United States Court of Appeals
For the First Circuit
Nos. 08-2588, 09-1017
ALEXANDER G. BALDWIN,
Plaintiff, Appellant/Cross-Appellee,
v.
JOHN W. BADER; STEVEN P. BOULET; MICHAEL L. BROUSSEAU;
SCOTT F. HALL; ROGER H. POULIN; JOHN A. POWELL,
Defendants, Appellees/Cross-Appellants.
APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MAINE
[Hon. D. Brock Hornby, U.S. District Judge]
[Hon. John H. Rich III, U.S. Magistrate Judge]
Before
Torruella and Boudin, Circuit Judges,
and Saris,* District Judge.
George J. Marcus with whom David C. Johnson and Marcus, Clegg
& Mistretta, P.A. were on brief for plaintiff, appellant/cross-
appellee.
Paul McDonald with whom Theodore A. Small and Bernstein Shur
were on brief for defendants, appellees/cross-appellants.
October 19, 2009
*
Of the District of Massachusetts, sitting by designation.
BOUDIN, Circuit Judge. This case arises from two
transactions in which WahlcoMetroflex, Inc. ("WMI" or "the
company") issued equity shares as compensation for agreements made
by most of its shareholders to guaranty personally loans made to
WMI. Alexander Baldwin, one of seven shareholders and founders of
WMI, filed suit alleging that WMI's directors breached their
fiduciary duties to him by issuing the two sets of shares, each of
which diluted his stake in WMI. The district court ruled on
summary judgment that WMI's directors were liable to Baldwin on the
second transaction but not the first, and both sides now appeal.
WMI is a Delaware corporation based in Lewiston, Maine,
that manufactures emissions control equipment used in power
generation and other industries. The company was formed in 2001
after Baldwin and six other investors1 acquired the assets of a
predecessor company in a bankruptcy proceeding. All made capital
contributions to WMI in the amount of approximately $14,285 each,
and, in exchange, received the company's shares in equal amounts
(14.28 percent each). The seven shareholders also comprised WMI's
board of directors for much of its existence, and Baldwin served as
chairman and president until 2004, when he resigned his positions
in management and on the board.
1
The six are John W. Bader, Steven P. Boulet, Michael L.
Brousseau, Scott F. Hall, Roger H. Poulin and John A. Powell. They
were the defendants in the law suit and the only directors of the
company at the time the suit began; we refer to them as "the
directors."
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At the outset, WMI's operations were financed primarily
by Wells Fargo Business Credit ("Wells Fargo"), which provided both
a loan of $365,000 to fund the acquisition of assets from the
bankrupt predecessor and a line of credit up to $3,385,000 for
future operations. These loans were backed not only by WMI's
assets, but also by personal guaranties from all seven founders:
Baldwin and one of the other directors, John W. Bader, provided
unlimited guaranties while the remaining shareholders provided
limited guaranties capped at 14.28 percent of any outstanding
principal and interest due. No compensation was provided to any of
the seven for giving the guaranties.
The Wells Fargo financing contained several limitations
unfavorable to WMI. The bank, for example, agreed to advance
funding based only on the value of existing assets and not on works
in process, which in practice limited WMI to drawing only about
half of the line of credit's face value. Needing more funding, WMI
in early 2001 borrowed roughly $900,000 from the Finance Authority
of Maine, the Androscoggin Valley Council of Governments ("AVCOG"),
and Coastal Enterprises, Inc. These loans too were backed by the
shareholders' personal guaranties, again without compensation.
Despite these additional loans, WMI operated at a net
loss in each of its first three years and during this period its
management and board sought either to sell the company or find new
investors, and also to replace Wells Fargo as its bank lender. By
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early 2005, Poulin, who acted as Director of Materials, told Bader
that WMI needed at least $200,000 to fund an additional project for
a customer--without which WMI would have to cease its operations.
AVCOG provided a loan of $205,000, conditioned on guaranties from
all of the shareholders; but, the company being now precarious,
three of them balked at providing uncompensated guaranties absent
a commitment from all to do so.
