Friday, February 1, 2013
Court of Appeal Clarifies Business Judgment Rule
By JACKIE FUCHS, Staff Writer
The board of directors of a dairy cooperative exceeded its authority when it instituted a supply management program that benefited some members to the detriment of others, the Fifth Appellate District Court of Appeal ruled yesterday.
A three-justice panel said that although the board acted within its discretionary authority when it decided to implement the program, the business judgment rule did not allow it to expand its discretionary authority and diminish the contractual rights and protections of the other parties.
Plaintiff John Scheenstra was a member of defendant California Dairies, Inc., a member-owned milk marketing and processing cooperative, whose purpose is to market members’ milk to best advantage. Its 18-member board of directors exercises its powers as set forth in Cal Dairies’ bylaws, which constitute the contract between the cooperatives and the members.
In the fall of 2007, the board began considering the need to reduce milk production by its members due to an increase in its members’ production and an industry-wide oversupply of milk.
Under the discretionary authority granted to the board under its bylaws, it instituted a program to restrict supply and keep deliveries within its capacity. Pursuant to the bylaws, the board assigned an internal production quota, or “base,” to each member and treated milk delivered in excess of that quota as having a lesser value.
Dairies who experienced hardship due to increasing production, including Scheenstra’s, were referred to a hardship committee, which the board established at its February 2008 meeting. The committee met for the first time in March 2008.
The committee recommended 11 dairies for an increase, but did not recommend one for Scheenstra.
During this period Scheenstra also met with the chief executive officer of Cal Dairies and offered to take his over-allocation milk elsewhere. The chief executive officer told him that he could not because the contract required him to deliver all of his milk to Cal Dairies, and said that if Scheenstra took any milk elsewhere there would be a penalty of 25 percent of the value of that milk owed to Cal Dairies.
Scheenstra also asked if he could take all of his milk elsewhere and was told that he could terminate the agreement only by notice before his member anniversary date, and the agreement would then continue until a year from that anniversary date.
Scheenstra gave such notice, but as a result of the supply management program, did not take his dairy up to the full designed capacity or proceed with a planned third milking. Nor did he replace his culls, which reduced his milking herd.
Despite these efforts, Scheenstra incurred penalties of $368,312.76 on the overproduction of milk delivered from April 2008 through May 2009.
After exhausting all available remedies with Cal Dairies, Scheenstra brought a lawsuit for breach of a written contract, breach of the covenant of good faith and fair dealing, and negligent misrepresentation.
Tulare Superior Court Judge Lloyd Hicks found that there was no misrepresentation, but concluded that Cal Dairies breached its contractual obligation to implement any supply management program equitably, uniformly, and based upon representative years of production.
He also ruled that the correct measure of damages was the difference between the money Scheenstra received under the improper formula, and what he would have received under a proper uniform, equitable plan.
On appeal, Cal Dairies challenged Hicks’ breach of contract determination, saying that the judge erred when he failed to apply the business judgment rule, which immunizes corporate directors from court intervention in those management decisions made by directors in good faith in what the directors believe is the organization‘s best interest.
Writing for the panel, Justice Donald R. Franson Jr. said that the management decision to establish the terms of a supply management program was subject to the terms of the contract between Scheenstra and Cal Dairies, and that the business judgment rule does not allow a board of directors to rewrite a contract to expand its own discretionary authority and diminish the contractual rights and protections given the other party.
The panel concluded that the supply management program adopted by Cal Dairies was neither fair nor uniform and, therefore, did not fall within the discretionary range of options available to the board of directors, because it did not equitably allocate base to the members to address the problem of oversupply.
Instead, it put some of its members in a better position than they would have been in if there had been no oversupply problem, and because it created benefits for some members to the detriment of others was not uniform.
The bylaws were, however, the panel said, ambiguous about what should be done when a member dairy does not have production from a representative period of years. Rather than assigning some members an internal production quota of zero because their dairies lack production over a representative period of years, Franson wrote, the proper resolution of the ambiguity was to make adjustments for such dairies
“Not being eligible for an internal production quota could be an economic death sentence for a dairy required to deliver all of its milk production to Cal Dairies,” Franson wrote. Hicks did not err, therefore, when he used raw data about production levels and rates of increase to make reasonable projections about future production levels, the justice said.
The panel went on to say that because Cal Dairies acted within the discretionary authority granted by the contract when it decided to implement a supply management program, the detriment proximately caused by Cal Dairies’ breach of contract was not the reduction in income resulting from the quota system, but the difference between what Cal Dairies paid Scheenstra under its quota system and what he would have been paid if Cal Dairies had assigned him a proper production quota that complied with the contract.
The justices concluded that Hicks’ award of damages complied with Civil Code Sec. 3358, which prohibited him from awarding Scheenstra a greater amount in damages for the breach of contract than he could have gained by Cal Dairies’ full performance of the contract. Thus, Franson wrote, Hicks did not err when he calculated damages based on the milk that actually was delivered to Cal Dairies by Scheenstra, rather than a hypothetical amount that he might have delivered.
Justices Rebecca A. Wiseman and Herbert Levy concurred in the opinion.
The case is Scheenstra v. California Dairies, Inc., 13 S.O.S. 495.
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