Franklin Mutual Reply to SEC Opposing Management's Exclusion of Shareholder Proposal

Grace K. Lee, Esquire
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

Re: Farmer Bros. Co. (the “Company”)
Shareholder proposal of Mutual Beacon Fund and Mutual Discovery Fund
Response to the Company’s September 12, 2003 letter

I am a member of the bar of the State of California and an officer of Franklin Mutual Advisers, LLC, the adviser of Mutual Beacon Fund and Mutual Discovery Fund (together, the “Funds”), each a series of Franklin Mutual Series Fund Inc. As you are aware, the Funds are shareholders of the Company who have submitted a proposal (the “Proposal”) to the Company for inclusion in the Company’s proxy statement and form of proxy for the Company’s 2003 Annual Meeting of Shareholders. Counsel for the Company has submitted a mini-treatise which mischaracterizes a straightforward exercise by shareholders of an explicit statutory right as an elaborate coercive mechanism which would force the Company to violate state law, its own charter, contractual obligations to its directors, and deceive its shareholders to boot. Implicit somewhere in Counsel’s manifesto must be the notion that the statute under which the Funds have submitted the Proposal is inherently flawed, because otherwise, any attempt by shareholders to exercise their right to determine whether directors’ conduct warranted Permissive Indemnification[1] would result in the havoc described in Counsel’s letter.

The reality is quite different. California Corporations Code §317(e) (the “Statute”) gives shareholders the non-exclusive right to determine whether directors’ conduct warrants the provision of Permissive Indemnification.[2] Far from contravening the Statute, the Proposal merely implements the Statute. The Proposal does not conflict with the Company’s Articles, Bylaws or anything else other than perhaps management’s belief that it alone has the prerogatives described in the Statute.

Counsel purports to establish four separate bases to exclude the Proposal. I will address each point in turn.

The Proposal is Illegal

First, the Company states that the Proposal would “cause the Company to not comply with the legally authorized process of permissive indemnification and would otherwise contravene California Corporations Code Section 317, and, therefore, cannot be implemented by the Company.” To put it in plain English, Counsel for the Company claims that the Proposal would be illegal. And why is it illegal?

Counsel opines that “any determination regarding the propriety of indemnification under CCC §317(e) must be made only after there is a pending or threatened claim giving rise to a claim for indemnification.” [their emphasis]. However, Counsel cites no cases which even remotely support its proposition. Nor does Counsel provide any helpful quotes from treatises, nor anything from applicable legislative history, nor even suggestions as to how the public policy underlying the Statute would be advanced by such an interpretation.

If Counsel’s “opinion” is true, the board would be powerless to deny indemnification to an officer caught red handed with his hands in the company till until after some prosecutor or plaintiff’s lawyer got around to bringing or threatening to bring a proceeding. What principle of corporate law suggests that CCC §317 was intended to tie the hands of the board or its shareholders until after a proceeding is threatened or begun?[3] Counsel’s “opinion” wrongly focuses on whether a “proceeding” exists or is threatened when the determination to be made by shareholders[4] under the Statute is based upon whether the directors have met the “applicable standards of conduct”, not on whether a “proceeding” exists.[5]

Counsel offers a second, and equally baseless, reason for asserting that the Proposal is illegal. Counsel accurately points out that CCC §317(e) provides four methods by which a corporation can authorize Permissive Indemnification:

However, Counsel states that “Nothing in CCC §313(e) [sic] suggests that failure to approve indemnification under one subsection would preclude indemnification under the other authorized means. Therefore, the Proposal improperly seeks to deny the ability of the Company to grant indemnification to the directors [by approval of the directors or by opinion of legal counsel].” Maybe nothing in CCC §317(e) does, but CCC §317(h) certainly does.

CCC §317(h) explicitly limits the ability of the Company to indemnify its agents (except for (i) Mandatory Indemnification where a director has been successful on the merits in defense of any proceeding, and (ii) Permissive Indemnification pursuant to a court order)

“… in any circumstances where it appears (1) That it would be inconsistent with a provision of the articles, bylaws, a resolution of the shareholders, or an agreement in effect at the time of the accrual of the alleged cause of action asserted in the proceeding in which the expenses were incurred or other amounts paid, which prohibits or otherwise limits indemnification.”

