WRONGFUL CORPORATE CASH DISTRIBUTIONS UNDER DELAWARE AND GEORGIA LAW. Donald A. Loft Morris, Manning & Martin, L.L.P.

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1 WRONGFUL CORPORATE CASH DISTRIBUTIONS UNDER DELAWARE AND GEORGIA LAW Donald A. Loft Morris, Manning & Martin, L.L.P. Atlanta, Georgia TABLE OF CONTENTS I. GENERAL DELAWARE PRINCIPLES APPLICABLE TO STOCK REPURCHASES AND DECLARATION AND PAYMENT OF DIVIDENDS. 1 A. A Summary of the Key Formula.. 1 B. Statutory Authority for Stock Repurchases and Payment of Dividends 2 C. Determination of Capital and Surplus.. 4 D. Liability of Directors for Wrongful Distributions. 5 II. PROCESS OF REVALUING ASSETS AND LIABILITIES.. 8 A. Introduction.. 8 B. The Valuation Processes Approved By the Courts in Klang and in Morris.. 9 C. Valuation Methodology.. 16 D. Valuation of Contingent Liabilities and Assets.. 20 E. Procedure to be Used By Independent Valuation Expert. 24 III. OTHER CAUSES OF ACTION. 24 A. Breach of Fiduciary Duties 24 B. Fraudulent Conveyance. 24 i

2 IV. WRONGFUL DISTRIBUTIONS UNDER GEORGIA LAW.. 26 ii

3 I. GENERAL DELAWARE PRINCIPLES APPLICABLE TO STOCK REPURCHASES AND DECLARATION AND PAYMENT OF DIVIDENDS The following summarizes key principles of applicable law and procedures under the General Corporation Law of the State of Delaware (the General Corporation Law ) in connection with distributions of cash by a corporation by means of a repurchase of stock or, alternatively, the declaration and payment of a dividend. A. A SUMMARY OF THE KEY FORMULA Title 8, sections 160 and 170 of the Delaware code allow a corporation to purchase its own stock or issue dividends, provided that such transactions do not result in an impairment of the corporation s capital. A transaction impairs capital if the amount of the distribution exceeds the amount of the corporation s surplus. Klang v. Smith s Food & Drug Centers, Inc., 702 A.2d 150, 153 (Del. 1997). Surplus is defined as the excess of net assets over the par value of the corporation s issued stock. Id.; Del. Code, tit. 8, 154. Net assets is further defined as the amount by which total assets exceed total liabilities. Id. Thus, the funds available for a lawful redemption or dividend are calculated as follows: funds available = total assets - total liabilities - par value of issued stock. If the amount calculated is less than the amount distributed, then the transaction is unlawful, and directors who willfully or negligently conducted the unlawful redemption are jointly and severally liable. Del. Code, tit. 8, 160,

4 B. STATUTORY AUTHORITY FOR STOCK REPURCHASES AND PAYMENT OF DIVIDENDS Section 160(a) of the General Corporation Law sets forth the general rules regarding a corporation s powers with respect to ownership of its stock. Section 160(a) provides in pertinent part as follows: Del. Code, tit. 8, 160(a). Every corporation may purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use and otherwise deal in and with its own shares; provided, however, that no corporation shall: (1) Purchase or redeem its own shares of capital stock for cash or other property when the capital of the corporation is impaired or when such purchase or redemption would cause any impairment of the capital of the corporation, except that a corporation may purchase or redeem out of capital any of its own shares which are entitled upon any distribution of its assets, whether by dividend or in liquidation, to a preference over another class or series of its stock, or, if no shares entitled to such a preference are outstanding, any of its own shares, if such shares will be retired upon their acquisition and the capital of the corporation reduced in accordance with Sections 243 and 244 of this title. Nothing in this subsection shall invalidate or otherwise affect a note, debenture or other obligation of a corporation given by it as consideration for its acquisition by purchase, redemption or exchange of its shares of stock if at the time such note, debenture or obligation was delivered by the corporation its capital was not then impaired or did not thereby become impaired; (2) Purchase, for more than the price at which they may then be redeemed, any of its shares which are redeemable at the option of the corporation; or (3) Redeem any of its shares unless their redemption is authorized by Section 151(b) of this title and then only in accordance with such Section and the certificate of incorporation. 2

