Summary
In Giancarlo, the Court held that dissolution under § 226(a)(3) is not proper when "the board asserts in good faith a plausible explanation for corporate inactivity that relates to a rational, lawful use of the corporate form."
Summary of this case from In re Seneca Investments LLCOpinion
Civil Action No. 10669.
Date Submitted: June 9, 1989.
Date Decided: June 23, 1989.
Kenneth J. Nachbar, Esquire, and Leone L. Ciporin, Esquire, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware, and WILLKIE FARR GALLAGHER, New York, New York, Attorneys for Plaintiff.
James C. Strum, Esquire, of RICHARDS, LAYTON FINGER, Wilmington, Delaware, and Henry B. Gutman, Esquire, and Kerry L. Konrad, Esquire, of O'SULLIVAN GRAEV KARABELL, New York, New York, Attorneys for Defendants.
MEMORANDUM OPINION
The complaint seeks the appointment of a liquidating custodian for OG Corporation, a Delaware corporation, formed in 1986. The ground asserted as justifying that relief is, in the language of the pertinent statute, that "the corporation has abandoned its business and has failed within a reasonable period to take steps to dissolve, liquidate or distribute its assets." 8 Del. C. § 226 (a) (3). Plaintiff is an individual owning 25% of the voting power of OG. He claims that the Company was formed for the purpose of holding and exploiting a certain patent but that it has taken no steps nor does it presently plan to take any steps designed to exploit the commercial value of that patent. Thus, he concludes that "the corporation has abandoned its business . . ." and, absent voluntary liquidation, should be forced to liquidate on his application.
Defendants are the corporation itself and an individual who owns, indirectly, 75% of its voting power and who, along with plaintiff, is a director of OG. Defendants deny that the corporation has abandoned its business although it is admitted that OG is not currently doing anything to exploit its patent. It has, it says, taken action to protect its patent and leaves open the possibility of various techniques of exploiting the asset in the future — including sale, licensing or otherwise. The Company has been maintained in good standing and its books and records are maintained.
The case has been tried. Based upon the evidence adduced and my understanding of the relevant law, I conclude that plaintiff has not shown himself entitled to the extraordinary remedy of the appointment of a liquidating custodian of a solvent corporation.
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This is the first suit brought in this court under Section 226(a)(3) since that section was first adopted in the 1967 revision of the Delaware General Corporation Law and this case is anomalous. The corporation that is sought to be involuntarily dissolved has a single valuable asset: a patent on certain electronic switching technology. Yet the shareholder who seeks to force liquidation of the corporation has disclaimed any interest in that asset. Rather, something other than his interest as a stockholder in OG admittedly motivates his suit.
At the heart of the matter lies plaintiff's desire to be free of constraints imposed upon him by a certain non-competition agreement that he entered into with OG in connection with the planned exploitation of OG's patent which was planned to include his employment with the firm. That agreement is governed by New York law. Plaintiff asserts that his ability to earn a living is detrimentally impacted by this agreement and, in effect, that the agreement serves no valid purpose of OG. The law generally is that such a conclusion, if reached by a court, would justify a refusal to enforce the agreement. See, e.g., 6A Corbin on Contracts § 1394 (1962); Restatement, Contracts § 515 Comment B;McCann Surveyors, Inc. v. Evans, Del. Ch., C.A. No. 1268-S (July 24, 1987); LewMor, Inc. v. Fleming, Del. Ch., C.A. No. 8355 (January 29, 1986); E.L. Conwell Co. v. Gutherlet, 298 F. Supp. 623 (D. Md. 1969), aff'd, 429 F.2d 527 (4th Cir. 1970). But plaintiff has chosen not to cast his complaint as an attack upon the present enforceability of the non-competition agreement; he has instead chosen to attempt to eradicate the holder of the right by which he feels oppressed. Thus, the case is brought as a corporation law matter seeking the first judicial application of Section 226(a)(3). In this effort to construe the legal meaning of our statutory corporation law, the court must take a very different approach than is appropriate when the question is whether equity will refuse to enforce a particular agreement.