Therefore, there is nothing improper about the Proposal’s potential “to deny the ability of the Company to grant indemnification to the directors [by approval of the directors or by opinion of legal counsel]”. That’s the whole point of CCC §317(e)(3) and CCC §317(h)![6]

To put it most simply, contrary to Counsel’s “opinion” that the Proposal “contravenes” CCC §317, the Proposal is the only feasible way for shareholders of the Company to exercise the rights granted to them by CCC §317.[7]

The Proposal Denies Directors Their Powers, Conflicts with the Company’s Articles, Breaches Contracts, and Embody Vague and General Objectives

Counsel next opines that the Proposal is not a proper subject because “(a) it seeks to deny the directors of the Company the ability to determine the propriety of a director’s claim for indemnification as provided by statute, and (b) it conflicts with a provision in the Articles of Incorporation that is intended to indemnify directors in excess of indemnification otherwise permitted by Section 317.” The very statute which gives the directors the ability to determine the propriety of a claim for indemnification[8] also gives that same ability to the shareholders.[9] How can a shareholder determination explicitly granted to them by statute not be a proper subject for a shareholder vote? What other method would Counsel suggest as being an appropriate avenue by which shareholders could exercise their rights under CCC §317(e)(3)? If a proposal which merely presents for shareholder consideration the determination given to them under CCC §317(e)(3) is not a proper subject for a shareholder proposal, then the right afforded to shareholders by CCC §317(e)(3) would be a nullity.

Counsel’s assertion that the Proposal conflicts with the Company’s Articles of Incorporation is also patently incorrect. As Counsel concedes, the Articles do no more than allow indemnification to the fullest extent permissible under California law. And that law provides that shareholders can determine whether directors are eligible for Permissive Indemnification. Therefore, the Proposal, as an exercise in what California law allows shareholders, does not conflict with the Company’s Articles.[10]

Although not a part of Counsel’s formal opinion, Counsel also asserts that the Proposal would result in a breach of the contract by the Company to indemnify its directors. Although an actual contract between the Company and directors is not referred to by Counsel and one may question whether one exists at all,[11] Counsel’s assertion that the Proposal “makes no provision for mandatory indemnification when a director has successfully defended himself or herself” and “… the Proposal on its face purports to nullify the right of a director to bring a legal action to determine his or her right to indemnification ….” is ingenuous, misguided or delusional. The Proposal has no effect on the ability of directors to obtain indemnification upon successful defense on the merits, or to seek judicial approval of Permissive Indemnification. The Supporting Statement says so in plain English.[12] If the Proposal is passed, directors’ rights under Article VI of the Bylaws for mandatory indemnification and the right to bring legal action (with the Company bearing the burden of proof that indemnification is not proper) remain unchanged. Therefore, there is not even the palest argument that the Proposal constitutes a breach of whatever Counsel insists is equivalent to a contract.

Contrary to Counsel’s assertions that the Proposal is vague and would require the Company to make determinations under objectives which are too general, the determination of whether any proceedings against directors would come under the ambit of the Proposal would be fairly straightforward. If the allegations track the language in (a), (b) or (c) of the proposed Resolution, the directors would not be eligible for Permissive Indemnification prior to their obtaining the judicial approval described in CCC §317(e)(4).[13] Of course, the directors’ right to mandatory indemnification under CCC §317(d) would remain unchanged.

The Proposal is False and Misleading

Contrary to Counsel’s assertion, the Proposal does not contain an unsupported assertion of fact. Counsel loses sight of the fact that the Proposal is merely a Resolution which shareholders can either accept or reject. The Resolution does not purport to assert a fact – it offers an assertion with which shareholders can either agree or disagree. A resolution could be submitted that states that the “The Moon is made of green cheese” or that “Law firms charge way too much money for inane opinions”. It would be of no moment that neither of the statements contained in the resolution is necessarily true – shareholders would simply be free to accept or reject the resolutions.

As for the assertions that each of the statements in the Supporting Statement is false and misleading, we respectfully disagree. Most of the assertions that the statements are false arise from Counsel’s distorted or inaccurate interpretations of their meaning. As Counsel states,

“All of these misstatements result from Proponent’s failure to comprehend the fact that the Proposal cannot change the rules governing indemnification as provided by Section 317 of the California Corporations Code, the Articles of Incorporation and Bylaws and, therefore, the Proposal cannot achieve its intended result. Accordingly, the Proponents’ statements concerning the effect of the Proposal are false and misleading.”

The Proposal DOES NOT purport to change any of the rules governing indemnification, and in fact, merely seeks to allow shareholders of the Company to exercise one of the rights which those very rules provide to them. If the staff agrees that any of the statements are factually inaccurate, we would be happy to clarify, correct or modify them to eliminate such inaccuracy.

