Last week, the Delaware Court of Chancery reached the rare conclusion that an independent, disinterested board breached its fiduciary duties in connection with an arm’s-length, third-party, premium merger transaction. The decision, In re Rural Metro Corp. Stockholders Litig., C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014), which relies heavily on findings that the board’s financial advisor had undisclosed conflicts of interest, holds the advisor liable for aiding and abetting the breaches, but does not reach the question of whether the directors themselves could have been liable, as they settled before trial. The decision sends a strong message that boards should actively oversee their financial advisors in any sale process.
Posts Tagged ‘Fiduciary duties’
This Spring, the Supreme Court will decide whether a for-profit corporation can refuse to provide insurance coverage for birth control and other reproductive health services mandated by the Affordable Healthcare Act (or “Obamacare”) when doing so would conflict with “the corporation’s” religious beliefs. Although the main legal issue in Sibelius v. Hobby Lobby Stores, Inc., et al. and Conestoga Wood Specialties Corp., et al. v. Sibelius concerns the extent to which the guarantee of free exercise of religion under the Constitution and the Religious Freedom Restoration Act may be asserted by for-profit corporations, the Court’s decision may also have important—and unsettling—implications for state corporate laws that define the fiduciary duties of boards of directors.
I’ve recently posted to SSRN a book chapter called “An Economic Theory of Fiduciary Law,” which will be published in Philosophical Foundations of Fiduciary Law by Oxford University Press. The editors are Andrew Gold and Paul Miller.
The purpose of my chapter is to restate the economic theory of fiduciary law. In doing so, the chapter makes several fresh contributions. First, it elaborates on earlier work by clarifying the agency problem that is at the core of all fiduciary relationships. In consequence of this common economic structure, there is a common doctrinal structure that cuts across the application of fiduciary principles in different contexts. However, within this common structure, the particulars of fiduciary obligation vary in accordance with the particulars of the agency problem in the fiduciary relationship at issue. This point explains the purported elusiveness of fiduciary doctrine. It also explains why courts apply fiduciary law both categorically, such as to trustees and (legal) agents, as well as ad hoc to relationships involving a position of trust and confidence that gives rise to an agency problem.
Based on a number of cases decided by the Delaware courts in 2013, below we summarize practice tips regarding careful drafting of contractual provisions and complying with technical and statutory requirements.
Disclaimers of Reliance and Accuracy Clauses Likely Do Not Bar Fraud Claims
The Delaware courts have had several opportunities to examine a range of disclaimer provisions in agreements, usually an integration (or “entire agreement”) clause and a disclaimer of extra-contractual statements, to determine if they were adequate in barring fraud claims. Although in the past the courts have disallowed fraud claims based on rather thinly worded disclaimers of extra-contractual statements (i.e., disclaimers that do not include an express statement of non-reliability or non-reliance), recently the courts seem to be requiring an express statement that the buyer was not relying on extra-contractual statements to bar such fraud claims. See, for example, the decisions of the Court of Chancery in Anvil Holding Corporation v. Iron Acquisition Company, Inc. (May 17, 2013), and of the Superior Court in Alltrista Plastics, LLC v. Rockline Industries (September 4, 2013) and TEK Stainless Piping Products, Inc. v. Smith (October 14, 2013).
In Red Oak Fund, L.P. v. Digirad Corp., the Delaware Court of Chancery held that the Digirad board of directors did not breach its fiduciary duties or create an unfair election process where: (i) preliminary election results that showed the incumbents in the lead were accidentally disclosed to a large stockholder; (ii) certain preliminary proxy reports inaccurately reported a large lead by management; (iii) the company delayed disclosure of negative financial results until after the election; and (iv) management proxy materials did not disclose that the board was considering a stockholder rights plan (a “poison pill”).
Plaintiff, owner of 5.6% of Digirad’s outstanding common stock, nominated a slate of five directors to replace the company’s incumbent board, but lost the ensuing proxy contest. Plaintiff filed suit, alleging that the incumbent directors breached their fiduciary duties and created an unfair election process.
The court found no breach of fiduciary duties and no valid claim of an unfair election process, holding that:
At common law, an interested director was barred from participating in corporate decisions in which he had an interest, and therefore “disinterested” directors became desirable. This concept of the disinterested, director developed into the model of an “independent director” and was advocated by the Securities and Exchange Commission (SEC or Commission) and court decisions as a general ideal in a variety of situations. The SEC’s view of the need for independent directors should be understood in the context of Adolph Berle’s theory of the 1930s that shareholders had abdicated control of public corporations to corporate managers, and fiduciary duties needed to be imposed upon corporate boards in order to compensate for this loss of shareholder control. Berle’s writings laid the foundation for shareholder primacy as the theory of the firm, a theory embraced by the SEC, which viewed itself as a surrogate for investors.
