United States: Maryland Appellate Courts To Hear Important Maryland Corporate Law Appeals

Last Updated: October 14 2016
Article by Scott R. Wilson and Tunji O. Williams

On Friday, October 7, 2016, the Court of Appeals of Maryland and the Maryland Court of Special Appeals will each hold oral argument in appeals with implications for Maryland corporations and their directors. In Oliveira v. Sugarman, No. 17 Sept. Term 2016, the Court of Appeals of Maryland will consider:

  1. Whether stockholders of a Maryland corporation may bring direct claims against a board of directors for alleged breaches of the duty of candor in a proxy statement and for alleged breaches of a stockholder-approved incentive stock plan?
  2. Whether a board of directors is entitled to the presumption of the business judgment rule contained in Section 2-405.1 of the Maryland General Corporation Law when responding to a stockholder demand without presenting evidence that the board acted independently, in good faith, and was reasonably informed as required by Boland v. Boland, 423 Md. 296 (2011)?

In Stisser v. SP Bancorp, Inc., No. 1790 Sept. Term 2015, the Maryland Court of Special Appeals will consider (among other things):

Are directors of a Maryland corporation subject to specific personal jurisdiction in Maryland for claims brought by or in the right of the corporation against the director?

Each of these cases could have significant ramifications for Maryland corporations and their directors.

Court of Appeals to Review Denial of Stockholder Demand

In February, we blogged that the Maryland Court of Special Appeals, in Oliveira v. Sugarman, 226 Md. App. 524 (2016), held that the rejection of a stockholder demand by a disinterested board of directors is entitled to the presumption of the statutory business judgment rule now codified in Section 2-405.1(g) of the Maryland General Corporation Law (formerly Section 2-405.1(e)). In reaching its decision, the Court of Special Appeals analyzed Boland, which concerned the applicable standard of review pertaining to decisions of a special litigation committee ("SLC"). In Boland, the Court of Appeals held that in order for the substantive conclusions of an SLC are entitled to judicial deference, the SLC must be independent, act in good faith, and make a reasonable investigation and principled factually supported conclusions. The Court further held that an SLC and corporate defendants are not entitled to a presumption as to those requirements. Consequently, where an SLC has resolved not to pursue a demand or to terminate existing derivative litigation, in order for that determination to result in the dismissal of derivative litigation, the SLC and the corporate defendants bear the initial burden with regard to independence, good faith, and the reasonableness of the investigation.

In Oliveira, the Court of Special Appeals considered whether the Boland standard – specifically the loss of the presumption as to independence, good faith and reasonable process– applies to a decision of a board of directors (comprised of a majority of disinterested directors) to refuse a stockholder demand or only to the decisions of an SLC (where the majority of the board of directors is interested or conflicted). The Court of Special Appeals held that an SLC is only necessary where the board as a whole lacks disinterestedness and independence. But where the board is otherwise able to establish a quorum of disinterested directors and act in response to a stockholder demand, the Boland standard has no application such that the court reviews the decision to reject a stockholder demand pursuant to the presumption contained in the statutory business judgment rule.

Somewhat conflated in the appellant-stockholder's briefing in Oliveira, however, are (1) the prior conduct of the board of directors that forms the substantive basis for the stockholder demand and resulting derivative claims, and (2) the decision of the board of directors to deny the stockholder demand. Without question, the actions of the board of directors with regard to item 1 are protected by the statutory business judgment rule. The issue presented in Oliveira is whether the decision of the board of directors to deny the stockholder demand and pursue the litigation at all (or take other remedial action) should be entitled to the same judicial deference following Boland. Stated otherwise, even if the Court of Appeals concludes that a denial of a stockholder demand by a board of directors should not be afforded the protection of the statutory business judgment rule, notwithstanding the plain language of Section 2-405.1 of the Maryland General Corporation Law, motions to dismiss will continue to serve as an important gatekeeping function as the underlying conduct and substantive decisions that form the basis for the derivative action will nevertheless be entitled to the protection of the statutory business judgment rule.

Do Stockholders Have Direct Claims for Breach of a Stockholder-Approved Long Term Incentive Plan?

A second issue presented in Oliveira, and the first issue that the appellant-stockholder chose to argue in its brief, concerns a species of litigation that has been popular in other jurisdictions: executive compensation litigation based upon alleged breaches of stockholder-approved equity incentive plans. In the lower courts, the appellant-stockholder argued that a breach of a corporation's long-term incentive plan, which stockholders approve at an annual meeting largely for tax reasons related to Section 162(m) of the Internal Revenue Code, results in a direct breach of contract claim in favor of each stockholder of the corporation or, alternatively, could be the basis for a direct tort claim against the board of directors under Shenker v. Laureate Education, Inc., 411 Md. 317 (2009). In Oliveira, the Court of Special Appeals rejected both of these arguments holding that such claims are quintessentially derivative under existing Maryland case law. The Court of Appeals will be called upon to revisit the distinction between direct and derivative litigation.

Impact of Amendments to Section 2-405.1 of the Maryland General Corporation Law

Interestingly, each of the issues presented in Oliveira will be argued on October 7, 2016 – six days after the effective date of recent amendments to Section 2-405.1. While the appellant relies heavily on Shenker and the common law duties outside of Section 2-405.1 owed directly to stockholders under Shenker, the amendments to the statute eliminate the distinction between managerial and non-managerial acts, resolve the surrounding confusion, and clarify that Section 2-405.1 is the sole source of a director's duties. As such, although the appellant-stockholder's arguments are largely divorced from Section 2-405.1, any future analysis of similar claims must start with the standard articulated in Section 2-405.1(c). Perhaps more importantly, if the Court of Appeals were to conclude that a direct action is appropriate under Section 2-405.1, any resulting litigation against a director will be subject to the statutory business judgment rule articulated in amended subsection (g). 

Court of Special Appeals to Consider Personal Jurisdiction of Maryland Directors

As we blogged in July 2015, in Gary W. Stisser v. SP Bancorp, Inc., Case No. 24-C-14-003610 (Balt. Cir. Ct. April 13, 2015) the Circuit Court for Baltimore City granted motions to dismiss in stockholder litigation (in part) for lack of personal jurisdiction over the director defendants. The Circuit Court held that service as a director of a Maryland corporation does not establish specific personal jurisdiction with regard to claims against the director brought by or in the right of the corporation. As previously discussed in our May 5, 2015 client alert, this holding appears contrary to an earlier interlocutory decision in Costa Brava Partnership III, L.P. v. Telos Corp., Case No. 24-C-05-009296 (Balt. Cir. Ct. March 30, 2006). For the Maryland appellate courts, this will be a matter of first impression.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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