Sinclair Oil Corp. v. Levien

Brief Fact Summary.

Levien (Plaintiff), a minority stockholder in Sinven, accused Sinclair (Defendant), the parent company, of using Sinven assets to finance its operations.

Synopsis of Rule of Law.

The intrinsic fairness test will be applied in a case where a parent company controls all transactions of a subsidiary, receives a benefit at the expense of the subsidiary’s minority stockholders, which places the burden on the parent company to prove the transactions were based on reasonable business objectives.

Facts.

Sinclair Oil Corp. (Defendant) is a holding company that markets, produces, and explores for oil.  Defendant owned 97 percent of the stock of Sinclair Venezuelan Oil Company (Sinven), a company engaged in petroleum operations in South America.  Levien (Plaintiff) owns approximately 3,000 of Sinven’s 120,000 publicly held shares.  Defendant controls the directors of Sinven.  From 1960 to 1966, Defendant caused Sinven to pay out excessive dividends of $108,000,000, amounting to $38,000,000 above its earnings.  In 1961, Defendant created Sinclair International (International) to coordinate Defendant’s foreign operations, and then caused Sinven to contract to sell crude oil to International at minimum quantities and specified rates.  When International failed to live up to the contract, Plaintiff and other minority shareholders of Sinven brought this derivative action requiring Sinclair to account for damages sustained by Sinven as a result of the excessive dividends and causing Sinven not to enforce the contract with International.  The Court of Chancery found for Plaintiff.  Defendant appealed.

Issue.

Does the business judgment rule protecting fiduciaries from judicial scrutiny also protect a parent company where it exerts such complete control over its subsidiary that the parent receives a benefit at the expense of the subsidiary?

Held.

(Wolcott, C.J.)  No.  Under the business judgment rule, unless there is evidence of gross and obvious overreaching, a court will not interfere with a board of director’s judgment.  However, this rule does not apply to a situation where a parent company appears to have benefited from its control over a subsidiary to the detriment of the subsidiary’s minority stockholders.  In such situations, any transactions will be tested by their intrinsic fairness if there is evidence of breach of the parent company’s fiduciary duty together with self-dealing.  For example, in this case, the allegation that Defendant caused excessive dividends to be paid out of Sinven is not sufficient to create a cause of action against the parent company for intrinsic unfairness.  Plaintiff must meet the burden of proving the dividend was not based on a reasonable business objective.  But, the court found that the dividends were not self-dealing as Defendant had received nothing to the exclusion of Sinven and its minority shareholders.  Therefore, regarding the dividends, the business judgment rule applied.  Regarding the allegations that the dividends had prevented Sinven from expanding, the court held that Plaintiff had not proved loss of business opportunities due to the drain of cash from Sinven, therefore the business judgment rule again protected Defendant.  However, the court held that there was self-dealing by Defendant in contracting with International, its dominated subsidiary.  Defendant caused International to breach its contract with Sinven to the detriment of Sinven’s minority shareholders.  But Defendant received products from Sinven through International and therefore benefitted from the transaction.  Defendant, however, failed to cause Sinven to enforce the contract.  And so, Defendant’s inherent duty to its subsidiary, Sinven, added to its self-dealing shifted the burden to it to show its breach of the International-Sinven contract was intrinsically fair.  The court found that Defendant failed to meet the burden.  Reversed in part, affirmed in part, and remanded.

Discussion.

The business judgment rule is an expression of the court’s reluctance to interfere with corporate decision-making.  It is a rule of evidence, not a rule of law.  The standard of intrinsic fairness is an extension of the business judgment rule in this respect.  For example, in this case, the court applied the business judgment rule and refused to interfere with Sinclair’s (Defendant) decisions on the dividends.  Basically, the burden to prove overreaching in order to knock down the business judgment rule was on Levien (Plaintiff), and it was not met.  But regarding the breach of the International-Sinven contract, the burden shifted to Defendant to prove it was intrinsically fair, a burden it failed to meet.  In cases such as this, the shift of burden of proof from the controlling stockholder-management to the accusing minority pivots on evidence of overreaching and self-dealing by the majority. re not self-dealing as Defendant had received nothing to the exclusion of Sinven and its minority shareholders.  Therefore, regarding the dividends, the business judgment rule applied.  Regarding the allegations that the dividends had prevented Sinven from expanding, the court held that Plaintiff had not proved loss of business opportunities due to the drain of cash from Sinven, therefore the business judgment rule again protected Defendant.  However, the court held that there was self-dealing by Defendant in contracting with International, its dominated subsidiary.  Defendant caused International to breach its contract with Sinven to the detriment of Sinven’s minority shareholders.  But Defendant received products from Sinven through International and therefore benefitted from the transaction.  Defendant, however, failed to cause Sinven to enforce the contract.  And so, Defendant’s inherent duty to its subsidiary, Sinven, added to its self-dealing shifted the burden to it to show its breach of the International-Sinven contract was intrinsically fair.  The court found that Defendant failed to meet the burden.  Reversed in part, affirmed in part, and remanded.