Whitestone REIT v. Hartman

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT United States Court of Appeals

Fifth Circuit

FILED

October 26, 2007

No. 07-20315

Charles R. Fulbruge III

Clerk

WHITESTONE REIT, formerly known

as HARTMAN COMMERCIAL

PROPERTIES REIT,

Plaintiff - Appellee

v.

ALLEN R. HARTMAN; HARTMAN

MANAGEMENT LP,

Defendants - Appellants

Appeal from the United States District Court

for the Southern District of Texas

USDC 4:06-cv-03897

Before HIGGINBOTHAM, WIENER, and GARZA, Circuit Judges.

WIENER, Circuit Judge:*

The Board of Trustees (the “Board”) of a Maryland-established, Texas-

based Real Estate Investment Trust (the “REIT”) defensively revised the REIT’s

bylaws and opted in to the Maryland Unsolicited Takeover Act (the “MUTA”) —

collectively, the “defensive actions” — in anticipation of a takeover attempt by

Defendant-Appellant Allen R. Hartman, the REIT’s founder, former Chairman,

*

Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not

be published and is not precedent except under the limited circumstances set forth in 5TH CIR.

R. 47.5.4.

No. 07-20315

and former CEO. Disregarding these steps taken by the Board, Hartman filed

with the Securities & Exchange Commission (“SEC”) a consent solicitation

statement (“CSS”), seeking to remove those Trustees who had instigated his

ouster and to install a new slate of trustees for the REIT.1 The Board responded

by seeking to enjoin Hartman’s consent solicitation in federal district court.

Hartman counterclaimed with a request to enjoin the implementation of the

Board’s defensive actions. Concluding that the Board’s defensive actions were

taken properly, the district court granted the REIT an injunction against the

CSS and denied Hartman’s injunction against implementing the defensive

actions. Hartman now appeals the district court’s order granting a preliminary

injunction to the REIT.

Satisfied that the Board properly amended the bylaws and properly opted

in to provisions of the MUTA, we affirm. In so doing, however, we emphasize

that our holding is confined to the unique facts of this case, in which we are

bound by — and thus must interpret and apply — Maryland’s corporation and

REIT laws to a situation in which takeover efforts of the company’s founder and

former CEO are being opposed by Trustees originally nominated by him but

most recently nominated by the Board.

I. FACTS & PROCEEDINGS

Plaintiff-Appellant Whitestone REIT was formed originally as Hartman

Commercial Properties REIT. On October 2, 2006, the Board removed Hartman

as Chairman and CEO, citing a series of misdeeds, conflicts of interest, and

disclosure failures. When Hartman refused to relinquish control of the REIT,

the Board filed a claim of breach of fiduciary duty and contractual obligations

against Hartman in Texas state court. That court granted multiple injunctions

1

As used in this opinion, “trustee” and “director” are synonymous and interchangeable.

2

No. 07-20315

against Hartman, effectively forcing him to surrender control of the REIT.

Hartman resigned from the Board on October 27, 2006.

One month later, Hartman attempted to solicit the consent of a majority

of the REIT’s shareholders to remove the Trustees and replace them with his

own slate. In response to this challenge, the Board (1) amended the REIT’s

bylaws, repealing a provision that permitted shareholders to remove trustees by

majority written consent as an alternative to doing so in a duly called meeting

of shareholders; and (2) opted in to three provisions of the MUTA: (1) instituting

a classified or staggered board, (2) instituting a two-thirds voting requirement

for removal of a trustee, and (3) increasing from ten percent to a majority of all

votes entitled to be cast as the number of shareholder votes required to call a

special shareholders meeting (at which action could be taken for, inter alia, the

removal of a trustee). In essence, these moves changed the REIT’s rules for

replacing trustees, effectively foreclosing Hartman’s consent solicitation.

Hartman nevertheless persisted with his attempt to ensconce his own board,

even after the SEC rejected his initial CSS.

Subsequent to Hartman’s filing of his CSS with the SEC, the REIT filed

suit in federal district court, to enjoin Hartman from circulating his CSS.

Hartman filed a counterclaim against the REIT, seeking to have the Board’s

defensive actions invalidated. The trial court granted the REIT’s application for

preliminary injunctive relief, preventing Hartman from distributing his CSS.