5 Sections 170(a) and 173 of the General Corporation Law set forth the general rules regarding declaration and payment of dividends. Section 170(a) provides in pertinent part as follows: (a) The directors of every corporation, subject to any restrictions contained in its certificate of incorporation, may declare and pay dividends upon the shares of its capital stock... either (1) out of its surplus, as defined in and computed in accordance with sections 154 and 244 of this title, or (2) in the case there shall be no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Del. Code, tit. 8, 170(a). Section 173 provides that [n]o corporation shall pay dividends except in accordance with this chapter. Del. Code, tit. 8, 173. Thus, the funds generally available to a Delaware corporation for the repurchase of shares of its common stock is the amount of the surplus of the corporation. Del. Code, tit. 8, 160(a). The statute defines the term surplus in relation to the corporation s capital, as outlined below. Any purchase of common stock requiring more than the amount of surplus would result in an impairment of capital within the meaning of Section 160. In re Int l Radiator Co., 92 A. 255, 256 (Del. Ch. 1914). Similarly, dividends may be paid only out of surplus, as that term is defined in the General Corporation Law. In the event there is no surplus, dividends may be paid out of the net profits of the corporation for the fiscal year in which the dividend is declared and/or the immediately preceding fiscal year. Dividends may not be paid, however, out of net profits of the corporation if the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets is impaired. Del. Code, tit. 8, 170(a). 3

6 C. DETERMINATION OF CAPITAL AND SURPLUS The capital of a corporation is determined pursuant to Sections 154 and 244 of the General Corporation Law. Section 154 of the General Corporation Law generally defines capital as that portion of the consideration received by the corporation for the issued shares of its capital stock that the directors determine to be capital, but in no event less than the par value of the shares. Del. Code, tit. 8, 154. More specifically, Section 154 provides: If the board of directors shall not have determined (1) at the time of issue of any shares of the capital stock of the corporation issued for cash or (2) within 60 days after the issue of any shares of the capital stock of the corporation issued for property other than cash what part of the consideration for such shares shall be capital, the capital of the corporation in respect of such shares shall be an amount equal to the aggregate par value of such shares having a par value, plus the amount of the consideration for such shares without par value. Del. Code, tit. 8, 154. The capital of the corporation, as so determined, may be increased from time to time by the board of directors, Del. Code, tit. 8, 154, and the capital of the corporation may be reduced under the procedures set forth in Del. Code, tit. 8, 244. Thus, the capital of a corporation in respect of shares having par value is an amount equal to the aggregate par value of the outstanding shares having par value, plus such portion of the net assets of the corporation as the board of directors by resolution has directed to be contributed to the capital in respect of such shares, minus such amounts by which the board of directors by resolution has caused the capital in respect of such shares to be reduced in accordance with Del. Code, tit. 8, 244, but in no event 4

