Investors who make substantial investments often demand a seat on their company’s board of directors. That is a reasonable request as it permits the investor to have a representative on the board of directors with a voice in the management of the company. It is well-settled that directors elected by stockholders of a Delaware corporation owe fiduciary duties to the company and all its stockholders once they serve on the board. Thus, they may make decisions in the exercise of their fiduciary duty that are different than what is in the best interest of the designating investor. The Court of Chancery’s decision on Feb. 15 in Air Products and Chemicals Inc. v. Airgas Inc. reflects this issue.
Air Products had sought to acquire control of Airgas since October 2009. When Airgas rebuffed its inquiries, Air Products launched a hostile tender offer. One of the conditions of its tender offer was that Airgas lift its "poison pill." The poison pill made it prohibitively expensive for Air Products to proceed. Airgas refused to lift the pill on the ground that the Air Products offer was inadequate.
Frustrated by its inability to proceed with a tender offer, Air Products nominated three directors to the Airgas board. It stated that its nominees would be impartial in their evaluation of the Air Products tender offer, although they would be replacing Airgas directors who had voted to maintain the Airgas poison pill. Air Products succeeded and its three nominees were elected by the Airgas stockholders to the Airgas board.
Once they were on the board of Airgas, the Air Products designees obtained their own legal and financial advisers. Based in part on the advice of their advisers and on their own assessment of the business plans of Airgas, these Air Products-nominated directors determined that the Air Products offer was inadequate and voted with their colleagues to maintain the Airgas poison pill.
In so acting, these directors acted consistently with Delaware law. As stated in the 1987 Chancery Court decision Phillips v. Insituform of North America Inc., the "law demands of directors … fidelity to the corporation and all of its shareholders and does not recognize a special duty on the part of directors elected by a special class to the class electing them."
While the Airgas directors’ conflict arose in a highly publicized battle for control of a public company, issues also arise in privately held companies where investors often condition their investment on the receipt of preferred stock and board representation.
For example, in its 2009 decision In re Trados Incorporated Shareholder Litigation, the Court of Chancery sustained a complaint on behalf of a class of stockholders who complained that directors designated by preferred stockholders, constituting a majority of the board, had interests that diverged from the interests of the common stockholders in approving a sale transaction. This divergence arose because the preferred stockholders received a substantial portion of their liquidation preference from the sale, while common stockholders received nothing. The preferred stockholder designated directors also held interests in entities that held preferred stock of the selling company. Those relationships bore on the court’s decision to treat the preferred stock designees as having interests potentially different from, and in conflict with, the interests of the common stockholders. As a result of this finding, the court denied a motion to dismiss because the plaintiffs’ allegations were sufficient to rebut the presumption of the business judgment rule.
These cases teach that directors designated by particular stockholders or investors owe duties generally to the company and all of its stockholders. Where the interests of the investor and the company and its common stockholders potentially diverge, the directors cannot favor the interests of the investor over those of the company and its common stockholders.
Conflicts also are likely to arise over the use of confidential information supplied to the designated directors. Designating directors who owe their livelihood or materially benefit from relationships with the designating investor sharpens the likelihood of conflicts of interest. Companies, investors and directors and their counsel should consider carefully the implications of directors designated by particular stockholders serving on boards of Delaware corporations.