The court also denied Hartman’s request for injunctive relief, ruling that the

Board properly (1) repealed the bylaws provision that permitted shareholders to

remove trustees by majority written consent, and (2) opted in to the MUTA

provisions described above. The district court stated that the Board’s opt-in was

protected by the business judgment rule, not to mention its being unreviewable

under the MUTA itself. This appeal followed.

II. ANALYSIS

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No. 07-20315

A. Standard of Review

We review de novo the legal questions presented on appeal relating to the

validity of the Board’s defensive actions, viz., repeal of the majority written

consent bylaw provision and opting in to the provisions of the MUTA.2 We

review the district court's grant of a preliminary injunction for abuse of

discretion.3 A court may grant a preliminary injunction when the movant shows:

(1) a substantial likelihood of success on the merits; (2) a substantial threat that

it will suffer irreparable injury absent the injunction; (3) the threatened injury

outweighs the harm that the injunction might cause defendant; and (4) the

injunction is not contrary to public policy.4

B. Repeal of Bylaw Amendments

The Board did not breach a duty to the REIT’s shareholders when it

repealed Article II, Section 13 of the REIT’s bylaws, a provision that permitted

shareholders to remove trustees by majority written consent. Even though the

REIT’s bylaw that gave the Board exclusive dominion over any and all

alterations or amendments to the bylaws is not conclusive per se, the fact that

the REIT was attempting to shield the shareholders from further harm at the

hands of an allegedly miscreant CEO does lead us to conclude that the Board

acted properly when it revised the REIT’s bylaws to eliminate the majority

written consent provision. Irrespective of whether Hartman or the REIT is

correct about the Board’s real motives for repealing the majority written consent

provision in the bylaws or about the standard the court should apply when

evaluating the propriety of the Board’s act, the Board did not breach any

2

United States v. Lynch, 114 F.3d 61, 63 (5th Cir. 1997).

3

Women's Medical Center of Northwest Houston v. Bell, 248 F.3d 411, 418-19 (5th Cir.

2001).

4

See, e.g., Lake Charles Diesel, Inc. v. General Motors Corp, 328 F.3d 192, 195-96 (5th

Cir. 2003).

4

No. 07-20315

fundamental duty to the shareholders when, as a means of protecting the

shareholders from Hartman, it eliminated the bylaw that permitted shareholder

action by majority written consent.

The exclusive power to amend the REIT’s bylaws is expressly delegated to

the Board. Article XIII of the REIT’s bylaws specifies that “[t]he Board of

Trustees shall have exclusive power to adopt, alter, or repeal any provision of

these Bylaws and to make new Bylaws.” As the REIT contends, in following this

express authorization, the Board was exercising its lawful power to amend the

bylaws. And, under the REIT’s properly amended bylaws, Hartman’s amended

consent solicitation to remove the directors was a nullity.

Our analysis cannot end here, however. Our review would be incomplete

if we were to approve plenary power for a board to amend a REIT’s bylaws

without any oversight based solely on the fact that these very bylaws contain a

catch-all clause like this REIT’s Article XIII. No bylaw may excuse a board’s

breach of a fundamental shareholder right or totally obviate a board’s duties to

its shareholders. Indeed, because most boards of directors or trustees have at

least some power to create or amend their own bylaws, including provisions like

Article XIII that give boards exclusive power over bylaws, no bylaw is entirely

sacrosanct. Article XIII cannot be interpreted to give the Board unlimited power

over all bylaws under all circumstances, as the REIT would have it. Even a

charter provision or bylaw that purports to vest a board with exclusive and

unrestricted power to amend and alter the bylaws cannot create an

unconditional, impenetrable shield for the directors or trustees.

Although we disagree with the REIT’s contention that Article XIII alone

immunizes the Board’s decision to repeal the majority written consent provision

of Article II, Section 13, we are satisfied that the Board’s repeal of this bylaw

was proper. The REIT explains that it repealed Article II, Section 13 solely to

eliminate an inconsistency between the bylaws and the REIT’s Declaration of

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No. 07-20315

Trust in the wake of a tender offer for the REIT from a competitor, and that its

decision to do so is protected by the lenient business judgment rule. Hartman

counters that the REIT’s explanation is a pretextual disguise of the truth that

the Trustees repealed the majority written consent provision to defend

themselves from his efforts to replace them. Hartman asserts that the Board’s

actions should be judged not by the business judgment rule but a higher

fiduciary standard, and that the Board breached a fiduciary duty to the

shareholders when it amended the REIT’s bylaws to prevent the shareholders

from acting by majority written consent as an alternative to voting at a duly

called meeting.

