SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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SCHEDULE 13D
(Rule 13d-101)
INFORMATION TO BE INCLUDED IN STATEMENTS FILED PURSUANT
TO RULE 13d-1(a) AND AMENDMENTS THERETO FILED PURSUANT TO
RULE 13d-2(a)
(Amendment No. 8)
Friendly Ice Cream Corporation
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(Name of Issuer)
Common Stock, $0.01 par value
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(Title of Class of Securities)
358497105
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(CUSIP Number)
Sardar Biglari
The Lion Fund, L.P.
9311 San Pedro Avenue, Suite 1440
San Antonio, Texas 78216
Telephone (210) 344-3400
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(Name, Address and Telephone Number of Person
Authorized to Receive Notices and Communications)
November 8, 2006
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(Date of Event which Requires Filing of This Statement)
If the filing person has previously filed a statement on Schedule 13G to
report the acquisition that is the subject of this Schedule 13D, and is filing
this schedule because of Rule 13d-1(e), 13d-1(f) or 13d-1(g), check the
following box [ ].
Note: Schedules filed in paper format shall include a signed original
and five copies of the schedule, including all exhibits. See Rule 13d-7 for
other parties to whom copies are to be sent.
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(1) The remainder of this cover page shall be filled out for a reporting
person's initial filing on this form with respect to the subject class of
securities, and for any subsequent amendment containing information which
would alter disclosures provided in a prior cover page.
The information required on the remainder of this cover page shall not be
deemed to be "filed" for the purpose of Section 18 of the Securities Exchange
Act of 1934 or otherwise subject to the liabilities of that section of the Act
but shall be subject to all other provisions of the Act (however, see the
Notes).
CUSIP No. 358497105
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1. NAME OF REPORTING PERSONS
I.R.S. IDENTIFICATION NOS. OF ABOVE PERSONS (ENTITIES ONLY)
The Lion Fund L.P.
2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP*
(a) [X]
(b) [ ]
3. SEC USE ONLY
4. SOURCE OF FUNDS*
WC
5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED
PURSUANT TO ITEMS 2(d) OR 2(e) [_]
6. CITIZENSHIP OR PLACE OF ORGANIZATION
Delaware
NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON
7. SOLE VOTING POWER
0
8. SHARED VOTING POWER
1,008,688
9. SOLE DISPOSITIVE POWER
0
10. SHARED DISPOSITIVE POWER
1,008,688
11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON
1,008,688
12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES*
13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11)
12.73%
14. TYPE OF REPORTING PERSON*
PN
CUSIP No. 358497105
---------------------
1. NAME OF REPORTING PERSONS
I.R.S. IDENTIFICATION NOS. OF ABOVE PERSONS (ENTITIES ONLY)
Biglari Capital Corp.
2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP*
(a) [X]
(b) [ ]
3. SEC USE ONLY
4. SOURCE OF FUNDS*
AF, WC
5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED
PURSUANT TO ITEMS 2(d) OR 2(e) [_]
6. CITIZENSHIP OR PLACE OF ORGANIZATION
Texas
NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON
7. SOLE VOTING POWER
0
8. SHARED VOTING POWER
1,008,688
9. SOLE DISPOSITIVE POWER
0
10. SHARED DISPOSITIVE POWER
1,008,688
11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON
1,008,688
12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES*
13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11)
12.73%
14. TYPE OF REPORTING PERSON*
CO
CUSIP No. 358497105
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1. NAME OF REPORTING PERSONS
I.R.S. IDENTIFICATION NOS. OF ABOVE PERSONS (ENTITIES ONLY)
Biglari, Sardar
2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP*
(a) [X]
(b) [ ]
3. SEC USE ONLY
4. SOURCE OF FUNDS*
AF,WC
5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED
PURSUANT TO ITEMS 2(d) OR 2(e) [_]
6. CITIZENSHIP OR PLACE OF ORGANIZATION
United States of America
NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON
7. SOLE VOTING POWER
0
8. SHARED VOTING POWER
1,008,688
9. SOLE DISPOSITIVE POWER
0
10. SHARED DISPOSITIVE POWER
1,008,688
11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON
1,008,688
12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES*
13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11)
12.73%
14. TYPE OF REPORTING PERSON*
IN
CUSIP No. 358497105
---------------------
1. NAME OF REPORTING PERSONS
I.R.S. IDENTIFICATION NOS. OF ABOVE PERSONS (ENTITIES ONLY)
Western Sizzlin Corp.
2. CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP*
(a) [X]
(b) [_]
3. SEC USE ONLY
4. SOURCE OF FUNDS*
WC
5. CHECK BOX IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED
PURSUANT TO ITEMS 2(d) OR 2(e) [_]
6. CITIZENSHIP OR PLACE OF ORGANIZATION
Delaware
NUMBER OF SHARES BENEFICIALLY OWNED BY EACH REPORTING PERSON
7. SOLE VOTING POWER
0
8. SHARED VOTING POWER
1,008,688
9. SOLE DISPOSITIVE POWER
0
10. SHARED DISPOSITIVE POWER
1,008,688
11. AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING PERSON
1,008,688
12. CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES CERTAIN SHARES*
13. PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11)
12.73%
14. TYPE OF REPORTING PERSON*
CO
CUSIP No. 358497105
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________________________________________________________________________________
Item 1. Security and Issuer.
No change.
________________________________________________________________________________
Item 2. Identity and Background.
No change.
________________________________________________________________________________
Item 3. Source and Amount of Funds or Other Consideration.
No change.
________________________________________________________________________________
Item 4. Purpose of Transaction.
The Reporting Persons have consulted with the chairman of the board of
directors and management of the Issuer concerning the business, operations and
future plans of the Issuer. Such consultation included a meeting on September
20, 2006, whereby the Reporting Persons requested two seats on the Issuer's
board of directors for Mr. Sardar Biglari and Dr. Philip L. Cooley. By letter to
Mr. Biglari dated October 3, 2006, the Issuer's Vice President and General
Counsel, Gregory Pastore, requested information regarding Mr. Biglari and Dr.
Cooley. A law firm representing the Reporting Persons provided such information
to Mr. Pastore by letter dated October 5, 2006. On October 16, 2006, a law firm
representing the Issuer responded by letter to the October 5 letter stating that
the Company would respond "in due course".
The Reporting Persons prefer to obtain the requested board seats through
action by the Issuer's board of directors, but absent such action, the Reporting
Persons intend to nominate Mr. Biglari and Dr. Cooley for election at the
Issuer's annual meeting of stockholders to be held in 2007, in accordance with
the Issuer's by-laws providing for such nominations. In such case, the Reporting
Persons intend to solicit proxies to be voted in favor of the nominees.
Accordingly, on November 8, 2006, The Lion Fund sent notice to the Issuer's
Secretary, in accordance with the Issuer's by-laws, of its intention to nominate
Mr. Biglari and Dr. Cooley for election as directors at the next meeting of
stockholders at which directors are to be elected. In addition, on November 8,
2006, Mr. Biglari sent to the Issuer a demand to inspect and copy the Issuer's
record of its stockholders, as permitted by the Massachusetts Business
Corporation Act.
If the Reporting Persons engage in solicitation of proxies, and are
successful in the election of one or both of Mr. Biglari and Dr. Cooley to the
Issuer's board of directors, the Reporting Persons will seek reimbursement of
their expenses from the Issuer.
The Reporting Persons are concerned with the current status of the board of
directors as all but one of the Issuer's current directors, including the
chairman of the board, are defendants in a pending shareholder derivative
lawsuit in which one of the founders of the Issuer's business and a substantial
stockholder, S. Prestley Blake, is the plaintiff. Copies of two court decisions
in this litigation, dated May 24, 2006, and August 25, 2006, are attached hereto
as Exhibits B and C.
As set forth herein, the Reporting Persons have beneficial ownership of
12.73% of the Issuer's common stock. The Reporting Persons believe such holdings
are more than the amount beneficially owned by any other stockholder or group
and more than all such stock owned by all of the Issuer's current directors
combined. Accordingly, the Reporting Persons believe that their interests are
aligned with those of other stockholders and that Mr. Biglari and Dr. Cooley
would be constructive contributors to the Issuer's board of directors.
The Reporting Persons will continue to evaluate the business prospects of
the Issuer, its management, and board of directors and may from time to time
consult further with the Issuer's management, one or more of its directors, or
with other stockholders.
The Reporting Persons may effect transactions that would change the number
of shares they may be deemed to own beneficially.
Except as set forth above, the Reporting Persons have no present plans or
intentions that would relate to or result in any of the actions described in
subparagraphs (a) through (j) of Item 4 of Schedule 13D.
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Item 5. Interest in Securities of the Issuer.
No change.
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Item 6. Contracts, Arrangements, Understandings or Relationships with Respect
to Securities of the Issuer.
No change.
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Item 7. Material to be Filed as Exhibits.
A. An agreement relating to the filing of a joint statement as required by
Rule 13d-1(f) under the Securities Exchange Act of 1934 is filed herewith as
Exhibit A.
B. The Court decision filed on May 24, 2006 between S. Prestley Blake v.
Friendly Ice Cream Corp. & Donald N. Smith is filed herewith as Exhibit B.
C. The Court decision filed on August 24, 2006 between S. Prestley Blake v.
Friendly Ice Cream Corp. and others is filed herewith as Exhibit C.
D. A description of the transactions by the Lion Fund since Amendment 5 to
the Schedule 13D filed by the Reporting Persons on September 25, 2006 is filed
herewith as Exhibit D.
SIGNATURE
After reasonable inquiry and to the best of my knowledge and belief, I
certify that the information set forth in this statement is true, complete and
correct.
November 8, 2006
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(Date)
THE LION FUND, L.P.
By: Biglari Capital Corp.,
General Partner
By: /s/ Sardar Biglari
--------------------------------
Sardar Biglari, Chief Executive Officer
BIGLARI CAPITAL CORP.
By: /s/ Sardar Biglari
--------------------------------
Sardar Biglari, Chief Executive Officer
SARDAR BIGLARI
/s/ Sardar Biglari
--------------------------------
WESTERN SIZZLIN CORP.
/s/ Robyn B. Mabe
--------------------------------
Robyn B. Mabe, Chief Financial Officer
Exhibit A
AGREEMENT
The undersigned agree that this Amendment to the Schedule 13D dated
November 8, 2006, relating to the Common Stock par value $0.01 of Friendly Ice
Cream Corporation shall be filed on behalf of the undersigned.
November 8, 2006
-----------------------
(Date)
THE LION FUND, L.P.
By: Biglari Capital Corp.,
--------------------------------
General Partner
By: /s/ Sardar Biglari
--------------------------------
Sardar Biglari, Chief Executive Officer
BIGLARI CAPITAL CORP.
By: /s/ Sardar Biglari
--------------------------------
Sardar Biglari, Chief Executive Officer
SARDAR BIGLARI
/s/ Sardar Biglari
--------------------------------
WESTERN SIZZLIN CORP.
By: /s/ Robyn B. Mabe
--------------------------------
Robyn B. Mabe, Chief Financial Officer
Exhibit B
Not Reported in N.E.2d
Not Reported in N.E.2d, 21 Mass.L.Rptr. 131, 2006 WL 1579596 (Mass.Super.)
(Cite as: 2006 WL 1579596 (Mass.Super.))
Superior Court of Massachusetts.
S. Prestley BLAKE
v.
FRIENDLY ICE CREAM CORP. et al. [FN1]
FN1. The Special Litigation Committee has filed an appearance, as
intervener, with respect to the motion to dismiss.
No. 030003.
May 24, 2006.
MEMORANDUM OF DECISION AND ORDER ON SPECIAL LITIGATION COMMITTEE'S MOTION TO
DISMISS DERIVATIVE ACTION AND PLAINTIFF'S REQUEST FOR RECONSIDERATION OF THE
DENIAL OF MOTION TO AMEND
JOHN A. AGOSTINI, Associate Justice.
INTRODUCTION
*1 In this shareholder derivative lawsuit, the defendant intervener, a
Special Litigation Committee (SLC) appointed by the defendant corporation's
board of directors, has moved to dismiss the action pursuant to G.L.c. 156D,
s. 7.44. Also before me is the plaintiff's motion for reconsideration
of my order denying his latest motion to amend the complaint. After a
non-evidentiary hearing [FN2] and considering the parties' oral and written
arguments and supporting documents, the SLC's motion to dismiss is DENIED and
the plaintiff's motion to reconsider and motion to amend are ALLOWED.
FN2. Neither party requested an evidentiary hearing.
BACKGROUND
The defendant, Friendly Ice Cream Corporation (Friendly), operates and
franchises hundreds of restaurants, primarily in the northeastern United
States, and manufactures frozen desserts distributed at retail locations in 15
states. The plaintiff, S. Prestley Blake, founded Friendly with his brother in
1935. Friendly was publicly held from 1968 until 1979, when it was sold to
Hershey Food Corporation (Hershey). In 1988, The Restaurant Company (TRC), an
investor group led by the defendant, Donald Smith (Smith), acquired Friendly
from Hershey and then brought Friendly public again in 1997. In the November
1997 initial public offering (the IPO) of stock, Blake became an owner of
Friendly common stock and currently owns approximately 10% of its outstanding
common shares.
Smith, widely respected for his expertise in the restaurant business, was
simultaneously chief executive officer (CEO) and chairman of the boards of
both Friendly and TRC from 1988 through February of 2003. In February of 2003,
Smith became the non-executive chairman of Friendly's Board of Directors (the
Board), such that he was no longer CEO but continued to chair the Board. At
all relevant times, Smith has also been the owner of approximately 70% of TRC,
which is a management company. [FN3] Two of TRC's divisions relevant to this
action are Perkins Family Restaurants (Perkins), a company which operates
restaurants, and Foxtail Foods (Foxtail), a company which from 1998 through
2004 sold between $4.4 and $5.3 million in food products to Friendly.
FN3. Smith has been the CEO of TRC and its predecessor since 1985. In
1999, Smith's ownership interest in TRC increased to 70%. TRC had been
the management company of Perkins and Friendly, both operating
companies. Okscin dep. p. 182.
TRC is the sole stockholder of TRC Realty, LLC, The Restaurant Company
of Minnesota, and Perkins Finance Corp. TRC is a wholly-owned subsidiary
of The Restaurant Holding Company (RHC), which according to TRC's 2004
10K Form (exh. 118), is owned principally by Smith and BancBoston
Ventures, Inc.
Friendly had a shareholder deficit of $85 million at the time of the IPO. As
of January 2002, this deficit climbed to $89 million, and in 2003 the deficit
was $98 million. Between 1999 and 2003, Friendly's total assets decreased to a
greater extent than the Board was able to reduce the debt. [FN4]
FN4. Daly dep. p. 37-38.
A principal activity of the Board has been to undertake financial actions to
reduce Friendly's debt and improve its operating performance. [FN5] From
November 1997 to March of 2005, the Board was comprised of the same five
members: Smith, Steven Ezzes (Ezzes), Michael J. Daly (Daly), Charles
Ledsinger (Ledsinger), and Burton Manning (Manning). In March of 2005,
Ledsinger stepped down and was replaced a few months later by Perry Odak
(Odak). The Board delegates to management the function of running Friendly.
Smith, as former CEO of Friendly, led its management team.
FN5. Daly dep. p. 36.
*2 Within the Board, three committees assume certain responsibilities: the
Audit Committee, the Compensation Committee, and the Nominating Committee. One
of the primary functions of the Audit Committee is to assist the Board with
the oversight of Friendly's financial reporting process, the systems of
internal controls and all audit processes. The Audit Committee reviews the
financial results of Friendly, the internal audits on its restaurants, and any
other financial matters deemed necessary at its meetings with the Audit
Committee and the CFO. Its role is to "ensure, number one, all systems,
procedures, and controls in the organization are proper and functioning well."
[FN6] Of particular significance to this action is that the Audit Committee
is responsible for scrutinizing related party transactions to ensure that the
interests of the shareholders and general public are protected. [FN7] The
Audit Committee, as described by Daly, is very active and diligent, and
typically meets six times a year. The members of the Audit Committee from 1997
until March of 2005 were Daly, Ledsinger, and Ezzes. [FN8]
FN6. Daly dep. pp. 10-12.
