Cheff v. Mathes

Supreme Court of Delaware · 1964 · Corporations

CorporationsCorporate stock repurchasesDirectors' fiduciary dutiesCorporate controlshare repurchasegreenmailcorporate controlentrenchment

Facts

After Arnold Maremont and Motor Products accumulated a substantial block of Holland stock and Maremont sought a board seat, Holland's board investigated Maremont's business history and was told he had engaged in quick-profit sales or liquidation practices and opposed Holland's direct retail sales system. The board also received reports of employee unrest and advice from corporate officers and professionals, and concluded Maremont posed a threat to Holland's continued operation in its existing form. The board then authorized purchases of Holland stock with corporate funds, including buying 155,000 shares from Motor Products at a price above market. Plaintiffs alleged the true purpose of the repurchase was to keep the incumbent directors in control.

Issue

When directors authorize a corporate repurchase of shares from a dissident stockholder whose accumulation of stock also threatens incumbent control, may the directors use corporate funds for that purchase? More specifically, did these directors carry their burden of showing the repurchase was primarily in the corporate interest rather than an improper effort to perpetuate themselves in office?

Rule

Although a Delaware corporation has statutory power to purchase its own shares, directors may not use corporate funds solely or primarily to perpetuate themselves in office. Where a repurchase is made to remove a threat that also implicates control, the burden is on the directors to justify the purchase as one primarily in the corporate interest. They satisfy that burden by showing good faith and reasonable investigation establishing reasonable grounds to believe a danger to corporate policy and effectiveness existed; directors are not liable for an honest mistake of judgment if the judgment appeared reasonable at the time.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Summit Glass Works, a Delaware corporation based in Toledo, learns that Victor Sloan has acquired 18% of its stock and is seeking enough shares to force changes in the company’s long-standing direct-sales model. After several meetings, the board authorizes the corporation to buy Sloan’s block with corporate funds, and minority stockholders sue derivatively, alleging the directors only wanted to keep their seats.

Who bears the burden of justifying the repurchase?

Explanation. When directors use corporate funds to repurchase shares in response to a threat that also implicates corporate control, the burden shifts to the directors to justify the purchase as one primarily in the corporate interest. The majority recognized the danger of entrenchment in that setting and required directors to show good faith and reasonable investigation. A general presumption of good faith does not control once this control-related repurchase issue is present.