Warren v. Century Bankcorporation, Inc.
1987 OK 14, 1987 Okla. LEXIS 156, 741 P.2d 846 (1987)
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Rule of Law:
When a parent corporation engages in self-dealing with its subsidiary, receiving a benefit not shared by the subsidiary's minority shareholders, the transaction's validity is judged by the 'intrinsic fairness' test, which shifts the burden to the parent to prove the entire transaction was fair.
Facts:
- Century Bankcorporation, Inc. (Century) was the majority shareholder of Century Bank, owning over 80% of its stock.
- The boards of directors for both Century and Century Bank were comprised of the same individuals.
- Century created Action Financial Corporation (Action), a wholly-owned subsidiary, to make loans in the same market area as Century Bank.
- A loan officer from Century Bank, Larry Johnson, was transferred to Action to become its chief operating officer.
- Action subsequently made loans to former customers of Century Bank and to individuals who knew Johnson from his time at the Bank.
- Century Bank paid management fees to Century for the consulting services of two executives, John Dean and Jack Cochran, who also served on the Bank's board of directors.
Procedural Posture:
- Minority shareholders of Century Bank brought a shareholders' derivative suit in the district court against Century Bankcorporation, Inc., Action Financial Corporation, and the Bank's directors.
- Following a bench trial, the district court found for the plaintiffs, holding that the defendants had diverted loan business and charged excessive management fees.
- The trial court enjoined Action's operations and entered a monetary award against Century and Action for the diverted loan income and the excessive fees.
- The trial court also awarded attorney's fees and costs to the plaintiffs.
- The defendants, Century and Action, appealed the district court's judgment to the Supreme Court of Oklahoma.
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Issue:
Does a parent corporation breach its fiduciary duty to the minority shareholders of its subsidiary by engaging in self-dealing transactions, such as diverting corporate opportunities and charging excessive fees, that are not proven to be intrinsically fair?
Opinions:
Majority - Justice Opala
Yes. A parent corporation breaches its fiduciary duty to the subsidiary's minority shareholders when it engages in self-dealing that is not intrinsically fair. When a parent corporation stands on both sides of a transaction and receives a benefit to the exclusion of the subsidiary's minority shareholders, the default 'business judgment' rule does not apply. Instead, the transaction is scrutinized under the 'intrinsic fairness' test, which places the burden on the parent company to prove the transaction's entire fairness. Here, Century failed to meet this burden because creating Action to compete with the Bank for loans constituted a diversion of corporate opportunities, and the management fees were found to be duplicative and unnecessary. The remedy of disgorgement, requiring the return of all income from the diverted business without deducting expenses, is an appropriate equitable remedy for a conscious fiduciary wrongdoer.
Dissenting - Justice Alma Wilson
No. The business judgment rule should apply to protect the directors' decisions absent fraud or gross overreaching. The corporate opportunity doctrine was misapplied because Century Bank was legally prohibited from branch banking at the time, meaning it could not have legally operated a business like Action. Therefore, the Bank was not deprived of an opportunity it could have pursued. Furthermore, the evidence showed that the Bank's overall revenues increased due to its dealings with Action. Courts should not second-guess good-faith business decisions, as doing so stifles the free enterprise and risk-taking that are central to corporate management.
Analysis:
This case formally adopts the 'intrinsic fairness' test in Oklahoma for evaluating self-dealing transactions between a parent corporation and its subsidiary. It establishes that in conflict-of-interest situations, the deference typically granted under the 'business judgment' rule is set aside, and a heavy burden of proof shifts to the controlling shareholder to demonstrate fairness. The ruling also affirms the potent equitable remedy of 'disgorgement' of gross profits, which serves as a significant deterrent against fiduciary misconduct by preventing wrongdoers from retaining any gains, even to the extent of denying them deductions for their business expenses.
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