FN7. Daly dep. pp. 149-50.
FN8. Daly dep. pp. 10, 12.
The Compensation Committee oversees all compensation practices of the
company. The three members of the Compensation Committee since late 1997 were
Daly, Ledsinger (up until his departure from the Board in March of 2005), and
Manning.
The Nominating Committee considers the ongoing performance of existing
directors, evaluates core competencies of Friendly's "governance oversight
capabilities," or in other words evaluates how well the Board functions. In
order to determine whether the directors are participating effectively, the
Nominating Committee surveys the five directors on the Board. The survey
results collected so far uniformly indicate that the directors feel that their
communications with management are satisfactory and that the Board is
effectively performing. [FN9] The Nominating Committee also makes
recommendations to the Board regarding promotions, directors, and senior
officers. Since 1997, the Nominating Committee has been comprised of Daly and
Smith, and perhaps also Manning. [FN10]
FN9. Daly dep. pp. 21-24.
FN10. Daly dep. p. 20.
Each director of Friendly receives compensation in the amount of $2,500 per
month ($30,000 per year), plus $1,500 for each Board meeting attended, plus
expenses. [FN11] Audit Committee members receive $1,500 for attendance at the
annual Audit Committee meeting. For serving as chairman, Smith has received
additional director compensation, which in 2004 was $8,333.34 per month.
[FN12] Friendly's directors also receive compensation in the form of stock
options. [FN13] Pursuant to Friendly's 1997 Stock Option Plan, each outside
director receives stock options reflective of his functions. Although the
amounts vary from year to year, for fiscal year 2004, each outside director
received at least 3,000 stock options; the Compensation Committee Chairman
(Manning) received an additional 1,500 stock options, and the Audit Committee
Chairman (Ezzes) received an additional 3,000 stock options. In fiscal year
2004, Ezzes, Ledsinger, Daly and Manning received 6,000, 3,000, 3,000 and
4,500 stock options, respectively. [FN14]
FN11. In fiscal year 2004, the Board met seven times and each director
attended at least 75% of the meetings of the Board, thus receiving at
least $7,875. Form DEF 14A Friendly SEC filing dated April 8, 2005, Exh.
A to Manning affid. of Jan 24, 2006.
FN12. Form DEF 14A, filed April 8, 2005, exh. A to Ezzes affid.
FN13. SLC's counsel stated at the motion hearing that the outside
directors' principal form of compensation is stock options. See 1/20/06
Hearing Tr. p. 78. The exercise price per share has fluctuated between
fiscal year 1999 and the present. The plaintiff does not argue that
these directors' compensation in this form has been inordinate.
FN14. Form DEF 14A, filed April 8, 2005, exh. A to Ezzes affid.
*3 Between 1999 and 2002, Blake grew suspicious about possible mismanagement
of Friendly's assets and self-dealing by Smith. On May 15, 2002, at a
shareholders' meeting, Blake voiced his concerns that Smith had caused
Friendly to pay costs toward a Learjet which largely benefited TRC and Smith,
directly or indirectly. This controversy has its roots in a 1994 agreement
between TRC and Friendly to share the fixed and variable costs of a corporate
aircraft, then a 1992 Beechjet 400A, for which TRC entered a ten-year contract
to lease from General Electric Capital Corporation . [FN15] In 1999, TRC's
Board of Directors decided to dispose of the Beechjet 400A for a cash purchase
price of not less than $3.2 million, [FN16] and to acquire a new Learjet 45
for a purchase price of $8,278,950, to be financed with General Electric
Corporation pursuant to an Aircraft Lease Agreement. [FN17]
FN15. There is no dispute that the plaintiff lacks standing to assert
claims relating to conduct prior to 1997 when he became a shareholder.
FN16. Exh. 93. There is no record of the Beechjet 400A sale proceeds
reaching Friendly.
FN17. Exh. 93.
Because in 1999, Friendly's five-year plan called for opening well over one
hundred franchises, the Board viewed the use of the Learjet as useful for
visiting potential franchise sites. No written agreement exists requiring
Friendly to pay for costs of the use of the Learjet.
Nonetheless, from 1999 through, at least, August of 2003, Friendly paid TRC
for 40% to 50% of the Learjet's fixed costs plus 100% of any variable costs
associated with Friendly's actual use of the aircraft. [FN18] Friendly's
comptroller, Allan Okscin (Okscin), who was responsible for paying TRC for
Friendly's share of the aircraft, did not receive or request from TRC
documentation such as underlying invoices substantiating the variable costs
(which included fuel, maintenance, engine costs, landing and parking fees,
pilot travel expenses, and catering) and fixed costs (which included lease
payments, pilots' salaries and benefits, pilot relocation costs, hangar
rental, crew expenses, property taxes, banking fees, set-up expenses,
training, amortization, insurance, dues and subscriptions, supplies and
telephone costs) billed to and paid by Friendly. [FN19] Instead, with respect
to fixed costs, Okscin never requested more than what TRC sent, which was an
annual projection of fixed costs and a monthly payment schedule. As to the
variable costs for flights charged to Friendly, Okscin received from TRC
bills, usually with flight manifests identifying who was on the plane and
where it went. Alter talking to others to make sure each billed flight was
taken, Okscin approved payment of these bills, even for some flights lacking
manifests. [FN20] Okscin also approved Friendly's payment for flights carrying
Smith's wife's children, and assumed that such flights were for business
purposes because one of the passengers, Jody Delrey, had been involved with
Friendly's Easter Seal campaign. [FN21]
FN18. Friendly's former general counsel, Aaron Parker, reported that
Friendly paid TRC the following amounts for the Learjet's fixed and
variable costs, respectively, in the fiscal years 2000 through 2002:
2000: $843,858; $82,756
2001: $612,548; $73,878
2002: $449,319; $0
Exh. 53, Parker memorandum dated June 26, 2002, p. 2. Thus in 2002,
Friendly paid TRC $449,319 for never using the Learjet that year.
Smith testified that Friendly's former chief financial officer (CFO),
Paul McDonald, and his counterpart at TRC, Steven McClellan, determined
how much of the aircraft costs would be paid by Friendly. Smith dep. pp.
52-53. In contrast, McClellan testified that it was Smith who decided
what portion of these costs would be borne by TRC and Friendly.
McClellan dep. p. 134. McClellan's version is supported by a handwritten
memo which appears to have been written in December of 1998 in which
Smith instructed Michael Donohoe of TRC, "The 'split' for the plane in
'99 will be: 60% Perkins--40% Friendly's based on projected usage. Don."
Exh. 119, also labelled as plaintiff's exhibit 57.
FN19. See Huron Report dated October 24, 2005, p. 7 and exhibit to 1994
Aircraft Reimbursement Agreement.
FN20. Okscin dep. p. 261.
FN21. Okscin dep. pp. 258-59.
By March of 2000, deteriorating economic conditions led Friendly to abandon
its ambitious five-year expansion plan. Rather than opening new franchises,
Friendly closed 150 locations and implemented a reduction in force. Friendly's
use of the Learjet as a percentage of the total hours it was flown diminished
from 33% in 1999 to 21% in 2000 to 16% in 2001 and to 4% in 2002. [FN22] In
the fall of 2000, Okscin and Paul Kelley, then Friendly's CFO, proposed to the
Audit Committee that Friendly cease its perceived obligation to share the cost
of the Learjet by making a payment to TRC. By late 2000, the Board concurred
that Friendly should dispose of the aircraft, and appointed Ezzes and
Ledsinger as a committee to handle this task which was difficult due to the
weak market. [FN23] In sum, Blake's major concerns expressed in May of 2002
regarding the Learjet were that Smith was having Friendly subsidize TRC's use
of the Learjet, that Friendly had no enforceable obligation pay toward its
costs, and that Smith was using the Learjet for nonbusiness purposes without
reimbursing Friendly appropriately.
FN22. Huron Report p. 7; Ledsinger dep. pp. 171-72.
FN23. Manning dep. pp. 97-100.
*4 Blake also took issue with Friendly's payments to TRC toward the costs
related to an office in Illinois used by Smith to conduct business for both
Friendly and TRC. [FN24] Friendly's corporate headquarters are in Wilbraham,
Massachusetts, and TRC's corporate headquarters are in Memphis, Tennessee.
Friendly has not at any time had operations in Illinois unless one considers
the office a Friendly operation. [FN25] Smith maintained his principal
residence in the Chicago area until February 2002. [FN26] According to Okscin,
Friendly's "purchasing group" used the office for meetings because Chicago is
"sort of the hub of the National Restaurant Association out there." [FN27]
The Board approved of Friendly's payment to TRC of these office expenses.
FN24. Ezzes dep. p. 79.
FN25. Ezzes dep. p. 75.
FN26. Okscin dep. p. 15.
FN27. Okscin dep. pp. 143-44.
The SLC asserts that Friendly's payments toward the costs of the Illinois
office--which totalled $770,630 between 1997 and 2004--were made pursuant to a
March 1996 management fee agreement executed by Friendly and TRC. [FN28] The
management fee letter agreement relied upon by the SLC is undated, bears no
handwritten signatures for either TRC or Friendly, and consists of a
three-paragraph letter. It states only that the maximum annual management fee
payable by Friendly to TRC would not exceed $800,000 in 1996, $824,000 in
1997, and $848,720 in 1998 unless the Board was to approve of an increase.
This document does not provide any information related to the nature of the
services covered by the agreement or how Friendly and TRC would allocate the
shared expenses. [FN29] Nonetheless, Friendly reported in its 1997 IPO filing
that the management fees compensated TRC for Smith's services to Friendly, the
office and secretarial services, and "other related expenses." [FN30] The SLC
asserts that the management fee agreement covers the following: (1) Smith's
compensation in 1997 (but not thereafter); (2) the maintenance of the office
in Illinois where Smith conducted business for both TRC and Friendly; (3) the
salary and benefits of a secretary at the Illinois office; (4) the salary of
one Rich Estlin (Estlin); and (5) fringe benefits for Smith, including his
life, medical, dental and AD & D insurance.
FN28. Over $400,000 of that total amount was to compensate Smith in
1997.
Prior to the IPO, when TRC was the management company of both Perkins
and Friendly and when Smith was an employee of TRC but not Friendly, TRC
charged both Perkins and Friendly a management fee. Okscin dep. p. 182.
See also Huron Report p. 22.
FN29. See Huron Report p. 17 and exhibit 2 to Huron Report.
FN30. Huron Report p. 18.
On May 21, 2002, Blake sent a demand letter to Friendly reiterating his
allegations regarding the Learjet and the Illinois office. Blake called for an
investigation and the right to inspect corporate records. Three days later,
Ledsinger, Ezzes, Manning and Daly signed a document entitled Unanimous
Written Consent of the Independent Directors of Friendly Ice Cream Corporation
in which they resolved to create a Special Committee (the 2002 Special
Committee) ultimately composed of Ledsinger, Daly and Ezzes to investigate
Blake's allegations and to recommend to the Board "what position should be
taken by the Corporation in reference thereto." The 2002 Special Committee, in
turn, asked Friendly's general counsel, Aaron B. Parker (Parker) to conduct
the investigation.
Parker had been special counsel to TRC from 1986 to 1997. In 1997, he became
associate general counsel for Friendly, and on November 22, 2001, Friendly
appointed Parker as its president, general counsel and secretary/clerk. Smith,
as Parker's "boss," reviewed his performance and recommended to the Board
whether or not Parker would receive a raise or bonus. [FN31]
FN31. Ledsinger dep. p. 150.
*5 On June 26, 2002, Parker sent to Ledsinger, Daly and Ezzes a three-page
memorandum containing what he called background facts and preliminary
investigative flndings, [FN32] although he never issued a follow-up document
with final investigative findings. [FN33] Parker reported that TRC's
comptroller told him that Smith had paid for the variable costs associated
with Smith's personal use of the Learjet. He also reported that the Learjet
cost-sharing arrangement replaced that of the Beechjet 400A, but Parker
supplied no documentation to support this assertion. The 2002 Special
Committee accepted Parker's conclusion without asking to see a contract or
other verification that Friendly actually had a written binding contractual
agreement to pay toward the cost of the Learjet.
FN32. Parker attached to his three-page memorandum TRC's aircraft
summaries (showing the total reported costs related to use of the
Learjet 45) in 2000 and 2001 and some flight manifests.
FN33. Ezzes dep. p. 119.
Parker's "investigation" did not consider the appropriateness or legitimacy
of the TRC-Friendly cost sharing arrangements with respect to either the
Learjet or the office. [FN34] Parker reported that Friendly's expenses
incurred in connection with the Illinois office in 2001 totalled $110,146 and
in 2002 were $157,458, representing 35% of the office rent, 50% of the salary
of Estlin, 35% of secretarial costs, and 35% of Smith's life, medical, dental
and AD & D insurance. [FN35]
FN34. Exh. 53.
FN35. Exh. 53.
Friendly's payments toward Estlin's salary were $87,960 in 1998, $98,666 in
1999, $107,438 in 2000, and $53,456 in 2001. Although it is clear that Smith
determined how TRC and Friendly would bear the cost of Estlin's salary,
[FN36] the reason for Friendly's payment of Estlin's salary was not adequately
explained in Parker's report or elsewhere. No substantive or adequate
documentation of Estlin's professional services for Friendly has been
presented to the Court. [FN37]
FN36. Exh. 53.
FN37. TRC's former CFO, Steven McClellan, testified at his deposition on
September 9, 2004, that Estlin "was supposed to represent [Smith] at
Perkins when [Smith] was at Friendly's ... [a]nd he was supposed to
represent [Smith] at Friendly's when [Smith] was at Perkins. In addition
to which, he was supposed to handle managing [Smith's] personal
financial matters, and I say supposed to, because that wound up, not
infrequently, falling on my shoulders ... [I]t started out with he was
going to be [Smith's] representative, provide us access to [Smith],
because [Smith] was not present a lot ... Although I had been warned by
the other members of the management team that--this was another FOD,
friend of Don, and that these type of folks had shown up before. Over a
period of time, I [began] to question whether it made sense for us to
continue to absorb the expenses related to [Estlin]. And, in fact I
asked him one time, because I got pretty frustrated. We were going
through some challenging financial times, Smith was not cooperating with
trying to, really, sell the aircraft, in my view, and we had--we were
absorbing [Estlin's] salary, or at least a significant portion of it.
And I did ask [Estlin] one time, you know, Rich, what exactly are you
doing, and what's your goals? And he looked me straight in the eye and
said, my goal is to play 200 rounds of golf a year, and he kind of
laughed." Other deponents' descriptions of Estlin's role were also
sketchy. Okscin testified only that Estlin "helped [Friendly] with
treasury and insurance issues" when Friendly's CFO left. Okscin dep. p.
142.
There in nothing in the record showing that the 2002 Special Committee made a
formal recommendation to the Board regarding Friendly's response to Blake's
first demand letter. Nonetheless, on September 26, 2002, Parker sent
plaintiff's counsel a letter declining the plaintiff's request to inspect
Friendly's records, and stating that "a special committee of Friendly's Board
of Directors comprised of three independent members of the Board has reviewed
the expenditures relating to the jet and determined that they were legitimate
business expenses of Friendly's." [FN38] Parker did not address in that
letter the plaintiff's other concerns.
FN38. Exh. 54.
On January 2, 2003, Blake brought this shareholder derivative suit against
Friendly and Smith. The first amended complaint, filed on February 26, 2003,
contains four counts: breach of fiduciary duty (Count I), misappropriation of
corporate assets (Count II), a request for declaratory judgment that the
plaintiff is entitled to inspect Friendly records relating to the Learjet and
the Illinois office (Count III), and a claim that Smith and Friendly are
estopped from refusing to produce certain financial records concerning the
aircraft (Count IV). On the defendants' motion to dismiss pursuant to
Mass.R.Civ.P. 12(b)(6) and Mass.R.Civ.P. 23.1, the Court (Carhart, J.)
dismissed the fourth count on October 28, 2003.
