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

Supreme Court of Delaware · Corporations

Corporationscapital impairmentsurplusdisclosureself-tenderboard reliance on expertsDGCL § 160DGCL § 154

Facts

SFD agreed to a transaction with Yucaipa involving a merger, recapitalization, a self-tender for up to fifty percent of SFD's shares at $36 per share, and a repurchase of preferred stock from Jeffrey Smith and his family. SFD retained Houlihan to render a solvency opinion, and Houlihan concluded that the transactions would not impair capital under DGCL § 160 because SFD had sufficient surplus after valuing assets under a market-multiple approach. The board relied on that opinion, adopted a resolution stating sufficient surplus existed, and stockholders approved the transactions. Although SFD's balance sheets showed a post-transaction deficit, the board's off-balance-sheet valuation showed surplus.

Issue

Whether SFD's repurchase of its own shares violated DGCL § 160 because the transactions impaired capital, despite balance sheets showing negative net worth. Whether the directors also breached their fiduciary duty of candor by failing to disclose allegedly material information before seeking stockholder approval.

Rule

A corporation may not repurchase its own shares if doing so would impair capital, meaning the repurchase exceeds available surplus under DGCL §§ 154 and 160. But balance sheets are not conclusive of surplus; directors may revalue assets and liabilities to reflect present values, and courts will defer to the board's determination if directors act in good faith, use acceptable data and methods they reasonably believe reflect present values, and their determination is not so far off the mark as to constitute actual or constructive fraud. When seeking stockholder action, directors must disclose all material reasonably available facts, i.e., facts a reasonable stockholder would view as significantly altering the total mix of information available.

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

Lakeview Grocers, Inc., a Delaware corporation headquartered in Phoenix, plans a cash repurchase of 30% of its common shares. Its year-end balance sheet shows negative stockholders' equity, but the board obtains a present-value analysis from Copper Mesa Advisory finding substantial unrealized appreciation in owned distribution centers and concluding the company will still have surplus after the repurchase.

A stockholder sues to invalidate the repurchase solely because the balance sheet showed negative equity after the transaction. Which is the best result?

Explanation. The majority held that for § 160 purposes, book balance sheets are not conclusive indicators of surplus. Directors have latitude to go behind the balance sheet and revalue assets and liabilities to reflect present values, so long as they act in good faith, use acceptable data, and employ methods they reasonably believe reflect present values. A plaintiff relying only on negative book equity does not establish impairment. (Derived from Klang v. Smith's Food & Drug Centers, Inc. (n.d.).)