California Court of Appeal Recognizes That Wide Discretion Granted to a Board of Directors Under the Business Judgment Rule May Be Tempered By a Corporation's Private Contractual Obligations to Its Shareholders/Members

by Sheppard Mullin Richter & Hampton LLP

In Scheenstra v. California Dairies, Inc., No. F062768, ___ Cal. Rptr. 3d ___, 2013 WL 363148 (Cal. App. 5th Dist. Jan. 30, 2013), the California Court of Appeal, Fifth District, affirmed the judgment of the California Superior Court, Tulare County, that the board of directors of defendant California Dairies, Inc. (“Cal Dairies”), a milk marketing and processing cooperative, had exceeded its discretion when it adopted a quota system that breached its contractual obligations to its members and exceed the grant of power in Cal Dairies’ Bylaws. This decision highlights that a board of director’s discretion under the business judgment rule may be limited by contractual obligations the corporation undertakes with the corporation’s shareholders/members.

Cal Dairies markets its members’ milk to the best advantage of its members. Upon joining Cal Diaries, a member agrees to be bound by the cooperative’s Bylaws as they exist and as they may be amended. The Bylaws thus constitute a contract between Cal Diaries and each of its members.

One such member was plaintiff John Scheenstra. Between 2002 and 2007, plaintiff began expanding his milk production capacity. In the fall of 2007, the board of directors of Cal Dairies began considering the need to reduce the milk production of its members due to anticipated overproduction. The board decided to exercise the discretionary authority granted in section 7.3 of Cal Dairies’ Bylaws to institute an internal production quota. Section 7.3 of the Bylaws obligates Cal Dairies to accept all of the milk of its members “subject to the right of the Board, in its discretion, upon written notice to the membership . . . to allocate equitably among the members on a uniform basis . . . the quantity . . . of milk to be received by the Association.” Cal Dairies adopted a system that set a production quota based upon average daily production numbers for 2007. At the time the board adopted the supply management program, it knew (1) there were member dairies with declining production and allocating a base using an annual average would provide those dairies with a base in excess of their actual production and such excess base would be a saleable asset; (2) there were a number of member dairies, including plaintiff’s, with increasing production; and (3) the base allocation would not account properly for dairies with increasing production.

After attempting (and failing) to obtain relief directly from the board by showing that the quota system was causing him extreme hardship, plaintiff filed a lawsuit for breach of a written contract, breach of the covenant of good faith and fair dealing, and negligent misrepresentation.

After a bench trial, the trial court dismissed each of plaintiff’s claims except for the claim for breach of contract. The trial court analyzed the terms of the Bylaws and concluded that Cal Dairies breached its contractual obligation to implement a supply management program equitably, uniformly and based upon representative years of production. With respect to damages, the trial court determined that the correct measure of damages was the difference between the amount plaintiff received under the improper formula, and the amount he would have received under a proper uniform, equitable plan.

Cal Dairies appealed, arguing that the trial court erred by failing to apply the business judgment rule and give deference to its board of directors’ choice of terms for the production quota system. The Court of Appeal rejected Cal Dairies’ argument. As a preliminary matter, it held that Cal Dairies, as a nonprofit cooperative association, was a membership corporation without capital stock. Accordingly, any deference given to its board of directors would be derived from the business judgment rule. (Even if Cal Dairies had been an unincorporated association, it still would have benefited from an analogous “judicial deference” rule. Like the business judgment rule, the “judicial deference” rule insulates from court interference management decisions made by directors loyally, with due care and in their good faith belief that the decisions are in the organization’s best interests.)

The application of the business judgment rule to the facts of this case, however, was not straightforward. The board decision at issue — establishing the terms of the production quota system — was subject to the terms of the contract between plaintiff and Cal Dairies. Thus, the board’s decision implicated both its management responsibilities and Cal Dairies’ contractual obligation to perform as agreed with plaintiff and the other member dairies. Here, the contract granted discretion to the Cal Dairies board on a matter involving business operations, but also limited that discretion by requiring the board to allocate milk quantities equitably among members on a uniform basis. In a situation where a contract grants a board limited discretion, the Court concluded, the board’s decision will not be afforded deference under the business judgment rule until after the court properly determines that the action of the board falls with the discretionary range of action authorized by the contract. Here, the Court of Appeal affirmed the judgment on the breach of contract claim in favor of plaintiff.

Scheenstra stands for the proposition that the business judgment rule will not protect board decisions in contravention of specific contractual obligations. To benefit from the deference granted by the business judgment rule, a board of directors must act within its authority and pursuant to its obligations to its shareholders/members.

For further information, please contact John Stigi at (310) 228-3717 or Alejandro E. Moreno at (619) 338-6664.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Sheppard Mullin Richter & Hampton LLP | Attorney Advertising

Written by:

Sheppard Mullin Richter & Hampton LLP

Sheppard Mullin Richter & Hampton LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.