, we believe that the proposition that a court must decide between a Zapata review and no review at all overlooks the most appropriate standard of review. Indeed, other courts employing the business judgment rule to SLC decisions have similarly concluded. In rejecting Zapata, the Alabama Supreme Court stated:
Roberts, 404 So.2d at 636. Similarly, the Miller court concluded:
Miller, 591 N.E.2d at 1343.
We further observe that some of Zapata's most fervent advocates have applied a "merits" review which could have adequately been accomplished under Auerbach's "procedural" review. For example, in Alford, the North Carolina Supreme Court, in adopting Zapata and reversing the trial court's grant of a motion to dismiss a derivative complaint, remanded to the trial court with instructions that it follow the following procedure:
Alford, 358 S.E.2d at 328. In this passage, the Alford court thus identified the need to inquire into (1) the qualifications of the committee, (2) the adequacy of their investigation and the accuracy of information provided, and (3) any structural bias built into the SLC appointment process. Although purporting to be a Zapata inquiry, the inquiry actually ordered by the Alford court is merely a thorough version of the procedural inquiry under Auerbach.
Given the level of scrutiny attainable under an inquiry into the SLC's independence and methodology, we are not persuaded by the pronouncement of some courts that adherence to the business judgment rule is wholly inadequate to protect shareholders rights. Instead, we conclude that a procedural review under the business judgment rule, although clearly the more deferential standard, nonetheless provides for a thorough review of an SLC's independence, good faith, and methodology, and such inquiry gives trial courts the ability to scrutinize SLC decisions and protect shareholders against collusive practices or inadequate investigations. Moreover, this approach protects against the danger of judicial overreach and "avoid[s] the problem in the second level of the Zapata test, which requires the judge to exercise his or her own business judgment."
One clear example of an SLC's unreasonable methodology is when the SLC itself defers to the decision of the directors, instead of making its own independent review of the transactions in question. In these situations, the SLC has cast aside its duty to conduct an independent review, and the directors cannot rely on its report for summary judgment. See, e.g., Roberts, 404 So.2d at 632-33 ("Upon finding that a special committee of disinterested directors has determined in good faith and after a thorough investigation that it is not in the company's best interests to allow an action to proceed, [the `business judgment' rule] would not allow the courts to interfere with the committee's determination.") (emphasis added); Hirsch v. Jones Intercable, Inc., 984 P.2d 629, 638 (Colo.1999) ("The purpose to be served by any [SLC] is to substitute its independent. . . judgment for the judgment of the directors who have been accused of wrongdoing.") (emphasis added); Einhorn v. Culea, 235 Wis.2d 646, 612 N.W.2d 78, 84 (2000) ("If the [SLC] is independent from the alleged wrongdoers, acts in good faith and conducts a reasonable inquiry upon which its conclusion is based, the committee's recommendation not to proceed with a derivative action is viewed as a proper exercise of the directors' business judgment and the court will dismiss the action.") (emphasis added).
Thus, Maryland courts should limit their inquiry. As in Auerbach, the SLC's substantive conclusions are entitled to judicial deference, provided that the SLC was independent, acted in good faith, and made a reasonable investigation and principled, factually supported conclusions. We emphasize, however, that the directors are entitled to no presumption regarding the above requirements. To create grounds for summary judgment, the directors must state how they chose the SLC members and come forward with some evidence that the SLC conducted a reasonable inquiry upon which its conclusion is based and that no significant business or personal relationships impugned the SLC's independence and good-faith, factual basis. Only then will the court have sufficient grounds to grant summary judgment on the basis of the SLC's report. Moreover, the plaintiff can still avoid summary judgment by presenting a genuine issue of material fact regarding these issues, in which case judicial review should be engaged and thorough.
John and Kevin have argued that we should abandon the SLC process altogether. In a motion to the Circuit Court on March 3, 2008, John and Kevin expressed their views on the SLC process as follows:
Similarly, before this Court, John and Kevin argued at length that the SLC process itself created bias, analogizing that process to "forum-shopping":
To be sure, John and Kevin's point addresses a valid issue, and one which we should not completely ignore. We acknowledge the likelihood that an SLC, more often than not, will side with the corporation, rather than the shareholders, in its conclusions. The correct response, however, is not to abandon the SLC process altogether. We reaffirm our belief that the SLC process, when coupled with the thorough standard of judicial review we have described above, provides significant protection for minority shareholders. Under this inquiry, the court may examine any significant formal or informal relationship between the parties, including societal or personal influences. Whatever the SLC's conclusion may be, the process itself requires near-complete transparency from the directors and increases their accountability for their decisions.
We now apply the above standards to the Circuit Court's review of the SLC opinion in this case.
Under our standard of review, the circuit court must first conclude that the SLC was independent and acted in good faith. As explained above, the SLC members are entitled to no presumption of independence and good faith, and the corporations must state in a motion for summary judgment how they chose the SLC members and come forward with some evidence that no significant relationships or influences impugned their "disinterested independence." See Auerbach, 419 N.Y.S.2d 920, 393 N.E.2d at 1003. If the plaintiff, in responding, comes forward with evidence of such relationships or influences, the court should then consider whether there is a genuine issue of material fact regarding independence or good faith.