*6 On January 31, 2003, at a special meeting, the Compensation Committee
resolved to recommend to the Board that Friendly discontinue incurring
expenses related to the Illinois office. This came approximately one month
after Smith informed Okscin that in February of 2002, he had moved his
principal residence from Illinois to Florida. When asked why the use of the
Illinois office was discontinued, Okscin replied, "[Smith] wasn't living in
Chicago any longer and the--the use of the office wasn't needed and it--it
wasn't used anymore, I guess." [FN39]
FN39. Okscin dep. p. 143.
On August 20, 2003, Ledsinger, Ezzes, Daly and Manning conducted a special
meeting, referring to themselves as the independent members of the Board.
According to the minutes, Parker and Okscin
reviewed a proposal from TRC Realty LLC to extinguish the Corporation's
obligations under the Aircraft Reimbursement Agreement between TRC Realty LLC
and the Corporation which agreement obligates the Corporation to share in the
expenses of a corporate aircraft.
That day, the Board approved a payment "not to exceed $900,000 ... to
terminate the Aircraft Reimbursement Agreement with TRC Realty LLC" for the
costs of the Learjet 45. The directors believed that Friendly had a commitment
to share the cost of the Learjet for another six years and viewed the payout
as an attractive alternative . [FN40]
FN40. Daly dep. pp. 142-43.
In May of 2004, Blake offered to loan Friendly up to $50 million at 2% over
the prime rate (adjustable), so long as the proceeds were used to reduce debt.
As consideration for this offer, Blake demanded that the Board "address the
improper payments that Friendly made to TRC ... for the Learjet and the
Illinois office," including, by way of reference to earlier correspondence,
that Smith resign from the Board. [FN41] The Board rejected the offer on the
grounds that if Friendly were to pay down its mortgage debt as required by
Blake's loan offer, it would incur a prepayment penalty of up to $18 million,
and that Friendly's $8.3 senior notes could not be prepaid until June 15,
2008. Additionally, Manning was not willing to accept the offer, believing
that it was not in Friendly's best interest because it would create a
relationship with Blake which could subject Friendly to undue influence.
[FN42]
FN41. Exh. 92 attached to Manning affid.
FN42. Manning dep. p. 139.
Subsequently, the plaintiff moved to amend his complaint again. In his
proposed complaint, Blake names as defendants Smith, individually and as
chairman of Friendly's Board, TRC, The Restaurant Holding Company, TRC Realty,
LLC, and Ezzes, Ledsinger, Daly and Manning as members of Friendly's Board. In
Count I of the proposed complaint, Blake asserts that all of the directors
violated their fiduciary duty by "ignoring and condoning improper actions
between Friendly, Smith and TRC, and by exercising their authority as
directors to condone and cover up improper conduct." This allegation is
exemplified in the proposed complaint by the attempt by the Board and the 2002
Special Committee to dismiss Blake's action without conducting an independent
investigation of related transactions with Smith and TRC, and the Board's
approval of payments to TRC for the Learjet after being on notice that
Friendly had no obligation to make them. Count II alleges misappropriation of
corporate assets by Smith and TRC. Count III alleges that all of the Board
members wasted corporate assets. Count IV asserts that the TRC companies and
Friendly's Board members aided, abetted, and directly participated in
misappropriating corporate assets by "exercising their authority to
consciously ignore, condone or cover up the improper transactions of Smith and
TRC after actual or constructive notice of the wrongdoing." Count V is for
restitution and alleges unjust enrichment against Smith, the TRC companies,
and "some of the directors" not specified. In Count VI, Blake seeks
declaratory relief against Smith and the Board members with respect to their
allegedly improper activities, their duty to disclose and their fiduciary
duty.
*7 In addition to his claims regarding the Learjet and the Illinois office,
Blake takes issue in his proposed amended complaint with several types of
transactions, including the following: (1) Friendly's payments to TRC's
division, Foxtail Foods (Foxtail), for the purchase of certain food products;
(2) Friendly's real estate transactions involving Smith's sons; (3) Friendly's
payment to TRC of management fees; and (4) Friendly's rejection of Blake's
loan offer.
On July 27, 2005, I denied, without prejudice, the plaintiff's motion to
amend in the absence of a demand letter regarding the additional claims as
required by G.L.c. 156D, s.7.42. After filing the motion to amend but
prior to entry of my order denying the plaintiff's motion to amend, on June
27, 2005, Blake sent a second demand letter to the Board pursuant to G.L.c.
156D, s.7.42. Blake's letter states that his lawsuit, his second
demand letter, and the proposed amendment to his complaint seek to redress two
fundamental concerns. The first is that Smith has enriched himself by shifting
assets or income from Friendly to TRC or by shifting costs from TRC to
Friendly. Blake explains in his demand letter that this "category of concern
includes any and all conduct that shifts financial benefit from Friendly to
TRC regardless of what form the transaction may take" including related party
transactions [FN43] and conflict of interest transactions. Blake points to a
non-exclusive list of three issues: (1) the difference in the cost of goods
sold margin of Friendly and TRC suggests that vendor arrangements (in which
Friendly purchased food products from Foxtail) were designed so that Friendly
would subsidize TRC without full and fair consideration. (2) Friendly's
financial statements represent that it paid $12.3 million to TRC for airplane
expenses, consulting fees, real estate transactions and food purchases between
1997-2003, yet TRC's financial statements represent that it only received $9.8
million in that period, while Smith was the chairman and CEO of both
companies. This discrepancy, asserts the plaintiff, has been ignored and left
unexplained by the Board. (3) the Board inexplicably rejected Blake's offer of
a low-interest loan to pay off $50 million in high cost debt, and instead has
opted to pay high interest rates, which suggests the existence of an
arrangement to favor TRC, Smith, or Ezzes, as some lenders and financial
underwriters have conflicts of interest including business relationships with
Ezzes or investment relationships with TRC.
FN43. Ledsinger defined related party transactions in these words:
"usually it has to do with a transaction where there is an exchange of
goods or services or money from one entity to another where there's
perhaps ownership or management ... It could be a public company that
has a director and that director has a business and that public company
does business with the business that the director is involved with ..."
Ledsinger dep. p. 29.
The second category of concern as described in Blake's demand letter relates
to the Board's conduct which "inappropriately shields or benefits Mr. Smith
and/or TRC" in violation of its fiduciary duty. Blake specifically cites as a
non-exhaustive list of evidence of the Board's misconduct its approval of
Smith's improper conduct, the 2002 Special Committee's failure to conduct a
meaningful or reasonable investigation, the Board's approval of a $950,000
airplane termination payment, its rejection of Blake's $50 million loan offer,
its apparent position that the interests of Smith and Friendly are one and the
same, because the Board retained for Friendly in this litigation the same
counsel which represents Smith, Ornate, Hall & Stewart, and its turning a
blind eye to conflicts of interest that are detrimental to Friendly, such as
Friendly's payment of up to $107,000 for the annual salary of Estlin, whose
professional services to Friendly are unsubstantiated.
*8 In July of 2005, the Board members were Smith, Daly, Manning, Ezzes, and
Perry Odak (Odak), who became a director of Friendly on May 11, 2005,
replacing Ledsinger. In response to the plaintiff's second demand letter,
Daly, Manning, Ezzes and Odak voted to appoint Odak and Daly to the SLC.
[FN44] The resolution provides that each member of the SLC would be
compensated in the amount of $10,000. On July 19, 2005, the SLC engaged as its
legal counsel Wilmer Cutler Pickering Hale and Dorr, LLC (Wilmer Cutler),
which in early August of 2005 retained Huron Consulting Group (Huron) to
provide forensic accounting services.
FN44. The voting directors signed separate signature pages to a document
entitled "Unanimous Written Consent of the Independent Directors of
Friendly Ice Cream Corporation" resolving to create the SLC to
investigate Blake's new claims and to decide for Friendly whether to
accept, reject or otherwise act upon Blake's demand. Smith, concededly
an interested director, did not participate in the resolution. Ezzes's
signature is dated July 14, 2005; Daly's signature is dated and was
faxed on July 15, 2005: and the signatures of Odak and Manning bear no
date of execution. The document states that the signatories "hereby
adopt ... the following resolutions with the same force and effect as if
they had been unanimously adopted at a duly convened meeting of the
Board of Directors ..."
On October 24, 2005, the SLC filed its 29-page report concluding that all
claims that have been brought on behalf of Friendly in this action lack merit
and that the continued prosecution of the derivative claims is not in the
interest of Friendly. [FN45] The SLC Report is unsigned by either of its
members. In its executive summary of the report, the SLC listed seven basic
conclusions:
FN45. The SLC also initially determined that: (1) Friendly should seek
$70,267 reimbursement from Smith for the variable costs of Smith's
non-business uses of the Learjet between 1998-2002 (although in a
supplemental report, Huron reduced this figure to $55,149); (2) Friendly
should seek reimbursement from TRC in the amount of $10,174 for the
variable costs of flights incurred by TRC but paid incorrectly by
Friendly (and concluding that, otherwise, the variable and fixed costs
were properly charged to Friendly); and (3) Friendly should review the
adequacy of its policies and procedures regarding documentation required
prior to the payment of invoices, joint negotiations with common vendors
as between Friendly and other companies, oral agreements with other
companies, related party transactions and review of the same by outside
auditors for Friendly, and the scope of the travel and entertainment
policy.
(1) Friendly and TRC had an implied-in-fact aircraft reimbursement agreement
which required Friendly to pay a portion of the fixed costs of the Learjet and
the variable costs attributable to Friendly's use of the aircraft;
(2) there is no evidence that Friendly overpaid for food products purchased
from Foxtail;
(3) there was insufficient evidence to support Blake's claim that joint
negotiations with vendors common to Perkins and Friendly were detrimental to
Friendly;
(4) there was no evidence that financial firms extended inferior credit and
other terms to Friendly so as to subsidize financial packages provided by
those institutions to TRC. The interest rates on Friendly's loans do not
represent collusion between Societe Generale, Fleet/Bank of America and
General Electric Capital, on the one hand, and Smith on the other hand, to
advantage TRC at the expense of Friendly. "[P]repayment and other penalties on
the existing company obligations approximate $18 million and make Mr. Blake's
[$50 million loan offer at favorable rates] economically unattractive."
(5) lease payments by Friendly to TRC for restaurants in Florida did not
disadvantage Friendly;
(6) Friendly received benefits from services provided by the $770,000 in
management fees it paid to TRC from 1997 through 2004, which fees covered,
among other things, the salary of Estlin "who assisted Friendly with insurance
and treasury functions."
(7) Friendly's decision to credit $112,500 in unearned development fees as
against amounts due for product purchases by TICC, a franchise owned by
Smith's two sons, was not improper.
On November 2, 2005. Smith reimbursed Friendly $65,323 for aircraft costs.
On November 30, 2005, the SLC submitted a Supplemental Report which contained
two conclusions: (1) Smith did not receive excessive compensation for the
period 1998 through February 2003, and (2) the corporate aircraft flight
variable costs associated with Smith's non-business use of the aircraft were
$15,118 less than that stated in the original SLC Report dated October 24,
2005.
*9 On January 4, 2006, I allowed the SLC's motion to intervene as a party
defendant for purposes of filing a motion to dismiss pursuant to G.L.c. 156D,
s.7.44. The SLC moved to dismiss this action pursuant to G.L.c. 156D,
s.7.44. [FN46]
FN46. Although the SLC moved to dismiss before it became a defendant
intervener in this action, the plaintiff does not challenge the motion
on those grounds. The SLC clarified at the hearing that its motion to
dismiss is intended to apply to the allegations contained in the first
amended complaint and to the allegations in the plaintiff's second
demand letter, upon which the plaintiff has sought to amend his
complaint again.
DISCUSSION
I. The Massachusetts Business Corporation Act
General Laws c. 156D, known as the Massachusetts Business Corporation Act,
became effective on July 1, 2004, and governs all Massachusetts business
corporations that were formerly governed by G .L.c. 156B. Comment to
Introduction to G.L.c. 156D. General Laws c. 156D, s.7.44, which sets
forth the requirements for the dismissal of derivative actions, provides in
pertinent part:
(a) A derivative proceeding commenced after rejection of a demand shall be
dismissed by the court on motion by the corporation if the court finds that
either (1) 1 of the groups specified in subsections (b)(1) or (f) has
determined in good faith after conducting a reasonable inquiry upon which its
conclusions are based that the maintenance of a derivative proceeding is not
in the best interests of the corporation; or (2) shareholders specified in
subsection (b)(3) have determined that the maintenance of the derivative
proceeding is not in the best interests of the corporation.
(b) Unless a panel is appointed pursuant to subsection (f), the
determination in subsection (a) shall be made by:
(1) a majority vote of independent directors present at a meeting of the
board of directors if the independent directors constitute a quorum; [or]
(2) a majority vote of a committee consisting of 2 or more independent
directors appointed by a majority vote of independent directors present at a
meeting of the board of directors, whether or not the independent directors
constituted a quorum; ...
(c) None of the following shall by itself cause a director to be considered
not independent for the purposes of this section:
(1) the nomination or election of the director by a person who is a defendant
in the derivative proceeding or against whom action is demanded;
(2) the naming of the director as a defendant in the derivative proceeding or
as a person against whom action is demanded; or
(3) the approval by the director of the act being challenged in the
derivative proceeding or demand if the act resulted in no personal benefit to
the director.
(d) If the corporation moves to dismiss the derivative suit, it shall make a
written filing with the court setting forth facts to show
(1) whether a majority of the board of directors was independent at the time
of the determination by the independent directors and
(2) that the independent directors made the determination in good faith after
conducting a reasonable inquiry upon which their conclusions are based.
Unless otherwise required by subsection (a), the court shall dismiss the suit
unless the plaintiff has alleged with particularity facts rebutting the
corporation's filing in its complaint or an amended complaint or in a written
filing with the court ...
*10 (e) If a majority of the board of directors does not consist of
independent directors at the time the determination by independent directors
is made, the corporation shall have the burden of proving that the
requirements of subsection (a) have been met. If a majority of the board of
directors consists of independent directors at the time the determination is
made ... the plaintiff shall have the burden of proving that the requirements
of subsection (a) have not been met.
(f) The court may appoint a panel of 1 or more independent persons upon
motion by the corporation to make a determination whether the maintenance of
the derivative proceeding is in the best interests of the corporation.
II. Standard of Judicial Review Applicable to SLC Decisions
"The special litigation committee is ... the 'only instance in American
Jurisprudence where a defendant can free itself from a suit by merely
appointing a committee to review the allegations of the complaint ...' "
Einhorn v. Culea, 612 N.W.2d 78, 91 (Wis.2000), quoting Lewis v. Fuqua, 502
A.2d 962, 967 (Del.Ch.1985).
The value of a special litigation committee is coextensive with the extent to
which that committee truly exercises business judgment. In order to ensure
that special litigation committees do act for the corporation's best
interest, a good deal of judicial oversight is necessary in each case. At the
same time, however, courts must be careful not to usurp the committee's
valuable role in exercising business judgment. At a minimum, a special
litigation committee must be independent, unbiased, and act in good faith.
Moreover, such a committee must conduct a thorough and careful analysis
regarding the plaintiff's derivative suit, ... The burden of proving that
these procedural requirements have been met must rest, in all fairness, on
the party capable of making that proof--the corporation.
Houle v. Low, 407 Mass. 810, 822 (1990).
A fundamental reason for forming an SLC is "to insulate the company's
decision making process from the influence of those under suspicion." Biondi
v. Scrushy, 820 A.2d 1148, 1156 (Del.Ch.2003). Consequently, in order for an
SLC to have rendered a valid determination under the statute, it must have
been appointed and constituted in accordance with the independence
requirements of s.7.44(b)(2). Section 7.44(b)(2) not only mandates
that the SLC consist of "2 or more independent directors," but also that the
independent members of the SLC have been "appointed by a majority vote of
independent directors present at a meeting of the board of directors, whether
or not the independent directors constituted a quorum." A motion to dismiss
premised upon the determination of an improperly constituted SLC is
statutorily insufficient. Cf. Houle v. Low, 407 Mass. at 824 (interpreting
predecessor to s.7.44, court reversed entry of summary judgment for
corporate defendant which had not shown the absence of a genuine issue of
material fact as to SLC's bias).
