Posts in Directors

Court of Chancery Rejects Attack on Board Discretion to Retain Directors

City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc., C.A. 4473-VCN (September 28, 2009).

This is the first Delaware decision to deal with the so-called Pfizer policy on when directors may be retained despite a shareholder vote on dissatisfaction. Axcelis had a bylaw that any director up for re-election who did not get a majority of the votes cast must tender her resignation to a committee of the whole Board, and that committee had the discretion to accept or reject the resignation. When three directors did not get the majority vote and tendered their resignations, the committee rejected the resignations and the directors stayed on the Board. The plaintiff then filed a books and records case to discover why.

The Court held that under the company policy the committee had the discretion to reject the resignations. In the absence of even a minimal showing that the exercise of discretion was wrongful, the Court denied inspection into the committee's reasoning. That seems consistent with existing Delaware law. Otherwise, any stockholder who disliked a board decision might demand inspection of corporate records to fish for a basis to sue.

The implications of this opinion are that any committee who rejects a director resignation under a policy giving it broad discretion will have its decision upheld. Indeed, the decision is virtually unreviewable.

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Court of Chancery Interprets Confusing Indemnification Provision

David A. Stockman v. Heartland Industrial Partners, LP, C.A. 4227-VCS (July 14, 2009)

This is possibly the best decision to read to understand how to interpret the often confusing advancement and indemnification rights contained in limited partnership agreements. The discussion of the history of those rights under Delaware law is very useful as well.

There are three basic holdings that should be noted: (1) ambiguous agreements are to be construed against the entity, be it partnership or corporation, (2) acquittal of criminal charges puts the burden on the entity to show why any conditions to indemnification have not been meet (such as the lack of good faith, etc.) by the claimant, and (3) there is no need to wait until all proceedings against a director are concluded before he is entitled to indemnification for the proceedings that he won.

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Court of Chancery Limits Use of Interested Directors' Votes

Sutherland v. Sutherland, C.A. No. 2399-VCL (Del. Ch. March 23, 2009)

This decision is a good outline of the effect of Section 144 of the Delaware General Corporation Law ("DGCL") that permits transactions to be judged on their merits, even if they are with interested directors. After explaining that law, the Court went on to hold that a certificate of incorporation provision that permitted interested directors' votes to be used to invoke the business judgment rule would be in violation of the DGCL and, thus, invalid.

This is important, because it means that, at least in a Delaware corporation, there are limits on what exculpation can be provided to directors in a certificate of incorporation. The law may well be different in an LLC or LP, of course.

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Court of Chancery Reaffirms The Business Judgment Rule

In re Citigroup Inc. Shareholder Derivative Litig., C.A. 3338-CC (Del. Ch. Feb. 24, 2009)

 

After the recent decision in the AIG case denying a motion to dismiss a complaint, there was some concern that perhaps the Court of Chancery was loosening the pleading requirements to state a claim under the Caremark line of case law. Caremark, of course, suggested that directors might be liable for failing to properly supervise management even when the directors did not receive any personal benefit as a result.

 

In this latest decision, the Chancellor has put those fears to rest. He distinguished the AIG decision and strongly affirmed that the business judgment rule protects directors when they make business decisions, even those that involve risk to the entity.

 

Thus, it is important to read the AIG decision and this decision together to get a full picture of how the Court is reacting to the calls to assign blame in the current financial crisis.

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Court of Chancery Explains how To Infer Scienter

American International Group Consolidated Derivative Litigation, C.A. 769 (Del. Ch. Feb. 10, 2009)

 

The Court of Chancery is often faced with the difficult task of deciding when a complaint has enough factual allegations to survive a motion to dismiss, particularly when there is no self dealing by directors and the business judgment rule is raised as a defense. This detailed 102-page decision illustrates the thought process that the Court uses.

 

The basic question presented was whether the plaintiff, could at the pleading stage, state sufficient facts to show that the case should go forward. As is typical, the defendants argued that all the complaint really alleged is that they made some bad decisions or that others below them in the corporate entity were the parties at fault. The Court denied the motion to dismiss because there was enough in the complaint to warrant an inference that the defendants must have known of the corporate wrongdoing. The keys to this result were: (1) the defendants were in position to know of the wrongs that had been committed; (2) they had practiced tight control over the entity so that they generally were aware of all that was going on; and (3) the bad acts were massive in scale and unusual in nature so as to have been unlikely to have been done without the defendants' knowledge. More ›

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Court of Chancery Explains "Validly In Litigation"

In re: Affiliated Computer Services, Inc. Shareholders Litigation, C.A. 2821-VCL (Del. Ch. Feb. 6, 2009)

 

Determining when a derivative complaint should be dismissed becomes complicated when the composition of the board of directors changes. What board do you look to to determine if a demand must be made on the board before suit may proceed? You start by looking at the board that existed at the time the complaint was filed. If demand on that board was excused, then the case was "validly in litigation" and may proceed even if the board composition later changes to include a majority of disinterested directors.

