Boland v. Boland; Boland v. Boland Trane Associates, Inc. (Ct. of Appeals)

Filed: October 25, 2011
Opinion by Judge Sally D. Adkins.

Held:

Holding 1: After a motion to dismiss or for summary judgment against a derivative plaintiff, Maryland courts must review a special litigation committee's ("SLC") independence, and whether it made a reasonable investigation and principled, factually-based conclusions. In this inquiry, the SLC is not entitled to a presumption that it was sufficiently independent from a corporation's directors.

Holding 2: When a court grants summary judgment in a derivative suit based on an SLC's determination that continuing the lawsuit is not in the corporation’s best interest, that court decision is not a final adjudication on the merits so as to preclude a direct suit under the doctrine of res judicata. The court makes no determination of the merits of the allegations when reviewing an SLC's decision. Moreover, a direct action, which asserts individual rights, is an entirely different cause of action than a derivative action, which is brought on behalf of the corporation.

Facts: Two lawsuits arose when a family business, consisting of two corporations and owned primarily by eight siblings (collectively, the "Corporation"), attempted to repurchase the stock of one sister upon her death pursuant to a Stock Purchase Agreement. When the sister's estate refused to sell the stock, the Corporation filed a declaratory judgment action seeking enforcement of the Stock Purchase Agreement. Meanwhile, non-director siblings who had learned of earlier stock transactions that resulted in director siblings acquiring additional corporate stock for themselves, sent a demand for litigation to the Corporation and filed a derivative action in the Circuit Court alleging self-dealing and a breach of fiduciary duty. They also filed "direct" claims, as cross-claims in the declaratory judgment action.

In response, the corporations appointed an SLC consisting of two newly hired "independent directors" to examine the claims. The SLC determined that the stock transactions were legitimate and the Stock Purchase Agreement was enforceable.

The Circuit Court, applying the business judgment rule, deferred to the judgment of the SLC and granted summary judgment to the Corporation on the derivative action. The Circuit Court also dismissed the cross-claims relying on res judicata.

Analysis: On appeal in the Court of Appeals, the Court upheld the application of the business judgment rule by the Circuit Court and held that after a motion to dismiss or for summary judgment against a derivative plaintiff, Maryland courts must review the SLC’s independence, and whether it made a reasonable investigation and principled, factually-based conclusions. However, in this inquiry, the SLC is not entitled to a presumption that it was sufficiently independent from the directors. Because the Circuit Court presumed the independence and good faith of the SLC without requiring that the Corporation prove the SLC's independence, the Court of Appeals vacated the Circuit Court's judgment and remanded for further proceedings.

The Court referred to its holding as an "Auerbach enhanced" standard, in reference to Auerbach v. Bennett, 393 N.E.2d 994 (N.Y. 1979). In so holding, the Court rejected the so-called Zapata standard under which Delaware courts review a SLC’s recommendation on the merits, applying their “independent business judgment.”

The Court reasoned that "a procedural review under the business judgment rule, although clearly the more deferential standard [toward the Corporation], nonetheless provides for a thorough review of an SLC’s independence, good faith, and methodology, and such inquiry gives trial courts the ability to scrutinize SLC decisions and protect shareholders against collusive practices or inadequate investigations."

On the issue of whether the non-director siblings' "direct" claims, brought as cross-claims in the declaratory judgment action were precluded by res judicata, the Court held that the Circuit Court's grant of summary judgment in the derivative action, based on a recommendation of the SLC, does not form a basis for res judicata because it is not a determination on the merits. Accordingly, the Court held that a trial court's resolution of a derivative complaint, when based on the recommendation of an SLC, cannot be said to be a final judicial resolution on the merits of the claims.

The full opinion is available in PDF.

Questar Builders, Inc. v. CB Flooring, LLC (Ct. of Appeals)

Filed: August 25, 2009
Opinion by Judge Glenn T. Harrell, Jr.

Held: Contract clauses allowing one party to terminate for "convenience" may be enforceable, subject to the implied obligation that the terminating party exercise its discretion in accordance with the implied obligations of good faith and fair dealing.

Facts: A contractor took bids from three subcontractors to install carpet in an apartment complex and entered into a contract with one of them. The contract provided that the contractor could terminate the contract for "convenience." When a dispute arose between the parties, the contractor terminated the subcontractor and hired one of the other bidders. As grounds for termination, the contractor alleged that it had cause - based on a failure to perform - as well as the right to terminate for convenience. The subcontractor objected, stating that it had not breached the contract and the contractor did not have an unfettered right to terminate.

At trial, the Circuit Court of Maryland for Baltimore County found that the subcontractor did not breach the contract. Regarding the contractor's right to terminate for convenience, the trial court rejected the contention that the contractor enjoyed a right to terminate for any reason. It rejected the contractor's assertion that its subjective loss of faith in the subcontractor satisfied whatever implied limitations there might be. Accordingly, the trial court concluded that the contractor terminated the contract improperly and awarded damages to the subcontractor. The contractor appealed.

Analysis: Before argument in the Court of Special Appeals, the Court of Appeals took the matter on its own initiative. The Court started with the principle that "illusory" contracts are not enforceable. A contract is illusory if "the promisor retains an unlimited right to decide later the nature or extent of his performance.”

The law prefers, however, to interpret contracts in a way that will render them effective rather than illusory. In addition, Maryland law implies an obligation to act in good faith and deal fairly with other parties to a contract. Accordingly, a party must exercise its rights in good faith and in accordance with fair dealing.

Consistent with this, the Court held that the contractor was not entitled to terminate for any reason whatsoever. Where the written right to terminate for no cause left off, "the implied obligation of good faith and fair dealing picks-up, thereby limiting the manner in which [the contractor] was permitted to exercise its discretion." The Court stated succinctly: "[The contractor] was permitted to terminate only if, in its discretion, it determined that continuing with the subcontract would subject it potentially to a meaningful financial loss or some other difficulty in completing the project successfully."

*The case contains an informative explication of the history and evolution of the concept of "termination for convenience."

The full opinion is available in PDF.