7 may the capital in respect of shares of stock having par value be less than the aggregate par value of the outstanding shares having par value. In turn, Section 154 provides that [t]he excess, if any, at any given time, of the net assets of the corporation over the amount so determined to be capital shall be surplus. Net assets means the amount by which total assets exceed total liabilities. Capital and surplus are not liabilities for this purpose. Del. Code, tit. 8, 154. As so determined, the surplus of a corporation is consequently an amount equal to the present fair value of the total assets of the corporation, minus the present fair value of the total liabilities of the corporation, minus the capital of the corporation (determined as described above). Id.; Klang v. Smith s Food & Drug Centers, Inc., C.A. No , 1997 WL , at *2 to *4 (Del. Ch. May 13, 1997), aff d, 702 A.2d 150 (Del. 1997); Morris v. Standard Gas & Electric Co., 63 A.2d 577 (Del. Ch. 1949); Farland v. Wills, C.A. No. 4888, 1975 WL 1960 (Del. Ch. Nov. 12, 1975). A line entry for paid-in capital on a corporation s balance sheet is not indicative of capital in addition to the total par value of the issued stock. Wright v. Heizer Corp., 503 F. Supp. 802, 810 (N.D. Ill. 1980). Rather, such a line entry is merely a descriptive accounting term and is not reflective of the corporation s capital for purposes of the redemption or dividend equation. Id. D. LIABILITY OF DIRECTORS FOR WRONGFUL DISTRIBUTIONS Section 174 of the General Corporation Law makes directors personally liable for their willful or negligent conduct in connection with the repurchase of stock or the payment of an unlawful dividend. The directors are liable to the corporation, and in the event of dissolution or insolvency, to its creditors, at any time within six years from the 5

8 date of the unlawful stock repurchase or the payment of the unlawful dividend, for the full amount of the payment. 1 However, Sections 141(e) and 172 of the General Corporation Law provide protection to directors who in good faith rely on the books of the corporation or on reports of officers or outside experts selected with reasonable care in determining whether there are sufficient funds legally available for a stock repurchase or payment of a dividend. Section 141(e) provides: A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of his duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation s officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation. Del. Code, tit. 8, 141(e). The principle set forth in Section 141(e) is restated with particular reference to stock repurchases and dividends in Section 172 of the General Corporation Law, as follows: A member of the board of directors, or a member of any committee designated by the board of directors, shall be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of its officers or employees, or committees of the board of directors, or by any other person as to matters the director 1 Liability for wrongful redemption can also attach to persons other than directors. Courts construing Delaware law have uniformly held that any shareholder who receives redemption proceeds with knowledge of the unlawful nature of the transaction is liable for repayment of those proceeds. See, e.g., PHP Liquidating LLC v. Robbins, 291 B.R. 592, 598 (D. Del. 2003); see also 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations and Business Organizations 5.32, at 5-77 (3d ed. 2005). 6

9 Del. Code, tit. 8, 172. reasonably believes are within such other person s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation, as to the value and amount of the assets, liabilities and/or net profits of the corporation or any other facts pertinent to the existence and amount of surplus or other funds from which dividends might properly be declared and paid, or with which the corporation s stock might properly be purchased or redeemed. Thus, directors are protected from liability for unlawful stock repurchases and wrongful declaration and payment of a dividend where they rely in good faith upon the books and records of the corporation, or rely in good faith upon the report of an independent expert selected with reasonable care, in determining whether there are sufficient funds legally available for such a stock repurchase or payment of a dividend. See also Klang. As noted by the Delaware Supreme Court in the context of a merger proposal in Smith v. Van Gorkom, 488 A.2d 858, 876 (Del. 1985), the advice of outside experts is not necessarily required in order for directors to exercise due care. The Court stated: [w]e do not imply that an outside valuation study is essential to support an informed business judgment; nor do we state that fairness opinions by independent investment bankers are required as a matter of law. Often insiders familiar with the business of a going concern are in a better position than are outsiders to gather relevant information; and under appropriate circumstances, such directors may be fully protected in relying in good faith upon valuation reports of their management. Id. 7

10 II. PROCESS OF REVALUING ASSETS AND LIABILITIES A. INTRODUCTION The board of directors of a Delaware corporation may determine that it is appropriate (solely for Delaware law purposes) to revalue assets and liabilities when it determines to repurchase capital stock or pay dividends. While the value of the net assets of a corporation is generally reflected on its books (based upon generally accepted accounting principles), the books do not necessarily reflect the current fair market values of the corporation as a going concern. Delaware courts have recognized this conflict and have permitted the directors of a corporation to revalue all of the assets and liabilities of the corporation, on the basis of acceptable data and by standards that the directors are entitled to believe reasonably reflect the present fair value of the assets and liabilities, for the purpose of determining the amount of surplus available for stock repurchases and dividend payments. The leading Delaware case discussing the process that should be applied by a board of directors in revaluing the assets and liabilities of the corporation is Morris v. Standard Gas & Electric Co., 63 A.2d 577 (Del. Ch. 1949). In Morris, the plaintiffstockholder challenged the declaration by the corporation of a dividend out of its net profits. The plaintiff claimed that the corporation s capital was less than the aggregate amount of capital represented by the issued and outstanding stock and, therefore, the corporation could not pay the dividend until the deficiency was repaired. See Del. Code, tit. 8, 170(a). The Court focused on the question of [w]hat legal standard will be applied in determining whether the directors have valued the corporate assets in a 8

