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Cheff v. Mathes
MyWikiBiz, Author Your Legacy — Friday December 06, 2013
The Delaware Supreme Court first addressed the issue of director conflict of interest in a corporate change of control setting in Cheff v. Mathes, 199 A.2d 548 (Del. 1964). This case is the progeny of future seminal corporate law cases including: Unocal Corp. v. Mesa Petroleum Co., Revlon v. MacAndrews, and Paramount v. Time.
Holland Furnace Company manufactured home furnaces. The company's marketing strategy involved door-to-door sales, which employed a large workforce. Cheff-Landwehr family group had effective control over the company, with 18.5% of Holland stock. Cheff, a family member, was Holland's Chief Executive Officer. From 1948-1956, Holland's sales declined by 25%. Management attributed the sharp drop to a boom in sales following World War II, which could not be sustained in later years. Mr. Maremot, an owner of an automotive parts manufacturing business, approached Cheff in 1957 to discuss the possibility of a merger between the two companies. . Cheff was not interested in a business combination. Maremont purchased 6% of Holland stock on the open market. Cheff ordered an investigation of Maremont, and learned that Maremont had engaged in corporate takeovers and liquidation of several companies. Cheff and Maremont met a second time, by which time Maremont owned 11% of Holland Stock. Maremont told Cheff that Holland's door-to-door sales tactic was obsolete and should be abandoned in favor of a wholesaler marketing strategy.
Upon learning of Maremont's plans, Cheffs and Holland's board of directors agreed that Maremont posed a threat to Holland's continued existence. Maremont's threat caused Holland to begin loosing many of its employees, who were quiting in anticipation of the threatened takeover. To eliminate Maremont's threat to Holland's existence, the Holland board of directors authorized the repurchase og Maremont's holdings of Holland stock at a price above the prevailing market stock price. Essentially, the board authorized the payment of greenmail to Maremont.
Business Judgment Rule
The Delaware Supreme Court first had to determine whether Holland's directors were protected under the business judgment rule. The court noted that directors are presumed to be protected by the business judgment rule, but where they are faced with a conflict of interest, such as when they use corporate funds to repurchase shares to protect their control of the company, they may not be protected. Therefore, the court had to decide whether the Board was so conflicted that they should not be afforded Business Judgment Rule protection.
Threat to Corporate Policy
"The question then presented is whether or not [the board] satisfied the burden of proof of showing reasonable grounds to believe a danger to corporate policy and effectiveness existed by the presence of the Maremont stock ownership. It is important to remember that the directors satisfy their burden by showing good faith and reasonable investigation; the directors will not be penalized for an honest mistake of judgment, if the judgment appeared reasonable at the time the decision was made."
The court held that the directors were protected by the business judgment rule, because they held a good faith belief that Maramont posed a threat to Holland's continued existence.
Therefore, after Delaware's holding in this case, a director could rebut any inference of a conflict of interest, and remain protected by the business judgment rule, if they showed that they held a good faith belief that they were pursuing a "business purpose" that would benefit the corporation.