On February 6, 2013, Chancellor Strine of the Delaware Chancery Court issued a bench ruling addressing the duty of independent directors of a Delaware corporation with significant operations or assets outside the United States. In re Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS (Del. Ch. Feb. 6, 2013). In a short but important bench ruling, Chancellor Strine refused to dismiss a breach of fiduciary duty claim against independent directors of a Delaware corporation who had failed to discover the unauthorized sale of assets located in China by the company’s chairman. Importantly, Chancellor Strine’s remarks implicated the duty of loyalty, which creates a risk of personal liability for directors and, potentially, the absence of corporate indemnification. While the facts in the case were somewhat extreme, the ruling in Puda Coal highlights the risks and challenges that may exist for directors of Delaware corporations with significant foreign assets or operations. Although Chancellor Strine recognized that each situation is undoubtedly dependent on its facts and will turn on the nature of the foreign operations, his ruling did include the following remarks:
Posts Tagged ‘Duty of loyalty’
This article concentrates on conflict of interest, secrecy and insider information of corporate directors in a functional and comparative way. The main concepts are loans and credit to directors, self-dealing, competition with the company, corporate opportunities, wrongful profiting from position and remuneration. Prevention techniques, remedies and enforcement are also in the focus. The main jurisdictions dealt with are the European Union, Austria, France, Germany, Switzerland and the UK, but references to other countries are made where appropriate.
In an October 1, 2012, ruling in Shocking Technologies, Inc. v. Michael, the Delaware Court of Chancery held that a dissident director breached his fiduciary duty of loyalty by sharing confidential information with a third party and trying to discourage that third party from investing in the company. The court’s post-trial ruling came in spite of the director’s claim that he acted in good faith and believed his actions would address certain governance disputes that he had with the other directors. The court observed that “fair debate” is an important issue in corporate governance, but there are clear limits on director conduct in trying to resolve disagreements. Among other things, the court’s decision serves as a reminder to stockholders who sit on boards or otherwise have board representation that directors’ duties run to all stockholders.
The decision involved a dissident director who was the sole board representative of two series of preferred stock. Over time, significant disagreements between the director and the other board members arose over executive compensation and whether there should be increased board representation for the preferred stock. The director argued that the company’s governance problems needed to be resolved before it could attract additional equity funding. The company alleged, however, that these disagreements were pretext for the director’s desire to increase his influence and control over the board at a time when the company faced financial difficulties.
A September 2011 Delaware Court of Chancery decision refused to dismiss claims alleging that a board of directors breached its fiduciary duty of loyalty in authorizing a sale of a corporation to a third party. The stockholder plaintiff alleged that the sale was motivated by the corporation’s former chairman and chief executive officer, who owned 37% of the corporation’s common stock and needed liquidity. The decision is significant for refusing to dismiss allegations of disloyal conduct against outside directors who were disinterested in the transaction and otherwise unaffiliated with the former CEO.
New Jersey Carpenters Pension Fund v. infoGROUP, Inc. involved the 2010 sale of infoGROUP, Inc., to a private equity fund. The stockholder-plaintiff alleged that the sale was motivated by the corporation’s former chairman and chief executive officer, who owned 37% of the company and “desperately needed liquidity” to fund a new venture and to satisfy $12 million in settlement obligations stemming from a Securities and Exchange Commission action and a derivative suit brought against him. The plaintiff claimed that the board of directors breached its fiduciary duties by capitulating to the former CEO’s pressure and approving a transaction that was not in the best interests of all shareholders.
The Program on Corporate Governance has recently issued as a discussion paper my piece, entitled Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling: Bad Appointments and Empty-Core Cycling at the Circus.
On the surface, the Ringling case appears to be an irrational spat over board seats by the heirs of a very successful enterprise. However, a closer inspection reveals that the investors were neither fighting over board seats nor were they irrational. Although Edith Ringling pushed her incompetent son and Aubrey Haley her inappropriate husband, they did so to their private advantage. Although the circus cycled from one management team to another, the investors always promoted the new teams for private gain.
I argue that the root of the Ringling dispute lay in the inability of the law to enforce duty-of-loyalty standards. When the law works as it should, fiduciary duties perform two functions: they remove the incentive to appoint corporate officials by kinship rather than ability, and prevent the empty core cycling that would otherwise plague so many close corporations. Here it performed neither. In the Ringling case, I argue that the various parties had incentives to defect in the next period regardless of the alliances they formed in the current period. When the law does not enforce a duty of loyalty, this allows cycling to occur. If the law gave each investor a return proportional to his or her interest in the firm, investor alliances would not cycle. Not only will investors not appoint inept kin, management will not cycle from alliance to alliance. The Ringling circus did not degenerate into the chaos in which it found itself because the investors were spoiled or irrational. It degenerated because the law could not enforce the duty of loyalty.
The full paper is available for download here.
In an opinion issued yesterday in ATR-Kim Eng Financial v. PMHI Holdings, Vice Chancellor Strine concludes that two directors breached their duty of loyalty to a minority shareholder by standing by silently while the majority shareholder essentially liquidated the corporation’s assets and placed them into entities controlled by his family. The court concludes that the directors, who “regarded themselves as mere employees of [the majority shareholder] and failed to take any steps” to stop the shareholder from “do[ing] whatever he wanted,” breached their obligation to protect the interests of the company and “all its stockholders” (emphasis mine). The directors could not seek refuge in the business-judgment rule, the court held, because permitting the majority shareholder to do as he wished was not “indicative of a good faith error in judgment,” but rather “reflects a conscious decision to approach one’s role in a faithless manner by acting as a tool of a particular stockholder.”
In crafting a remedy for the aggrieved minority shareholder, the court takes the unusual step of holding the directors jointly and severally liable for the judgment against the majority shareholder. And even though the court acknowledges that the majority shareholder was more culpable than his abettors on the board–and thus that the directors may be able to recoup any monies paid to the plaintiffs through an action against the majority shareholder–Delaware directors would do well to take note of footnote 129 of the opinion. There the Vice Chancellor indicates that, “when persons act as mere tools for malefactors and contribute to harm to others, public policy might limit their ability to seek indemnification from their ‘boss.’”