*11 Beyond that initial hurdle of showing that the SLC was properly
constituted, the party moving to dismiss the derivative action bears the
burden of submitting a written filing with the court setting forth facts to
show that a majority of the Board was independent when the independent
directors made their determination, and that the independent directors--here
the SLC--made the determination in good faith after conducting a reasonable
inquiry upon which its conclusions are based. See G.L.c. 156D,
s.744(d). [FN47] If the SLC makes this showing, the court must dismiss the suit
unless the plaintiff alleges with particularity facts rebutting the SLC's
written statement of facts. Id.
FN47. The statute does not instruct whether the "determination" referred
to in s.7.44(d) and (e) signifies the independent directors'
appointment of the SLC or the SLC's determination not to pursue the
derivative suit. But see Einhorn v. Culea, 612 N.W.2d at 92
(independence test is concerned with factors at time special litigation
committee is formed). In this case, the composition of the directors was
the same at both times and therefore it makes no difference which of
these interpretations conforms to the intent of the Task Force on the
Revision of the Massachusetts Business Corporation Law, which drafted
the statute.
If the SLC satisfies this burden of setting forth such facts regarding
independence and the plaintiff alleges with particularity facts rebutting the
SLC's written filing under s.7.44(d), the court assesses the evidence
as to whether or not the SLC was independent and whether it determined in good
faith after conducting a reasonable inquiry upon which its conclusions are
based that maintenance of the derivative proceeding is not in the best
interests of the corporation.
General Laws c. 156D, s.7.44(e), places the burden of proving that
the requirements of s.7.44(a) have been met upon either the
corporation or the plaintiff, depending upon whether or not the majority of
the board of directors consists of independent directors "at the time the
determination by independent directors is made." s.7.44(e). If the
majority of the board is not independent, the SLC has the burden of proving
that its determination was in good faith and after a reasonable inquiry upon
which its conclusions were based. See s.7.44(a) & (e). If, on the
other hand, the majority of the board is independent, the plaintiff bears the
burden of showing that the SLC's determination was flawed because it was not
made in good faith after conducting a reasonable inquiry upon which its
conclusions were based. Id. Comment 2 to s.7.44 explains as follows:
Section 7.44 adopts neither of the so-called New York or Delaware approaches
[FN48] to judicial scrutiny of the decisions of special litigation committees
... Section 7.44 steers a middle ground, applying the business judgment rule
when a majority of the board is independent ... with the burden of proof
being on the plaintiff, ... and the "reasonable and principled" review
standard ... with the burden of proof being on the corporation [ ] when a
majority of the board is not independent. Unlike Harhen, [431 Mass. 838
(2000),] the corporation is required in either case, in connection with a
motion to dismiss, to present to the court a filing containing facts
justifying application of the business judgment rule. The plaintiff then has
an opportunity to rebut those facts.
FN48. The New York approach, also called the traditional version of the
"special litigation committee defense," is described in Auerbach v.
Bennett, 47 N.Y.2d 619, 633, 419 N.Y.S.2d 920, 393 N .E.2d (1979). This
approach requires the trial court to determine as a matter of fact
whether the SLC members were disinterested and whether they conducted an
adequate investigation. If the court answers both questions
affirmatively, it must dismiss the derivative action. See id. In
contrast, the Delaware formulation, set forth in Zapata Corp. v.
Maldanado, 430 A.2d 779, 787- 89 (Del.1981), commences with the Auerbach
analysis but adds a second, discretionary step in which the court
applies its own business judgment to the SLC's conclusion.
Therefore, if the plaintiff bears the burden under s.7.44(e) yet
fails to plead and prove that the SLC members were not independent or did not
act in good faith after a reasonable inquiry, the SLC is entitled to the
business judgment rule and the action must be dismissed. See Comment 2 to
s.7.44 (to deprive the SLC of the business judgment rule's protection,
the plaintiff must "plead and prove that the directors making the
determination were not independent or did not act in good faith after
reasonable inquiry"). The business judgment rule "affords protection to the
business decisions of directors, including the decision to institute
litigation, because directors are presumed to act in the best interests of the
corporation." Harhen v. Brown, 431 Mass. 838, 845 (2000). The business
judgment rule
*12 limits judicial review of corporate decision-making when corporate
directors make business decisions on an informed basis, in good faith and in
the honest belief that the action taken is in the best interests of the
company. The business judgment rule shields, to a large extent, the
substantive bases for a corporate decision from judicial inquiry. The
business judgment rule also ensures that management remains in the hands of
the board of directors and protects courts from becoming too deeply
implicated in internal corporate matters.
Einhorn v. Culea, 612 N.W.2d at 84.
III. Standard of Independence
Because the question of independence is fundamental to every aspect of
judicial inquiry under s.7.44, it is essential at this point to pin
down the principle. The statute contains no definition of this critical term,
yet lists three circumstances, none of which by itself shall cause a director
to be considered not independent: (1) the director's nomination or election by
a defendant or one against whom action is demanded; (2) the naming of the
director as a defendant in the derivative proceeding or as a person against
whom action is demanded; or (3) the approval by the director of the act being
challenged in the derivative proceeding or demand if the act resulted in no
personal benefit to the director. G.L.c. 156D, s.7.44(c). See also
Kaplan v. Wyatt, 499 A.2d 1184, 1189 (Del.1985) ("Even a director's approval
of the transaction in question does not establish a lack of independence").
These factors do not support the conclusion that the Legislature intended to
set a low threshold for the standard of independence. See Einhorn v. Culea,
612 N.W.2d at 86-87 (rejecting lower courts' conclusion that Wisconsin
statute, which in relevant part precisely tracks the independence standard of
G.L.c. 156D, s.7.44, sets an "extremely low threshold" for examining
the independence of directors on a special litigation committee). The statute
calls for the court to assess independence based upon whether or not a
director has actual bias or a personal interest in the dispute, as a director
may be named as a nominal defendant yet still be independent. See id. at 86.
See also In re Oracle Corp. Derivative Litig., 824 A.2d 917, 939 (Del.Ch.2003)
(independence test permits corporation to terminate derivative suit if board
is comprised of directors who can impartially consider a demand).
Nor is there any support in the language of s.7.44 or the drafters'
comments for the SLC's argument that there are only two forms of bias relevant
to the inquiry of the SLC members' independence: structural and pecuniary.
[FN49] Rather, the term "independent" as used in Section 7.44 more broadly
encompasses both "disinterest" which is a lack of a personal interest in the
challenged transaction as opposed to a benefit upon the corporation or
shareholders generally, and "independent" which is freedom from influence in
favor of the defendants due to personal or other relationships. Comment 1 to
G.L.c. 156D, s.7.44, citing Aronson v. Lewis, 473 A.2d 805, 812-16
(Del.1984).
FN49. As observed by the Supreme Judicial Court, legal commentators have
described structural bias occurring in a director's assessment of a suit
as generated by a combination of psychosocial mechanisms, including the
appointment of directors to the board or special litigation committee,
the defendant directors' control of pecuniary or nonpecuniary rewards to
the independent directors, the independent directors' prior associations
with the defendants, and their common cultural and social heritages.
Houle v. Low, 407 Mass. at 815-16. These mechanisms can, according to
the commentators, generate biases which result in the independent
directors reaching a decision which insulates their co-directors from
legal sanctions. Id. at 816.
The SLC shrinks the concept of structural bias considerably and argues
that it boils down to domination and financial dependence. (1/20/06 Hrg.
Tr. pp. 14-15). In an unpublished decision, the court in Klein v. FPL
Group, Inc., 2004 WL 302292 *19, *23 (S.D.Fla.2004), flatly rejected the
same argument, that "dominance and control" or "financial interest" are
the only two factors in determining the independence of SLC members
under Florida's statute, which in relevant part is similar to G.L.c.
156D, s.7.44(a)- (b).
*13 Prior to the enactment of s.7.44, the Supreme Judicial Court
explained the disinterested aspect of independence.
The purpose of the distinction between interested and disinterested directors
is to ensure that the directors voting on a plaintiff's demand can exercise
their business judgment in the best interests of the corporation, free from
significant contrary personal interests and apart from the domination and
control of those who are alleged to have participated in wrongdoing.
Harhen v. Brown, 431 Mass. at 843.
Directors are considered independent if they are in a position to base their
decision on the merits of the subjects before the board rather than being
governed by extraneous considerations and influences. See, e.g., Kaplan v.
Wyatt, 499 A.2d at 1189; Einhorn v. Culea, 612 N.W.2d at 92 ("[T]he test (of
independence) is primarily concerned with whether factors exist at the time
the committee was formed that would prevent a reasonable person from basing
his or her decisions on the merits of the issue"); Brehn v. Eisner, 746 A.2d
244, 257 (Del.2000) (test of whether majority of board was disinterested and
independent is whether they were incapable, due to personal interest or
domination and control, of objectively evaluating a demand); Aronson v. Lewis,
473 A.2d at 815 (lack of independence is established where it is shown that
directors are so under the influence of other directors that their discretion
would be sterilized). Thus, the "director's position with respect to the
allegations of the claim and all extraneous influences are subject to the
court's scrutiny." Desaigoudar v. Meyercord, 108 Cal.App.4th 173, 189, 133
Cal.Rptr.2d 408, 419-20 (Cal.App.2003). A director's independence may
reasonably be doubted if there is "evidence that in the past the relationship
caused the director to act non-independently vis-a-vis an interested
director." Beam ex rel. Martha Stewart Omnimedia, Inc. v. Stewart, 845 A.2d
1040, 1051 (Del.2004) (discussing presuit demand independence standard).
Where, as here, the SLC has unconditional authority to act on behalf of the
Board in investigating a shareholder's demands and in deciding whether or not
to litigate the shareholder's claims, courts assess the SLC's independence by
considering the totality of the circumstances. See, e.g., Johnson v. Hui, 811
F.Sup. 479, 486 (N.D.Cal.1991). The totality of the circumstances test
considers the following nonexclusive list of factors: (1) an SLC member's
status as a defendant and whether this potential liability is small or
substantial, direct or indirect; (2) whether the SLC member's participation in
or approval of the alleged wrongdoing was substantial or the result of
innocent or pro forma involvement or affiliations; (3) an SLC member's past or
present business dealings with the corporation; (4) an SLC member's past or
present business or social dealings with individual defendants; (5) the number
of directors on the SLC, such that with the greater number of directors, less
weight may be accorded to any disabling interest affecting only one director;
and (6) the structural bias of the SLC, such as whether the manner in which
the SLC was appointed and proceeded was inevitably bound to be empathetic to
the defendants and therefore biased in favor of terminating the litigation.
See id.; In re Oracle Securities Litigation, 852 F.Sup. 1437, 1441
(N.D.Cal.1994). Some courts add as a seventh factor the roles of corporate
counsel and independent counsel, such that an SLC is more likely to be found
independent if it retains counsel who has not represented individual
defendants or the corporation in the past. See Einhorn v. Culea, 612 N.W.2d at
90.
IV. Whether the SLC Was Properly Constituted
A. The Independence of the SLC
*14 The determination of whether the SLC was properly appointed and
constituted in conformity with the requirements of s.7.44(b)(2) begins
with an evaluation of the independence of the SLC, and specifically Daly, as
the plaintiff concedes the independence of Odak. As noted above, Section
7.44(b)(2) requires that the SLC consist of "2 or more independent directors."
In his affidavit filed in support of the SLC's motion to dismiss, Daly denied
having any relationship which might impair his independence and denied being
subject to a controlling influence of anyone with a material pecuniary
interest in the transactions and conduct at issue in this action which might
impair his independence. [FN50] The SLC's factual submissions and argument
that Daly is independent focus upon Daly's illustrious history with Baystate
Health Systems (BHS). [FN51]
FN50. Daly recited in his affidavit that he has no "business, financial
or familial relationships with Mr. Smith and/or the Company beyond
receipt of standard board compensation and compensation for my service
as a member of the SLC that would reasonably be expected to affect my
judgment as a member of the SLC in a manner adverse to the Company ...
Neither I, nor any person with whom I have a business, financial or
familial relationship has any material pecuniary interest in the
transactions and conduct alleged to give rise to this action such that
my judgment as a member of the SLC would be affected in a manner adverse
to the Company ... I am not subject to a controlling influence by any of
the named Defendants or anyone else who has a material pecuniary
interest in the transactions or conduct alleged to give rise to the
derivative claims that could reasonably be expected to affect my
judgment as a member of the SLC with respect to the transactions or
conduct in a manner adverse to the Company."
FN51. From December 1981 until December 2003, Daly was the president and
CEO of BHS, and from January of 2004 to December of 2005 he was its vice
chairman. Daly is also currently a director, and previously was chairman
of the board, of BHS Insurance Company Limited, which writes group
health insurance contracts and which pays money to Baystate Medical
Center and other organizations for medical services.
Daly's role in Friendly falls within each of the three types of circumstances
listed in G.L.c. 156D, s.7.44(c), none of which by itself suffices to
label Daly as not independent: Daly was invited to the Board by Smith, Daly is
named in the proposed complaint and as a person against whom Blake demanded
action in his second demand letter, and Daly approved of the acts or
transactions challenged by Blake in the proposed and current complaint,
although there is no direct evidence (nor does the plaintiff contend) that
they resulted in personal benefits to Daly. See G.L.c. 156D, s.7.44(c)
; Kaplan v.. Wyatt, 499 A.2d at 1189.
Several of the factors in the totality of circumstances test do not impugn
Daly's independence. Nothing indicates that Daly had significant business,
economic, personal, family or social dealings with Friendly or the other
individuals named in the proposed complaint. The plaintiff points to a recent
revelation that Friendly employees in the Springfield area must use BHS or
Baystate Medical Center for medical care, but there is no evidence that Daly
was personally involved in imposing that requirement or that he has benefited
in any way from this arrangement. See Kaplan v. Wyatt, 499 A.2d at 1189
(director's association with businesses that transact with the corporation
being sued does not, by itself, establish a lack of director's independence).
Smith's invitation to Daly to join the Board does not demonstrate Daly's bias
in favor of Smith or support an inference that Daly would not faithfully
discharge his fiduciary duty to Friendly's shareholders. See In re Oracle
Securities Litigation, 852 F.Sup. at 1441-42; Aronson v. Lewis, 473 A.2d at
816 (director's method of election does not touch on independence). Further
supporting a finding of independence of the SLC is its retention of counsel--
Wilmer Cutler--which has not previously represented Friendly or any of the
individual defendants. Finally, on its face, Daly's compensation in the form
of stock options, $10,000 for his membership on the SLC, his annual
compensation of approximately $30,000 as a director, additional annual
payments of approximately $7,875 for attending Board meetings, plus $1,500 for
membership on the Audit Committee, while far from de minimis, has not been
shown to be beyond the norm so as to demonstrate, by itself, a lack of
independence.
*15 At first glance, Daly appears to meet many of the requirements for
independence. Consideration of other factors, however, highlights the level of
Daly's involvement in conduct which Blake alleges amounts to a breach of
fiduciary duty and establishes that he is more than a merely nominal defendant
in the proposed complaint. Daly has been a member of Friendly's largely
static, relatively small, five-member Board and on its Audit Committee,
Compensation Committee, and Nominating Committee since the November 1997 IPO.
As a member of the 2002 Special Committee, Daly was asked to investigate
Blake's allegations that Smith improperly used Friendly funds to pay toward
cost of the Illinois office and the Learjet for the direct or indirect benefit
of Smith and/or TRC. That investigation therefore implicated Daly's oversight
duties on the Audit Committee, the Compensation Committee, and the Nominating
Committee. Daly's responsibilities on these committees, his decisions as a
Board member with respect to the transactions in question, and his passive,
largely nonresponsive role on the 2002 Special Committee render his
involvement in conduct which Blake alleges to be a breach of his fiduciary
duty substantial and direct, rather than merely nominal or pro forma. Contrast
In re Oracle Securities Litigation, 852 F.Sup. at 1441 (special litigation
committee member who was not a member of board of directors when alleged
wrongdoing occurred was independent); Kaplan v. Wyatt, 499 A.2d at 1189 (there
was no evidence of a lack of independence of director who abstained from
voting on transaction in question).