Regardless of the Board’s motive for eliminating the REIT’s majority

written consent provision, and regardless of whether that act is tested under the

business judgment rule or a stricter fiduciary duty standard, the Board clearly

acted in the best interest of the shareholders when it erected defensive barriers

to protect the REIT from Hartman. Thus, the Board could not have breached

any duty to the shareholders, no matter how reviewed. The Board’s defensive

actions under these circumstances would satisfy any standard by which boards

are judged. Hartman had allegedly done harm to the REIT during his tenure at

its helm. The Board did not disenfranchise the shareholders; rather, in a

legitimate effort to save the REIT from a ruinous sequel, the Board simply

eliminated one alternative method for shareholders to exercise their voting

rights. As repeal of the majority written consent provision was so obviously a

good faith attempt to protect the interests of the REIT and its shareholders, the

Board could not have violated any duty owed to the shareholders, regardless of

whether the Board’s act is tested under the business judgment rule or a stricter

fiduciary standard.

Hartman’s self-serving attempt to don a pro-shareholder white hat is

unconvincing. The Board’s repeal of the bylaws’ majority written consent

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No. 07-20315

provision was a legitimate exercise of the Board’s duty to protect the REIT and

its shareholders. Regardless of how the exact duty owed by the Board to the

REIT’s shareholders is defined, or what the actual motive for the Board’s repeal

of the majority written consent provision was, the Board breached no duty when

it amended the bylaws to protect the REIT from Hartman, with the obvious

purpose of advancing, not harming, the shareholders’ interests.

C. The MUTA Opt-In

Hartman advances two reasons why the REIT’s opt-in to the MUTA was

improper: (1) It did not meet the MUTA’s opt-in requirement of three

independent trustees; and (2) the REIT’s Declaration of Trust prohibits the

Board from opting in to the MUTA. We disagree with both assertions.

1. Independent Trustees

Before addressing Hartman’s two principal arguments regarding trustee

independence, we note preliminarily that, as with the Board’s decision to repeal

the majority written consent bylaw provision, it is of no consequence in this case

whether the business judgment rule or a stricter fiduciary standard applies to

the Board’s opt-in to the MUTA. The REIT contends, and the district court

agreed, that the business judgment rule applies to the Board’s decision to opt in

to the MUTA provisions. In contrast, Hartman insists that a stricter fiduciary

standard should apply. It matters not whether a stricter fiduciary standard or

the more lenient business judgment rule is applicable, because Maryland law

expressly dictates that a board member has no duty to shareholders to refrain

from opting in to the MUTA. Specifically, subsection (d) of section 2-405.1,

which is expressly incorporated into Maryland’s REIT statute, states: “The duty

of the directors of a corporation does not require them to: . . . refrain from

electing on behalf of the corporation to be subject to any or all of the provisions

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No. 07-20315

of Title 3, Subtitle 8 of this article [the MUTA].”5 Consequently, if opting in to

the MUTA was itself proper, then the Board could not have breached any duty

to the REIT’s shareholders by opting in.

We also note preliminarily that, contrary to the district court’s belief,

Maryland law does not prohibit judicial review of a board’s action to opt in to the

MUTA. True, courts are prohibited from reviewing a board’s substantive

decision to opt in to the MUTA; but courts may review whether the procedural

prerequisites for opting in are satisfied.6 Here then, the “method by which” the

Board opted in to the MUTA — the very question posed in the instant case — is

subject to judicial review.7 We now address whether the method employed by

the Board was proper.

First, the Board did meet the MUTA’s opt-in requirement for three

independent trustees. The MUTA mandates that, to opt in to the provisions of

the statute, an entity must have at least three independent directors “who, at

the time of any election are not officers or employees of the corporation; are not

acquiring persons; are not directors, officers, affiliates, or associates of an

acquiring person; and were not nominated or designated as directors by an

acquiring person.”8 We recognize that this statutory language could be twisted

abusively by boards of directors or trustees to immunize themselves from

shareholder influence and thereby improperly subvert shareholder interests. In

the context of the instant case, though, we read the language of the MUTA to

5

MD. CODE CORPS. & ASS’NS § 2-405.1(d).