11 manner deemed sufficient to comply with the requirements of Section 34(b)? 63 A.2d at In addition, in Klang, the plaintiff-stockholder challenged the validity of a stock repurchase, claiming that the stock repurchase impaired the corporation s capital and thereby violated Section 160. The plaintiff s claims, and therefore the relevant analysis, centered on the board s calculation of available surplus and the valuation methodology employed in making such calculation. B. THE VALUATION PROCESSES APPROVED BY THE COURTS IN KLANG AND IN MORRIS The Court s description in Morris of the valuation process used by the board of the defendant corporation in determining whether to pay the dividend 3 in question demonstrates a careful and thorough decision-making process: On December 7, 1948, the directors met, and reference was made to the possibility mentioned at the November 17, 1948 meeting that a dividend might be declared on the prior preference stock. The meeting was advised that an 2 Section 34(b) was the predecessor section to Del. Code, tit. 8, 170 governing payment of dividends by Delaware corporations. 3 Case law and commentaries discussing dividends pursuant to Del. Code, tit. 8, 170, 173 and 174 help to define the limitations on stock repurchases under Del. Code, tit. 8, 160, and vice versa. As one commentator has stated: [T]he power to purchase or redeem shares is co-extensive with the corporation s power to pay conventional dividends and is a function of the excess of the value of its net assets over its designated capital. The considerations which go into the determination of asset value for repurchase purposes are identical to those applicable to dividends and the board s duties and responsibilities are the same. Indeed, Section 174, which imposes liability upon directors for unlawful distributions to stockholders, equates Section 160 with Section 173, the dividend authorization provision. 9

12 application had been made to the [Securities and Exchange] Commission for authority to pay such dividend. The chairman advised the meeting that consideration had been given to the Delaware statute and that in order that the company might have evidence of its compliance with the Delaware statute, W.C. Gilman and Company, at his request, prepared an appraisal of the assets to determine whether in its judgment the assets less the liabilities exceeded $88,500,000--this figure is the approximate total of the aggregate capital represented by the $7, $6, and $4 preferred, plus the sum required to pay a quarterly dividend on the prior preference stock ($87,350, plus $749,609). It is not denied that W.C. Gilman and Company possesses expert competence in appraisal matters and is familiar with the defendant s assets by reason of having been engaged to study them for other purposes. The factual appraisal made by Gilman and Company and submitted to the meeting was necessarily somewhat general. This appraisal discussed the values of the various stocks owned by the defendant by reference to market value, past, present, and future earnings, percentage of stock owned and knowledge based on other studies and sources of information. The report concluded that the net assets of the defendant had a fair value substantially in excess of $88,500,000. The meeting also heard a report made by G. W. Knourek, Vice President and Treasurer of the defendant corporation. Mr. Knourek was eminently qualified both in education and experience to make such a valuation. His complete familiarity with the defendant s assets is clearly demonstrated. This report dated December 6, 1948, also discussed the value of the stocks and concluded that the fair value of the defendant s net assets substantially exceeded $88,500,000. In this report Mr. Knourek stated that in appraising the assets he gave consideration to market prices, capitalization of current dividends, capitalization of average earnings for the two years nine months ending September 30, 1948, appraisals made in 1943 in connection with the defendant s recapitalization, and the recent orders of the S.E.C. with respect to Louisville Gas and Electric Co. (Del.) and a sale of Oklahoma Gas and Electric Co. stock. The chairman made a statement to the meeting that he had examined the Gilman and Company report and the statement by Mr. Knourek, and that in his opinion a fair value of the net assets was in excess of $88,500,000. He explained to the meeting the methods he used in his study 10