Daly's deposition testimony taken in 2004 reveals that neither he nor other
members of the 2002 Special Committee sought adequate information or
documentation about the Learjet cost-sharing arrangements between TRC and
Friendly, even though Blake's demand raised a red flag which ought to have
triggered a meaningful inquiry into the propriety of these payments. Daly did
not think it was necessary to find out if there was a contract requiring
Friendly to pay TRC toward the Learjet costs. [FN52] Daly further testified
that this was never even an issue considered by the Audit Committee or the
Compensation Committee, and that he had no reason to doubt the contents of
Parker's superficial report to the 2002 Special Committee. [FN53] Similarly,
as a member of the Audit Committee responsible for overseeing Friendly's
financial controls and procedures, Daly failed to detect or correct the
comptroller's payments of large sums over the course of several years for the
Learjet without underlying invoices or other sufficient documentation for
fixed and variable costs. This is in stark contrast to Daly's testimony that
the Audit Committee and the entire Board reviewed related party transactions
with much greater care than normal business activities. [FN54]
FN52. Daly dep. p. 65.
FN53. DaIy dep. pp. 77-78. In his deposition on August 11, 2004, Daly
claimed that what he knew about the corporate aircraft arrangement was
presented to him in Parker's three-page memorandum dated June 26, 2002.
Daly dep. p. 43. Daly denied knowing when the change in aircraft
occurred or that the change was discussed at a Board meeting before the
plaintiff made an issue of it. Daly dep. pp. 45-47.
FN54. Daly dep. pp. 149-50.
Other examples of Daly's ignorance abound. Daly testified that he was unaware
of what Estlin did for Friendly or that Smith owned 70% of TRC. When asked
whether it would have been good for Friendly and bad for TRC if Friendly could
have obtained the corporate aircraft by paying TRC less than it had, Daly
replied, "I don't know that." [FN55] Equally ludicrous is Daly's denial in
his deposition that under some circumstances, Friendly payments to TRC could
benefit Smith or TRC. [FN56]
FN55. Daly dep. pp. 76-77.
FN56. Daly dep. p. 81.
*16 Daly was sure of one thing: his reliance upon arrangements made by
Friendly's management, including Smith. When asked, "What precautions were
taken in this case to make sure that the jet transactions were consistent with
the market?" Daly replied,
I don't know. If you have confidence in your management--and I am not just
speaking of Mr. Smith, I'm talking about the entire senior team--there is no
reason to question that the arrangements made were not in the best interest
of the company and I have such confidence in the management of this
organization.
When asked if he continued to have that confidence when he was functioning
as a member of the 2002 Special Committee, Daly answered, "Absolutely. This is
a senior management team with senior executives who have earned my respect."
Daly's belief that there was no reason to question the propriety of the
aircraft cost-sharing arrangement, even when tasked with investigating it as a
member of the 2002 Special Committee, establishes that he was not able to
evaluate Blake's claims impartially at least between 2002 and 2004, when he
gave this testimony.
A director must be reasonably informed, which means that he or she is
"responsible for considering only material facts that are reasonably
available, not those that are immaterial or out of the Board's reasonable
reach." Brehm v. Eisner, 746 A.2d at 259. [FN57]
FN57. "All corporate power shall be exercised by or under the authority
of, and the business and affairs of the corporation shall be managed
under the direction of, its board of directors ..." G.L.c. 156D,
s.8.01(b).
In discharging his duties, a director who does not have knowledge that
makes reliance unwarranted is entitled to rely on information, opinions,
reports, or statements ... if prepared or presented by ... (1) one or
more officers or employees of the corporation whom the director
reasonably believes to be reliable and competent with respect to the
information, opinions, reports or statements presented; (2) legal
counsel, public accountants, or other persons retained by the
corporation as to matters involving skills or expertise the director
reasonably believes are matters (i) within the particular person's
professional or expert competence or (ii) as to which the particular
person merits confidence; or (3) a committee of the board of directors
of which the director is not a member if the director reasonably
believes the committee merits confidence ...
G.L.c. 156D, s.8.30(b) (emphasis supplied). See also Juergens v.
Venture Capital Corp., 1 Mass.App.Ct. 274, 278 (1973) (it is the duty of
directors to keep themselves informed about the conduct of the
business).
While directors may confer, debate, resolve their differences through
compromise, or by reasonable reliance upon the expertise of their colleagues
and other qualified persons, the end result, nonetheless, must be that each
director has brought his or her own informed business judgment to bear with
specificity upon the corporate merits of the issues without regard for or
succumbing to influences which convert an otherwise valid business decision
into a faithless act.
Aronson v. Lewis, 473 A.2d at 816. See also Kaplan v. Wyatt, 499 A.2d at
1189 ("it is the care, attention and sense of individual responsibility to the
performance of one's duties that touch on independence").
Despite his duty as a director to oversee the business affairs and management
of Friendly, and his obligations as a member of the 2002 Special Committee,
the Audit Committee, the Compensation Committee, and the Nominating Committee,
Daly remained oblivious and failed to apprise himself of reasonably available,
material facts regarding the transactions in question. This record fails to
show that Daly exercised meaningful oversight in any of these various
capacities, for most of which he received compensation. At a bare minimum,
Daly ought to have realized from a cursory review of Parker's three-page
memorandum to the 2002 Special Committee that the "investigation" to that
committee regarding Blake's claims was largely devoid of critical analysis and
impaired by obvious significant gaps in the documentation. Furthermore, a
reasonable director would have questioned whether or not his reliance upon
Parker was warranted, in light of the shallow nature of Parker's memorandum
and Smith's role in recommending to the Board whether or not Parker would
receive a bonus. Daly's unreasonable and unwarranted reliance upon what he was
or was not told by Parker, Smith, Okscin; and/or Friendly's management invites
skepticism with respect to his claimed ignorance of or indifference toward the
alleged improprieties and casts serious doubt on his ability to be independent
in assessing Blake's claims. See Beam ex rel. Martha Stewart Omnimedia, Inc.
v. Stewart, 845 A.2d at 1051.
*17 Moreover, as a member of the SLC investigating Blake's expanded
allegations that, inter alia, the directors breached their fiduciary duty by
condoning and ignoring the improper conduct, Daly was essentially being asked
to evaluate his own conduct on the Board, its committees, and as a member of
the 2002 Special Committee . [FN58] Because Daly was substantially and
personally involved in the conduct challenged by Blake he may face personal
liability for breach of fiduciary duty as alleged in the proposed complaint.
See Allied Freightways, Inc. v. Cholfin, 325 Mass. 630, 634 (1950) ("A
director of a corporation cannot avoid liability for losses sustained by the
wrongful conduct of corporate officers by showing that he had abandoned his
duties as director or that his ignorance of such conduct was due to what
amounted to wilful neglect of his duties"). In all these circumstances, it is
far from clear that Daly was in a position to have objectively assessed
Blake's demands or to have based his decision as an SLC member on the merits
of the issues rather than on extraneous considerations or influences, such as
concern about his own liability, a dynamic of group loyalty geared toward
insulating other members of the Board from liability, and/or an improperly
deferential relationship to Smith, Parker, Okscin, and others in dereliction
of his duties.
FN58. The SLC argues strenuously that because Blake did not challenge
Daly's independence as a member of the 2002 Special Committee, he cannot
do so now plausibly. What the SLC ignores is that the conduct of the
2002 Special Committee is being attacked in Blake's proposed amended
complaint. Daly's independence before the creation of the 2002 Special
Committee could only be challenged on the ground that Daly, as a
director and member of some Board committees, approved of payments for
the Learjet and Illinois office. In contrast, the current independence
assessment takes into account Daly's role on the 2002 Special Committee
and as a director acting on that committee's recommendation.
The SLC has failed to show Daly's independence. Because the SLC was not
comprised of "two or more independent directors" as required by G.L.c. 156D,
s.7.44(b)(2), it was improperly constituted, not independent and
lacked authority to render a valid determination as to whether or not to
maintain the derivative proceeding. See Houle v. Low, 407 Mass. at 824.
Accordingly, the SLC's motion to dismiss fails.
B. Whether the SLC Was Appointed By a Majority of Independent Directors
Nonetheless, the Court turns to consider another aspect of the validity of
the SLC; whether it was appointed by a majority vote of independent directors
as required by G.L.c. 156D, s.7.44(b)(2). With Daly's status settled,
at issue is the independence or lack thereof of Ezzes and Manning, since all
parties agree that Smith is not independent and Odak is.
1. Ezzes
Ezzes is a financial expert, securities analyst, and has been a financial
advisor and managing director for numerous financial services firms and other
entities. He is hailed by Manning as an "extremely sophisticated financial
guy, [with a] financial mind." From 1991 until sometime in 1998 or 1999, Ezzes
was a member of the Board of Directors of Perkins, the Perkins Management
Corporation, and TRC. [FN59] From 1998 to October 1999, Ezzes was a managing
director of S.G. Cowen, a subsidiary of Societe Generale, an international
financial services institution. In 1997, Societe Generale was one of three
co-managers in the 1997 Friendly IPO.
FN59. Ezzes could not recall at his deposition in February of 2005 how
long he served on the TRC board, but instead responded, "I served on the
TRC board for a period of time. I'm not sure of the exact dates."
Although Ezzes originally denied being on the board of directors of TRC
or Perkins in 1999, he later testified that he did not recall whether or
not he was on either of those boards in August of 1999 when it voted to
upgrade the corporate aircraft. In his affidavit filed in January of
2006, Ezzes stated that his service on all boards affiliated with
Perkins ceased in 1998.
Ezzes first was a director of Friendly from 1991-1992, and rejoined the Board
in 1995 at the request of Don Cameron, who had taken Ezzes's place on the
Board. [FN60] Ezzes has been a director of Friendly continuously since 1995.
FN60. Ezzes dep. p. 10-11; Ezzes affid, p. 9.
*18 Ezzes's deposition testimony, given on February 1, 2005, was marked by
evasion, surliness, and memory loss. [FN61] When asked whether at any time the
Audit Committee had discussed or reviewed related party transactions between
Friendly and TRC or Perkins, Ezzes eventually disclosed that the Audit
Committee had discussed the fact that there are purchases between these
companies involving ice cream and pancake mix and that it involves a "fairly
de minimis" amount of money. The SLC concedes that Friendly paid TRC or
Perkins at least $4.4 million from 1998 trough 2004. [FN62] Ezzes denied that
the Audit Committee had ever discussed the corporate aircraft or management
fees, and stated that the aircraft issue had been raised only at meetings of
the full Board.
FN61. For example, when asked whether Friendly was paying management
fees to TRC, Ezzes replied that he could not answer the question without
a definition of management fees, despite his roles as a director at both
Friendly and TRC when in March of 1996 the two companies purportedly
entered the management fee agreement (which appears to have been the
sole management fee agreement known to the Friendly directors), and his
membership on the Audit Committee.
FN62. The SLC earlier calculated the total to be $5,389,000, based upon
Friendly's Annual Reports (Forms 10-K) filed for the years in question.
Ezzes testified that in deciding as a director of Friendly to dispose of the
Beechjet and to acquire the Learjet, it was not relevant to him to know the
extent of Smith's ownership interest in TRC or Perkins and that he was unaware
of this information at any time. [FN63] Ezzes voted as a Board member to pay
an amount not to exceed $900,000 to terminate what he believed was an
obligation under an aircraft reimbursement agreement. When asked for the basis
of this belief, Ezzes replied that it is not a director's obligation to
examine every contract entered into by the corporation, and that the Board did
not perform any more due diligence to determine whether Friendly had such an
obligation than if it had to determine whether Friendly had an obligation to
pay for butter or milk or trucks. [FN64] This contradicts Daly's testimony
that related party transactions received far more scrutiny by the entire Board
as well as by the Audit Committee than normal business activities. [FN65]
Ezzes testified that as a member of the 2002 Special Committee he did not
discuss whether or not Smith's use of the Learjet for commuting was a
nonbusiness purpose. [FN66]
FN63. Ezzes dep. p. 56.
FN64. Ezzes dep. p. 83.
FN65. Daly dep. pp. 148-52.
FN66. Ezzes dep. p. 127.
When pressed on the issue of whether Smith would have an incentive to put TRC
or Perkins first over Friendly if he owned more of TRC/Perkins than Friendly,
Ezzes repeatedly attempted to dodge the questions by challenging their
relevance and asserting his disagreement with the line of questions because,
as Ezzes put it,
You're opining his professionalism ... You are besmirching his
professionalism. I would say that you are going down the wrong road ... I do
not believe Mr. Smith is anything other than the most utmost professional and
he will spend whatever time he believes, based on his professionalism, at
Friendly's and/or Perkins.
Ezzes testified that, as a member of the 2002 Special Committee, he and the
other committee members used Parker as counsel because they trusted him, and
that this did not raise an issue in Ezzes's mind about whether Parker could be
completely objective about claims of Smith's misdeeds even though Smith was
Parker's immediate supervisor. [FN67]
FN67. Ezzes dep. p. 65.
When asked to describe the role of Estlin, Ezzes replied that he was either a
consultant or an employee of Friendly's and possibly Perkins, and that "he
provided some type of consulting relationship to the firm." Ezzes had met
Estlin numerous times at Friendly Board meetings, and, as a Board member,
approved of Friendly's payments for Estlin's salary, yet denied knowing
anything more about Estlin. [FN68] This is difficult to square with Ezzes's
role as a 2002 Special Committee member responsible for assessing the merits
of the plaintiff's claims at that time, which in part questioned Friendly's
payment to TRC for Estlin's salary as part of the Illinois office expenses.
FN68. Ezzes dep. pp. 78-79, 83.
*19 Ezzes testified that he was not aware of the Board reviewing the terms of
Friendly's $55 million General Electric Capital mortgage, or whether the Board
approved it, or even discussed the interest cost of that mortgage. [FN69] His
deposition testimony was also that he did not know whether Friendly had a
travel and entertainment policy, an ethics policy relating to Friendly
officers, or who was responsible for enforcement of Friendly's policy
concerning related party transactions. [FN70]
FN69. Ezzes dep. pp. 179-80.
FN70. Ezzes dep. pp. 51-52, 59, 60.
Ezzes spent seven years on the Board and the Audit Committee, and was
responsible as a 2002 Special Committee member for investigating Blake's
claims regarding the aircraft and office. Consequently, as a director who
approved of many of the challenged transactions, and as one blamed in the
plaintiff's second demand letter and proposed amended complaint for engaging
in conduct which inappropriately shields or benefits Smith and/or TRC in
violation of his fiduciary duty, Ezzes's direct involvement in the conduct and
transactions at issue may render him personally liable to the corporation. See
Allied Freightways, Inc. v. Cholfin, 325 Mass. at 634. Ezzes is not merely a
nominal defendant in the proposed complaint and is an interested director.
In this context, Ezzes's testimony portrays a stunning degree of ignorance,
whether feigned or real, about the transactions material to the plaintiff's
allegations. As with Daly, Ezzes's admission that he did not request or review
basic documentation to support or negate Friendly's significant and
questionable payments in related party transactions, and his utmost confidence
in Smith, can fairly be viewed as placing unreasonable and unwarranted
reliance upon others, in an apparent abandomnent of duty to inform himself of
reasonably available material facts. See Brehm v. Eisner, 746 A .2d 259.
All these factors support an inference that Ezzes was subject to extraneous
considerations and influences. The SLC has not presented facts establisbing
Ezzes's independence as required by Section 7.44. See Aronson v. Lewis, 473
A.2d at 816; Einhorn v. Culea, 612 N.W.2d at 86.
2. Manning
Manning has been on Friendly's Board since November of 1997, at the
invitation of Smith. Manning has not sat on the TRC board at any time.
