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Rules of the Road for Directors Serving Two Masters

August 31, 2015

Appeared in Law360 on August 31, 2015. Originally appeared in the Kaye Scholer M&A and Corporate Governance Newsletter

—by Diane Holt Frankle

It is common for one or more directors of corporations, »  Click here to read more articles from our latest M&A and Corporate Governance Newsletter. whether publicly held or private, to hold a seat on a board of directors by virtue of a particular stockholder or group of stockholders. There are many examples of such director-stockholder relationships.

Perhaps the most common example is a company that has received a significant investment from venture capital or private equity firms; here, the company typically provides a right, either through a charter provision or a shareholder rights agreement, to those significant investors to designate one or more directors to be nominated for board seats, and a voting agreement among significant stockholders to vote in favor of the firms’ designees.

Another common example is an operating subsidiary where the parent corporation, while retaining majority control, has provided equity to the subsidiary’s employees, and yet as majority holder, designates and elects all or most of the directors of the subsidiary.

Further, in the public company context, we often see activist stockholders negotiating with a board to have one or more designees added to the board. Debtholders and unions may also have rights to designate one or more directors.

These directors, sometimes referred to as “constituency directors,” may have day jobs as employees of the venture capital or private equity firm, parent corporation, activist hedge fund, lender or union that designated them for the board seat they now hold. If so, such directors owe separate duties to their employer. Family stockholders might appoint a family member as a director. Sometimes these directors serve on multiple portfolio companies on behalf of a particular stockholder. In these cases, the directors can be seen to have personal interests aligned with the stockholder who appointed them.

In other cases, director nominees are selected by the stockholder because these persons have business experience and judgment the stockholder believes will be helpful to the corporation, and these directors have no other relationship with the stockholder.

Constituency directors may receive compensation or other benefits from the corporation for their service as a director. As noted above, in some cases, a constituency director may also be an employee of the stockholder, or its affiliate, or may have some other compensation arrangement with the stockholder or affiliate.[1] What issues should directors elected by virtue of a particular stockholder or group of stockholders keep in mind and what standards apply to these directors while they serve on a board of directors

Duty of Care and Duty of Loyalty Owed by All Directors to All Stockholders

Section 141(a) of the General Corporation Law of the State of Delaware (the DGCL) provides that the corporation’s business and affairs are managed by or under the direction of its board of directors. Delaware courts explain that “[i]n performing their duties, the directors owe fundamental duties of loyalty and care to the corporation and its shareholders.”[2] The Delaware Supreme Court has explained that there is “‘no dilution’ of the duty of loyalty when a director ‘holds dual or multiple fiduciary obligations.’ If the interests of the beneficiaries to whom the dual fiduciary owes duties are aligned, then there is no conflict.”[3]

Thus, as long as the constituent stockholders’ interests are aligned with the interests of all stockholders (i.e., if such stockholders simply wish to grow the business successfully), a special relationship between a director and a particular stockholder does not create a legal issue. If instead, the constituent stockholder has a special interest different from some or all other stockholders on a matter being considered by the board, in some cases, a constituency director associated with that stockholder director may be viewed as having a potential or actual conflict of interest, as discussed below.

Keep in mind, however, that, for the most part, constituency directors face no conflict in their role as a director as a result of their relationship to the particular stockholder who might have designated them for election. In most matters coming before the board, the interests of all of the stockholders are completely aligned. In such cases, all directors are intent on the same overall goal, seeking to promote the value of the corporation for the benefit of its stockholders. This goal is truly the job of all directors; as the Delaware Chancery Court recently explained, “by increasing the value of the corporation, the directors increase the share of value available for the residual claimants.”[4]

A focus on increasing the aggregate value of the enterprise typically serves the interests of all stockholders. The directors might consider a wide range of matters, from selection and retention of the chief executive officer, to strategy for the corporation, to compensation or governance decisions, to oversight of the financial controls and even to the sale of the company, where the stockholders’ interests are not divergent. In each case, directors are called upon to act in what they reasonably perceive as the best interest of the corporation and its stockholders to enhance the overall value of the corporation.

Of course, constituency directors may have differing views from their fellow directors, which may, but do not necessarily, derive from their relationship with the stockholders who designated them to the board. Like all directors, these constituency directors come to the board with their own experience and their own point of view on the right or best ways to build stockholder value. Beyond that, constituency directors may be provided with information or perspectives from their stockholder designee giving them a particular point of view on issues that arise, including the methods most likely to result in value creation.