13 and valuation. The chairman also stated that since this was the first time this matter had come before the board in many years, he had obtained opinions from two Delaware attorneys and one Chicago attorney as to whether a dividend might legally be declared under the Delaware statute. The opinion, which was read to the meeting, stated that based on the assumptions contained therein the company might legally pay the dividend under the Delaware law. The minutes recite that the board made numerous inquiries and discussed the asset value problem generally. A balance sheet of the company as of October 31, 1948, and a statement of its income for the twelve months ending that date were presented to the meeting. * * * The directors met on December 20, 1948, and... unanimously adopted a resolution providing for a dividend... out of the net profits of the defendant corporation... Morris, 63 A.2d at In sum, the board of the defendant corporation had three meetings to consider the dividend, during which they were provided with extensive information, including: (i) the financial records of the corporation; (ii) the report of an independent outside appraiser as to the value of the corporation s assets; (iii) the report of the Treasurer of the corporation as to his valuation of the corporation s assets; and (iv) three opinions of legal counsel stating that payment of the dividend was permissible under Delaware law. Based on this record, the Court found that the board of the defendant corporation took great care to obtain data on the point in issue, and exercised an informed judgment on the matter. The Court held that the statute permits... no one objective standard of value and that the directors must be given reasonable latitude in ascertaining value. Id. at 585. The Court also held that under the circumstances 11

14 presented it could not substitute either plaintiff s or its own opinion of value for that reached by the directors where there is charge of no fraud or bad faith. Id. at 585. Accord In re Amsted Indus., Inc. Litig., Cons. C.A. No. 8224, 1988 WL 92736, at *14 to *15 (Del. Ch. Aug. 24, 1988), aff d sub nom. Barkan v. Amsted Indus., Inc., 567 A.2d 1279 (Del. 1989). In Klang, Smith s Food & Drug Centers, Inc. ( SFD ) effected a series of transactions with The Yucaipa Companies ( Yucaipa ) whereby, inter alia, (i) a supermarket chain controlled by Yucaipa was merged into a wholly-owned subsidiary of SFD resulting in Yucaipa becoming a stockholder of SFD, and (ii) SFD commenced a tender offer for 50% of its outstanding shares of common stock. In connection with such transactions, the SFD board retained the services of a financial advisor. At the meeting at which the SFD board approved the stock repurchase, the financial advisor rendered a report to the SFD board as to the results of four separate tests, one of which was described by the Court as the Delaware Law Test. A summary of the report was provided to the directors prior to the meeting, and the Chief Financial Officer of SFD informed the Board that he had reviewed [the financial advisor s] report and that the results confirmed his own opinion that SFD s capital would not be impaired as a result of the transactions. Klang, 1997 WL at *4. The financial advisor thereafter rendered a formal written opinion on the date that the tender offer closed that immediately after and on a pro forma basis giving effect to the Transactions, the fair value and present fair saleable value of the Company s assets would exceed its total stated liabilities and identified contingent liabilities by at least the aggregate par value of its issued capital stock. Id. at *2. 12

