Klang v. Smith's Food and Drug Centers, Inc.

Supreme Court of Delaware · Corporations

Corporationscapital impairmentsurplusdirector disclosure dutiesself-tender offersmergersDGCL § 160DGCL § 154

Facts

SFD agreed to a transaction with Yucaipa involving a merger, a recapitalization with substantial new debt, a self-tender offer to repurchase up to fifty percent of its outstanding shares at $36 per share, and a repurchase of preferred shares from Jeffrey Smith and his family. SFD retained Houlihan to render a solvency opinion, and Houlihan advised the board that the transactions would not impair capital under 8 Del. C. § 160. Relying on that opinion, the board determined on May 17, 1996 that sufficient surplus existed, stockholders approved the transactions on May 23, 1996, and the self-tender was oversubscribed and fully consummated. Plaintiff argued that the repurchases impaired capital because post-transaction balance sheets showed negative net worth and that directors failed to disclose material facts before the stockholder vote.

Issue

Whether SFD's self-tender and related repurchases violated 8 Del. C. § 160 because they impaired capital, and whether SFD's directors breached their fiduciary duty of candor by omitting material information from disclosures seeking stockholder approval. More specifically, the court considered whether a board is bound by balance-sheet figures in determining surplus and whether the challenged omitted facts were material.

Rule

For purposes of 8 Del. C. § 160, a corporation is not bound by its balance sheets in determining surplus; directors may revalue assets and liabilities to reflect present values. A court may defer to the board's surplus determination unless the plaintiff shows the directors failed to evaluate assets on acceptable data and by standards they were entitled reasonably to believe reflected present values, or that the determination was made in bad faith, was fraudulent, or was so far off the mark as to constitute actual or constructive fraud. When seeking stockholder action, directors must disclose all material reasonably available facts, with materiality turning on whether a reasonable stockholder would view the fact as significantly altering the total mix of information.

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Redwood Outfitters, Inc., a Delaware corporation based in Portland, plans a cash repurchase of common shares. Its post-transaction book balance sheet would show negative net worth, but the board relied on a valuation report from Pine Harbor Advisory finding that recently appreciated warehouse properties create present-value surplus sufficient to fund the repurchase.

If a stockholder sues solely on the ground that the post-transaction balance sheet shows negative net worth, what is the strongest response?

Explanation. The majority held that balance sheets are not conclusive indicators of surplus for purposes of DGCL § 160. Directors may depart from book figures and revalue assets and liabilities to reflect current realities, because unrealized appreciation or depreciation may make book numbers inaccurate. Thus, negative book net worth alone does not establish capital impairment. (Derived from Klang v. Smith's Food and Drug Centers, Inc. (n.d.).)