Supreme Court of Maryland Overrules Prior Distinction Between Director’s Managerial and Non-Managerial Duties and Reaffirms That the MGCL Is the “Sole Source” of Director Duties to the Corporation and Its Stockholders

4 min

In one of the most significant Maryland corporate law cases in several years, involving an inter-generational family contest between (a) a 28% stockholder and former director and employee (“Mekhaya”) and (b) the corporation and Mekhaya’s brother, a continuing director and employee, the Supreme Court of Maryland (renamed from the Court of Appeals of Maryland as of last year), in a well-reasoned opinion by Justice Gould, (1) rejected the unprecedented distinction of the Court of Appeals in Shenker v. Laureate Education, Inc., 411 Md. 317 (2009), between “managerial” and “non-managerial” duties of a board of directors of a Maryland corporation, (2) recognized Section 2-405.1 of the Maryland General Corporation Law (the “MGCL”) as the “sole source” of the duties of a director of a Maryland corporation to both the corporation and its stockholders, (3) held that (a) the acts of the directors in terminating Mekhaya at the same time the corporation was paying excessive compensation to other family members and withholding dividends and bonuses from Mekhaya were “illegal, fraudulent, or oppressive” under Section 3-413(b)(2), which provides a statutory basis for a stockholder to petition for dissolution, and (b) a court may impose appropriate equitable relief short of dissolution, (4) reiterated that a board may determine the amount of profits that should be reserved by the corporation and (5) applied the presumption of Section 2-405.1(g) (that a director’s act or omission has complied with the three-part standard of 2-405.1(c)) in the absence of “sufficient facts” to overcome the presumption.  Eastland Food Corp. v. Mekhaya, No. 37, SEPT. TERM, 2022, 2023 WL 5616313 (Md. Aug. 31, 2023).

In addition, the concurring opinion by Justice Booth, joined in by Chief Justice Fader, explicitly stated that (1) “application of the business judgment rule has been codified by the General Assembly in Section 2-405.1” and (2) further noted:  “In codifying the standard for director conduct, the General Assembly replaced the common law duties that had historically governed Maryland corporations”, citing (a) Section 8.30 of the Model Business Corporation Act (the Official Comment to which, when enacted, expressly disavowed the “fiduciary” characterization of director duties as potentially confusing with the law of trusts) and (b) the Maryland Corporation Law treatise.  Emphasizing the latter point regarding “fiduciary duties” of Maryland corporation directors, Justice Booth stated later in her opinion that there are “no fiduciary duties owed by a director of a Maryland corporation to the corporation or its stockholders other than the duties arising under the standard of conduct set forth in Section 2-405.1.”  These statutory duties, as set forth in Section 2-405.1(c), are “good faith”, reasonable belief that the director’s actions are “in the best interests of the corporation” and the care of an “ordinarily prudent person in a like position . . . under similar circumstances.”

The Supreme Court also observed the following noteworthy points:

First, in addressing the claim of stockholder “oppression”, the Court held that Mekhaya, who, at the request of his father, had left his prior employment to join Eastland – a family-owned business – with promises of employment, managerial responsibilities and ownership, had a “reasonable expectation . . . [1] that continued employment and managerial input as a director would go along with the stock ownership” and “[2] that he would receive his share of the distributable profits in accordance with his ownership percentage.”  The Court added that the suggestion of the Appellate Court of Maryland (the former Court of Special Appeals) that the MGCL does not foreclose “de facto dividends” was unnecessary to resolve the issue and nothing in the Supreme Court’s opinion or the Appellate Court’s opinion “should be interpreted as altering or creating exceptions to the statutory framework governing the authorization and payment of dividends by Maryland corporations.”

Second, the Court held that Mekhaya’s allegations that the directors breached their duties in connection with the payment of excess compensation, diversion of corporate funds for personal use and the taking of profits without paying Mekhaya his rightful share are derivative claims (as opposed to direct claims by Mekhaya) as the injury was sustained by Eastland, not Mekhaya personally.  Because Mekhaya did not sue derivatively (and therefore did not make demand upon the Eastland Board), the claim for breach of duties was dismissed.  The Court also noted that the business judgment presumption applies to the alleged action undertaken by the Eastland Board.  In her concurring opinion, Justice Booth correctly noted that the “plain text and statutory history of the 2016 amendments to Section 2-405.1 clearly reflect that the business judgment rule applies to direct stockholder claims.” 

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As always, our colleagues and we are available at any time to discuss these or other matters.

Jim Hanks
Hirsh Ament
Judah Rosenblatt