15 The plaintiff attacked, inter alia, the calculations of the SFD board. Specifically, the plaintiff argued that the SFD board had improperly determined the amount of liabilities in its resolutions approving the repurchase by failing to include current liabilities. In addition, the plaintiff argued that even if the amount of liabilities set forth in the resolutions was correct, the SFD board had failed to use an acceptable method for revaluing SFD s assets. The Court of Chancery rejected the plaintiff s argument that use of goingconcern valuation methods are inappropriate in the context of asset valuation and calculation of available corporate surplus, and, relying upon Morris, rejected the notion that there is only one valuation standard. Id. at *4. The Court explained: Directors are not restricted in the way they value assets or liabilities as long as they fulfill their duty to evaluate the assets on the basis of acceptable data and by standards which they are entitled to believe reasonably reflect present values. Thus, the issue is not whether [the financial advisor s] method is expressly permitted under section 160, but whether SFD s directors based their revaluation on acceptable data and whether they were entitled to believe that [the financial advisor s] valuation of SFD s assets reasonably reflected SFD s values both before and after the repurchase. Id. (quoting Morris, 63 A.2d at 582). The Court acknowledged that mistakes may have been made in the board s translation of the financial advisor s report for the purpose of documenting in the board resolutions that the transactions did not impair SFD s capital. However, after noting the expertise of the financial advisor in the field, the confirmation of the financial advisor s analysis by the Chief Financial Officer of SFD and the opportunity of the SFD board to review the analysis, and after noting the relevant portions of Section 172 of the General Corporation Law, the Court found that 13

16 the plaintiff had failed to provide any evidence that the financial advisor s valuation was not data upon which the SFD board could rely. The Court concluded that there was no evidence that the repurchase impaired SFD s capital. The Delaware Supreme Court affirmed the decision of the Court of Chancery in Klang. In so affirming, the Delaware Supreme Court rejected plaintiff s argument that a corporation is bound by its balance sheet in calculating available surplus. Klang, 702 A.2d 150 (Del. 1997). Thus, the Court stated that it adhered to the principles of Morris and held that a corporation may revalue its assets and liabilities to show a surplus and thus conform to [Section 160]. Id. at 154. The Delaware Supreme Court also rejected plaintiff s claim that the revaluation methodology employed by SFD was inappropriate as a matter of law. In this connection, the Court noted that plaintiff did not fully understand the financial advisor s opinion. According to the Court, the opinion of the financial advisor, when properly analyzed, provided substantial evidence as to compliance with Section 160. Having failed to demonstrate bad faith or fraud and having failed to demonstrate that the SFD directors had failed to evaluate the assets on the basis of acceptable data or by standards which they were entitled to believe reasonably reflect present values, we defer to the board s determination of surplus, and hold that SFD s self-tender offer did not violate Del. Code, tit. 8, 160. Id. at 156. By way of contrast to Morris and Klang, in Farland v. Wills, C.A. No. 4888, 1975 WL 1960 (Del. Ch. Nov. 12, 1975), the Court criticized the board there involved for not having made a reasonable effort in valuing the assets of the corporation in connection with certain stock purchase arrangements. In invalidating the challenged stock 14

17 purchases, the Court cited Del. Code, tit. 8, 160, which forbids a corporation from purchasing its own capital stock when the capital of the corporation is impaired or when such [purchase] would cause any impairment of the capital of the corporation and, following the decision in Morris, held that even though the directors were not required to make a formal appraisal, they did have a duty to evaluate the assets and liabilities of the corporation on the basis of acceptable data by standards that they are entitled to believe reasonably reflect present values. Id. at *6. The Court found that the directors of the defendant company had made no effort in this regard. The purpose of the limitations on the sources of funds for effecting valid stock repurchases contained in Section 160 and permissible dividends contained in Section 170 are to protect creditors (and in some cases stockholders as well) from fraud. See, e.g., Klang, 702 A.2d at 154; Pasotti v. United States Guardian Corp., 156 A. 255, 257 (Del. Ch. 1931); In re Int l Radiator Co., 92 A. 255 (Del. Ch. 1914). Therefore, it appears that the reference to value in Morris must be read as a reference to fair market value of assets and liabilities because it is only fair market value that represents a potential fund from which creditors claims may be satisfied. See also Klang, 702 A.2d at 154. Fair market value has been defined by the Delaware courts as the price that would be agreed upon by a willing seller and a willing buyer under usual and ordinary circumstances, after consideration of all available uses and purposes, without any compulsion upon the seller to sell or upon the buyer to buy. See Poole v. N. V. Deli Maatschappij, 243 A.2d 67 (Del. 1968). Thus, before stock is repurchased or a dividend is paid, a board of directors must determine whether there are sufficient funds legally available for such repurchase or 15