Here, the directors never attested to how they chose the SLC members or that the SLC members had no significant business, personal, or social relationships with the directors. Instead, they argued that the SLC was entitled to a presumption of independence and good faith, and from then on simply stated, without proving, that the SLC was independent. Thus, as explained above, the Circuit Court did not have sufficient grounds for summary judgment on the basis of the SLC's report, and we therefore vacate its judgment and remand for further proceedings. On remand, to create sufficient grounds on this issue, the directors would need to state how they chose the SLC members and assert that no significant business, personal, or social relationships impugned the SLC's independence or good faith. Then, if the plaintiffs raises a genuine issue of material fact, the court should complete a thorough investigation.
The independence inquiry should not end with an examination of business relationships. In some instances, the plaintiff can raise a genuine issue of material fact regarding the SLC's independence and good faith by presenting evidence of significant personal or social relationships. For example, the Delaware courts, whose "independence" inquiry we find persuasive in crafting our standards,
Finally, although we have declined John and Kevin's suggestion that we recognize a per se bias arising from the SLC appointment process, the court may properly examine the specific circumstances surrounding the selection and delegation of responsibility to the SLC in determining whether it has shown its independence. For example, in Biondi v. Scrushy, 820 A.2d 1148 (Del.Ch.2003), the Delaware Court of Chancery relied on "an odd confluence of unusual and highly troubling facts" regarding the appointment of the SLC to determine that it could not show its own independence. Id. at 1165-66. Specifically, the Biondi Court observed that an "at best, begrudging and, at worst, inadequate, original delegation of authority" to the SLC, when coupled with repeated public pronouncements of support for the defendants by corporate members (including the SLC chairman) during the investigation, created "a reasonable doubt that its investigation was designed to paper a decision that had already been made." Id. As this discussion shows, not all SLC appointment processes are equal.
The court should require that the directors at least attest to the lack of a significant business, personal, or social relationship with the SLC members and state why they chose the SLC members and how they learned of them. Inquiring only into the SLC members' formal or financial ties with the defendants is inadequate. Nonetheless, the independence inquiry does not require the directors to show, beyond all doubt, that no conceivable theory of influence exists between them and the SLC.
John and Kevin challenged the procedure adopted by the SLC in this case with multiple allegations. Generally, John and Kevin argued that the SLC report was superficial and devoid of details. More specifically, John and Kevin challenged the scope of the SLC's investigation and charged that it provided a deferential standard of review:
On this point, John and Kevin further averred that "[t]he committee could not identify any standard that they used to measure the asserted "reasonableness" of the self-aggrandizing transaction." As explained below, the SLC report itself created a genuine issue of material fact regarding the reasonableness of the SLC's methodology, and the court therefore should have examined that methodology in more detail.
The reviewing court must examine the methodologies and procedures of the SLC's investigation, and whether there was a reasonable basis for its conclusions. Again, the SLC is not entitled to a presumption that its investigation and conclusions were reasonable. Indeed, the court may find evidence of procedural unreasonableness in the report itself. See Hasan, 729 F.2d at 378 (holding that the "report itself raises serious questions about the integrity of his committee's findings"). Moreover, the mere length of the report and the sheer volume of items considered should not be given undue weight by the court. Page totals are a shallow metric, especially given the "relative ease with which a committee could construct a record of apparently diligent investigation after having predetermined the outcome of the investigation." Abella, 546 F.Supp. at 799. See also Oracle, 824 A.2d at 925 (rejecting the SLC's recommendation for failure to show independence, even though the SLC "reviewed an enormous amount of paper and electronic records[,] . . . interviewed seventy witnesses, some of them twice[,] . . . [and] produced an extremely lengthy Report totaling 1,110 pages").
Under our standards, although the court should not question the SLC's substantive conclusions, it should examine what issues the SLC actually set out to address. The SLC cannot arrive at a reasonable answer if addresses the wrong issues. Thus, addressing the wrong issues is an example of unreasonable methodology.
Here, in reviewing the SLC's investigation, the court focused primarily on the sheer volume of the SLC's exhibits and report, stating, in its entirety:
Next, the court reviewed the reasonableness of each of the SLC's findings, holding they were reasonable.
As its opinion shows, the court believed that any further investigation into the SLC's report was unnecessary.
Because the Circuit Court inappropriately afforded the SLC's methodology a presumption of reasonableness, its analysis on that point was inappropriately framed. The Circuit Court opinion discusses the
It is unclear, from the above passage, whether the SLC independently determined that the stock sales were fair to the corporation or, as the emphasized language suggests, merely gave deference to the Board's determination under the business judgment rule.
Comparing the Circuit Court's review with the standards described above, we are unable to give our blessing to its decision. The report, as submitted, did not provide sufficient explanation of its methodology to allow meaningful judicial review of the methodology's reasonableness. Therefore, the court should not have granted summary judgment, which it apparently did based on a presumption that the SLC's methodology was reasonable. See Hirsch
We next consider the circuit court's dismissal of John and Kevin's cross-claims on the grounds that they were precluded by res judicata.
The doctrine of res judicata, or claim preclusion, prevents parties from re-litigating issues that have already been decided by the courts. The doctrine is applicable if the following requirements are met: "[1] if there is a final judgment [on the merits] in a previous litigation [and 2] where the parties, the subject matter and causes of action are identical or substantially identical as to issues actually litigated and as to those which could have or should have been raised in the previous litigation." R & D 2001 v. Rice, 402 Md. 648, 663, 938 A.2d 839, 848 (2008) (citations omitted).