However, in or around October of 2004, Smith asked Manning to serve as a
consultant to Perkins/TRC and to assist in the development of a marketing and
advertising program, for $5,000 per day plus expenses. In his deposition on
November 11, 2004, Manning testified that Smith asked him to serve as a
marketing consultant to Perkins, and that Manning had reviewed Perkins'
advertising, visited Perkins' restaurants in Orlando, and considered potential
vendors, like art decorators, and that "I ... have been trying to come up with
a strategy that would be useful." [FN71] When asked "The amount of time
you've devoted to it," Manning replied, "I would say in total about three
days." Manning stated that his fee arrangement for his expertise is $5,000 a
day plus expenses. [FN72] In his post-motion hearing affidavit signed January
2, 2006, however, Manning contradicted his earlier testimony and stated that
he had only spent one day doing market consulting for Perkins and that he did
not receive payment for his work in that capacity.
FN71. Manning dep. pp. 26-27.
FN72. Manning dep. pp. 27-28.
*20 It is not necessary to consider the credibility of these apparently
irreconcilable representations in order to assess Mainning's independence in
2005, because his sworn statements, like those of Daly and Ezzes, depict a
director who is largely oblivious to his obligations as a director, as well as
the nature of the challenged transactions at the crux of this lawsuit. Manning
testified at his deposition that he did not recall any discussion at Board
meetings of related party transactions concerning management fees, shared
employees other than Smith, real estate leases, or food purchases. Manning did
recall a discussion at a Board meeting that Smith had an office in Illinois,
but did not know that Friendly paid TRC for part of that office. [FN73]
FN73. Manning dep. p. 119.
Manning was not aware until his deposition in November of 2004 that Friendly
was making payments to TRC toward the costs of the Learjet; Manning had
assumed that Friendly was paying a share of those costs to the financing
company. [FN74] Although Manning approved of Ezzes's appointment to the 2002
Special Committee, he did not learn until late 2004 that Ezzes had been on
TRC's board for most of the 1990s. Even more startling is Manning's testimony
that he was unaware that Parker had played a role with respect to the 2002
Special Committee, or that it might have been inappropriate for Parker to have
done so in light of his relationship to Smith. Manning explained,
FN74. Manning dep. p. 96.
I had no knowledge nor really any interest in how the Committee was--I
trusted the people to do their job. And I wasn't concerned about the process.
And I knew they would do [their job] without fear of favor, they got too much
of their own lives at stake. So I knew whatever it was, they would say it.
[FN75]
FN75. Manning dep. p. 152.
This is particularly troubling because the 2002 Special Committee only had
authority to make a recommendation to the Board regarding Blake's claims, as
Board members including Manning retained the authority and responsibility to
decide, based upon informed business judgment, whether litigation of those
claims was in Friendly's best interests. Manning's lack of concern in this
respect and his failure to inform himself reasonably or adequately about
material aspects of related party transactions, despite his lengthy tenure and
obligation as a director to review these carefully, and despite Blake's
original demand and complaint flagging potential problems as to these issues,
are at the heart of the plaintiff's claims in the proposed amended complaint
and potentially expose Manning to personal liability for breach of fiduciary
duty. See Allied Freightways, Inc v. Cholfin, 325 Mass. at 634. Manning, like
Daly and Ezzes, placed an unreasonable and unwarranted reliance upon others
rather than undertaking any discernible oversight for which he was
compensated. This lockstep loyalty approach to his responsibilities forecloses
the conclusion on this record that Manning could be impartial regarding
Blake's allegations. These circumstances support an inference that Manning was
not independent but subject to extraneous influences when he voted to appoint
the SLC. [FN76]
FN76. The relatively small size of the Board and the interdependent
functions of its committees may lend some credence to Blake's theory of
structural bias as described in Houle, and perhaps could explain the
peculiar pattern of ignorance (or wall of silence) manifested by
Manning, Daly and Ezzes in their deposition testimony taken prior to the
SLC's formation. It is ironic that the directors have ranked their
performance as satisfactory when much of their deposition testimony
evidences a lack of knowledge about material facts relating to
Friendly's major related party transactions reviewed by the 2002 Special
Committee. Whether these circumstances point to a sustained or systemic
failure by the Board to exercise adequate oversight of Friendly's
business and affairs is an issue which need not be reached at this
juncture. Cf. In re Sonus Networks, Inc., 442 F.Sup.2d 281 (D.Mass.2006)
(demand futility case).
*21 The SLC has not shown that Daly, Manning or Ezzes were independent in
2005 when they (along with Odak) appointed the SLC in July of 2005 (or when
the SLC issued its determination later in 2005). The statute plainly
contemplates that the vote to create a special litigation committee be by a
board which has more than one independent director; the three references to
independent directors are all in the plural form. See G.L.c. 156D, s.
7-44(b)(2) ("a majority vote of a committee consisting of 2 or more
independent directors appointed by a majority vote of independent directors
present at a meeting of the board of directors, whether or not the independent
directors constituted a quorum"). Here, only one member of the Board, Odak, is
independent. Although he may constitute, by himself, a majority in the minute
class of independent directors, it is doubtful that the drafters of s.
7.44 intended that a sole independent director could legitimately create an
SLC under G.L.c. 156D, s.7.44(b)(2). [FN77] Because only Odak
qualifies as an independent director, the SLC was not appointed by a majority
vote of independent directors as required by G.L.c. 156D, s.7.44(b)(2)
. Consequently, the SLC's motion to dismiss fails.
FN77. Equally without merit for the same reason is the SLC's newest
argument, advanced in its post-hearing memoranda, that in the Board's
ratification meeting, the decision to dismiss the suit was also valid
under G.L.c. 156D, s.7.44(b)(1), as it was by "a majority vote
of independent directors present at a meeting of the board of
directors." The sole independent director, Odak, could not have met the
quorum requirement of G.L.c. 156D, s.7.44(b)(1).
C. Procedure in Appointing the SLC
At the motion hearing, I expressed concern that the Unanimous Written Consent
purporting to create the SLC did not comport with the requirement in
s.7.44(b)(2) that the SLC be appointed by a majority vote of independent
directors present at a meeting of the board of directors. The plaintiff now,
for the first time, challenges the constitution of the SLC on this basis, and
the SLC acknowledges that the original appointment procedure was defective.
[FN78]
FN78. The directors' adoption of resolutions relating to the SLC
purports to have been accomplished "by Unanimous Written Consent in
accordance with Chapter 156B, s.59," which until July 1, 2004,
was the statute which authorized directors to take certain actions
without a meeting if there were unanimous written consent. The new
statute, G.L.c. 156D, s.8.21(a), reads in relevant part:
Unless the articles of organization or bylaws provide that action
required or permitted by this chapter to be taken by the directors may
be taken only at a meeting, the action may be taken without a meeting if
the action is taken by the unanimous consent of the members of the board
of directors. The action must be evidenced by 1 or more consents
describing the action taken, in writing, signed by each director ...
In an effort to remedy this infirmity, the SLC reports that on February 1,
2006, at a special teleconferenced meeting of the Board, its "independent"
members (identified in the document describing the vote as Daly, Ezzes,
Manning and Odak) resolved to ratify, confirm and approve the "resolutions set
forth in the Unanimous Written Consent of the Independent Directors of
Friendly Ice Cream Corporation dated as of July 14, 2005, pertaining to a
Special Litigation Committee ..."
Telephonic conferences can satisfy the requirement that the vote take place
while the directors are present at a meeting of the board of directors, so
long as the articles of corporation or bylaws do not provide otherwise. See
G.L.c. 156D, s.8.20(b). [FN79] Even assuming without deciding for
present purposes that Massachusetts law recognizes the principle of
ratification in this context, [FN80] the SLC has not shown that the attempted
ratification was valid.
FN79. General Laws c. 156D, s.8.20(b), reads in relevant part,
Unless the articles of organization or bylaws provide otherwise, the
board of directors may permit any or all directors to participate in a
regular or special meeting by, or conduct the meeting through the use
of, any means of communication by which all the directors participating
may simultaneously hear each other during the meeting. A director
participating in a meeting by this means is considered to be present in
person at the meeting.
FN80. The SLC's blanket assertion that "directors can ratify any prior
action taken" precedes a string of cites to cases which are either not
authoritative or inapposite, along with a deceptively incomplete
quotation from 18B Am.Jur.2d Corporations s.1424 (2004).
The test of the effectiveness of the ratification of an unauthorized act of
an officer or officers of a corporation is whether the corporation or its
board of directors making the ratification could in the first instance have
authorized such an act. For example, if there is no power to make a contract
there can be no power to ratify it.
*22 Boyce v. Chemical Plastics, Inc., 175 F.2d 839, 842 (8th Cir.1949). See
also 18B Am.Jur.2d Corporations s.1419 (2004) ("Moreover, the act must
be one that is capable of ratification, and those through whom the
ratification is to be accomplished must have the power to effect such a
ratification").
Here, the glaring defect in both the ratification and the consent it
purported to cure remains, as discussed above, that a majority of the
independent directors did not vote to appoint the SLC as required by Section
7.44(b)(2). The invalid appointment of the SLC precludes allowance of the
SLC's motion to dismiss. [FN81]
FN81. The statutory framework undercuts the SLC's oral argument that an
improperly constituted SLC results only in shifting to the SLC the
burden of proving that it determined not to maintain the derivative
action in good faith after a reasonable inquiry. See 1/20/06 Hearing
Transcript p. 32. The SLC confuses two separate issues laid out in the
statute. Section 7.44(b)(2) requires for the proper constitution of the
SLC that it be appointed by a majority vote of independent directors
present at a meeting of the board of directors. It does not require that
a majority of the entire board be independent in order for there to be a
valid SLC. In contrast, Section 7.44(d), which allocates the parties'
burdens regarding the reasonableness and good faith of the SLC's
inquiry, focuses upon "whether a majority of the board of directors was
independent at the time of the determination by the independent
directors." Thus, there is no support in the statutory language for the
SLC's argument that the appointment of a special litigation committee by
a majority vote of independent directors automatically entitles the
special litigation committee to the business judgment rule. See 1/20/06
Hearing Transcript p. 77.
V. Assessment of Good Faith and Reasonableness of SLC's Inquiry
Assuming only for the sake of argument that the impaired constitution of the
SLC does not mandate denial of the SLC's motion to dismiss, the lack of
independence of the majority of the Board which appointed the SLC at a minimum
results in the SLC bearing the burden of proving that its determination was in
good faith and after a reasonable inquiry upon which its conclusions were
based. See s.7 .44(a), (e). The SLC cannot meet this burden because it
failed to conduct a thorough and careful analysis regarding Blake's claims.
In general, the SLC Report is missing adequate supporting documentation.
Blake points out that neither the SLC Report nor the Huron Report includes an
attestation to the accuracy of their contents. This is significant because the
SLC Report contains numerous conclusory assertions attempting to justify
questionable payments, yet often fails to cite to any specific source for
verification of its conclusions. [FN82]
FN82. Several attachments to the SLC Report, such as the table listing
Friendly's share of costs purportedly related to the Illinois office (or
management fees) and describing Estlin's role, in exhibit F to the SLC
Report, do not identify sources for the information contained therein or
provide any form of supporting documentation for the figures.
Likewise, the SLC attempts to justify the Board's $112,500 credit to
TICC, owned by Smith's sons, by citing to the Huron Report at page 27,
which in turn states (without attestation or other documentation apart
from a chart generated by Friendly) that Friendly's treatment of TICC
was consistent with its treatment of other franchisees. The soundness of
this conclusion is further debilitated by the figures presented by
Huron, which indicate that by far, Friendly's largest refund or credit
was issued to TICC, with the next largest combined amount of refunds and
credits being $77,500, according to a chart generated by Friendly but
otherwise lacking verification.
Attached to the SLC Report is a list of fourteen persons interviewed in
preparation for the report, real estate statements and correspondence from
General Electric to Friendly, and a 33-page report by Huron (the Huron
Report), which in turn has 3 pages of exhibits. The list of interviewees
consists mostly of current and former executives and directors of TRC and
Friendly, and Friendly's comptroller. The SLC notably did not elect to
interview TRC's former comptroller, McClellan, whose criticism of Smith and
Estlin has fueled Blake's cause. An examination of several major topics of the
SLC Report confirms that the SLC's investigation was so lacking in substance,
scope and support as to raise serious questions about the good faith and
reasonableness of the SLC's inquiry.
A. Learjet Costs
The SLC Report and the Huron Report, which the SLC Report refers to as an
accounting report containing analysis, contribute no critical analysis of or
even adequate reason for Friendly's payments to TRC with respect to the costs
of the Learjet. Because no written contract obligated Friendly to make such
payments on what it treated as a ten-year payment obligation, the statute of
frauds rendered the purported ten-year lease agreement unenforceable. See
G.L.c. 259, s.1 ("No action shall be brought ... upon an agreement
that is not to be performed within one year from the making thereof [ ] unless
the ... agreement upon which such action is brought, or some memorandum or
note thereof, is in writing and signed by the party to be charged therewith
...."). The Huron Report completely sidesteps the basis for Friendly's payments
to TRC for the fixed costs of the Learjet, while the SLC ignores the issue of
enforceability, instead citing non-persuasively to a lengthy and repetitious
series of non-authoritative and inapposite sources for the proposition that an
implied-in-fact contract arose from the parties' course of conduct.
*23 Moreover, neither the SLC Report nor the Huron Report meaningfully
addresses Blake's claim that the fixed costs charged to Friendly were not
reasonably paid, allocated or determined. This is problematic not just because
of the drop in total business use of the Learjet by TRC and Friendly from 54%
in 2000 to 28% in 2001 to 18% in 2002, but also because the bills to Friendly
for fixed costs were not supported by documentation for fixed costs actually
incurred. Rather than evaluating, as it was required to do, whether the fixed
costs were reasonably and legitimately chargeable to Friendly (putting aside
for the moment the question of the enforceability of an implied-in-fact
ten-year aircraft reimbursement agreement), the SLC simply reported that
Friendly paid these bills.
Likewise, the SLC has failed to justify Friendly's payments for variable
costs without even minimal documentation such as representative receipts for
fuel, maintenance, parking and other costs. Its conclusion that Friendly
should, in the future, review the adequacy of its policies and procedures
regarding documentation provided prior to the payment of invoices "is too
little too late" does not seriously address the issues before the SLC. Another
indicia of the shallowness of the reports by the SLC and Huron is that they
offer no explanation for why Friendly was charged for maintenance flights
under both categories of variable and fixed costs.
The SLC Report condones Friendly's treatment of flights carrying Smith
between airports near his residences and Friendly headquarters in
Massachusetts, including flights with a stopover of less than one hour, as
business flights up until sometime in 2002. The SLC does not, however, provide
an adequate justification for this position, since (1) it is far from clear
that the Illinois office, which operated as a convenience to Smith and closed
when he moved his residence to Florida, rendered these flights as between one
Friendly office to another; and (2) IRS guidelines and the Ernst & Young study
for TRC at least raise a significant issue as to whether under tax and
accounting principles these flights were for commutes not properly chargeable
to Friendly. The SLC's perfunctory treatment of the Learjet costs paid by
Friendly falls far short of a reasonable inquiry into Blake's claims.
B. Foxtail Purchases and Joint Vendor Agreements
Friendly's purchasing department negotiates and pays for $240 million worth
of goods per year, determining which products to buy based upon costs and
quality specifications from competing vendors. [FN83] From 1997 to 2004,
Friendly paid a total of between $4,400,000 and $5,389,000 to purchase food
products from Foxtail, including pancake mix, frozen muffins, cakes, cookie
clusters and compotes. The SLC has not produced evidence that Friendly's
purchase of these products resulted from a competitive bidding process or that
the Foxtail products were determined to be superior based upon a review or
other testing. The SLC makes the bare assertion that Bill Fraser, Friendly's
former Vice President of Purchasing, reported that he had negotiated a better
price on Foxtail's pancake mix than with Friendly's previous vendor.
FN83. Okscin dep. p. 199.