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The applicable statutory words are few:
(a) the Court of Chancery, upon the application of any shareholder, may appoint . . . a custodian . . . when:
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(3) the corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate or distribute assets.
Analysis of the central legal issue of this case involves an interpretation of the statutory words "abandoned its business." That analysis may be broken up into two parts. The first part asks, to what do the words "its business" refer. The second part constitutes a factual inquiry into the question whether that business has been "abandoned."
As to the first issue, plaintiff lays stress upon the pronoun "its" that modifies the word "business." He has offered testimony and other evidence relating to the original plan or intention of those who incorporated OG (or on whose behalf it was incorporated). This original conception, plaintiff says, is for OG "its" business. The evidence shows, plaintiff says, that that business importantly involved, indeed was entirely made up of, plans to exploit the patent that OG would own. But, plaintiff says, the evidence shows that that business was never engaged in and has been abandoned.
I am, however, unable to agree that in employing the phrase "its business," Section 226(a)(3) refers to any original understanding of the purposes to be served by the corporation. To accept plaintiff's premise would mean, for example, that corporate boards that decide (with the concurrence of a majority of shareholders) to sell substantially all of the firm's assets and to re-deploy them in a radically different type of enterprise might safely do so only with unanimous concurrence of shareholders — since such a step might involve an abandonment of the original idea of the reason for the corporation. But it is far too late in the evolution of the corporate form of organization to return to a regime in which corporations are only formed for particular or specified purposes. Our law, expressly since 1967 (see Section 102(a)(3)) and implicitly from a much earlier date, has recognized that a corporation may validly be formed in order "to engage in any lawful activity." It would be a mistake and unwarranted to conclude that the legislature intended to insert the concept of a binding, limiting, original intention through the device of Section 226(a)(3) at the very time that it amended Section 102(a)(3).
That is, prior to the 1967 revision, it was the common practice to insert into a charter's purposes clause standard language running sometimes to several pages in length.
Accordingly, I conclude that "its business" does not refer to any original intention more narrow than the purposes clause of a corporation's charter. Rather, in my opinion, "its" business refers to any business within the purposes clause of the corporation's charter in which the corporation purports to be engaged.
Thus, it seems to me the dispositive question here is not whether the present situation with respect to OG was or was not within the plan of its originators, but whether the corporation is engaging in any business whatsoever presently or has it "abandoned" all business.
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In addressing this question, I note two preliminary points. First, Delaware courts have traditionally demonstrated caution to the point of reluctance in appointing receivers for solvent corporations. See e.g., Drob v. National Memorial Park, Inc., Del. Ch., 41 A.2d 589 (1945); Zuchowski v. Boxwood Coastal Corp., Del. Supr., 93 A.2d 119 (1952); Hall v. John S. Isaacs Sons Farms, Inc., 163 A.2d 288 (1960). That reticence has in recent years been tempered by a concern for rights of 50% shareholders who are effectively excluded from an equal voice in the selection of the directors who manage the enterprise. See Giuricich v. Emtrol Corp., Del. Supr., 449 A.2d 232 (1982);Marciano v. Nakash, Del. Ch., C.A. No. 7910, Berger, V.C. (May 14, 1985), aff'd, 535 A.2d 400 (1987). While Giuricich teaches that a reluctance to take the radical step of appointing a receiver for a solvent corporation cannot be taken to the point of failing to give to a clear statute its apparently intended effect, it remains the case that such relief constitutes a radical step that ought not to be granted unless the plaintiff has rather plainly shown his entitlement to it.
The second preliminary point concerns the purpose of this statute. It has been said that every statute has a purpose, the imaginative discovery of which is the surest guide to its correct interpretation. In discerning the purpose of Section 226(a)(3), we are not assisted by legislative history, for there is none. Moreover, neither side has called to my attention contemporaneous statements of commentators relating to the purpose of Section 226(a)(3). Finally, the prior case law does not expose a problem to which the statute was especially addressed.