6

Goldstein v. Lincoln National Convertible Securities Fund, Inc., 140 F.Supp.2d 424,

438 (E.D. Pa. 2001), vacated in part on other grounds, 2003 WL 1846095 (3rd. Cir. 2003).

7

Id.

8

MD. CODE CORPS. & ASS’NS § 3-802(b).

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No. 07-20315

require that at least three of the REIT’s Trustees be independent of Hartman at

the time that the REIT opted in to the MUTA.

Hartman makes two challenges to trustee independence. He first asserts

that two of the four Trustees do not qualify as independent directors under the

MUTA because, as a result of their status as limited partners in one of his

unrelated non-REIT partnerships, they were his “associates” and thus not

independent, as defined by the statute. Hartman is mistaken. The MUTA

precisely defines “associate” of an acquiring person, and the two Trustees of the

REIT singled out by Hartman do not meet this definition.9 The fact that these

two Trustees of the REIT were limited partners in an entity unrelated to the

REIT itself does not compromise their independence.

Meriting closer scrutiny, however, is Hartman’s second contention

concerning the independence of the REIT’s Trustees, viz., that, because he is

attempting to acquire the REIT, and he originally nominated three of the four

current Trustees to the Board, these three individuals do not qualify as

independent directors. Under the MUTA, board members who “were nominated

or designated as directors by an acquiring person”10 are not independent for opt-

in purposes. Hartman contends that, as he originally nominated three of the

REIT’s four Trustees, his current status as an acquiring person forever bars

these three individuals from being independent vis-à-vis him, i.e., “once

nominated, forever nominated.” But Hartman fails to recognize that the statute

9

Under the MUTA, "associate" means: “(1) Any corporation or organization (other than

the corporation or a subsidiary of the corporation) of which such person is an officer, director,

or partner or is, directly or indirectly, the beneficial owner of 10 percent or more of any class

of equity securities; (2) any trust or other estate in which such person has a substantial

beneficial interest or as to which such person serves as trustee or in a similar fiduciary

capacity; and (3) any relative or spouse of such person, or any relative of such spouse, who has

the same principal residence as such person or who is a director or officer of the corporation or

any of its affiliates.” Id. § 3-801(e).

10

Id. § 3-802(b) (emphasis added).

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No. 07-20315

considers a director’s status only “at the time of any election.”11 The three

Trustees were independent for purposes of the votes here at issue because,

before this election, they had been re-nominated by the Board, not by Hartman.

Their terms of office during which the vote was taken to amend the bylaws and

opt in to the MUTA were terms for which they had been nominated by the Board

itself. Under the instant circumstances, the only nomination that matters is the

most recent one. Any taint connected to an acquirer’s prior nomination of a

trustee evanesces with a subsequent nomination for re-election of the trustee by

a non-acquirer (e.g., the Board or a third party). The MUTA subparagraph at

issue reads “were not nominated or designated,” not “were never nominated or

designated.” The Maryland legislature could have used the latter phraseology

or something similar if it had intended to make the taint of nomination by one

party permanent. We thus follow the language enacted by, and what we judge

to be the intent of, the Maryland legislature, and hold that the three Trustees

in question were independent when the Board opted in to the MUTA.

It is obvious to us that, in this case, the Board was justly trying to protect

the REIT and its shareholders from a former CEO who had allegedly done

damage to the REIT. In more predictable fact patterns, our reading of the

MUTA language at issue could conceivably open the door for a potentially

acquiring person to stack a board with his own nominees, and then claim that

those same nominees later became independent because they were most recently

re-nominated by the very same stacked board. We are not unmindful, therefore,

that our interpretation of the MUTA could allow managers to perpetuate

incestuous, self-serving boards, thereby emasculating the intended protection of

shareholders. Today, however, we are bound by the plain language of the

statute: We leave to the legislature or courts of Maryland the task of revising

11

Id. § 3-802(b)(1).

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No. 07-20315

and clarifying this provision of the MUTA if either finds that our statutory

interpretation and application has missed the mark.