*24 The SLC Report states that, "Internal Foxtail Foods pricing grids suggest
that the price that Friendly paid for Foxtail Food products was lower than the
price paid by non-affiliated third-party purchasers." This conclusion is
wholly unsupported; the portions of these reports stamped "redacted" omit data
permitting a comparative analysis of the prices charged by Foxtail to Perkins,
Friendly, and third-party customers. [FN84] The value of the report is further
diminished by the facts that Huron only reviewed invoices received by Friendly
from Foxtail related to Friendly's purchase of pancake mix in 2004 and 2005,
not for any other years or other products, and that between 1998 and 2004,
Friendly dramatically decreased its food purchases from Foxtail from $945,000
to $340,000. [FN85]
FN84. Next to the column of years from 2001 through 2004, the price
columns for the three purchasers are blank, as is another portion of the
text below the table.
FN85. Huron Report, p. 14.
There is no documentation to confirm independently the "analysis provided by"
Smith's attorney, Lee Abrams, regarding the prices charged by Foxtail to
Friendly and Perkins. Similarly unsubstantiated is SLC's crediting the opinion
by Fraser at some unspecified time that Friendly and Perkins "collectively
saved $6-7 million per year by leveraging their purchasing volume with common
vendors." [FN86] The highly restricted scope of data presented in the SLC
Report and the Huron Report belies the SLC's argument that its conclusions
regarding the Foxtail purchases and joint vendor agreements were grounded upon
a reasonable, careful or thorough inquiry.
FN86. SLC Report p. 15.
C. Management Fees
The unsigned and undated management fee letter agreement cited by the SLC as
binding Friendly to pay such fees to TRC is riddled with problems. It does not
describe the nature of the services covered by the agreement or how TRC and
Friendly would allocate shared expenses. [FN87] It does not mention that
Friendly would pay TRC for any portion of Smith's salary or benefits, the
costs of the Illinois office and secretary, or Estlin's salary.
FN87. See exhibit 2 to Huron Report.
Despite the thin evidence of Friendly's obligation to pay these fees, and in
light of SLC's and Huron's task to analyze this and other related party
transactions, the reports' discussion of management fees is devoid of analysis
as to the propriety of paying and disclosing the payment of those fees.
Regarding Estlin's salary, the SLC makes the following conclusory statements:
Our review of the services he provided to Friendly confirms that the Company
received value for its payment of the management fee with respect to Mr.
Estlin, who provided insurance, internal audit and treasurer services for
Friendly. He also served as Friendly's acting Chief Financial Officer in late
1998 while the Company was looking for a replacement for a previous Chief
Financial Officer who had left the Company. [FN88]
FN88. SLC Report p. 20.
In this context, where the value of Estlin's services and his role are
directly in question, these statements by the SLC are so vague as to be
meaningless and are entirely unsubstantiated.
For example, the Huron Report notes that its summary of the net management
fees paid by Friendly to TRC from 1998 through 2004 is based upon "information
received from the Company." The specific basis or source for that information
is not identified, and the SLC acknowledges in its report that Friendly did
not receive Estlin's W-2 forms documenting Friendly's and TRC's payments to
Estlin. [FN89] Moreover, Huron does not offer any additional information
about Estlin's services to Friendly, but simply reports that Friendly
reimbursed TRC for 50% of Estlin's salary and fringe benefits. [FN90] There is
not a shred of documentation in the Huron Report or anywhere in the record to
substantiate the SLC's representations about Estlin's services for Friendly,
nor does the SLC attempt to quantify meaningfully (independently of the
reported salary amounts) the value of Estlin's services.
FN89. SLC Report p. 20 n. 52.
FN90. Huron Report p. 21.
*25 Although on their face, the amounts paid to TRC for management fees are
not shocking, fundamental questions as to the legitimacy of these expenses
remain unanswered, apart from superficial, unsupported conclusions by the SLC
and Huron. The SLC failed to conduct a minimally reasonable inquiry into
Friendly's payment of the costs purportedly related to the Illinois office
and/or management fees.
Viewed together, all of these inadequacies in the SLC's investigation and
report regarding Friendly's payments for the Learjet, Foxtail products and
joint vendor agreements, and management fees persuade me that the SLC's
conclusions and determination not to pursue Blake's claims are not grounded
upon a reasonable, good faith inquiry.
ORDER
For all the foregoing reasons, it is hereby ORDERED that the Special
Litigation Committee's motion to dismiss is DENIED. It is further ORDERED that
the plaintiff's motion to reconsider is ALLOWED and that the plaintiff's
motion to amend complaint is ALLOWED.
SCHEDULING
The plaintiff shall perfect service of the amended complaint on the
defendants on or before June 9, 2006. The responsive pleadings shall be filed
on or before June 30, 2006. The parties shall appear for a scheduling
conference on Friday, July 14, 2006, in the Berkshire Superior Court, at 2:00
p.m. The purpose of the conference will be to review all discovery requests,
identify potential motions and consider possible trial dates. In this regard,
the parties shall submit to the court (filed in Hampden with a copy to
Berkshire) on or before July 1 a joint schedule to complete any remaining
discovery, identify any anticipated motions and identify any issues that
should be addressed. Should the attorneys be unavailable for the July 14th
conference, a mutually convenient date in July shall be agreed upon with the
Clerk to reschedule the conference.
Not Reported in N.E.2d, 21 Mass.L.Rptr. 131, 2006 WL 1579596 (Mass.Super.)
END OF DOCUMENT
Exhibit C
Not Reported in N.E.2d
Not Reported in N.E.2d, 2006 WL 2714976 (Mass.Super.)
(Cite as: 2006 WL 2714976 (Mass.Super.))
Only the Westlaw citation is currently available.
Superior Court of Massachusetts,
Hamden County.
S. Prestley BLAKE
v.
FRIENDLY ICE CREAM CORPORATION and others. [FN1]
FN1. Donald N. Smith, individually and as Chairman of Friendly Ice Cream
Corporation's Board of Directors; the Restaurant Company, The Restaurant
Holding Corporation, TRC Realty, LLC, and Steven L. Ezzes, Charles A.
Ledsinger, Jr., Michael J. Daly, and Burton J. Manning as members of
Friendly Ice Cream Corporation's Board of Directors.
No. Civ. 03-0003.
Aug. 24, 2006.
MEMORANDUM OF DECISION AND ORDER ON SPECIAL LITIGATION COMMITTEE'S MOTION FOR
RECONSIDERATION OR, IN THE ALTERNATIVE, TO REPORT CASE TO THE APPEALS COURT
AGOSTINI, J.
*1 The SLC's arguments for reconsideration essentially repeat those set out
in its motion to dismiss. [FN2] The following is not intended to alter my
ruling on that motion, but only to respond to certain aspects of the motion
for reconsideration meriting additional comments.
FN2. The request for a hearing on this motion is denied.
1. Independence Standard
The SLC first asserts that the Court has applied the wrong independence
standard and that "none of the traditional indicia of lack of independence
apply to Mr. Daly." The SLC refers to the lack of evidence that Daly had a
personal financial interest in the challenged transactions and the lack of
direct evidence that Daly's social or business relationships with other
directors caused him to make corporate decisions without being adequately
informed. The SLC advocates an independence assessment restricted to the
question of whether or not Daly's relationships with Smith, other directors,
management, or the corporation show their dominion or control over Daly.
[FN3] Consistent with that position, the SLC also wants the Court to disregard
evidence permitting an inference that Daly did not exercise valid, informed
business judgment in making decisions on relevant corporate transactions and
in recommending to the Board, as a member of the 2002 Special Committee, the
rejection of Blake's first demand letter.
FN3. The SLC's version of the independence standard on a motion to
dismiss by an SLC has been strongly criticized by more than one court In
Oracle Corporation Derivative Litigation, 824 A.2d 917, 937-938 (Del.
Ch.2003), the court opined,
"[I]n my view, an emphasis on 'domination and control' would serve only
to fetishize much-parroted language, at the cost of denuding the
independence inquiry of its intellectual integrity.... Delaware law
should not be based on a reductionist view of human nature that
simplifies human motivations on the lines of the least sophisticated
notions of the law and economics movement."
Without the benefit of Massachusetts appellate case law elucidating the
standard for independence under G.L. c. 156D, s.7.44, and cognizant
that this statute articulates new terms and procedures for disposing of
motions to dismiss derivative actions, the Court looks for guidance on this
point to other courts' interpretations of analogous statutes. Prior to the
enactment of G.L. c. 156D, s.7.42 & 7.44, the independence
inquiry was triggered by motions to dismiss brought in one of two general
procedural postures: (1) where the plaintiff failed to make pre-suit demand
(demand futility cases), and (2) where the plaintiff made pre-suit demand but
directors or a Special Litigation Committee (SLC) refused the demand (demand
refused cases). [FN4] To date, it appears that no courts have decided whether
the substantive standard of independence in an SLC case (or other type of
demand refused case) differs from that in a demand futility case. See Beam v.
Stewart, 845 A.2d 1040, 1055 (Del.2004). In either scenario, "[i]ndependence
is a fact-specific determination made in the context of a particular case ."
Id. at 1049 (demand futility case). See also In re Oracle Corporation
Derivative Litigation, 824 A.2d 917, 941 (Del. Ch.2003) (Delaware approach to
inquiry of SLC's independence is contextual and takes into account all the
circumstances).
FN4. Because G.L. c. 156D, s.7.42, requires shareholders
commencing a derivative proceeding to make written demand upon the
corporation, the pre-suit demand independence inquiry for actions
brought after July 1, 2004, no longer occurs.
Courts conducting an independence analysis of SLC members employ the
"totality of the circumstances" test, which calls for an examination of not
just the SLC members' relationships with other directors and the corporation,
but also factors including but not limited to the size of the SLC and whether
the manner in which the SLC proceeded was bound to be biased in favor of
terminating the litigation. [FN5] See, e.g., Johnson v. Hui, 811 F.Supp. 479,
486 (N.D.Cal.1991); In re Oracle Securities Litigation, 852 F.Supp. 1437, 1441
(N.D.Cal.1994) ("Whether a special litigation committee's decision to
terminate derivative litigation is independent or not depends upon the
'totality of the circumstances" '); Strougo v. Bassini, 112 F.Supp.2d 355, 362
(S.D.N.Y.2000); In re Oracle Corporation Derivative Litigation, 824 A.2d at
941 (Delaware courts test independence of SLC by taking into account all the
circumstances). Nothing in the case law relied upon by the SLC or elsewhere
supports the myopic argument that a director's independence as an SLC member
can or should be gauged without considering among the totality of
circumstances his or her record of using or failing to use informed business
judgment. [FN6]
FN5. The information available in considering the independence of SLC
members is generally greater due to the opportunity for limited
discovery, in contrast to the demand futility context, in which
independence analysis is (or was, by most courts) confined to the
particularized allegations of the plaintiff's complaint. See Beam v.
Stewart, 845 A.2d at 1955. The court in Beam noted, "As a practical
matter, the procedural distinction relating to the diametrically opposed
burdens [of proof on the plaintiff in a demand futility case and on the
SLC in an SLC case] and the availability of discovery into independence
[in the SLC context] may be outcome determinative on the issue of
independence. Moreover, because the members of an SLC are vested with
enormous power to seek dismissal of a derivative suit brought against
their director-colleagues in a setting where presuit demand is already
excused, the Court ... must exercise careful oversight of the bona fides
of the SLC and its process." 845 A.2d at 1955.
The comments by the Beam court regarding the burdens of proof and
discovery opportunities in the two types of motions to dismiss do not
reflect practices in Massachusetts in litigation predating G.L. c. 156D.
In Harhen v. Brown, 431 Mass. 838 (2000), a demand refused case, the
court determined whether the directors were independent based upon the
sufficiency of the plaintiff's allegations in her complaint rather than
upon discovery. See id. at 839, 845-846. In contrast, in another case
not based upon the current statute, a trial judge considering directors'
disinterestedness in a demand futility case permitted discovery,
conducted an evidentiary hearing, and determined the directors'
disinterestedness on that record, while assuming, without deciding, that
the directors bore the burden of proving their disinterestedness. See
Demoulas v. Demoulas Supermarkets, Inc., 2006 WL 2057476, *3-4
(Mass.App.Ct. July 25, 2006) (this Rule 1:28 unpublished decision is not
cited here as authoritative for any point of law, but merely to describe
procedures used--but not scrutinized on appeal--in shareholder
derivative suits not governed by the current statute).
As observed by other courts, the case law is not entirely free from
ambiguity or inconsistent application. See In re Oracle Corp. Derivative
Litigation, 824 A.2d at 939 (recognizing that Delaware courts have
applied independence standards inconsistently).
FN6. The language relied upon by the SLC emphasizing the relationship
aspect of the independence analysis is largely derived from cases
involving a motion to dismiss for failure to make demand. See, e.g.,
Beam v. Stewart, 845 A.2d at 1052 (in demand futility cases, court
determines whether plaintiff pled facts to create a reasonable doubt as
to a director's independence by alleging facts "that would support the
inference that because of the nature of a relationship or additional
circumstances other than the interested director's stock ownership or
voting power, the non-interested director would be more willing to risk
his or her reputation than risk the relationship with the interested
director"). Even in demand futility cases, however, the independence
standard is not limited to direct evidence of overtly influential
relationships, but rather recognizes the potential relevance of "other
circumstances" which can impair a director's independence. See id.;
Aronson v. Lewis, 473 A.2d 805, 812 (Del.1984) (shareholder plaintiffs
can only defeat a motion to dismiss for failure to make a demand by
pleading with particularity facts creating a reasonable doubt that the
directors are disinterested and independent, or that the challenged
transaction was otherwise the product of a valid exercise of business
judgment).
The SLC cites Harhen v. Brown, 431 Mass. 838, 843 (2000), for the
proposition that directors are independent if they "can exercise their
business judgment in the best interests of the corporation, free from
significant contrary personal interests and apart from the domination
and control of those who are alleged to have participated in
wrongdoing." This quoted passage from Harhen explains the purpose of the
distinction between interested and disinterested directors based upon
the definition of "interested" in the American Law Institute Principles
of Corporate Governance. Id. at 842-843. Comment I to G.L. c. 156D,
s.7.44, explains, "Only the word 'independent' has been used in
s.7.44(b) because it is believed that this word necessarily also
includes the requirement that a person have no interest in the
transaction." Neither s.7.44 or its comments suggest that the
definition of an independent director is limited to the definition of
"interested" in the Principles of Corporate Governance or that a
director could qualify as independent if he or she were unable to
exercise business judgment in the best interests of the corporation,
regardless of an absence of direct evidence that specific relationships
influenced the director's decisions.
*2 More importantly, regardless of whether the independence inquiry occurs in
the SLC context or the demand futility context,
"At bottom, the question of independence turns on whether a director is, for
any substantial reason, incapable of making a decision with only the best
interests of the corporation in mind. That is, the Supreme Court cases
ultimately focus on impartiality and objectivity."
In re Oracle Corp. Derivative Litigation, 824 A.2d at 938 (emphasis added;
noting that test of SLC's independence is "wholly consistent with the teaching
of Aronson" ). The Aronson court instructed that, "Independence means that a
director's decision is based on the corporate merits of the subject before the
board rather than extraneous considerations or influences." Aronson v. Lewis,
473 A.2d 805, 816 (Del.1984), overruled on other grounds, Brehm v. Eisner, 746
A.2d 244 (Del.2000). See also In re Veeco Instruments, Inc. Securities
Litigation, 434 F.Supp.2d 267, 2006 WL 1650656, *5 (S.D.N.Y.2006) (same, in
demand futility case). Therefore, the Court declines to confine the assessment
of Daly's independence to the identification of specific relationships
directly and overtly demonstrating undue influence upon Daly, and instead, in
the unusual circumstances of this case, considers among the pertinent
"totality of circumstances" factors which can negate or reveal evidence
bearing on the ultimate independence question of whether Daly was capable of
basing his decisions on the corporate merits.
"Thus, as with the Aronson test, under the Rales test, directors'
independence can be implicated by particularly alleging that the directors'
execution of their duties is unduly influenced, manifesting 'a direction of
corporate conduct in such a way as to comport with the wishes or interests of
the [person] doing the controlling.' A lack of independence also can be
indicated with facts that show that the majority is 'beholden to' directors
who would be liable or for other reasons is unable to consider a demand on
its merits, for directors' discretion must be free from the influence of
other interested persons."