The SEC has generally succeeded in imposing its corporate governance views in the wake of scandals. Following the sensitive payments enforcement program of the 1970s, the SEC embarked on an activist corporate governance reform program. During the merger and acquisition frenzy of the 1980s, the SEC used the Williams Act to foster the view that the market for corporate control constrained incompetent managers. After the bursting of the technology bubble in 2000, and the financial reporting scandals that ensued, the SEC was able to incorporate its views on independent directors into the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). Following the financial crisis of 2008, the SEC further enforced its views on the requirements for independent directors in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).
The composition and behavior of securities markets and investors has changed drastically since the SEC was established in 1934. Yet, the SEC has persisted in its path-dependent view that independent directors, ever more stringently defined, should dominate the boards of public companies.
In In re Sirius XM Shareholder Litigation,  Delaware Chancellor Strine dismissed a complaint that the Sirius board had breached its fiduciary duties by adhering to the provisions of an investment agreement with Liberty Media that precluded the Sirius board from blocking Liberty Media’s acquisition of majority control of Sirius through open-market purchases made by Liberty Media following a three-year standstill period. By holding the complaint to be time-barred under the equitable doctrine of laches the Delaware court did not address the merits of whether the Sirius board breached its fiduciary duties. However, In re Sirius still offers the opportunity to recap the guidance on “creeping takeovers” that can be derived from existing Delaware case law:
In In re Bioclinica, Inc. Shareholder Litigation, the Delaware Court of Chancery (VC Glasscock) dismissed a stockholder suit alleging that the members of a board of directors breached their fiduciary duty of loyalty in a sale process for a transaction that had since closed, and where plaintiffs’ allegations previously had been found insufficient to support a pre-closing motion to expedite. Under those circumstances, the court found the chances of those same allegations surviving a post-closing motion to dismiss to be “vanishingly small.” Moreover, the court reaffirmed that reasonable deal protections, such as no-solicitation provisions, termination fees, information rights, top-up options, and stockholder rights plans, in the context of an otherwise reasonable sales process, are not preclusive and do not, in and of themselves, demonstrate a breach of the duty of care or loyalty. Finally, the court dismissed claims against the acquirer that it aided and abetted the directors’ breach of fiduciary duties because no breach of such duties was found.
As we previously detailed here, BioClinica engaged in an eight-month sale process, which led to a two step tender offer acquisition that closed on March 13, 2013. Before the closing of the tender offer, the court found that plaintiffs’ allegations that the board members had breached their fiduciary duties were not colorable, and the court declined to expedite the litigation (or enjoin the transaction). Such a finding typically leads to a voluntary dismissal by plaintiffs. Here, however, plaintiffs nonetheless chose to pursue this action, and, because the exculpation provisions in the company’s certificate of incorporation absolved the directors from monetary damages arising out of breaches of the duty of care, plaintiffs were forced to allege that the directors breached their duty of loyalty or acted in bad faith.
In a 2004 lecture, Jeffrie Murphy noted that “John Rawls claimed that justice is the first virtue of social institutions,” but Murphy went on to ask “what if we considered agape to be the first virtue? What would law then be like?” A variant on Murphy’s question has been chosen as the motivating question for the Law and Love Conference, to be held at Pepperdine University School of Law, on February 7-8, 2014, at which this article will be presented. As propounded by the convokers, the question read “What would law be like if we organized it around the value of Christian love [agape]? What would be the implications for the substance and the practice of law?” This article poses those questions with respect to partnership law.
When I was asked to contribute a paper on business organization law to the Pepperdine conference, the conference call immediately brought to mind Benjamin Cardozo’s opinion in Meinhard v. Salmon,  which famously held that a managing partner “put himself in a position in which thought of self was to be renounced, however hard the abnegation.”  The parallels between Cardozo’s framing of the partner’s duties and, to cite but one example, Kierkegaard’s formulation of agape, which avers that “[l]ove of one’s neighbor … is self-renouncing love,”  are obvious and striking. What then would partnership fiduciary duty law be like if it were organized around the value of agape?
The boards of public companies are increasingly being assessed by a hoard of short-term focused “activist” investors and an increasingly third-party-advised stockholder base that relies heavily on proxy advisory firms to make important voting decisions for them. It is estimated that over 75 percent of all shares of public companies are held in a managed fund or institutional account.
Institutional Shareholder Services (ISS) and Glass Lewis control 97 percent of the market for proxy advice; and the two dominant proxy advisors reportedly affect 38 percent of votes cast at U.S. public company shareholder meetings. Their dominance in the proxy marketplace not only affects numerous votes but, more importantly, how companies manage and deal with their shareholders. Both firms wield enormous influence without having “skin in the game.” Perhaps even more concerning, given the influence they have on public companies, the proxy advisors (i) are understaffed and therefore establish generic voting recommendations and (ii) profit from engaging in activities involving material conflicts of interest, including marketing their advisory services to many of the same companies for which they provide proxy recommendations. In addition, Glass Lewis is owned by an activist fund with an agenda.