Lacking cash to pay for guaranties, the board acting
with legal advice determined at a March 2005 meeting that
shareholders that guarantied the AVCOG or any future financing
would be issued WMI common shares equaling 5 percent of the
company's outstanding equity for each $100,000 of corporate debt
guarantied. The six directors later provided unlimited personal
guaranties for the AVCOG financing, and AVCOG made the loan without
a guaranty from Baldwin, which Baldwin had declined to provide.
Because of counsel's concern that Baldwin might have had
insufficient notice or information, however, no compensatory shares
were issued to anyone for the AVCOG transaction.
Even after the AVCOG loan, the company continued to incur
losses and, by the beginning of August 2005, WMI had $303,641 in
accounts payable over 60 days past due and liabilities in excess of
assets by more than $846,000. Concluding that it was on the verge
of forced liquidation, the company in the same month secured a
commitment from Androscoggin Savings Bank ("ASB") to provide
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approximately $3.6 million in financing, partly in loans and partly
in a line of credit, to extinguish the company's existing bank debt
and--by contrast to the Wells Fargo loan terms--effectively allow
limited draws on the line of credit based on works in process.
However, ASB required personal guaranties from WMI's shareholders,
and because of the large and more flexible line of credit, these
guaranties carried greater risk for the guarantors.
On August 10, 2005, Powell--who had succeeded Baldwin as
president--sent Baldwin a letter outlining the general terms of the
ASB refinancing, including the guaranties required, and informing
him that, under the formula earlier adopted, his equity in WMI
would be diluted if he chose not to provide a guaranty. Baldwin
objected to the short five-day period allowed to him to decide, so
the ASB refinancing went ahead on August 18 with compensation for
the guaranties being deferred. The refinancing repaid Wells Fargo
and extinguished the earlier guaranties of Baldwin and the others
to Wells Fargo.
The board deferred issuing compensatory shares while
Baldwin pondered whether to provide a guaranty and, when he failed
to meet a year-end deadline, the board on January 19, 2006, voted
unanimously to issue compensatory shares to themselves in exchange
for having guarantied the ASB financing. The board used the same
formula as had previously been adopted for the more modest $205,000
loan from AVCOG but not then utilized. As a result of the share
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issuance, Baldwin's stake in WMI was diluted from 14.28 percent to
5.04 percent. This is the first of the two transactions later
challenged by Baldwin's law suit.
WMI's financial condition began to improve after the 2005
refinancing. It earned a profit in 2006 and was now able to
finance more and bigger projects, and it soon drew down nearly all
of the available line of credit. The board then unanimously voted
in late 2006 to increase by $1,000,000 WMI's revolving line of
credit with ASB and to increase by $100,000 a preexisting term
loan. ASB again asked for personal guaranties from WMI's
shareholders, and on December 26, 2006, Baldwin was advised that
his guaranty would be required to receive new compensatory shares.
Although provided current financial information about the company,
Baldwin eventually declined to guaranty the new loan.
The 2007 ASB financing closed on January 18, 2007, with
all WMI shareholders except Baldwin providing unlimited personal
guaranties. On January 19, 2007, the board voted to issue
themselves compensatory shares; although the company's prospects
had substantially improved, the board used the original 5 percent
per $100,000 formula in determining compensation. The new shares
were issued on February 1, 2007, and their issuance further diluted
Baldwin's equity interest in WMI from 5.04 percent to 3.25 percent;
had Baldwin instead provided a guaranty, his interest would have
increased from 5.04 percent to 8.32 percent. The directors, in
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their capacity as six of the seven shareholders of WMI, later
ratified the issuance of the new shares at an April 12, 2007,
shareholder meeting.
Baldwin filed suit in the federal district court in Maine
in March 2007. He claimed that both issuances of compensatory
shares comprised a breach by the directors of their fiduciary
duties as directors and shareholders, and he asked for damages and
that the shares be voided. Baldwin then moved for summary judgment
as to both transactions, and the directors cross-moved for summary
judgment as to the first of the two. Based on a recommendation by
the magistrate judge, the district judge in September 2008 granted
the directors summary judgment on the first transaction and Baldwin
summary judgment as to liability on the second.