Given my understanding that the first clause of Section 226(a)(3) meant to refer to the abandonment of all substantive business activities, the rationale behind the section, however, seems discernible from its own words alone. The corporation in a residual sense (and originally) represents the collective investment of the shareholders. The directors are elected by the shareholders to manage the enterprise. If the directors cease to manage the assets committed to them, if they abandon the business, they may be said to forfeit their claim to control those assets. Thus, Section 226(a)(3) recognizes that where that has occurred and no steps have been taken to dissolve the enterprise, the court is authorized to appoint a custodian. So understood, the statute seems less innovative than it may first appear. Even before its enactment, I have no doubt that upon a showing of the elements required to be shown under that provision, the Court of Chancery would have been authorized to issue a mandatory injunction requiring the directors to either engage in business or liquidate. In such circumstances, to do neither would constitute a repudiation of the directors' obligation to manage the enterprise in an effort to promote the corporation's welfare and, derivatively, the interests of its shareholders.
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Does the evidence then show that OG has abandoned all business and its directors are breaching a duty in failing to liquidate the firm? I cannot so conclude.
The evidence shows no current activity, but it does show that OG prosecuted its U.S. patent application in 1987. The U.S. patent issued in 1988. In 1987, OG pursued related patent filings in foreign jurisdictions and took action in that connection in 1988. OG made payments to counsel with respect to that work in 1988 and 1989. Additional funds to finance this work were advanced to OG by its other shareholder (who is controlled by the individual defendant) in 1987 and 1988.
OG presently has no operating expenses other than to maintain its registered agent, pay its franchise tax, maintain a small checking account and preserve its foreign patent filings. It must as well bear the cost of this suit.
It is, of course, plain that a corporation may be formed and maintained as a passive instrumentality — for example, an entity that does no more than take and hold title to intangible investments is a commonly encountered phenomenon. But even investment holding companies typically receive interest, dividends or other distributions with respect to their investments and do typically change investments from time to time. OG has but one intangible "investment" and it generates no income at present. At present, it is inert. Defendants offer explanations for this consistent with their position that inactivity does not mean abandonment. They say that the corporation will have to achieve additional capital in order to try to exploit its patent and that the prospect of such new capital is dim so long as certain litigation (not involving OG but involving claims relating to its technology) pends. The corporation has expended such funds as are necessary to secure its patent and to protect it abroad.
The course that OG is now pursing — simply waiting to see if an opportunity presents itself to realize a return on its investment — is not irrational given its circumstances. The board that elects to pursue that policy of inaction in these circumstances cannot be seen as breaching a duty to the corporation or its shareholders. In my opinion, a court must be able to conclude it is a breach of duty not to liquidate the firm in the face of the circumstances presented before it can conclude that the corporation has "abandoned its business."
I do not regard the question of abandonment under Section 226(a)(3) as being entirely a question left to the business judgment of the board. The enactment of this statute requires the court to decide objectively, so to speak, whether the business has been "abandoned." But in making that judgment, the court must keep in mind, in my opinion, that it is the board not the court that is charged with managing the enterprise. As a consequence, I am of the view that whenever the board asserts in good faith a plausible explanation for corporate inactivity that relates to a rational, lawful use of the corporate form, an order under Section 226(a)(3) is not warranted.
This, in my view, is the situation in this instance. The corporate form is being used rationally to hold an asset to await future developments. I cannot conclude that such course of action constitutes any part of a breach of fiduciary duty to the minority (although obviously in some circumstances it might) or that the goal sought is illegitimate. That the present situation represents a different turn of events than the individuals involved contemplated at the outset is, as I noted above, irrelevant. That this is a result that disadvantages plaintiff in his posture of one who has contracted with the corporation is even more clearly irrelevant to a proceeding of this type.
For the foregoing reasons, judgment will be entered in favor of defendants and against plaintiff. Defendants may submit a form of judgment order on notice.