Directors of a Closely Held Corporation Breached Fiduciary Duty in Approving Bonuses to Themselves
September 8, 2008
In Julian v. Eastern States Construction Service, Inc., the Delaware Chancery Court found that the directors of a closely held Delaware corporation had breached their fiduciary duty of loyalty in approving certain bonus payments to themselves. The court applied the entire fairness standard of review to the transaction since the directors were self-interested. The court found that each of the components of entire fairness, fair price and fair dealing, was lacking. In addition, the court found that the board engaged in an unfair process in which there was no “coherent, credible reason” for the bonuses other than to dilute the company’s net book value to minimize a redemption payment to another director who had resigned. The court also found the process to be unfair to the extent that “there was no notice, meaningful deliberation, or independent advice or research” before board action.
In particular, the court was suspicious that the board only met for 30 minutes, it consulted no independent source and at least one board member was not certain what he approved. The court also held that the amount of the bonus was unfair. In this regard, the court noted that a bonus of 20% of earnings was not in line with prior years’ bonuses, which did not exceed 4% of earnings. For the breach of the fiduciary duty of loyalty, the court ordered the self-interested directors to disgorge the bonuses and to pay interest and attorneys’ fees incurred in prosecuting the claim. Julian is a reminder that fair process and fair dealing are even more important in administering the affairs of a closely held corporation, where many transactions are approved by self-interested directors.
http://courts.delaware.gov/Opinions/(v1odeg45audtdl555jy1dizb)/download.aspx?ID=109020
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