Each side now appeals from the judgment so far as it
favored the other. Although the district court's decision did not
determine the relief to be afforded to Baldwin on the second
transaction, the parties thereafter arrived at an agreement as to
the relief, roughly $70,000, if the judgment of the district court
were affirmed. Because both transactions were disposed of on
summary judgment, our review on all issues presented on this appeal
is de novo.
The parties agree that Delaware law applies to the
transaction--WMI was incorporated in that state--and the pertinent
precepts are familiar: that in the ordinary case there is a
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presumption that the directors have acted properly and the
"business judgment" rule provides substantial latitude for the
directors' judgment, Cede & Co. v. Technicolor, Inc., 634 A.2d 345,
360-61 (Del. 1993); that directors owe a triad of fiduciary duties
(good faith, loyalty and care), id. at 361; Emerald Partners v.
Berlin, 787 A.2d 85, 90 (Del. 2001); that a breach of duty can
displace the business judgment rule's protection, Emerald Partners,
787 A.2d at 91; and that even a breach of duty is not fatal if the
directors can show that a transaction was fair, id.; see also
Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983).
But Delaware law also provides more ambiguous guidance
about how fairness is determined and the relationship of fair price
to other fairness factors, see Weinberger, 457 A.2d at 711; and it
gives weight depending on the circumstances to such variables as
emergency conditions, id.; cf. In re NVF Co. Litig., 1989 Del. Ch.
LEXIS 167, at *23-24 (Nov. 21, 1989) (unpublished), and to the fact
that benefits accruing to the directors as shareholders are also
made available to other shareholders on equal terms.2
Our case turns on two concepts--requisite care and
fairness. Nothing in the facts provides a triable issue on the
charge that the directors acted in bad faith as to either
2
Gilbert v. El Paso Co., 575 A.2d 1131, 1146 (Del. 1990); H-M
Wexford LLC v. Encorp, Inc., 832 A.2d 129, 150-51 (Del. Ch. 2003);
Shields v. Shields, 498 A.2d 161, 170 (Del. Ch. 1985); cf. Unocal
Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957-58 (Del. 1985).
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transaction or that they were disloyal in their duty to foster the
best interests of the company and its shareholders. Patently, both
issuances of shares were actions by the board that benefitted the
board members as principal shareholders; but the company needed
funding in each instance and the opportunity to acquire the same
shares on the same terms was provided to the only remaining
shareholder, Baldwin.
Nor, as events transpired, did the directors discriminate
unfairly against Baldwin by giving him too little time or too
little information. Admittedly, Baldwin (being no longer an inside
figure) was at a disadvantage in assessing the terms offered. But
the initial deadlines for the first transaction were extended, and
Baldwin's brief does not effectively argue that necessary
information that he sought was withheld from him in either case.
Given the incentives to secure his guaranty and to avoid
litigation, the other directors had good reason to accommodate
Baldwin as to both time and information and appear to have done so.
Nevertheless, in issuing shares to themselves as
compensation for their guaranties, the directors had a duty of care
to seek a fair valuation; true, Baldwin had the same opportunity to
acquire shares. Yet he was not obliged to take it up while the
directors remained obliged to avoid overpaying and thereby diluting
unnecessarily other stockholders' interests. It is not clear that
the directors dispute that they had this duty. In all events, we
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agree with them that--in the first instance--Baldwin had the burden
of showing that the directors were careless in setting the formula
for each of the challenged transactions.
As to the first one, no refinement of the duty of care is
needed in order to acquit the directors of liability. By early
2005, the company was in serious trouble: it had a record of
losses, restrictive bank credit, and a looming prospect of failure
even after the initial modest $205,000 loan from AVCOG. The offer
from ASB in August 2005 thus created a major opportunity to
refinance on terms that would allow growth of the business. But
the opportunity was juxtaposed with a lender demand for shareholder
guaranties--this time guaranties made more risky by the large line
of credit, which might entail greater personal liability if the
shareholders ever had to pay.
Certainly rescuing the company provided prospects of
rewards in the future, but those would accrue to all shareholders.