2. Prohibition in REIT’s Declaration of Trust

Hartman nevertheless contends in the alternative that the Board is

prohibited by the REIT’s Declaration of Trust from opting in to the MUTA. This

argument is without merit. The MUTA expressly authorizes a board,

“notwithstanding any contrary provision in their charter or bylaws,” to opt for

staggered boards,12 two-thirds voting requirement for the removal of trustees,13

and special meetings exclusively called by a majority of shareholders entitled to

cast votes.14 Even though the MUTA does state that “[t]he charter of a

corporation may contain a provision or the board of directors may adopt a

resolution that prohibits the corporation from electing to be subject to any or all

provisions of this subtitle” — and the REIT’s Declaration of Trust does expressly

prohibit any amendment to the bylaws that adversely affects the rights of

shareholders — the REIT’s general statement is not the sort of “provision” or

“resolution” that is contemplated by this provision of the MUTA. The statute

requires more than a mere general statement that might be interpreted to create

some sort of conflict with the MUTA. It requires a specific resolution that, in

effect, declares “no MUTA!” The REIT’s general proscription of any amendments

that adversely affect the rights of shareholders is not the type of specific opt-out

statement that is contemplated by the MUTA.15 This broadly stated truism is

12

Id. § 3-803(a)(1).

13

Id. § 3-804(a).

14

Id. § 3-805.

15

C.f. Sarofim v. Trust Company of the West, 440 F.3d 213, 220 & n. 10 (5th Cir. 2006)

("contractual language required to opt out of the FAA must be ‘clear and unambiguous'")

(citations omitted); Sweeney v. Savings First Mortgage., LLC, 879 A.2d 1037, 1042 (Md. 2005)

("Had it been the intent of the General Assembly to take advantage of the opt out, we believe

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No. 07-20315

therefore ineffectual to bar the REIT from opting in to the MUTA. The Board

properly invoked a staggered board, a two-thirds voting requirement for the

removal of trustees, and the MUTA provision requiring action by a majority of

shareholders entitled to vote to call a meeting of shareholders. In the absence

of a more specific provision or resolution, the MUTA expressly trumps such

provisions. Besides, in this instance, we perceive nothing in the MUTA

provisions adopted by the Board that adversely affects the rights of the REIT’s

shareholders — and, the general condition in the Declaration of Trust is

conditioned on creating an adverse effect.

III. CONCLUSION

Although we cannot agree with every aspect of the district court’s

reasoning, we do agree that the Board acted properly when it (1) repealed the

REIT’s bylaw provision that permitted shareholders to remove trustees by

majority written consent and (2) opted in to the MUTA. Our holding is confined

to the peculiar facts of this case and should not be seen as precedent for

managers to create incestuous boards and inoculate themselves from

shareholder influence. The MUTA should not be interpreted as a facilitating leg

in the “race to the bottom” for unqualified management protection and

entrenchment. If a different former CEO had been seeking to take over the

board of this REIT, or if the Board had not acted in the best interest of the

shareholders in protecting the REIT from an alleged malefactor, we might well

have been inclined to examine the questions before us in a different light.

Moreover, if our interpretation of the MUTA does violence to the intent of

Maryland’s elected representatives, we are comfortable in the knowledge that

the State’s legislature or its courts will set the matter straight. But, based on

the unique facts and statutory language before us, we cannot say that the

it would have acted to do so in explicit terms.").

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No. 07-20315

district court abused its discretion in granting a preliminary injunction to the

REIT. The judgment of the district court is, therefore,

AFFIRMED.

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No. 07-20315

EMILIO M. GARZA, Circuit Judge, specially concurring:

I join in the excellent opinion of the Court, with the exception of the dicta

in Section II.B. Article XIII of the bylaws of REIT (“Bylaws”) specifically

empowers the Board to “adopt, alter, or repeal any provision of these Bylaws. . .

.” Acting pursuant to this express delegation of authority in Article XIII, the

Board acted in good faith and in the best interests of the shareholders by

repealing Article II, Section 13 of the Bylaws to eliminate inconsistencies

between the Bylaws and the declaration of trust, and to protect REIT from

Hartman who had been removed from REIT after his misdeeds damaged the

trust. Because the Board’s action in this case was authorized by the Bylaws and

taken in good faith to advance the best interests of the shareholders, I would

leave to another day the question: under what circumstances a Board, acting

pursuant to the bylaws of its firm, may breach shareholder rights or obviate its

duties to the shareholders.

14