The doctrine's first requirement, that there be a previous final judgment on the merits, is not met when the earlier case was resolved without a judicial resolution of the factual dispute at issue. For example, in Williams v. Messick, 177 Md. 605, 11 A.2d 472 (1940), a derivative suit that followed a "direct action" requesting receivership, we stated that the res judicata issue turned on whether the court's termination of the "direct action" involved a factual resolution of the claims. In that previous action, the court denied the plaintiff's request for appointment of a receiver. See Williams v. Salisbury Ice Co., 176 Md. 13, 3 A.2d 507 (1939). In the later action, this Court observed such a judgment could be rendered either on the merits of the plaintiff's claim, or for reasons not related to the merits:
Messick, 177 Md. at 611, 11 A.2d at 475. The Court then examined the prior decision, in which it had held that the complaint did not demonstrate "fraud, spoliation, or imminent danger of the loss of the property" so as to necessitate the appointment of a receiver. Salisbury Ice Co., 176 Md. at 27, 3 A.2d at 514. Because that prior decision was resolved on the merits of the plaintiff's claim, it formed a basis for res judicata in the later action. Messick, 177 Md. at 612, 11 A.2d at 475. See also Jessica G. v. Hector M., 337 Md. 388, 398-99, 653 A.2d 922, 927-28 (1995) (determining whether an earlier paternity suit by a mother precluded later paternity suit by the child by observing that the dispositive fact in other jurisdictions had been whether the mother's suit was resolved on a factual finding of non-paternity, or was resolved on grounds other than the merits); Cassidy v. Bd. of Educ., 316 Md. 50, 52 557 A.2d 227, 228 (1989) (dismissal for failure to allege precondition to lawsuit was not a decision on the merits so as to allow res judicata).
Applying these standards to the derivative and direct causes of action here, we hold that the Circuit Court's grant of summary judgment in the derivative action, based on a recommendation from the SLC, does not form a basis for res judicata on the direct action because it is not a determination on the merits. Like a court's refusal to appoint a receiver, a court's resolution of a derivative suit could either be on the merits, that is, if the complaint failed to state a claim, or merely because the SLC, considering a broad range of aspects, including some outside of the merits of the case, had reasonably concluded that dismissal was warranted. In this latter case, as we have described, the court's decision on whether to accept an SLC's recommendation does not turn on the merits of the claim, but rather on whether the SLC was independent, conducted a thorough investigation, and came to reasonable and principled conclusions. As the Sixth Circuit has recently detailed,
Booth Family Trust, 640 F.3d at 139. Although, as the Circuit Court in this case observed, the SLC may address and resolve factual issues, res judicata requires a final judicial resolution of the merits of the case, not a final judgment rendered by private parties. Moreover, the SLC decision, itself, may turn on other considerations than the merits of the case, and, in an extreme case, the SLC may affect a dismissal even though the plaintiff's claims are meritorious. Thus, a trial court's resolution of a derivative complaint, when based on the recommendation of a Special Litigation Committee, cannot be said to be a final judicial resolution of the merits of
Finally, we reach the issue which began this litigation: whether the Stock Purchase Agreements entered into by the Boland children are enforceable. After the corporations sued to enforce the Agreement against Colleen Boland's estate, the estate, along with John and Kevin, resisted, arguing that the stock purchase agreements had been breached, that the contract had not endured past Mr. Boland's death, and that the Agreements were invalid and unenforceable contracts of adhesion. The Circuit Court disagreed, and held that the stock purchase agreement signed by Colleen Boland was valid and enforceable, granting summary judgment to the corporations.
When reviewing a trial court's grant of summary judgment, the appellate court must determine whether there is a dispute as to a material fact sufficient to require an issue to be tried. See Frederick Rd. Ltd. P'ship v. Brown & Sturm, 360 Md. 76, 93, 756 A.2d 963, 972 (2000) ("[A]n appellate court's review of the grant of summary judgment involves the determination whether a dispute of material fact exists."). "Summary judgment is not a substitute for trial. . . . Evidentiary matters, credibility issues, and material facts which are in dispute cannot properly be disposed of by summary judgment." Id.
Haas v. Lockheed Martin Corp., 396 Md. 469, 479, 914 A.2d 735, 741 (2007). "Merely proving the existence of a factual dispute is not necessarily fatal to a summary judgment motion." Appiah v. Hall, 416 Md. 533, 546, 7 A.3d 536, 544 (2010). A "dispute as to facts relating to grounds upon which the decision is not rested is not a dispute with respect to a material fact and such dispute does not prevent the entry of summary judgment." Salisbury Beauty Schs. v. State Bd. of Cosmetologists, 268 Md. 32, 40, 300 A.2d 367, 374 (1973).
The first allegation we review under this standard is the Petitioners' claim that the stock purchase agreements were not supported by consideration. The Circuit Court held as follows:
We agree with the Circuit Court that a right to redeem stock can be valuable consideration for a shareholder. Other courts have so held. For example, in Mayer Hoffman McCann, P.C. v. Barton, 614 F.3d 893 (8th Cir.2010), the Eight Circuit Court of Appeals held that a buy-sell stock agreement provided sufficient consideration, i.e., a guaranteed buyer for stock which may have been difficult to alienate, in return for the shareholders' promise not to compete after ending their employment.
