Breach of fiduciary duty, entire fairness standard, business judgment rule, derivative action, summary judgment.
By Michael Farinacci | Managing Editor
Plaintiff was a minority shareholder of Bancorp. Bancorp was an entity member of Northeast Community Bank (“NECB”). NECB had a tiered corporate structure. MHC was the top-tier entity, and MHC owned 55% of Bancorp. The remaining 45% of Bancorp stock was publicly traded on the Nasdaq. The Defendants were the board of directors of both MHC and Bancorp.
Plaintiff made a demand on Defendants (Bancorp’s board) to adopt a second step conversion plan (“Second Step”) which would make Bancorp a fully public corporation or, in the alternative, appoint independent board members to consider the plan. Defendants refused Plaintiff’s demand. Plaintiff brought a shareholders’ derivative action against the Defendant-board for a breach of its fiduciary duty. Both parties filed motions for summary judgment.
Defendants argued that the board’s decision was protected by the business judgment rule. Typically, a board’s decision to refuse demand is evaluated under the business judgment rule, and courts will defer to the decision of the board as long as there is not a breach of fiduciary duty or a conflict of interest.
Plaintiff argued for a finding of a breach of fiduciary duty or partial summary judgment to declare that the board’s decision must be evaluated by the entire fairness standard. Plaintiff claimed that the application of the business judgment rule was not appropriate since the Defendants had a conflict of interest—being the board of directors for both MHC and Bancorp. Therefore, Plaintiff sought a declaration that the Defendants breached their fiduciary duty to Bancorp, or, in the alternative, that Defendants’ decision should be evaluated under the burdensome, entire fairness standard because the decision to adopt the Second Step involved self-dealing by the Defendants, the controlling shareholder of Bancorp.
When assessing the applicable standard of judicial review to apply to a board’s decision, the court must review the board’s fiduciary duties. Here, the court found “the fiduciary duties owed by the [Defendant-]Directors to MHC’s members and Bancorp’s public shareholders are incompatible in considering whether to [exercise the] Second Step.” The Second Step would dissolve one company for the benefit of the other. Consequently, the Defendants cannot act in the best interest of both MHC and Bancorp.
The court found that the entire fairness standard would apply to the Defendants’ decision because MHC was the majority shareholder of Bancorp. “When a transaction involving self-dealing by a controlling shareholder is challenged, the applicable standard of judicial review is entire fairness, with the defendants having the burden of persuasion . . . of proving that the transaction with the controlling stockholder was entirely fair to the minority stockholders.” Under the entire fairness standard, the defendants have the burden of proving the transaction was entirely fair to the minority shareholders. The defendants must establish the two elements of entire fairness: fair process and fair price. Here, the court concluded that record was not sufficient to make a fair process determination on summary judgment. Since the first element was not met, the court did not evaluate the fair price element.
The court dismissed the Defendants’ motion because the business judgment rule did not apply and granted the Plaintiff’s motion in part; holding that the entire fairness standard should apply, and that trial must be had to establish whether there was entire fairness or a lack thereof by the Defendants’ decision.
Stilwell Value Partners, IV, L.P. v. Cavanaugh, Index No. 653011/2011, 10/23/2015 (Ramos, J.).