Lewis v. S. L. & E., Inc.
629 F.2d 764 (1980)
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Rule of Law:
When a corporate transaction involves interested directors who have a conflict of interest, the business judgment rule does not apply. The burden of proof shifts to the directors to affirmatively demonstrate that the transaction was fair and reasonable to the corporation.
Facts:
- S.L. & E., Inc. (SLE), a corporation owned by the Lewis siblings, had as its only significant asset a property complex in Rochester, New York.
- Lewis General Tires, Inc. (LGT), a tire dealership, was owned and operated by three of the Lewis brothers: Richard, Alan, and Leon, Jr.
- LGT leased the property from SLE. The directors of SLE were the same individuals who were officers, directors, and shareholders of LGT.
- In 1962, all SLE shareholders entered into an agreement requiring any shareholder not also an LGT shareholder by June 1, 1972, to sell their SLE shares to LGT at book value.
- LGT's 10-year lease with SLE expired in 1966, but the LGT-affiliated directors of SLE made no effort to negotiate a new lease or increase the rent.
- From 1966 to 1972, LGT continued to occupy the property, paying the old rent of $14,400 per year, which the defendant directors never considered raising despite rising property taxes paid by SLE.
- The defendant directors largely ignored SLE's separate corporate existence, viewing it as a 'shell' existing solely for the benefit of LGT.
- Plaintiff Donald E. Lewis, an SLE shareholder who held no interest in LGT, came to believe the low rent artificially deflated SLE's book value ahead of the mandatory 1972 stock sale and refused to sell his shares.
Procedural Posture:
- Donald E. Lewis filed a shareholder derivative suit on behalf of S.L. & E., Inc. (SLE) against his brothers, Alan, Leon Jr., and Richard, in the U.S. District Court for the Western District of New York.
- Lewis General Tires, Inc. (LGT) intervened in the action, filing a complaint against Donald for specific performance of an agreement to sell his SLE stock.
- Following an eight-day bench trial, the district court held that Donald had failed to prove his claim of waste and entered judgment for the defendant directors.
- The district court also granted LGT's request for specific performance and awarded attorneys' fees to the defendants and SLE.
- Donald E. Lewis, as plaintiff-appellant, appealed the district court's judgments to the United States Court of Appeals for the Second Circuit.
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Issue:
In a shareholder derivative suit challenging a transaction between two corporations with identical directors, does the burden of proof lie with the plaintiff shareholder to prove waste, or with the defendant directors to prove the transaction was fair and reasonable?
Opinions:
Majority - Kearse, J.
No. In a transaction involving interested directors, the burden of proof lies with the defendant directors to prove the transaction was fair and reasonable. The business judgment rule, which normally protects directors' decisions from judicial review, presupposes that directors have no conflict of interest. When directors stand on both sides of a transaction, as the Lewis brothers did with SLE and LGT, they cannot invoke the rule. Instead, under both the prior and current versions of New York Business Corporation Law § 713, the interested directors must affirmatively establish that the transaction was fair and reasonable to the corporation. Here, the defendant directors failed to carry this burden. They presented no evidence that they made any effort to determine a fair rental value for the property between 1966 and 1972, admitting they viewed SLE as existing purely for LGT's benefit. The evidence they did present, such as appraisals from later years and data on LGT's profitability, was either irrelevant, distorted, or actually suggested that the fair rental value was substantially higher than what was paid. Therefore, the district court erred in placing the burden of proof on the plaintiff.
Analysis:
This decision strongly affirms the core fiduciary duty of loyalty and clarifies the application of New York's interested-director statute, BCL § 713. It establishes that the business judgment rule's protection is forfeited in self-dealing scenarios, placing a heavy burden of proving fairness squarely on the conflicted directors. The case serves as a crucial precedent, particularly for closely-held and family-owned corporations, warning against disregarding corporate formalities and using one entity to improperly benefit another when ownership interests are not identical. This ruling reinforces that minority shareholders have a potent legal remedy when controlling directors engage in transactions that benefit themselves at the corporation's expense.
