Sinclair v. Levien and corporations' hidden contracts

Bob Thompson has an interesting discussion of the venerable Delaware decision of Sinclair v Levien, which happens to be one of my favorite cases in the corporation course. As Bob explains, the case apparently expanded the space for selfish action by controlling shareholders – that is, the intrinsic fairness review appropriate to self-interested decisions doesn't apply if the controlling shareholder isn't getting something at the expense of the minority. So in Sinclair a parent corporation avoided intrinsic fairness review of a decision to get dividends from a non-wholly-owned sub (Sinven) since the dividends went proportionately to controlling and minority holders.

Bob points out that the case neatly illustrates the fine distinctions courts make in judging corporate decision-making and how this translates into standards of review. So, in class, we can ask why intrinsic fairness applies here and not there, both regarding the various board decisions involved in Sinclair, and the cases that came after, which as Bob said ended up applying a more complex set of distinctions than Sinclair itself hinted at.

In addition to being enjoyable and insightful, Bob's article gives me a chance to let out a theory I've long had about this case: when you get outside the realm of fiduciary relationships (which as I've argued in Are Partners Fiduciaries? exist only where a party is exercising open-ended delegated discretion), the scope of permissible selfish conduct depends on the parties' contract.  Unfortunately, in corporate cases (unlike in partnership cases, as I've argued here), the contractual analysis is often obscured by fiduciary language.  The nifty thing about Sinclair is that the contract is the only way to explain the case.

Sinven was outside the fiduciary realm, and in the land of obligations among shareholders, each with the right to vote its interest selfishly.  The question is, what are the limits on this selfish behavior? 

The Sinven minority understood that Sinclair had subsidiaries in each of the many countries it was operating in, and that each would exploit the oil in its respective country. That was the implied contract that arose out of the deal. So as long as Sinclair wasn’t, in effect, giving an opportunity that arose within Sinven's territory to another sub, Sinclair met its contractual obligation. And that is exactly what the court held in Sinclair, after you boil away the fiduciary language.

But the really interesting aspect of the case is the claim that involves a contract for the purchase of oil by Sinclair's wholly owned subsidiary, International, from Sinven. Sinven claimed that International’s payments under this contract were late, and that International failed to buy all the crude it had contracted to buy.

The court applied the intrinsic fairness test to the subsidiary’s claim that this contract was breached. As the court held, “late payments were clearly breaches for which Sinven should have sought and received adequate damages.” This doesn't need much more analysis. The tricky part is that

[a]s to the quantities purchased, Sinclair argues that it purchased all the products produced by Sinven. This, however, does not satisfy the standard of intrinsic fairness. Sinclair has failed to prove that Sinven could not possibly have produced or some way have obtained the contract minimums. As such, Sinclair must account on this claim.

But why does intrinsic fairness apply to this claim? Bob says it’s because (footnotes omitted)

[t]his claim fit within the traditional self-dealing claim in which a conflicted director or shareholder was on both sides, but held a different proportion of the claims on each side so as to tilt its incentives. Thus in the International/Sinven contract in which Sinclair owned all of International and 97% of Sinven, Sinclair would receive 100 cents of every dollar directed toward International but only 97 cents of every dollar directed to Sinven. If it were negotiating on behalf of both, an outside observer would expect that Sinclair would prefer a contract favoring the side where it would receive 100% of the benefit.

Not so fast, as I note in questions following the case in my casebook (at p. 553). After all, in the claim to which the court applied the business judgment rule, Sinclair was accused of effectively allocating oil opportunities to other wholly-owned subs. So Sinven was left without any oil to sell International. Why not force the subsidiary to prove that it should have had oil to sell to International, just as it was forced to prove that Sinclair deprived it of an opportunity it was entitled to?

I don't I think the answer has anything to do with fiduciary duties.  Rather, the answer boils down to the contract.  As the court said, "[a]lthogh a parent need not bind itself by a contract with its dominated subsidiary, Sinclair chose to operate in this manner." There was an explicit contract to sell a certain amount of oil to International, and the court could simply point to that contract as an indication of the limits of Sinclair’s selfish behavior. But there was no such contract governing the other claim. In fact, as I noted above, the circumstances pointed in the opposite direction.

Once you’re outside of fiduciary land, as you are in Sinclair, parties in a commercial relationship can act selfishly to each other, governed by their contracts. Sometimes the contract is implied and not obvious. But the court should look hard for these contractual guideposts. The fog of fiduciary language often obscures the search. This is the basic lesson of Sinclair. 

Unfortunately, fiduciary analysis continued to cloud the post-Sinclair cases.  Instead of a single rule of "apply the contract," we have a zillion different fiduciary rules. Maybe the only way out of this is to chuck the corporation and all of its baggage.