In a blow to corporate directors, Maryland’s highest court has limited the deference that judges should give a Special Litigation Committee’s conclusion that a corporation should not sue its leadership.
The Court of Appeals’ 6-1 decision requires the company to establish that the committee was truly independent, acted in good faith and followed reasonable procedures.
That marks a break from prior cases, which put the burden on shareholder-plaintiffs to show that the SLC lacked independence from the corporate board.
Last week’s decision revived two lawsuits involving a family business in Gaithersburg, a derivative suit and a direct action.
In the derivative shareholder suit, two siblings, acting as shareholders, allege self-dealing by their three brothers who ran the family companies, Boland Trane Associates Inc. and Boland Trane Services. In the direct action, the siblings are suing the companies for breach of fiduciary duty and self-dealing.
The Montgomery County Circuit Court had granted summary judgment to the brothers in the derivative lawsuit based on the SLC’s conclusion that the brothers had not engaged in improper self-dealing in buying stock from the companies. The court held that the SLC’s conclusion could be trumped only by evidence of bad faith on the SLC’s part.
But the Court of Appeals said the burden of persuading the court rests not with the shareholders opposing the SLC, but with the company leaders defending it.
“[T]he 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,” Judge Sally D. Adkins wrote for the majority. “We emphasize, however, that the directors are entitled to no presumption regarding the above requirements.”
In the direct action, the circuit court had found the claims were precluded by its earlier ruling on the derivative claims. The high court overturned that ruling as well.
Attorney Michael F. Flynn Jr., who represented the companies and defended the SLC before the high court, said the decision “does lay out a new framework” requiring corporations and directors to defend the independence of the reviewing committees.
Even so, “We’re confident on remand that we are going to be able to establish the requisite independence,” said Flynn, of Gleason, Flynn, Emig & Fogleman Chtd. in Rockville.
Joseph P. Suntum, the attorney for the plaintiff siblings, did not return telephone messages seeking comment Friday afternoon. Suntum is with Miller, Miller & Canby Chtd. in Rockville.
Shortly before his death in 2003, Lewis Boland Sr. chose his sons Lewis Jr., Sean and James to run the family businesses, with his other children serving as shareholders.
The Boland companies continued to do well, with dividends approaching $6 million in 2005.
The controversy arose that year when the three brothers engaged in a series of stock purchases to increase their share in the Boland companies.
The purchases were made not with cash but with promissory notes, meaning the stocks would eventually pay for themselves based on the companies’ annual dividend distributions, according to the high court’s opinion.
The other Boland children sued, alleging improper self-dealing by the brothers.
The company, named as a plaintiff, appointed an SLC to provide an independent opinion on whether the lawsuit against the brothers should proceed. The SLC members were Rockville lawyer James J. Cromwell and Kensington accountant Charles J. Wolf II. Rockville attorney Albert D. Brault, of Brault Graham LLC, was appointed to be the SLC’s independent counsel.
The SLC found the brother’s stock purchase was valid and concluded the derivative action should not proceed.
“To give stock in whole or in part in return for services is certainly well accepted and within the business judgment rule,” the SLC said.
In light of the SLC’s report, the brothers moved for summary judgment and the circuit court granted the motion with a hearing. The Court of Special Appeals affirmed.
But the Court of Appeals last week said the lower courts had been too deferential and unquestioning of the independence, good faith and procedural propriety of the SLC report.
In sending the case back for trial, the high court said Lewis Jr., Sean and James and will have to show that the SLC members were truly independent and had “no significant business, personal or social relationships” with them. The brothers will also have to show that the “SLC independently determined that the stock sales were fair to the corporation” and did not simply defer to the board’s determination, the court said.
Judge Lynne A. Battaglia, the sole dissenter, assailed as “unworkable and unnecessarily intrusive” the high court’s requirement that directors defend the SLC’s independence by showing that its members had no significant personal or social relationships with them.
The court “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,” Battaglia wrote.
What the court held
John L. Boland et al. v. Sean F.X. Boland et al. and John L. Boland v. Boland Trane Associates Inc. et al., CA Nos. 123 and 129 Sept. Term 2010. Reported. Opinion by Adkins, J. Dissent by Battaglia, J. Argued May 9, 2011. Filed Oct. 31, 2011.
(1) Did the judge err in granting summary judgment based on a Special Litigation Committee report that a lawsuit against company leaders should not proceed? (2) Did the judge err in ruling that the shareholders’ direct claims were precluded by res judicata?
Yes. (1) The company leaders must show the SLC acted with true independence. (2) Summary judgment on a derivative action is not a final adjudication on the merits that would preclude a direct suit.
Joseph P. Suntum for petitioners; Michael F. Flynn Jr. and John M. Quinn for respondents.
RecordFax # 11-1031-22 (95 pages).