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Supreme Court Clarifies Stockholder Ratification Law

Gantler v. Stephens, C.A. 132,2008 (Del. Jan. 27, 2009)

 

This is an important decision because it limits when stockholder approval of a transaction has the effect of ratifying director action. Moreover, it limits the effect of stockholder ratification by holding that the business judgment level of review still applies to the directors' action, rather than holding that ratification extinguishes any claim.

 

The ratification holding is that stockholder ratification only occurs when the stockholders approve a transaction that the directors are empowered to take without the approval of the stockholders. For example, because directors are able to issue stock without stockholder approval, the added approval of the stockholders would ratify their decision to sell stock. In contrast, because a merger already requires stockholder approval, the approval of the stockholders does not constitute "ratification" of the directors' decision to recommend the merger. They approve it but do not "ratify" it. How is that for a distinction?

 

The rationale for this tightly reasoned result lies in the difference under Delaware law between complying with a controlling statute's requirements to carry out a transaction and having a good reason for doing the transaction in the first place. In other words, in Delaware just because you have the power to act (the stockholders voted for it) does not mean you should act (a decision that is measured by Delaware's law of fiduciary duty).

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Court of Chancery Approves Option Back Dating Case Settlement

Ryan v. Gifford, C.A. 2213-CC (Del. Ch. Jan. 2, 2009)

 

In this decision the Court approves the settlement of a stock option back dating case. The opinion carefully goes through all the analysis of when to approve a settlement, particularly when the recovery is adequate under the circumstances.

 

The attorney fee award of $9,000,000 or about $1,100 per hour shows that contrary to some beliefs, the Court is prepared to award significant fees for hard, excellent work that achieves a good result.

 

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The Delaware "Bad Faith" Dilemma: The Problem And A Possible Solution

Introduction
A recent Delaware Court of Chancery decision has generated much discussion over whether disinterested directors may be held liable for approving a transaction that appeared reasonable to them and their advisors. Indeed, by holding that the directors may have acted in “bad faith,” the decision seemed to some to be a threat to the core principles embodied in the business judgment rule. That rule protects directors from being second guessed by courts long after the business decision has been made. These concerns are overstated. This article will: (1) outline the background to the current controversy over “bad faith” in Delaware, (2) predict how the Delaware Supreme Court will clarify the Delaware law of “bad faith” and (3) suggest a possible solution to address lingering concerns over director liability for disinterested business decisions.

The “Problem”
For many years Delaware limited director liability for disinterested business decisions to those decisions properly held to be grossly negligent. This high standard seemed adequate to protect directors from inappropriate judicial second guessing. Then in 1985, Smith v. Van Gorkom held a board was grossly negligent. Many commentators felt Van Gorkom demonstrated the inability of courts to understand what should constitute gross negligence. The Delaware Legislature promptly responded to Van Gorkom by adopting Section 102(b)(7) of the Delaware General Corporation law. That new statute permitted Delaware corporations to include a provision in their certificate of incorporation that immunized directors for even grossly negligent decisions. Section 102(b)(7) has its exceptions, however. One of those is that actions “not in good faith” lose the statutory protection from liability.

As might be expected, if directors could not be successfully sued for actions “in good faith,” it was only a matter of time before plaintiffs filed claims alleging directors had acted in “bad faith”.

Bad Faith
Bad faith remained largely undefined until 2005. After much debate regarding whether good faith was an independent fiduciary duty and what exactly constitutes good (and bad) faith, Chancellor Chandler defined bad faith as an “intentional dereliction of duty, a conscious disregard for one’s responsibilities” and a “[d]eliberate indifference and inaction in the face of a duty to act.” The Delaware Supreme Court then set out three different categories of fiduciary behavior that might deserve the “bad faith pejorative label.” The first, fiduciary conduct motivated by an intent to do harm, was aptly labeled “subjective bad faith” The second category involves “fiduciary action taken solely by reason of gross negligence and without any malevolent intent,” a lack of due care. The court decided, however, that gross negligence without more does not constitute bad faith, and thus does not breach the duty of loyalty. The third category is the Chancellor’s definition of bad faith, as intentional dereliction of duty, a conscious disregard for one’s responsibilities. In Stone v. Ritter, the court further stated bad faith is a “fail[ure] to act in the face of a known duty to act, thereby demonstrating a conscious disregard for [one’s] responsibilities,” and thus not exculpated under § 102(b)(7). More ›

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Court of Chancery Upholds Director Decision Rejected by Stockholders

In re Lear Corp. S'holder Litig., C.A. 2778-VCS (Del. Ch. Sept. 2, 2008)

In this decision the court dismissed claims against directors whose decision to approve a merger was rejected by the stockholders and the company then had to pay a termination fee. The Court carefully explains why directors may sometimes be wrong, but without incurring any liability for that decision.

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Court of Chancery Defines Bad Faith, Again

McPadden v. Sidhu, C.A. 3310-CC (Del Ch. Aug. 29, 2008) 

This decision again affirms that bad faith is not the same a gross negligence and explains the difference. That distinction is important because usually directors are immunized from decisions made in good faith, even if negligent.