To provide incentives for individual shareholders to give the
guaranties, added shares for those who cooperated were proper: the
only issue is whether reasonable terms were fixed. Ordinarily, one
would try to calculate the current value of the company and the
value of the guaranties, and then price the compensation in shares
accordingly; but, based on Bader's advice as Chief Financial
Officer and the directors' own knowledge, the board had a basis for
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fearing that WMI was insolvent and had a negative forced
liquidation value.
There was no easy way to determine a perfect compensation
formula but the one adopted at the March 2005 board meeting--a 5
percent grant of shares for each $100,000 of corporate debt
guarantied--was not (quite) plucked out of the air. In late 2004
or early 2005, negotiations had occurred between WMI and CEI, a
potential investor. CEI never made a formal offer for WMI's shares
but the directors came to believe that offering CEI up to a 10
percent ownership stake in WMI might have been sufficient to entice
it to invest $200,000 in WMI--roughly the amount that WMI
ultimately secured from AVCOG. The 5 percent formula adopted at
the March 2005 meeting conformed to this belief but, as the
directors have conceded, the formula was also "the only number that
all guarantors could agree upon"--a market test although not very
reliable because of the built-in incentive to be generous.
In theory, the board could have hired an outside
consultant, but consultants cost money, the company was operating
on a shoestring, and time was of the essence. If all the
shareholders gave guaranties, there would be no dilution and
pricing would not matter; and at the time, the directors had no
assurance that the loan would be provided unless all of the
existing shareholders signed guaranties. When AVCOG relented and
made the loan without Baldwin's guaranty, it was because the
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current directors had all agreed to go along, knowing that everyone
on the board would share in the risk. Some compensation for doing
so while Baldwin held out was reasonable.
It is true that the shares were not issued until later
and the company's fortunes were now improving. But the extra time
was provided so that Baldwin, now with an extended option provided
to no one else, could review data and reflect. The other directors
had signed on specific terms, and it would hardly have been fair,
even if the company's prospects improved between March and December
2005, to deprive them of their bargain for the original risk. Nor
is it clear how a much better estimate of fair compensation could
have been achieved--at least without spending money to secure it.
Even without the business judgment rule, no jury could reasonably
find that the directors in emergency conditions breached their duty
of care as to the first transaction.
The second transaction poses a harder problem for the
directors. By late 2006, when they voted to increase their loan
and substantially increase their line of credit, the company's
prospects were much improved. It was on its way to completing its
first year of achieving net profit rather than a year-end loss; it
had a book of business that had almost exhausted its line of
credit; and it had sufficient promise of more business to seek
additional financing. The company was no longer on the verge of
collapse. So, when the directors proceeded with the new loan
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arrangements and issuance of shares, the circumstances were quite
different.
On December 26, 2006, the directors advised Baldwin that
he would be required to provide a guaranty in order to receive
compensatory shares for the enlarged loan and line of credit; he
declined several days later. The loan closed on January 18, 2007,
all other shareholders providing unlimited personal guaranties; and
on January 19, 2007, the board voted to issue themselves
compensatory shares, thus diluting Baldwin's proportionate
ownership even further. The original compensation formula, 5
percent of WMI's equity for each $100,000, was again employed. The
directors were entitled to some compensation; the question is
whether they exercised due care in determining the amount.
Seemingly, the directors made no documented effort to
determine whether the old formula was justified under current
conditions, and that is the opening problem for them. Worse still,
at this point the board had available a valuation study that the
company had commissioned for insurance purposes in early 2006.
This valuation report, which was written by WMI's accounting firm
Purdy Powers and released in June 2006, estimated that the fair
market value of 100 percent of the common equity interest in WMI
was $2,470,000. By the end of the same year, when the new
financing was secured, the situation might well have looked even
better for reasons already described.
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It is difficult to value the equity in a closely-held
company; but it cannot easily be argued that 5 percent of WMI's
equity at the end of 2006 was worth no more than an equivalent
percentage of the same company in 2005 when it appeared on the
verge of collapse. Further, the new financing surely did not need
to be achieved on so tight a time-table as the previous
transaction, and, in any case, the directors could have agreed to
provide personal guaranties at once with fair compensation to be
fixed after a more careful study. This time the directors were
giving guaranties as an investment in what would likely be future
profits and faced a reduced threat that the guaranties would be
triggered by a company default.