Id. at 820. See also O'Neal and Thompson, 1 Close Corporations and LLCs: Law and Practice § 7:3 (Rev. 3rd Ed.2010) ("One of the most distinctive features of any closely held enterprise is the lack of a market for selling one's interest in the entity. . . . It is not surprising that many participants in closely held businesses are interested in ways to provide liquidity to themselves or their heirs upon their death, disability, retirement, or their leaving the business.").
John and Kevin do not dispute that the SPA's promise of redemption upon the death of a shareholder formed valid consideration for the contract. Instead, John and Kevin's consideration argument is based on an alternate theory of consideration, that is, an assurance that "during [Colleen's] lifetime, the companies would remain in the ownership and control of her parents, siblings, and select key employees, without the threat of new, unwanted,
The second issue raised by John and Kevin is the intended duration of the Stock Purchase Agreements. The brothers observe that the SPAs have no stated duration in the agreements, and argue that "the purpose of the agreements were to insure absolute control by Mr. Boland . . . [and that there is no evidence] that the stock purchase agreements were intended to serve as succession documents."
The Circuit Court, however, disagreed that the intended duration of the SPAs was unclear:
As John and Kevin correctly observe, a contract may not exist in perpetuity in the absence of an express provision, and in such absence, "a reasonable duration will be implied by the court." Lerner v. Lerner Corp., 132 Md.App. 32, 45, 750 A.2d 709, 716 (2000). Yet, even absent any explicit length of time, the contract's duration may be defined by contingent future events. See Pumphrey v. Pelton, 250 Md. 662, 665, 245 A.2d 301, 303 (1968) ("The fact that Clause 19 provides that it terminates upon the expiration of the patents and copyrights saves it from the rule that a contract may not exist in perpetuity in the absence of an express provision." (emphasis added)). As the Circuit Court observed, the duration of the SPAs until the death of the shareholder
As we have alluded to above, the main thrust of John and Kevin's "contract" argument is that the alleged threats and oppressive acts of the majority shareholders have invalidated the contract. The Circuit Court rejected these claims as an inappropriate attempt to "bootstrap" their direct claims into a traditional contract analysis. We agree with the Circuit Court that, if the contract was supported by consideration and otherwise valid, it should be enforced against the estate.
In reaching this holding, we are not completely unreceptive to the allegations by John and Kevin. Rather, we merely conclude that the brothers have raised them in the wrong venue. Pursuant to our above holding, John and Kevin will have an opportunity to have their direct claims, alleging oppression and requesting dissolution, heard. In the "dissolution" action, they may raise their claims regarding improper threats to use the corporate repurchase right contained in the SPAs. A shareholder's action for dissolution invokes the equitable jurisdiction of the court, and gives the court an opportunity to fashion appropriate relief:
16A William Meade Fletcher, Cyclopedia of the Law of Private Corporations § 8043 (2003 Rev. Vol.). Although Maryland's dissolution statute does not explicitly contain such an enumeration of equitable remedies, see CA Section 3-413, neither does it foreclose them. On this point, we agree with the Court of Special Appeals' conclusion in Edenbaum, 165 Md.App. at 260, 885 A.2d at 380, where the court stated:
(citing Baker v. Commercial Body Builders, Inc., 264 Or. 614, 631-35, 507 P.2d 387, 395-96 (1973)). Thus, should John and Kevin convince the court on those claims, the court may fashion appropriate equitable relief, including the relief sought by them here. In particular, we believe that
In conclusion, our holding that the contract was enforceable against Colleen's estate does not give the corporations cover to use the SPAs in any manner they see fit, or to violate the rights of the minority shareholders. We merely conclude, as the Circuit Court did, that the Stock Purchase Agreement's repurchase upon death provision, a common feature of family-owned corporations, was a valid and enforceable contract in these circumstances. We therefore affirm the Circuit Court's grant of summary judgment with regard to the enforceability of the Stock Purchase Agreements.
BATTAGLIA, J., dissents.
BATTAGLIA, J., dissenting.
I respectfully dissent. What we and our colleagues have been asked to do in this case is wade in on an intra-family financial dispute in which siblings are vying for financial hegemony in their two family owned and operated corporations. Two of the Boland brothers seek to have this Court consider their siblings on the boards of directors "as a serpent's egg"
What the majority does in its opinion is introduce a new standard of judicial review for a refusal to pursue litigation in a shareholder derivative action when a disinterested special litigation committee has recommended against pursuit of litigation. I would instead give our historical deference, referred to as the business judgment rule, to decisions made as a result of the recommendation of a special litigation committee (SLC), which is comprised of members who are disinterested in the subject of their investigation and recommendation. Further, I disagree with the majority's insistence on investigating any personal aspects of the lives of the members of the SLC to determine their disinterest and would hold that the directors are independent for the purposes of demand refusal where they are not financially involved in any way with the challenged board decision.
To put the whole case in context:
The boards of directors of the corporations, Boland Trane Services, Inc. and Boland Trane Associates, Inc., are comprised of five members, including three Boland siblings, Sean, James, and Louis, Jr., and two long-term employees of the corporations, Lawrence Cain and John Heise. In 2005, the boards of directors voted to sell stock to James, Louis, Jr., Mr. Cain, and Sean, Jr., Sean's son. Mr. Heise was not present at this meeting. Each director abstained from the vote on their purchase, and Sean did not vote on his son's purchase. After siblings John and Kevin, Petitioners, learned of these stock purchases, they challenged them in two separate actions before the Circuit Court for Montgomery County, both filed on May 1, 2007.
