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Delaware Supreme Court Rules That Directors Lack Standing to Bring Derivative Suits

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Schoon v. Smith, C.A. No. 554, 2006 (Del. Feb. 12, 2008).

In an important ruling, the Delaware Supreme Court upheld bedrock principles of Delaware corporate law and governance and rejected plaintiff’s argument that directors of Delaware corporations should have standing to bring derivative suits on behalf of companies upon whose boards they sit.

In Schoon, Plaintiff Richard Schoon was a director of Troy Corporation. He was elected to the Troy board by the Series B stockholder, Steel, which had the right to appoint one member to a five member board. Schoon himself owned no Troy shares but rather acted at the behest of Steel. Schoon brought derivative claims purportedly on behalf of Troy alleging breaches of fiduciary duty by his fellow board members.  Steel had also sought books and records pursuant to Section 220 of the Delaware General Corporation Law (“DGCL”).

The defendants moved to dismiss the case, arguing that Schoon lacked standing to assert such derivative claims. The Court of Chancery agreed and dismissed the action. The Court of Chancery relied upon well established precedent, albeit precedent that had never been tested at the Supreme Court level. Schoon appealed.

On appeal, the Supreme Court affirmed the Court of Chancery’s ruling that a director, qua director, has no standing to assert claims on behalf of a company. The Court discussed the equitable concept of derivative standing as it had originated in England as a means of preventing a “failure of justice” and ultimately concluded that granting derivative standing to directors was unnecessary given the ability of stockholders to pursue books and records demands.

Statutory restrictions to bringing derivative claims do exist generally in modern law and specifically in the DGCL to limit derivative suits. Section 327 and Court of Chancery Rule 23.1 require a derivative plaintiff to be a stockholder at the time of the wrong complained of and throughout the litigation. Unlike other Sections of the DGCL, such as Section 220 and Section 225, which expressly grant to directors the right to bring certain kinds of claims, the DGCL does not authorize directors to bring derivative claims.

This lack of statutory authorization is unsurprising. As the Supreme Court noted, a “bedrock statutory principle” is that the “business and affairs of every corporation … shall be managed by or under the direction of the board of directors.” The board acts as a collective body, with rules governing such matters as notice for, and quorums at, proper board meetings contained in the DGCL. Thus, the concept that a single director could, on his own volition, act on behalf of a company to bring a suit (or take any other action) without actual authority granted at a board meeting or through appropriate delegation from such a properly constituted board is contrary to Delaware law.

Plaintiff in Schoon, however, argued that director standing was necessary to protect shareholder rights and that the Supreme Court should, even in the absence of a legislative directive, grant directors standing on equitable grounds. Schoon argued for adoption of ALI Principles of Corporate Governance, which expressly provide for director standing. The Court rejected Schoon’s arguments. With minor exceptions, states have not adopted the ALI Principles and Delaware’s General Assembly had never seen fit to grant directors standing to bring derivative claims. Further, given the fact that stockholders have the right to bring derivative actions, and the right to seek books and records for information, there was no need to create a new category of equitable standing absent a complete failure of justice. As a practical matter, granting such standing would have created the possibility that directors would have a fiduciary obligation to file such derivative actions and, therefore, would have exposed directors to potential personal liability for any failure to bring such actions. The Supreme Court’s ruling thus closes an attempt to expand derivative standing and gives appropriate deference to the collective decision-making authority that is the responsibility of a board of directors under Delaware law.

**Posted by Michael A. Weidinger and Patricia R. Uhlenbrock.  Mr. Weidinger and Ms. Uhlenbrock are partners in the corporate and commercial litigation department of Morris James LLP.  They were counsel to the director defendants in the case discussed herein.**

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