Johnson v. Trueblood
629 F.2d 287 (1980)
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Rule of Law:
Under Delaware's business judgment rule, a plaintiff challenging a board of directors' decision must show that the directors' sole or primary purpose for the decision was to retain control of the corporation. The mere fact that a decision has the effect of maintaining control is not enough to rebut the presumption of good faith if the decision can be attributed to any rational business purpose.
Facts:
- Gilbert and Hervey Johnson owned a 47% minority interest in Penn Eastern Development Co., while defendants Samuel Trueblood, Arnold Trueblood, and Harry Salwen collectively owned the controlling 53% interest.
- Beginning in 1972, Penn Eastern began experiencing severe cash flow problems related to its sole major asset, a shopping center development.
- In November 1973, the defendant-controlled board proposed accepting a loan from a third party, Frank Pierce, to address the financial issues.
- The Johnsons opposed the Pierce loan and offered their own loan to the corporation, but the terms of the Johnsons' proposed loan would have resulted in a shift of corporate control to them.
- The board rejected the Johnsons' proposal and approved the Pierce loan.
- When the Pierce loan failed to solve the company's financial problems, the defendants proposed selling a major property at auction. The board rejected the Johnsons' offer to cover the loan payments to avoid the sale.
- In November 1975, the defendants proposed selling new shares of stock to Arnold Trueblood to raise capital. The Johnsons counter-offered to buy the shares at a higher price, which would have given them control.
- The board rejected the Johnsons' higher offer and approved the sale of stock to Arnold Trueblood, which maintained the defendants' control.
Procedural Posture:
- Gilbert and Hervey Johnson filed a shareholder derivative action in U.S. District Court against the majority shareholders and directors of Penn Eastern Development Co., alleging breaches of fiduciary duty under Delaware law.
- During the litigation, the corporation's main asset was lost to foreclosure, but the trial court denied the plaintiffs' motion to amend their complaint to add this loss as a basis for liability.
- A motion to amend the complaint mid-trial to add a negligence claim was also denied.
- After a 72-day trial, the jury returned a verdict in favor of the defendants.
- The plaintiffs (appellants) appealed the judgment to the United States Court of Appeals for the Third Circuit.
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Issue:
To rebut the presumption of the business judgment rule in a case involving corporate control, must a plaintiff prove that the directors' sole or primary motive was to retain control, or is it sufficient to show that retaining control was merely 'a' motive for their actions?
Opinions:
Majority - Seitz, C.J.
No. To rebut the presumption of the business judgment rule, a plaintiff must show that the directors' sole or primary purpose was to retain control. The court reasoned that the purpose of the business judgment rule is to protect directors from judicial second-guessing and to validate decisions even where some self-interest, such as the desire to remain a director, is present. A standard requiring plaintiffs to show only that control was 'a' motive would negate the rule's purpose, as control is arguably always a motive for any director. Citing Delaware precedent like Cheff v. Mathes, the court concluded that unless a plaintiff can provide evidence from which a factfinder could infer that the impermissible motive of retaining control predominated, the presumption that directors acted in the corporation's best interest remains intact. So long as a rational business purpose supports the directors' decision, the mere fact that it also results in the retention of control does not constitute bad faith.
Dissenting - Rosenn, J.
Yes. A plaintiff need only show that the desire to retain control was 'a' motive in the challenged business decision to rebut the business judgment rule. The dissent argued that once a decision implicates corporate control, a conflict of interest is created which should dissipate the presumption of good faith. The burden should then shift to the defendant directors to justify the transaction as being primarily in the corporation's best interest. The dissent interprets Delaware cases like Bennett v. Propp as establishing this burden-shifting framework. It contends that the majority's 'sole or primary' motive test imposes a burden on plaintiffs that is inconsistent with Delaware law and makes it exceedingly difficult to hold directors accountable when their self-interest is intertwined with their decisions.
Analysis:
This decision solidifies a high evidentiary standard for plaintiffs in shareholder derivative suits who allege that directors acted to entrench themselves in power. By adopting the 'sole or primary motive' test, the court makes it significantly more difficult for minority shareholders to challenge board decisions that have the effect of preserving the existing control structure. The ruling provides substantial deference to boards of directors, allowing them to defeat breach of fiduciary duty claims by articulating any rational business purpose for their actions. This precedent strengthens the business judgment rule's protective shield and raises the bar for proving that a board's actions were motivated by bad faith self-interest rather than legitimate corporate concerns.
