In re Biglari Holdings, Inc. S'holder Derivative Litig. (Taylor v. Biglari): Court Affirms Dismissal of Shareholder Derivative Suit
In In re Biglari Holding, 813 F.3d 648 (7th Cir. 2016), the United States Court of Appeals for the Seventh Circuit affirmed the lower court’s dismissal of a shareholder derivative suit brought by shareholders Chad Taylor and Edward Donahue (the “Plaintiffs”) against Biglari Holdings, Inc. (“Biglari Holdings”) CEO and board chairman Sardar Biglari (“CEO”) and four other members of the Biglari Holdings board (collectively, the “Defendants”).
According to the complaint, the board of Biglari Holdings approved three separate transactions in 2013, including the sale of Biglari Capital Corporation (“BCC”) back to the CEO at “a low price” and a stock offering valued at $75 million. In the case of the stock offering, the Plaintiff alleged that the company had not retained a “financial advisor.” In addition, the board approved a licensing agreement to use the CEO’s name and likeness for the purposes of promoting Biglari Holdings to consumers. A term in the licensing agreement required the company
to pay [the CEO] 2.5 percent of the company's gross revenues from products and services that bear [the CEO’s] name as royalties for the use of his name and likeness for five years if he's removed as CEO, resigns because of an involuntary termination event, or loses his sole authority over capital allocation, or a majority of the board is replaced, or someone other than [the CEO] or the company's existing shareholders obtains more than 50 percent of the shares and therefore acquires control of the company.
The Plaintiffs alleged these transactions amounted to entrenchment, and were “intended to cement Biglari’s control” of Biglari Holdings and “enrich him at the expense of other shareholders.” The Plaintiffs contended that the board was not independent and its members were beholden to the CEO. Specifically, the Plaintiffs alleged the independence of the Biglari Holdings board had been compromised by the personal and business connections of several individual directors to the CEO. The Plaintiffs further argued such a costly royalty payment attached to the licensing agreement, triggered by replacement of the board or the CEO, amounted to entrenchment of the current board. Finally, the Plaintiffs alleged the board failed to adequately deliberate before the stock offering or consider the entrenching effects of such an offering.
Traditionally in a shareholder derivative action, shareholders must demand that “the board either correct the improprieties alleged or initiate an action on behalf of the corporation against members of the board.” The Plaintiffs instead asserted “demand futility.” Under Indiana law – following guidance from Delaware in such cases –“demand futility” can be shown by facts that create a reasonable doubt that a majority of directors was disinterested, that the board was independent, or that the board had exercised reasonable business judgment. Additionally under Indiana law, there is a strong presumption a director is not liable for any action taken unless the alleged breach or failure to perform constitutes willful misconduct or recklessness.
With respect to the entrenchment claim arising from the licensing agreement, the opinion pointed to the lower court’s conclusion that Plaintiffs had not “alleged that any of the directors were in peril of being removed from the board and, if they were not, it is unlikely that their motivation for approving the challenged transactions was entrenchment.”
With regard to director independence, the court found the facts surrounding the connections between the CEO and other members of the board were insufficient to raise reasonable doubts regarding the independence of the board. The court conceded that the director who had been the CEO’s professor could “raise a question” about independence but that the allegations concerning the other four directors were insufficient. The court, however, rejected claims of non-independence for a director who served on the board of a company that the CEO tried to take over and director who, because of the fees received, would “kowtow” to the CEO. The same was true of a director who served on a board of a company that was 12.8% owned by Biglari Holdings and had allegedly developed business relationships with the CEO prior to becoming a director.
The court also determined that the three transactions challenged by Plaintiffs did not adequately establish a claim for entrenchment. With respect to the licensing agreement, the court questioned the allegations that the replacement of the board would “trigger costly royalty obligations.” See Id. (“Thus the net earnings figure does not reveal the true financial health of the company, and so the required royalty need not have the grave impact that the plaintiffs allege.”).
Concerning the sale of BCC, the court addressed the claim that the amount paid by the CEO was less than the value of the asset. The court determined that the $1.7 million sales figure was reasonable in light of the benefits to Biglari Holdings, including “a reduction in regulatory burdens related to investments and by avoiding potential conflicts of interest”. Finally, the court disagreed with the Plaintiffs’ claim regarding the stock offering, noting the offering contained an oversubscription feature, which allowed existing shareholders to purchase the shares not taken. The court found the CEO had simply exercised his right to buy more shares under the subscription feature, while other shareholders declined to do so, resulting in the change in ownership interests.
For the above reasons, court found none of the Plaintiffs’ allegations created a substantial doubt the transactions were a product of valid business judgment by an independent board. Accordingly, the court affirmed the lower court’s dismissal of the Plaintiffs’ complaint.
The primary materials for this case can be found on the DU Corporate Governance website.