In the first action, John and Kevin filed a cross-claim and counterclaim in an ongoing dispute between the corporations and the estate of their sister, Colleen Boland. In this dispute, the corporations sought to enforce, by declaratory judgment, a shareholder purchase agreement that Colleen had signed prior to her death in which she had agreed to resell her stock to the corporations. John and Kevin, as shareholders, alleged that the directors' approval of the stock purchases by the directors and Sean, Jr. constituted oppression, fraud, illegality, breaches of the fiduciary duties of loyalty and good faith, and self-dealing.
In another action, John and Kevin themselves filed a derivative complaint as shareholders, purportedly on behalf of the corporations, against Sean, James, Louis, Jr. and Mr. Cain, the four directors who voted in approval of the stock purchases. Similar to the direct claims in the first action, the derivative complaint alleged that the directors engaged in oppression, fraud, illegality, breaches of the fiduciary duties of good faith and loyalty and self-dealing when they approved the stock purchases. The two actions were consolidated by the circuit court.
Thereafter, the boards of directors, in response to John and Kevin's previously-made
The SLC was comprised of James J. Cromwell, Esq., and Charles J. Wolf, II, CPA, two individuals who had no interest in the disputed transactions. The SLC also engaged independent counsel, Albert D. Brault, Esq., who similarly had no interest in the transactions under scrutiny.
After a five-month investigation, the SLC determined that the pursuit of John and Kevin's claims was not in the best interests of the corporation, and thus recommended termination of the derivative actions, a decision commonly known as "demand refusal." Thereafter, on May 23, 2008, the defendant directors moved to dismiss, or in the alternative, for summary judgment in the derivative action. The circuit court granted summary judgment in favor of the defendant directors in the derivative action, applying the business judgment rule and deferring to the business judgment of the corporations upon finding that the SLC conducted its investigation and reached its recommendation independently, reasonably and in good faith. Following the grant of summary judgment, the corporations and defendant-directors also moved for dismissal, or in the alternative summary judgment, as to John and Kevin's claims against the corporation and directors in the direct action, asserting that the doctrine of res judicata prevented John and Kevin from re-litigating claims that were already resolved by the circuit court in the derivative action. The circuit court agreed and dismissed John and Kevin's claims.
We have historically deferred to the board of directors's business judgment, presuming that their actions are in the best interest of their corporation unless otherwise demonstrated. In his treatise, Maryland Corporation Law, James J. Hanks, Jr. explains that the business judgment rule
Section 6.8, at 189 (2007 Supp.), quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del.2000), and Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del.1971). Under this standard, Maryland courts review internal disputes of shareholders challenging the decisions of the board of directors by asking "whether any rational business person could have reached that result, proceeding independently and in good faith with the best interests of the corporation in mind." Bender v. Schwartz, 172 Md.App. 648, 667, 917 A.2d 142, 152 (2007), citing Aronson, 473 A.2d at 812.
For more than a hundred and fifty years, we have employed a presumption of validity upon the decisions of the board of directors made on behalf of the corporation and later challenged by shareholders. In the mid-19th century, we held in Anacosta Tribe v. Murbach, 13 Md. 91, 94-95 (1859), that the corporation's own regulations, rather than the equitable powers of the court, were to generally govern disputes between shareholders themselves or with directors. In 1864, we observed in Mayor and City Council of Baltimore v. Baltimore & Ohio Rail Road Company, 21 Md. 50, 92 (1864), that "the decision of questions of expediency, as to the fitness of the means employed, are properly confided by the law to the Board of Directors. Courts of Justice will not pass upon them—they are manifestly incompetent to the task—and to attempt to do so, would often defeat the ends of the law."
In 1894, in Shaw v. Davis, 78 Md. 308, 316-17, 28 A. 619, 621, we reiterated our refusal to review "internal disputes between shareholders" or shareholders and directors, "unless there be something illegal, oppressive, or fraudulent." In Shaw, a minority shareholder sought to enjoin his company from entering in a lease. We refused the intervention and opined that we should "leave all such matters to be disposed of by the majority of stockholders in such a manner as their interests may dictate," 78 Md. at 316, 28 A. at 621, rather than to the will of a minority shareholder with the assistance of the courts, absent a showing of fraud, illegality or conduct showing ultra vires, to avoid contravening the ideals of free government:
And if the proposed lease be not ultra vires or unlawful or fraudulent, no court, at the instance of a minority stockholder, or at the instance of anyone else, has the power or the right to restrain the majority from dealing with the property as they may deem most advantageous to their own interests. Any other doctrine would put it in the power of a single stockholder, owning but one share out of many hundreds, to transfer the entire management of a corporation to a court of equity and would effectually destroy the right of the owners of the property lawfully to control it themselves. It would make a court of equity practically the guardian, so to speak, of such a corporation, and would substitute the chancellor's belief as to what contracts a corporation ought, as a matter of expediency, or policy, or business venture to make, instead of allowing such questions to be settled by the persons beneficially interested in the property. No such arbitrary or dangerous power has ever been claimed by any court, and, if laid claim to, it would never be tolerated in a free government.