Shoen v. SAC Holding Corp., 137 P.3d 1171, 2006 WL 1916868, *9 (Nev. July
13, 2006) (emphasis added).
There is ample evidence that Daly did not make informed decisions or exercise
informed business judgment with respect to several significant transactions
and Board decisions directly relevant to Blake's claims, even after sitting on
the 2002 Special Committee specifically charged with investigating them. The
record permits an inference that Daly remained so poorly informed that his
recommendation to the Board, as a member of the 2002 Special Committee, and
his decisions as a member of the Board and the Audit Committee in those
matters were not based upon their corporate merits, and therefore were not
objective but based upon extraneous considerations. Cf. In re Enivid, Inc.,
345 B.R. 426, 2006 WL 1933807, *12 (Bankr.D.Mass. July 12, 2006) (concluding
that it was reasonable to infer that directors lacked ability to consider
transactions objectively because CEO and director withheld pertinent
information from them).
*3 Against that backdrop, Daly's ability as a member of the SLC to evaluate
impartially the claims in Blake's most recently amended complaint is even more
dubious. Blake asserts that Daly and other directors breached their fiduciary
duty by "ignoring and condoning improper actions between Friendly, Smith and
TRC, and by exercising their authority as directors to condone and cover up
improper conduct," such as in the conduct of the 2002 Special Committee and in
paying aircraft costs after being told by Blake that Friendly had no
obligation to pay them. These allegations of intentional misconduct can fairly
be read to claim that Daly and other directors were improperly influenced by
Smith, at least, in exercising their authority as directors. In light of
Daly's substantial and direct involvement in the challenged conduct and
evidence that he previously failed to exercise informed business judgment in
rendering decisions in these matters, as well as consideration of all the
factors discussed in the decision on the motion to dismiss, I conclude that
the SLC has not shown that Daly was impartial or able to consider the
plaintiff's demand on its merits. Daly's deposition testimony, when viewed in
the totality of circumstances, supports an inference that Daly was unduly
influenced by Smith, if not also by certain other individuals in Friendly's
management and employ, due to "personal or other relationships." See In re
Oracle Corporation Derivative Litigation, 824 A.2d at 939. This is more than
adequate to create a reasonable doubt about Daly's independence. See In re
Enivid, Inc., 345 B.R. 426, 2006 WL 1933807, *13 (Bankr.D.Mass. July 12, 2006)
(director's repeated declarations of loyalty and deference to another director
and officer [Filipowski], his failure to challenge publicly Filipowski's
judgment in spite of disagreements between the two, indicated that director
was dominated by Filipowski and permitted inference that director lacked
independence in his duties). In sum, the SLC has failed to meet its burden of
demonstrating Daly's independence. The same independence standard set forth in
my decision and discussed further here applies to Ezzes, Ledsinger, and
Burton. [FN7]
FN7. The SLC wrote in page 9 of its memorandum in support of the motion
to reconsider, "There is no requirement, as the Court misunderstands,
that the independent directors comprise a majority of the board. The
composition of the Board as a whole is relevant only to the burden of
proof under the statute." The SLC appears to have misread footnote 81 of
the decision it challenges. That footnote reads in pertinent part, "
Section 7.44(b)(2) requires for the proper constitution of the SLC that
it be appointed by a majority vote of independent directors present at a
meeting of the board of directors. It does not require that a majority
of the entire board be independent in order for there to be a valid SLC.
In contrast, Section 7.44(d), which allocates the parties' burdens
regarding the reasonableness and good faith of the SLC's inquiry,
focuses upon 'whether a majority of the board of directors was
independent at the time of the determination by the independent
directors." ' As noted, this footnote corrected the SLC's argument on
this issue at the oral hearing.
2. Personal Liability
In connection with the independence analysis, the SLC also takes issue with
the conclusion that, "Because Daly was substantially and personally involved
in the conduct challenged by Blake he may face personal liability for breach
of fiduciary duty as alleged in the proposed complaint, ... In all these
circumstances [described in the previous pages in that decision], it is far
from clear that Daly was [independent]." (Emphasis added). First, at the risk
of belaboring the point, the determination that the SLC had failed to meet its
burden of showing Daly's independence does not rise and fall on one or two
factors, but is based upon a consideration of the totality of the
circumstances in this unique case. The factors weighing against Daly's
independence, even excluding, for the sake of argument only, questions about
his personal liability, are sufficient to generate reasonable doubts about
Daly's independence to defeat the SLC's motion.
*4 The SLC is correct in pointing out that it is not enough that Daly may
face personal liability, and that to qualify as a factor undermining
independence, a director must face a substantial likelihood of liability. See
Aronson v. Lewis, 473 A.2d at 815. The question of whether Daly faces a mere
threat of liability or a substantial likelihood of liability is a close one,
and calls for a more detailed look at the particularized allegations and
materials pertinent to claims that Daly breached his fiduciary duty.
The fiduciary duty encompasses the duties of care (or attention), loyalty,
and good faith. See In re Abbott Laboratories Derivative Shareholders
Litigation, 325 F.3d 795, 808 (7th Cir.2003). The duty of care "consists of an
obligation to act on an informed basis ." Shoen v. SAC Holding Corp., 137 P.3d
1171, 2006 WL 1916868, *5 (Nev. July 13, 2006); In re Caremark Intern. Inc.
Derivative Litigation, 698 A.2d 959, 967, 968 (1996) ("Where a director in
fact exercises a good faith effort to be informed and to exercise appropriate
judgment, he or she should be deemed to satisfy fully the duty of attention").
"Section 8.30 ... defines the general standard of conduct for directors ...
by focusing on the manner in which the director performs his duties, not the
correctness of his decisions, and by emphasizing the decision-making process,
not the decision itself.... A director is not liable for injury or damage
caused by his decision ... if, in performing his duties he met the
requirements of s.8.30."
Introduction to Comments to G.L. c. 156D, s.8.30. See also In re
Enivid, Inc., 345 B.R. 426, 2006 WL 1933807, *15 (Bankr.D.Mass. July 12, 2006)
(whether court believes director made substantively wrong, stupid or even
egregious decision "provides no ground for director liability, so long as the
court determines that the process employed was either rational or employed in
a good faith effort to advance corporate interests").
To meet the burden of showing a substantial likelihood of liability for
breach of a director's non-exculpated fiduciary duty to exercise appropriate
attention, a plaintiff must show
"a sustained or systematic failure of the board to exercise oversight--such
as an utter failure to attempt to assure [that] a reasonable information and
reporting system exists, .... or particularized facts that support an
inference that the directors did possess knowledge of facts suggesting
potential accounting improprieties ... and took no action to respond to
them."
In re Sonus Networks, Inc. Shareholder Derivative Litigation, 422 F.Supp.2d
281, 287 (D.Mass.2006) (internal quotations and citations omitted). See also
In re Caremark Intern. Inc. Derivative Litigation, 698 A.2d at 971. Proof of a
liability-triggering breach of the duty of care has been described as
"the most difficult task of all: demonstrating that the outside directors had
breached their duty of care, not as a result of trying to do their job but
still making mistakes of a gross nature, but because the directors' level of
indolence was so extreme that it arose to a conscious decision to take the
salary of director while intentionally failing to discharge one's fiduciary
obligations."
*5 Teachers' Retirement System of Louisiana v. Aidinoff, 900 A.2d 654, __,
2006 WL 1725572, * __ (Del. Ch. June 21, 2006). See also Guttman v. Huang, 823
A.2d 492, 506-507 (Del. Ch.2003) (dismissing claims that directors failed to
exercise oversight where plaintiff did not allege that audit committee had
clear notice of serious accounting irregularities in violation of legally
mandated accounting and disclosure standards yet chose to ignore them or to
encourage their continuation).
The record supports an inference consistent with the plaintiff's
particularized allegations in the amended complaint that Daly chose to ignore
the clear "red flags" in the plaintiff's first demand letter and by crediting
Parker's patently superficial "report" to the 2002 Special Committee. Despite
his appointment to the 2002 Special Committee to investigate the plaintiff's
allegations of Smith's improprieties regarding the aircraft and Illinois
office, at no time during his membership on that committee or from that time
until his deposition in 2004 did Daly inform himself adequately about the
substance of the corporate transactions at issue. Moreover, the plaintiff
alleges that Daly consciously condoned and covered up improper transactions
between Smith, TRC and Friendly. (See Counts I and IV of the plaintiff's
current complaint). The plaintiff thus alleges that Daly intentionally failed
to discharge his fiduciary duties with respect to a series of corporate
transactions spanning several years.
These particularized allegations, on the record before me, permit a
reasonable inference Daly consciously took his director's salary while
intentionally failing to discharge his fiduciary obligations, see Teachers'
Retirement System of Louisiana v. Aidinoff, 900 A.2d 654, __, 2006 WL 1725572,
* __ (Del. Ch. June 21, 2006), and/or that he participated in part of a
"sustained or systematic failure of the board to exercise oversight ." In re
Sonus Networks, Inc. Shareholder Derivative Litigation, 422 F.Supp.2d at 287.
The "duty of loyalty requires the board and its directors to maintain, in
good faith, the corporation's and its shareholders' best interests over anyone
else's interests." Shoen v. SAC Holding Corp., 137 P.3d at __, 2006 WL
1916868, at *5. Although G.L. c. 156D, s.8.30, does not explicitly
reference the duty of loyalty, that principle is articulated in s.
8.30(a)(3), and requires each director to discharge his or her duties "in the
manner that the director reasonably believes to be in the best interests of
the corporation."
Similarly, a director's duty of good faith is breached where
"the fiduciary intentionally acts with a purpose other than that of advancing
the best interests of the corporation, where the fiduciary ... intentionally
fails to act in the face of a known duty to act, demonstrating conscious
disregard for his duties."
In re Walt Disney Company Derivative Litigation, __ A.2d __, 2006 WL 156466,
* __ (Del. June 8, 2006). See also In re: Tower Air, Inc., 416 F.3d 229, 240
(3d Cir.2005) (directors' alleged rubber-stamping of major capital
expenditures is consistent with bad faith); In re Walt Disney Company
Derivative Litigation, 825 A.2d 275, 289 (Del. Ch.2003) ("Knowing or
deliberate indifference by a director to his or her duty to act faithfully and
with appropriate care is conduct, in my opinion, that may not have been taken
honestly and in good faith to advance the best interests of the company. Put
differently, all of the alleged facts, if true, imply that the defendant
directors knew that they were making material decisions without adequate
information and without adequate deliberation, and that they simply did not
care if the decisions caused the corporation and its stockholders to suffer
injury or loss"). In contrast, even gross negligence, including a failure to
inform one's self of available material facts, without more, does not
constitute a breach of the duty of good faith. In re the Walt Disney Company
Derivative Litigation, __ A.2d __, 2006 WL 1562466, 1, *25 (Del. June 8, 2006)
. [FN8]
FN8. As acknowledged by the court in In re the Wait Disney Company
Derivative Litigation, __ A.2d __, 2006 WL 1562466, 1, *24 (Del. June 8,
2006), "the duty to act in good faith ... to date is not a
well-developed area of our corporate fiduciary law" and is "relatively
uncharted."
*6 The same facts alleged by the plaintiff as described above and supported
by the record persuade me that Daly faces a substantial, rather than mere,
threat of liability for breach of the fiduciary duties of care, loyalty and/or
good faith. This factor lends additional though not indispensable support to
the ultimate conclusion that the SLC has not shown Daly's independence.
3. The Business Judgment Rule
The SLC's claim of entitlement to the business judgment rule is devoid of
merit as it misplaces reliance upon Harhen v. Brown. Four years before G.L. c.
156D, s.7.44, became law, the Harhen court wrote,
"In a demand refused case, because it is presumed that a disinterested board
of directors acts in good faith ... and because directors as a matter of
business policy may refuse to bring a suit, a disinterested board of
directors that has refused a plaintiff's presuit demand is entitled to the
protection of the business judgment rule....To show that directors are not
entitled to the protection of the business judgment rule, a plaintiff must
allege facts that challenge the board's good faith or the reasonableness of
the board's investigation of the plaintiff's demand."
Id., 431 Mass. at 844-845 (emphasis supplied; internal citations, ellipses,
and quotations omitted).
Harhen does not aid the SLC. The passage quoted above protected directors
with the business judgment rule only upon the assumption that they were
disinterested. See id. at 844. More relevant is that G.L. c. 156D, s.
7.44(e), uniquivocally directs that
"[i]f a majority of the board of directors does not consist of independent
directors at the time the determination by independent directors is made, the
corporation shall have the burden of proving that the requirements of
subsection (a) [that the SLC determined in good faith after conducting a
reasonable inquiry upon which its conclusions are based that the maintenance
of a derivative proceeding is not in the best interests of the corporation]
have been met."
Therefore, while this new statute articulates some new standards for ruling
on motions to dismiss shareholder derivative suits, neither it nor prior case
law affords interested or non-independent directors the protection of the
business judgment rule. Because the SLC has not met its burden of showing that
a majority of the board of directors was independent at the time the SLC was
appointed or rendered its decision, the SLC's claim to the business judgment
rule's protections is baseless. See G.L. c. 156D, s.7.44.
4. The SLC Report
The SLC asks the Court to consider the newly submitted affidavits of Attorney
Lori Martin and Huron's Managing Director, Joseph Floyd, to "cure" doubts
about the reasonableness or good faith of its investigation. The SLC states
that it had not previously presented a "fully developed record" concerning its
investigation because the plaintiff never challenged its scope, the SLC's good
faith, or took discovery of the SLC or Huron after the SLC Report was filed.
Contrary to the SLC's argument, the plaintiff did, in his opposition to the
SLC's motion to dismiss, challenge the responsiveness and thoroughness of the
SLC's investigation as reflected in its report. Regardless of the SLC's
interpretation of the plaintiff's legal strategy, G.L. c. 156D, s.
7.44(d), requires the corporation moving to dismiss the derivative suit to
*7 "make a written filing with the court setting forth facts to show ... (2)
that the independent directors made the determination in good faith after
conducting a reasonable inquiry upon which their conclusions are based."
Moreover, the two new affidavits do not alter the conclusion that the SLC has
failed to meet its burden. Sworn statements that the SLC's counsel, with the
aid of others, reviewed large volumes of documents and testimonial evidence,
in addition to conducting numerous interviews, does nothing to fill in the
significant gaps in the SLC's "analysis," which failed to answer serious,
longstanding questions raised by the plaintiff's demand letter and complaint,
and which are not without support in the discovery materials. Martin's
affidavit adds nothing helpful to the SLC Report, but repeats some of the same
vague, unsubstantiated conclusions appearing in the SLC Report. Floyd's
affidavit, which describes the extent of Huron's work (reviewing thousands of
pages of meeting minutes, agreements, accounting reports and supporting
documents), likewise does not address the flaws in the SLC Report.
5. Request to Report Case
As noted above, the court is mindful of the judicial landscape and the
paucity of decisions in this area of law. In balancing the rights and age of
the plaintiff with the issues raised by the defendants, I am disinclined to
stay this case for a lengthy period of time to allow for appellate review.
Given that the Appeals Court has recently denied Friendly's Petition pursuant
to G.L. c. 231, s.118, I do not believe that the denial of the motion
to dismiss "so affects the merits of the controversy that the matter ought to
be determined by the appeals court before any further proceedings" here. See
Mass. R. Civ. P. 64(a).
ORDER
For the foregoing reasons, it is hereby ORDERED that the motion for
reconsideration is DENIED.
Not Reported in N.E.2d, 2006 WL 2714976 (Mass.Super.)
END OF DOCUMENT
Exhibit D
Transactions in the Shares -- Lion Fund, BCC and Sardar Biglari
Date of Number of Shares Price Per
Transaction Purchase Share
9/26/06 27,400 $10.15
9/27/06 1,000 $10.22
9/28/06 13,000 $10.16
10/3/06 11,500 $10.76
10/4/06 5,400 $10.62
SK 25298 0001 719861