Under Delaware law, the directors were not freed from any
duty to value the compensation fairly merely because the offer was
made to all shareholders. See Smith v. Van Gorkom, 488 A.2d 858,
872 (Del. 1985). This is so even ignoring the fact that when the
loan was finally secured and compensation fixed in early 2007, the
directors knew that Baldwin was not going to participate. Arguably
some deference is still accorded to the directors' judgment despite
their self-interest--the case law points in this direction, Kaplan
v. Goldsamt, 380 A.2d 556, 568 (Del. Ch. 1977)--but the self-
interest may temper the extent of deference. Anyway, fine-tuning
is not necessary: the directors do not seriously argue that in the
second transaction due care was exercised.
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Instead, they say that a lack of due care merely shifts
to them the burden of proving that the transaction was fair, that
the district court did not fully appreciate the dimensions of the
fairness test, and that they were entitled to a trial in which the
issue of fairness could be fully tested. The first of these
propositions is correct: although Delaware law could go directly
from a lack of due care to the question of relief, it provides
instead that the directors can still avoid liability if the
transaction was shown to be fair. Emerald Partners, 787 A.2d at
91. This avoids, among other things, a mechanical right to relief,
such as the voiding of shares.
Still, bearing the burden of showing fairness, the
directors were obliged--by the rules governing Baldwin's motion for
summary judgment--to show that the evidence raised a material issue
of fact for a jury. See Triangle Trading Co. v. Robroy Indus.,
Inc., 200 F.3d 1, 2 (1st Cir. 1999). Putting to one side for a
moment the relevance of other factors bearing on fairness, the
value of the shares and the value of the guaranties were both
critical issues in determining whether the 5 percent per $100,000
formula was fair as of early 2007. What evidence, then, was
proffered or pointed to by the directors to create a factual issue?
The directors did develop expert testimony relating to
the fairness of the price but it was excluded in a Daubert hearing,
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see Daubert v. Merrill Dow Pharm., 509 U.S. 579 (1993),3 and the
directors do not challenge (or even explain) this exclusion on
appeal. Instead, they make two arguments: first, that the
fairness of the price could be shown by facts in the record other
than the excluded expert testimony; second, that consideration of
"entire fairness"--a concept they say that the district court
short-changed--could have led the fact-finder at trial to conclude
that non-price factors demonstrated that the transaction was fair.
The claim that the district court misunderstood Delaware
law on "entire fairness" is doubtful. The charge turns on the
district court's statement that the fairness of the price is the
most critical concern; the directors say that the Delaware case
quoted involved a distinguishable context. It is hard not to give
price a central position when the ultimate challenge is to the
extent of compensation. Cf. Delaware Open MRI Radiology Assocs.,
P.A., v. Kessler, 898 A.2d 290 (Del. Ch. 2006). But what the
district court thought does not matter because our review on
summary judgment is de novo. And, doubtless, on some facts a price
3
The defendants' expert, John T. Gurley, used a substitution
method to price the guaranties in which he assumed that they
carried a similar risk to an equity investment and valued them
accordingly. See Baldwin v. Bader, No. 07-46-P-H, 2008 U.S. Dist.
LEXIS 56236, at *20 (D. Me. July 23, 2008). The lower court,
however, found that the treatises cited by Gurley failed to support
this (relatively novel) methodology; and, in any event, Gurley had
never before valued a personal guaranty. Id. at 26-27.
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could be deemed fair based largely on non-price circumstances (the
first transaction in this case could be an example of that).
So we accept that under Delaware law the fairness of the
second transaction is properly judged by both price and non-price
considerations and, further, that their cumulative support could be
greater than either factor taken separately. Also, under summary
judgment standards it is enough for the directors merely to show
that the evidence creates a material issue warranting a full trial.
Triangle Trading Co., 200 F.3d at 2. But--and this is critical--
there must still be enough evidence of fairness proffered in
opposing summary judgment to permit a reasonable fact finder to
decide in their favor. See Celotex Corp. v. Catrett, 477 U.S. 317,
322-23 (1986); In re Spigel, 260 F.3d 27, 31 (1st Cir. 2001).