Although the business judgment rule may be an exercise in restraint, it is not a "rubber stamp." At the turn of the twentieth century, in Du Puy v. Transportation & Terminal Company, 82 Md. 408, 33 A. 889 (1896), we found the fraud necessary under the business judgment rule to intervene when two minority shareholders claimed that the corporation's majority shareholder, board of directors, and appointed trustee had engaged in a series of fraudulent acts to wind up the solvent corporation. Shortly after the minority shareholders, the Du Puys, had purchased shares, the president of the board of directors and the majority shareholder took the Du Puys' money for themselves and wound up the corporation by appointing a trustee who agreed to distribute the corporation's assets to members of the board and associates of the majority shareholder. In intervening, we recognized the risk of inefficiency and continued fraudulent and wrongful conduct were we not to act and maintained that a receiver appointed by the circuit court, rather than the court itself, would review the corporation's actions:
Id. at 442, 33 A. at 895.
In 1907, in Sloan v. Clarkson, 105 Md. 171, 66 A. 18, we applied the business judgment rule to review a demand refusal in a shareholder derivative action. In that case, the corporation refused the demand of a minority shareholder and director, Frank S. Clarkson, to require majority director, majority shareholder, and corporate officer, E. Eugene Sloan, to produce accounting records of his work for the corporation. As the managing agent of the corporation, Sloan was entrusted with overseeing its entire business, collecting its profits and taking a commission for himself before handing over the remainder to the corporation. Clarkson's bill alleged, and neither Sloan nor the corporation in their demurrer denied, that the refusal of his demand by the majority of directors was the result of fraudulent and improper motives. The circuit court overruled the demurrer and we affirmed, holding that the corporation and Sloan must provide an answer because the business judgment rule enunciated in Shaw and Du Puy did not insulate the corporation where, if proven, the demand was refused with a fraudulent or improper motive.
Thus, our business judgment rule is premised on the belief that the will of the majority, and the decisions of experienced business professionals on the board of directors, should be afforded a presumption of validity, unless a minority shareholder shows that such acts are fraudulent, illegal, conduct of ultra vires, or grossly negligent. McQuillen v. National Cash Register Co., 112 F.2d 877, 883 (4th Cir.1940) (applying Maryland law); see also Williams v. Salisbury Ice Co., 176 Md. 13, 23, 3 A.2d 507, 512 (1939) ("There must be proof of fraud, and the onus of that proof is upon the complainant.").
In 2001, in Werbowsky v. Collomb, 362 Md. 581, 766 A.2d 123, we reviewed the application of the business judgment rule in shareholder derivative actions. We declined to fully adopt the approach in Aronson v. Lewis, 473 A.2d 805, 814 (Del.1984), which held that a shareholder's pre-suit demand on the corporation may be excused where there is a reasonable doubt as to whether the directors were independent and whether the challenged transaction was the product of proper business judgment. In so doing, we reasoned that the value in the demand requirement is tied to business judgment rule protection enjoyed by directors against inappropriate challenges of minority shareholders:
Id. at 618-19, 766 A.2d at 144. We concluded that, "If demand is made and refused, that decision, and the basis for it, can be reviewed by a court under the business judgment rule standard." Id. at 619, 766 A.2d at 144.
The robustness of the business judgment rule is now being questioned by the majority's adoption in shareholder derivative actions of what it calls a middle ground in the application of the business judgment rule to acts of an SLC. Auerbach v. Bennett, 47 N.Y.2d 619, 419 N.Y.S.2d 920, 393 N.E.2d 994 (1979), and Zapata Corporation v. Maldonado, 430 A.2d 779 (Del.1981), are the two leading approaches nationally to judicial review of demand refusals. The Auerbach standard adheres to the New York business judgment rule and limits judicial review to the disinterested
The majority's adoption of "enhanced Auerbach," also known as the first prong of the Zapata standard, removes the presumption of our traditional business judgment rule in favor of the corporation. This ruling is contrary to our jurisprudence and the goal of acknowledging the will of the majority, absent a showing of director abuse by the plaintiff shareholder; our standard, like New York's Auerbach standard, has placed the burden on the plaintiff shareholder to demonstrate that the director action, including a demand refusal, was made unreasonably, in bad faith, or while the director was on both sides of the transaction and thus interested.
In the case sub judice, the circuit court reviewed the SLC's report under the deferential business judgment rule as recognized by the Court of Special Appeals as one to defer "to the decision of the board or committee not to pursue litigation unless the stockholders can show either that the board or committee's investigation or decision was not conducted independently and in good faith, or that it was not within the realm of sound business judgment." Boland, 194 Md.App. at 499, 5 A.3d at 119, quoting Bender, 172 Md.App. at 666, 917 A.2d at 152. The SLC members and counsel were disinterested and independent, the circuit court found, because each individual had never "been employed by, done business with or provided services for either corporation." The trial judge also found that the SLC's investigation and conclusions were made in good faith and reasonably in light of their "comprehensive investigation lasting approximately 5 months," including interviews with John and Kevin as well as 9 other individuals, a 30 page report and 32 exhibits. The circuit court held, and the Court of Special Appeals agreed in its reported opinion, that John and Kevin as derivative plaintiffs failed to rebut the presumption that the SLC, as the disinterested directors for the corporations, acted in the best interests of the companies. Just as did our colleagues on the Court of Special Appeals, I would affirm the reasoned application by the circuit court of the business judgment rule.