If you have any questions or require any other information, please do not hesitate to contact me via telephone (973.912.2152), fax (973.912.0646) or email (bradt@msfi.com).

[1] Permissive Indemnification is the authorization of indemnification PRIOR to a director being successful on the merits in defense of any proceeding. Mandatory Indemnification is the right to indemnification which the Company’s directors have AFTER being successful on the merits in defense of any proceeding.

As summarized below, California Corporations Code §317(e) provides four ways by which a California corporation can authorize Permissive Indemnification:
                a. Approval by a majority of a quorum of directors,
                b. Opinion by independent legal counsel,
                c. Approval of shareholders, or
                d. Court order

[2] CCC §317(e) states:

Except as provided in subdivision (d), any indemnification under this section shall be made by the corporation only if authorized in the specific case, upon a determination that indemnification of the agent is proper in the circumstances because the agent has met the applicable standard of conduct set forth in subdivision (b) or (c), by any of the following:

(1) A majority vote of a quorum consisting of directors who are not parties to such proceeding.

(2) If such a quorum of directors is not obtainable, by independent legal counsel in a written opinion.

(3) Approval of the shareholders (Section 153), with the shares owned by the person to be indemnified not being entitled to vote thereon.

(4) The court in which the proceeding is or was pending upon application made by the corporation or the agent or the attorney or other person rendering services in connection with the defense, whether or not the application by the agent, attorney or other person is opposed by the corporation.

[3] In fact, CCC §317(h) indicates otherwise, as it restricts the ability of the company to authorize Permissive Indemnification “… in any circumstances where it appears (1) That it would be inconsistent with … a resolution of the shareholders, or an agreement in effect at the time of the accrual of the alleged cause of action asserted in the proceeding in which the expenses were incurred or other amounts paid ….” [emphasis added].

[4] Or the board, independent legal counsel, or a court.

[5] Even if Counsel’s interpretation is correct, not one, but several “proceedings” (defined in CCC §317(a) as “… any threatened, pending or completed action or proceeding, whether civil, criminal, administrative or investigative” are currently pending which, among other things, alleges that one of the directors of the Company is abusing his position as a principal of the Company to further his own self-interest, exactly the behavior described in clause (c) of the Proposal. In the Matter of Roy E. Farmer I Children’s Trust, Case No. 8P079060, filed April 22, 2003 in Los Angeles Superior Court, and other similar petitions filed at the same time. In other words, Counsel’s “opinion” is based upon a flimsy premise, which is itself undercut by facts which Counsel has failed to acknowledge.

[6] As to Counsel’s complaints that the Proposal would take away directors’ rights to Mandatory Indemnification or Permissive Indemnification pursuant to a court order and would therefore be illegal, the Proposal’s Supporting Statement clearly states that directors would still have those two avenues to indemnification even if shareholders approved the Proposal.

[7] The staff should note that the cases referred to in Counsel’s letter all relate to purported attempts to limit Mandatory Indemnification (i.e., indemnification after a successful defense on the merits). In contrast, the Proposal only purports to exercise the explicit statutory right afforded to shareholders by CCC §317(e)(3) to make a Permissive Indemnification determination and does nothing to limit the directors’ ability to obtain Mandatory Indemnification or Permissive Indemnification upon a favorable court ruling.

[8] CCC §317(e)(1)

[9] CCC §317(e)(3)

[10] Counsel also throws in the notion that the Proposal somehow acts improperly on a retroactive basis. How this assertion squares with Counsel’s argument that the Proposal is also premature is beyond explanation. If, as Counsel argues, the Proposal cannot be considered until some future date when a proceeding is threatened or instituted, wouldn’t the retroactive impact be even greater at that point? Counsel can’t have it both ways.

[11] Counsel makes a cryptic reference that the contract in question “derives from the Bylaws”.

[12] The Supporting Statement says “Adopting this resolution will not be unfair to any director who can establish that he actually deserves indemnification. The directors will still have the right to be fully indemnified under CCC §317(d) if they succeed on the merits in defense of any claim, or under CCC §317(e)(4) if a court determines that the director met the applicable standards of conduct.”

[13] For example, the actions pending against one director referred to in footnote 5 above would, to the extent that it relates to conduct since July 2002, be covered by the Proposal, and that director would not be able to vote any shares for or against the Proposal.