Swing and a miss: the Missouri Court of Appeals attempts to interpret Delaware corporation law.

• Author: Ferguson, David

HCI Investors, LLC v. Fox, 412 S.W.3d 424 (Mo. Ct. App. 2013).

1. INTRODUCTION

   The intricate details of obscure legal doctrines may sometimes veil the applicable law governing a dispute. In turn, this obscuration may sometimes lead to a court's misapplication of the relevant legal principles. The Missouri Court of Appeals for the Western District's decision in HCI Investors, LLC v. Fox seems to tit squarely within this camp. In attempting to resolve a dispute relating to the fiduciary duties of self-interested directors, the court declined to explicitly determine the applicable legal principle at play and then saw fit to fundamentally rework the ambiguous standard that it chose. (1) Unfortunately, the court's misapplication was not performed in a vacuum, and the precedential consequences of its decision could be substantial. (2)

   Traditionally, under Delaware corporation law, a corporate director could not successfully abdicate her fiduciary duty to make informed business decisions to other parties, including her attorney. (3) Although Delaware courts utilize two standards in analyzing corporate decisions made by directors and majority shareholders, neither of these standards condone this form of abdication. (4) Under the director-friendly business judgment rule, the Delaware Supreme Court has expressly forbidden this sort of behavior. (5) Further, under the more minority shareholder-friendly entire fairness standard, Delaware courts have likewise prohibited corporate directors from abdicating their responsibility to make informed business decisions. (6)

   However, in HCI Investors, the Missouri Court of Appeals for the Western District implicitly condoned the abdication of determination of financial terms by a self-interested corporate director to his attorney. (7) In analyzing a case that required the imputation of Kansas corporation law, which itself required an analysis of Delaware corporation law, the court found that a corporate director had not violated the entire fairness standard by leaving the terms of a complex debt-shifting scheme up to his attorney. (8) With this decision, the court signaled a substantial departure from the existing body of Delaware corporation law and the law of those states, like Missouri, that regard Delaware's corporation law as persuasive in the context of the duties of corporate fiduciaries under both the business judgment rule and entire fairness standard. (9)

   This Note examines the court's analysis in implicitly adopting this new interpretation of the duties of corporate fiduciaries under the entire fairness standard and argues that by essentially ignoring the dichotomy between the standards and misapplying the relevant case law, HCI Investors was improperly decided. Part II examines the background of the underlying transaction at issue in the case, the parties' arguments, the lower court's disposition, the appellants' arguments on appeal, and the appellate court's disposition. Part III gives some legal background for the issues at play, including the adoption of Delaware's corporation law by the Kansas courts generally and the application of the business judgment rule and the entire fairness standard more specifically. Part IV details the court's decision, specifically its innovative approach to corporate fiduciary duties and its failure to expressly choose an applicable standard of fiduciary duty. This Note concludes by determining that, when faced with arcane legal principles that may have obscured the dispute at issue, the court in HCI Investors ducked its responsibility to clearly delineate the tenets of its decision, and, in doing so, the court effected a fundamental alteration in the construction of the relevant fiduciary duties that may have immediate and lasting consequences.

2. FACTS AND HOLDING

   In January 2011, the appellants, the Fox Family, (10) were minority shareholders of Hillcrest Bancshares ("Bancshares"), a one-bank holding company ("Holding Company") incorporated in Kansas. (11) The shares of the Hillcrest Bank ("Bank") were almost entirely held by Bancshares. (12) Further, approximately 99.5% of the common stock of Bancshares was held by seven families: respondent Fingersh and his family owned 31.66%, respondent Blitt and his family owned 25.45%, the Copaken Family owned 10.32%, the White Family owned 10.51%, the Morgan/Dreiseszen Family owned 6.84%, and the Fox Family owned 14.71%. (13) Together, respondents Fingersh, Blitt, and their families held a majority of the outstanding stock with over 57%. (14)