In addition to removing the presumption of business judgment rule, however, the majority also further requires the judiciary to enter the bowels of the corporation to determine the SLC independence. The majority defines the standard of independent business judgment to require an individual on the SLC to have no consequential formal, informal, professional or personal ties with the directors who are parties to the case, to the extent that the circuit court is required to conduct a background check on the SLC members and its independent counsel and require the SLC and the board of directors to disclose to the court their social, personal and other business affiliations. This standard is unworkable and intrusive.
We review the independence of SLC members, specifically their care, attention and sense of individual responsibility, to ensure that each member is "in a position to base his decision on the merits of the issue rather than being governed by extraneous considerations or influences." Kaplan
In affirming the circuit court's finding of SLC independence, the Court of Special Appeals observed that "[t]here never has been a serious assertion by the appellants of lack of independence or good faith on the part of Cromwell or Wolfe or their counsel, Brault." 194 Md.App. at 512, 5 A.3d at 127. As the opinion stated, the SLC members could not be disqualified merely because the corporations and their directors were based on the fact that SLC members were appointed by the board of directors, as interested directors may appoint the SLC under Maryland law. Id. at 512 n. 16, 5 A.3d at 127 n. 16, quoting Rosengarten v. Buckley, 613 F.Supp. 1493, 1499 (D.Md.1985).
The majority, though, asserts that the circuit court's review of professional ties of the corporations and the SLC members was inadequate. Rather, the majority opines that the corporation must demonstrate that the SLC members experienced no influence from the interested directors, emanating from any professional, recreational, social, religious, or non-profit organization affiliations. Six degrees of separation, however, could potentially remove the "influence" from participating on an SLC.
The majority's independence inquiry beckons the question: how far must the circuit court go in order to establish the independence of the SLC members? For that matter, as the corporation now must bear the burden of proving the SLC's independence under the majority's standard, how much must the SLC members and Board Defendants disclose to show the SLC's ability to make an independent decision? Will the circuit court review the per stirpal lineage of each SLC member and explore whether an SLC member is within six degrees of separation from the members of the board of directors? Where a minority shareholder was once required to prove fraud, illegality or ultra vires on the part of the board of directors to proceed beyond a demand refusal, Sloan v. Clarkson, 105 Md. 171, 66 A. 18 (1907), the majority now encourages the shareholder to pursue a derivative action, upon a simple showing that the SLC members and interested directors are members of collegial groups, such as, for example, the Maryland State Bar Association.
The independence of the SLC members and their counsel only should turn on whether they are financially interested in the board of directors's action or decision at issue. Rather than a review of the multifarious personal and professional relationships that will become unworkable and unnecessarily intrusive, a review of the members' financial relationship with the challenged transaction serves as a bright-line per capita approach to director independence. In this case, the Circuit Court for Montgomery County and the Court of Special Appeals properly concluded that, having no prior employment, business and thus financial connection to the boards' approval of stock purchases, Mr. Cromwell, Mr. Wolfe and Mr. Brault were all sufficiently disinterested to reach a decision regarding John and Kevin's demand without the inappropriate influence of the defendant directors. As to the derivative action, the circuit court properly applied the business judgment rule to the SLC report and granted summary judgment in
The circuit court also correctly applied the doctrine of res judicata to John and Kevin's counterclaim and cross-claim that alleged the same facts as those underlying the derivative action. "Res judicata literally means `a thing adjudicated,' and generally indicates `[a]n affirmative defense barring the same parties from litigating a second lawsuit on the same claim . . . .'" Lizzi v. Washington Metropolitan Area Transit Authority, 384 Md. 199, 206, 862 A.2d 1017, 1022 (2004), quoting Black's Law Dictionary 1336-37 (8th ed.2004). "The doctrine embodies three elements: (1) the parties in the present litigation are the same or in privity with the parties to the earlier litigation; (2) the claim presented in the current action is identical to that determined or that which could have been raised and determined in the prior litigation; and (3) there was a final judgment on the merits in the prior litigation." R & D 2001, LLC v. Rice, 402 Md. 648, 663, 938 A.2d 839, 848 (2008).
In this case, there is no dispute that the parties are identical or that the factual basis for John and Kevin's direct action do not diverge from that of the derivative action. Rather, the majority maintains that the circuit court's grant of summary judgment did not reach the merits of the derivative claim, but only the independence, good faith and reasonableness of the SLC and its investigation. I disagree.
A case need not reach trial before a court's resolution serves as a final judgment on the merits for res judicata purposes. See deLeon v. Slear, 328 Md. 569, 616 A.2d 380 (1992); Adkins v. Allstate Insurance Co., 729 F.2d 974, 976 n. 3 (4th Cir.1984) ("For purposes of res judicata, summary judgment has always been considered a final disposition on the merits."). In deLeon v. Slear, 328 Md. 569, 616 A.2d 380 (1992), we observed that "summary judgment for the defendant is a valid and final judgment" and that the doctrine of res judicata barred subsequent identical claims between the same parties or parties sharing privity with those of the earlier litigation. 328 Md. at 580, 616 A.2d at 385, citing Section 19, Comment g, of the Restatement (Second) of Judgments (1980).