 

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Court of Chancery Answers its Critics of the Ryan Decision

Ryan v. Lyondell Chemical Company, C.A. 3176-VCN (Del Ch. Aug. 29, 2008)

The recent decision in this case denying summary judgment has set off a storm of protest that the Court of Chancery is ignoring the business judgment rule and the director exculpation statute. The critics argue that when directors are disinterested in a merger, have independent advice and secure a market premium, their decision cannot be reviewed. This more recent decision in the same case denying an application to take an appeal effectively answers those critics.

This opinion makes it clear that the Court knows very well that even gross negligence is not the same thing as bad faith. Thus, a board that is negligent cannot be held liable for a bad decision when its company has a director exculpation provision in its charter. The opinion carefully reviews the key precedents that discuss the limited circumstances where bad faith will exist, particularly when there is an "intentional dereliction of duty or a conscious disregard of one's responsibilities."

The key to the prior opinion, as the court’s opinion points out many times, is that it was based on a limited summary judgment record that required the court to accept all the allegations of the complaint and draw all reasonable inferences against the directors. Indeed, two even more recent decisions make it clear the Court of Chancery is upholding the business judgment rule and the statutory protection of directors who act in good faith. See McPaddin v. Sidhu, C.A. 3310-CC (Del. Ch. Aug. 29, 2008) and In re Lear Corporation Shareholders Litigation, C.A. 2728-VCS (Del. Ch. Sept. 2, 2008).

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Court of Chancery Denies Advancement for Litigation Instituted by a Director

Donohue v. Conning, C.A. 3733-VCS (Del. Ch. June 20,2008)

The Delaware Supreme Court has upheld a claim for fee advancement in litigation instituted by a former director, even though advancement has usually been thought of as a right to defense fees. This decision shows how limited that right may be when the advancement provision relied upon does not clearly provide for fees when the director starts the fight. For in such a case, the court held that there is no right to have fees advanced.

The decision has some unusual facts and may not cover another case were the director is clearly threatened with ligitaion and wins the race to the couthouse.

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District Court Denies Motion to Dismiss, Allows Duty of Care, Loyalty and Fraud Claims to Proceed

Ad Hoc Comm. of Equity Holders of Tectonic Network, Inc. v. Wolford, 2008 WL 212 7464 (D. Del. May 21, 2008)

The District Court recently allowed claims for breach of the duties of care and loyalty against former directors and officers of Tectonic Network, Inc. (the “Company”) to go forward, rejecting Defendants’ jurisdiction, standing and insufficient claim arguments. Plaintiff, an Ad Hoc Committee of Equity Holders in the Company, sued Defendants for purportedly improper conduct in connection with the acquisition of three businesses and the resulting sale of one of the Company’s subsidiaries. Plaintiff alleged that Defendant Officers (Officer #1 and Officer #2) committed fraud related to the Company’s actions, and all Defendants breached their fiduciary duties. Specifically, Plaintiff alleged that the Defendants breached their fiduciary duties in recommending and/or approving the acquisition of the three businesses, all of which Officer #1 had a majority interest in. Plaintiff also alleged that the Defendant Officers committed fraud in making material misrepresentations to the board regarding the profitability of the acquired businesses and the prospective profitability of a future business plan that resulted in the sale of the Company’s subsidiary. Subsequent to acquisitions and sales, the Company’s financial picture worsened, and it filed for voluntary Chapter 11 bankruptcy. The Bankruptcy Court lifted the stay to allow Plaintiff to press its claims outside of the bankruptcy proceedings. More ›

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District Court Finds That Participation in Delaware Merger Confers Jurisdiction, Denies Motion to Dismiss

G & G LLC v. White, 2008 WL 205150 (D. Del. Jan. 25, 2008)

In this opinion declining to dismiss for lack of personal jurisdiction, the District Court found that it had personal jurisdiction over both the directors/officers of a Delaware corporation and over a foreign corporation that invested in a Delaware corporation. Plaintiff was a Virginia limited liability company that loaned $2.5 million to a Utah corporation. Plaintiff was granted a security interest in the Utah corporation’s assets, and perfected that interest by filing the required financing statements in Utah. However, the Utah corporation subsequently was merged with and into a Delaware corporation. Plaintiff asserted that this was done at the insistence of various defendants that were seeking to invest in the Utah corporation after Plaintiff informed them that it would not agree to subordinate its security interest to theirs. Plaintiff posited that the investor defendants thereafter controlled the Utah corporation and the Delaware corporation it was merged into, and fraudulently concealed the merger to prevent Plaintiff from perfecting its security interest upon the merger, while at the same time perfecting their own in Delaware. Plaintiff pointed to numerous instances where the Utah corporation, the Delaware corporation, their counsel, the directors/officers of the Delaware corporation (who were appointed by the investor defendants), and the investor defendants failed to notify Plaintiff of the merger and/or made misrepresentations regarding the continuing status of the corporation as a Utah corporation. Taking the allegations as true, the Court found that the actions of the investor defendants and the directors they appointed was sufficient to confer specific jurisdiction over them.  More ›

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