Smith’s Food & Drug Centers, Inc. (SFD), is a Delaware corporation that owns and operates a chain of supermarkets in the southwestern United States. Jeffrey P. Smith, SFD’s chief executive officer,...

Smith’s Food & Drug Centers, Inc. (SFD), is a Delaware corporation that owns and operates a chain of supermarkets in the southwestern United States. Jeffrey P. Smith, SFD’s chief executive officer, and his family hold common and preferred stock constituting 62.1 percent voting control of SFD. On January 29, SFD entered into a merger agreement with the Yucaipa Companies that would involve a recapitalization of SFD and the repurchase by SFD of up to 50 percent of its common stock. SFD was also to repurchase 3 million shares of preferred stock from Jeffrey Smith and his family. In an April 25 proxy statement, the SFD board released a pro forma balance sheet showing that the merger and self-tender offer would result in a deficit to surplus on SFD’s books of more than $100 million. SFD hired the investment firm of Houlihan Lokey Howard & Zukin (Houlihan) to examine the transactions, and it rendered a favorable solvency opinion based on a revaluation of corporate assets. On May 17, in reliance on the Houlihan opinion, SFD’s board of directors determined that there existed sufficient surplus to consummate the transactions. On May 23, SFD’s stockholders voted to approve the transactions, which closed on that day. The self-tender offer was oversubscribed, so SFD repurchased fully 50 percent of its shares at the offering price of $36.00 per share. A group of shareholders challenged the transaction alleging that the corporation’s repurchase of shares violated the statutory prohibition against the impairment of capital.

They argued that

a. the negative net worth that appeared on SFD’s books following the repurchase constitutes conclusive evidence of

capital impairment and

b. the SFD board was not entitled to rely on a solvency opinion based on a revaluation of corporate assets.

Explain who should prevail.