18 payment. In making this determination, the board may rely on the books of the corporation if such reliance is in good faith. The board may also determine that the books of the corporation do not accurately reflect the value of the corporation s assets and liabilities, and revalue them. If the board determines that revaluation is appropriate, it must take into account all relevant information, which includes valuing all assets and liabilities. Though it is not required, a board should retain an independent outside expert to assist in valuing the assets and liabilities. Any such revaluation must be based on the fair market values of the assets and liabilities of the corporation as determined in the good faith exercise of the board s business judgment after reasonable investigation. C. VALUATION METHODOLOGY Delaware courts have recognized that questions of how particular assets should be valued in this context are among the most difficult posed under the General Corporation Law. As the Court noted in Morris: Morris, 63 A.2d at 581. The problem is one of valuation which is surpassed in difficulty only in the domestic relations law. The numerous and varied standards applied in the legal, accounting and business fields have mapped a wavering course for one required to resolve a substantial problem of valuation. As set forth above, the Morris court held that directors have a duty to evaluate the assets on the basis of acceptable data and by standards which they are entitled to believe reasonably reflect present values. Id. at 582. The courts have provided few 16

19 specific guidelines on what factors or methods a board of directors should consider in performing such valuations. Rather, it has been noted that: It is not practical to attempt to lay down a rigid rule as to what constitutes proper evidence of value for the consideration of directors in declaring a dividend under Section 34(b). The factors considered and the emphasis given will depend upon the case presented. Id. Similarly, the Delaware Supreme Court in Klang stated that: Klang, 702 A.2d at 152. Corporations may revalue assets to show surplus, but perfection in that process is not required. Directors have reasonable latitude to depart from the balance sheet to calculate surplus, so long as they evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud. Nonetheless, the question of the proper method for valuing assets in considering the net assets available for dividend payment purposes was directly considered by the court in the Morris case. There, the defendant corporation was a public utility holding company whose assets consisted of ownership of various stock interests in public utility companies. The plaintiff in Morris challenged the result of the valuation process employed by the defendant corporation. Among other things, the plaintiff challenged the defendant corporation s valuation on the ground that nothing short of an actual appraisal of the assets in the underlying companies whose stock was owned by the defendant would be sufficient to comply with the directors statutory duty to value the assets of the corporation prior to paying a dividend. 63 A.2d at 581. Although the analysis in Morris focused primarily on the valuation of the stock that the holding 17

20 company held as assets, it appears that the broad principles enunciated by the Morris court are similarly applicable in the context of valuing assets other than stock of other corporations. Under Morris, for purposes of valuing the assets of a corporation, a board of directors is permitted to value the shares of capital stock of each of its subsidiaries, if any, based on going-concern value without engaging in a formal appraisal of the subsidiaries underlying assets. Similarly, to the extent that the corporation s assets consist of plants, equipment or divisions and such assets could be sold in business units as a whole, it appears a Delaware court would find appropriate a methodology which would value such assets as if they were sold on a going-concern basis (i.e., as if a particular plant or unconsolidated division were sold as a whole to a third party). See Klang at *2 to *4. Implicit in such analysis is the recognition that corporate assets such as a division or particular business unit may be sold at a price in excess of the break-up value of the assets of such division or business unit. On the other hand, to the extent that the assets of the corporation or its subsidiaries are not susceptible of being sold on a going-concern basis, such assets should be valued on an individual basis to determine the amount which could be realized if the corporation were required to sell such assets in order to satisfy creditors. Under the circumstances present in Morris, the Court held that no such valuation of the individual assets of the underlying companies was required: If by an appraisal plaintiff means that all the assets had to be viewed and evaluated separately by the directors or experts in a manner similar to a valuation for purposes of a reorganization of the type currently popular at least in the utility field, then I conclude that the statute imposes no such 18

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