   For decades, the Copaken, White, and Blitt families, in association with their long-time legal representative Fingersh, had engaged in a variety of real estate ventures and investment opportunities in conjunction with their Kansas City commercial real estate firm. (15) However, the Fox Family did not have the same historical investment relationship with the other families involved in the Bancshares corporation. (16) In fact, the Fox Family's business relationship with the other families was limited to its investments in Bancshares and two shopping malls. (17) Likewise, as minority shareholders of Bancshares, no member of the Fox Family served on its board of directors. (18) Moreover, in their limited role in the corporation, the Fox Family had "never received any cash or other benefit from the ownership interest in Bancshares" and had never been called upon to make additional cash contributions to any of the three investments in which they participated. (19)

   For the majority of its existence the Bank had been a solid investment. In fact, by all accounts, the Bank had been "thriving and profitable" for some time. (20) However, in the midst of the substantial downturn that affected the commercial real estate market in 2008, the Bank began to encounter difficulties similar to those faced across the county by other "financial institutions with outstanding real estate loans." (21) As the Bank's borrowers were increasingly unable to make payments on loans secured by real estate, the Bank's proportion of these nonperforming assets began to approach financially untenable levels. (22) Historically, the Bank had maintained nonperforming assets somewhere in the range of 1%. (23) However, with the increasing defaults the Bank was now encountering ratios of 5% to 7%. (24) Conscious of the potential for undesirable regulatory consequences of an impending FDIC examination in May 2008, the Bank's directors began moving toward a plan to divest the Bank of a portion of the unwanted nonperforming assets. (25)

   Because Fingersh and Blitt realized that the Bank's level of nonperforming assets were a serious issue that would need to be remedied before the Bank's pending examination, they began exploring potential options for reducing the Bank's rate of nonperforming assets below 5%. (26) Although Fingersh was not an official officer of the Bank, he had functioned as its "de facto CEO, sat on its board and loan committee and had," in his words, "'shepherded' the Bank for many years." (27) Continuing in the role of de facto CEO, Fingersh proposed a transaction (the "Transaction") in which he and Blitt would organize limited liability companies ("LLCs") that would purchase the nonperforming assets from the Bank and later sell them off in the market. (28)

   In a memorandum sent to all Bancshares shareholders on April 14, 2008, Fingersh explained that all Holding Company shareholders would be given the opportunity to participate in the Transaction by agreeing to become members of the LLCs. (29) However, membership came with substantial risks. (30) Fingersh proposed that the LLCs' members would be bound by the operating agreements to make capital calls to fund the LLCs' obligation and, further, that they would be required to personally guarantee the debt incurred by the LLCs to acquire the nonperforming assets. (31) Though Fingersh was confident that most of the families would voluntarily participate, (32) he intended to incentivize participation in the Transaction by providing a penalty for those who opted out. (33) According to Fingersh's plan, the Transaction involved issuing warrants to Bancshares' shareholders who agreed to participate "allowing them 'on a pro rata basis and without additional consideration, to acquire stock in the Holding Company equal to 25% of the stock owned by the nonparticipating shareholder.'" (34) The 25% figure was originally set by Fingersh at 20% on the advice of Richard Degen, chief financial officer of the Bank, and attorney Stan Johnston, who was a partner in the Lewis, Rice & Fingersh law firm once headed by Fingersh. (35) However, Fingersh decided to raise the rate by 5% following his conversation with Degen and Johnston. (36)

   The Fox Family was initially hesitant to participate in the Transaction. (37) However, after hearing Fingersh's representations regarding the likely losses to be incurred by the LLCs, (38) the terms of the loans to be taken out by the LLCs in purchasing the nonperforming assets, (39) and the individuals who would be placed in charge of collection efforts of the nonperforming assets by the LLCs, the Fox Family signed on to the Transaction. (40) In fact, all of Bancshares's shareholders except the Morgan and Dreiseszun Families agreed to participate in the Transaction following the presentation of the operating agreements for signature in June 2008. (41)

   Following execution of the operating agreements by the participating families, the LLCs successfully secured loans totaling approximately $28 million from two banks. (42) After combining these loans with the capital contributions made by the LLCs' members, the LLCs had over $40 million available to purchase nonperforming assets from the Bank. (43) However, as predicted, after purchasing these nonperforming assets the LLCs began making capital calls to fund the various costs of owning and marketing the nonperforming assets that they had acquired. (44) Although the...