In the case sub judice, the circuit court's prior grant of summary judgment against John and Kevin's derivative claims, which mirror the claims raised directly,
I respectfully dissent.
In the declaratory judgment action, the Petitioners presented the following questions:
As the Court of Special Appeals concluded, however, this lawsuit is properly labeled a "demand refused" lawsuit. See Boland v. Boland, 194 Md.App. 477, 496, 5 A.3d 106, 117 (2010) (The "case at bar" is a "demand refused case."). Petitioners do not contest such a label. Moreover, as we will discuss further, see infra, the distinction between a "demand refused" and "demand excused" case is not dispositive here.
The other was a CPA who founded a data processing service company and a payroll services company. He was a member of many accounting and business professional associations, and sat on the boards of many community organizations.
The Circuit Court held a hearing on January 16, 2009 to clarify the procedural posture of the two cases. At that hearing, counsel for John and Kevin asked the court, among other things, to clarify its earlier rulings so that their cross-claims of oppression, and various counterclaims were still viable.
That section further provides that "[a] person who performs his duties in accordance with the standard provided in this section shall have the immunity from liability [arising from performance of those duties]" and that "[a]n act of a director of a corporation is presumed to satisfy the standards of . . . this section." CA § 2-405.1(c), (e).
Over time, courts and legislatures have moved towards a "universal demand" requirement. See generally Werbowsky v. Collomb, 362 Md. 581, 602, 766 A.2d 123, 135 (2001). This Court has yet to close the door on the "futility" exception to demand requirement, although we have recognized that it is applicable in narrow circumstances:
Id. at 620, 766 A.2d at 144.
Under Werbowsky, a demand on the board may be required, or at least advisable, even though the board itself may not be in a position to render the decision itself, due to the nature of the allegations or the existence of adverse interests. Indeed, one justification for the expanded demand requirement is to give the corporation an opportunity to engage an SLC. See Werbowsky, 362 Md. at 619, 766 A.2d at 144 (observing that a demand sent to the board members "may be their first knowledge that a decision or transaction they made or approved is being questioned, and they may choose to seek the advice of [an SLC] of independent directors, which has become a common practice"). Thus, the line between a special litigation committee and a distinct "demand committee" has blurred.
One byproduct of the narrowing "futility" exception is that the procedural distinctions between a "demand excused" and "demand refused" action may no longer be viable. Courts and commentators have often drawn strict distinctions between the two actions. See, e.g., Dennis J. Block, Nancy E. Barton, & Stephen A. Radin, 2 The Business Judgment Rule: Fiduciary Duties of Corporate Directors 1689-90 (5th ed. 1998) ("[The] special litigation committee termination procedure need not be utilized when demand is required because if demand is required the board as a whole may act in a manner that will be judged pursuant to the business judgment rule."); Zapata Corp. v. Maldonado, 430 A.2d 779 (Del.1981) (limiting its additional "independent business judgment" review to demand excused cases).
Because courts have encouraged derivative plaintiffs to file such a demand, including in cases where the Board may find it advisable to appoint an SLC, see Werbowsky, 362 Md. at 619, 766 A.2d at 144, it is clear that the derivative plaintiff may continue to contest the independence of the board members after filing such a demand, and should not be prejudiced by that choice.
Roberts v. Alabama Power Co., 404 So.2d 629, 632 (Ala.1981).
In re Oracle Corp. Derivative Litig., 824 A.2d 917, 938 (Del.Ch.2003).
Miller v. Bargaheiser, 70 Ohio App.3d 702, 591 N.E.2d 1339, 1344 (1990).
Kaplan v. Wyatt, 484 A.2d 501, 507 (Del.Ch. 1984).
We think the SLC report itself suggests the need for the directors to come forward with some evidence supporting the independence and good faith of the SLC. Near the end of its report, the SLC raised, by itself the issue—the "Adequacy of the Plaintiffs as Shareholder Representatives." After listing the factors a court usually considers, the SLC stated: "Here, the majority shareholders disagree with the Plaintiffs and it is therefore obvious that they do not adequately represent all the shareholders." This reasoning is faulty because such a standard would effectively preclude all suits by minority shareholders in a close corporation. The suddenness of this conclusion, raised sua sponte by the SLC, invokes the question of whether the SLC was objectively considering the claims presented, or whether it had adopted the hostile attitude of the defendants in considering these claims.
As potential evidence of this latter possibility, the SLC, although claiming that it "has not attempted to nor could it understand the complicated family dynamics in play[,]" opted to descend into the intra-family struggle:
The SLC's conclusion that John and Kevin's deceased father chose the right children to run the business, and its casual identification of a hidden agenda, is unnecessary for an independent committee tasked with making an objective decision for the corporation about a stock transaction benefitting some of the directors.
With respect to the accusations regarding the acquisitions of Mrs. Boland's stock, the Circuit Court stated:
With regard to the allegations regarding the Stock Purchase Agreements, the Court observed:
R & D 2001 v. Rice, 402 Md. 648, 663, 938 A.2d 839, 848 (2008) (citations omitted).
Mayer Hoffman McCann, P.C. v. Barton, 614 F.3d 893, 904 n. 20 (8th Cir.2010).
Senate Judicial Proceedings Committee Bill Analysis for Senate Bill 169, at 4 (1999).