That evidence is hard to find. As to price, the
directors point to the unconsummated 2004 negotiations for an
investment by CEI that bolstered the original formula and the
assertion that that formula was the least the directors would
accept for the second transaction. But the 2004 negotiations never
led to a formal offer in the amount specified, the June 2006 study
done for insurance showed that the company was more valuable
already, and the year-end net gain and works in progress bear this
out. As for the claim that the board members would not accept
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less, the basis for the assertion appears thin,4 and, unlike the
company's earlier do-or-die situation in August 2005, nothing in
late 2006 compelled the company to acquiesce.
Understandably, the directors place their main stress on
the non-price evidence of fairness, which (they assert) includes
the following: the company's legitimate need for more financing;
the use of a formula developed earlier on the basis of then
available information; the offer of an equal opportunity to
Baldwin; the supply to him of information about the company's 2006
financial status; and the advice of counsel. The problem is not
that any of these is irrelevant in principle but rather that,
examined closely, most do not weigh in the company's favor on the
present facts.
The need for financing and the earlier formula are almost
beside the point: the pressure the second time around was far less
urgent than in the original transaction. The basis for the
original formula depended far more on urgency and the lack of
better information; in fact, the original formula did not have much
substantive support but it did assure that those who took on more
risk in a desperate situation got some reward and created an
4
Indeed, there is no evidence suggesting that the directors
revisited the pricing formula after its creation in March 2005;
this is not surprising, as the formula provided that it would apply
not only to the initial AVCOG loan but also to "any additional
future financing." But this does not excuse the failure to revisit
the issue in new circumstances. See Brehm v. Eisner, 746 A.2d 244,
259 (Del. 2000).
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incentive for all to do so. The contrast between the two time
periods does more to underscore the lack of care in early 2007 than
to support a claim of fairness.
The provision of an equal opportunity to Baldwin, given
that information was supplied to him, did provide a measure of
procedural fairness, but--as we read Delaware law--merely providing
an opportunity for all to participate does not itself vindicate a
self-interested management. See Van Gorkom, 488 A.2d at 872.
Management is still not allowed to overpay itself where, as here,
it had better information and more time but merely copied an
outworn formula which was not binding. Delaware law could easily
be explained by the inherent disadvantage suffered by non-
management stockholders; but in any event we are bound by it.
This leaves the excuse of advice of counsel. Reliance
upon legal counsel, as the directors note, can evidence "'good
faith and the overall fairness of the process.'" Cinerama, Inc. v.
Technicolor, Inc., 663 A.2d 1156, 1175 (Del. 1995) (quoting
Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1142 (Del. Ch.
1994)). But it is only one factor in the analysis--"a 'relevant
but not dominant consideration.'" Id. (citation omitted); see also
Valent Pharm. Int'l v. Jerney, 921 A.2d 732, 751 (Del. Ch. 2007).
And while counsel advised on the original formula it is far from
clear that counsel advised on the use of the same formula long
afterwards and in quite different circumstances.
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In short, the directors have provided very little, either
in price or non-price evidence, to show that using the old
compensation formula was fair in 2007. Even well after the event
a financial expert could have offered a supported retrospective
judgment as to what in early 2007 would have been the fair value of
a 5 percent share of the company and compared it with the
corresponding estimated value of the new guaranty. If the two
figures were within sight of one another, the absence of any
admissible expert evidence to that effect is hard to explain and,
without it, a fact finder could not on the very thin evidence
available rationally conclude that the directors had carried their
burden of proof to show fairness.
None of this reflects upon the good faith of the
directors, nor is it obvious that the just outcome--even if
liability were established--should necessarily result in anything
more than the directors restoring to the company any excess
compensation over value or providing Baldwin directly his share of
that excess. It appears that comparatively modest damages have
already been settled by stipulation, assuming affirmance. Given
the cost of further litigation, this was presumptively a good
resolution for which counsel on both sides likely deserve credit.
The judgment of the district court is affirmed. Each
side shall bear its own costs on this appeal.
It is so ordered.
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