As an example, the venture capital designee might tap into the venture fund’s deep experience in building successful companies, and might therefore disagree with a founder of the company sitting on the board about the best way forward in a tough business climate. Another example might be a director appointed by virtue of an activist hedge fund, who might have a more short-term view of value creation, while a founder director might have a much longer time horizon for value creation. One could expect, of course, that a stockholder with a particular point of view would recruit a director nominee presumed to be aligned with those views. So long as the constituency director is applying his or her judgment and seeking to enhance the value of the corporation, he or she is acting in the best interests of the corporation and all the stockholders.

Exercising Independent Judgment

Note, however, that the constituency director must exercise his or her own judgment on the matter facing the board in fulfilling his or her duties to the corporation and stockholders.

Once elected or appointed as a director, the director is not permitted to simply defer to the advice or wishes of the stockholder who designated him or her for appointment when deciding corporate matters. Instead, the director must decide each matter that comes before the board of directors in the best interests of the corporation and all stockholders, and may not favor the interests of the stockholder who brought about its directorship.

Said another way, the “duty to act for the ultimate benefit of stockholders does not require that directors fulfill the wishes of a particular subset of the stockholder base.”[5] Indeed, “during their term of office, directors may take good faith actions that they believe will benefit stockholders, even if they realize that the stockholders do not agree with them.”[6] One court explained, “the corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of the shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.”[7]

Thus, regardless of whether the director is an employee of the stockholder, or simply owes his director position to the stockholder, the director cannot blindly follow the instructions of that stockholder in deciding matters as a director. Instead, the director must exercise his or her independent judgment on the matter. As the Delaware Supreme Court explained:

Independence means that a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences. While directors may confer, debate, and resolve their differences through compromise, or by reasonable reliance upon the expertise of their colleagues and other qualified persons, the end result, nonetheless, must be that each director has brought his or her own informed business judgment to bear with specificity upon the corporate merits of the issues without regard for or succumbing to influences which convert an otherwise valid business decision into a faithless act.[8]

As noted above, the director can and should consider information available to the director, including information provided by the director’s own experience or by the stockholder in question, but then must form a view of the matter as a director independently from any position taken by the stockholder. This may mean that such director draws a conclusion different from that favored by the stockholder who was the instrument of his or her appointment or election.

A good modern example of directors making their own judgment, instead of just deferring to or following the instructions of their nominating stockholder, can be seen in the recent takeover battle between Airgas and Air Products.[9] Air Products launched a tender offer in February 2010 to acquire Airgas, and then succeeded in electing three directors to the Airgas board as a result of a proxy contest in September 2010. One of the three directors explained to ISS, a proxy advisory service, during the proxy contest that, if he were elected, “he would immediately represent all the shareholders of Airgas.” After the stockholder meeting, the Airgas board, including these three directors nominated by Air Products, evaluated an updated five-year plan presented by management, and heard advice from three financial advisers, including a new financial adviser hired at the request of the three new directors.

The Airgas board, including the three newly seated directors nominated by Air Products, then voted against accepting Air Products’ most recent bid and in favor of maintaining the “poison pill” or rights plan currently in place. This decision, based on a review of the information presented to the Airgas board, was contrary to the publicly expressed opinions of Air Products, which had nominated the three directors, and also contrary to the desires of a majority of the Airgas stockholders, who were in favor of a deal.[10]

The Chancery Court was called upon to review the Airgas board’s decision with respect to these two matters. While acknowledging that the Airgas stockholders disagreed with the Airgas board, the Chancery Court held that the Airgas board was complying with its fiduciary duties in retaining the rights plan preventing the Air Products tender offer from closing. In commenting on the role of the three directors elected by Air Products, then-Chancellor William Chandler made it clear that there was no requirement that the nominees agree with the incumbents.

He explained:

Air Products could have chosen three ‘independent’ directors who may have a different view of value than the current Airgas board, who could act in a manner that would still comport with their exercise of fiduciary duties, but would perhaps better align their interests with those of the short-term arbs, for instance. As an example, Air Products could have proposed a slate of three Lucian Bebchuks (let’s say Lucian Bebchuk, Alma Cohen, and Charles Wang) for election. In exercising their business judgment if elected to the board, these three academics might have reached different conclusions than Messrs. Clancey, Miller, and Lumpkins did — businessmen with years of experience on boards who got in there, saw the numbers, and realized that the intrinsic value of Airgas in their view far exceeded Air Products’ offer. Maybe Bebchuk et al. would have been more skeptical. Or maybe they would have gotten in, seen the numbers, and acted just as the three Air Products Nominees did. But the point is, Air Products chose to put up the slate that it did.[11]

Thus, the court confirms that once elected, constituency directors are required to exercise their own independent judgment.

Conflicts of Interest and Independence

A corollary of the requirement that directors need to form their own independent judgment on issues that come before the board is that directors must consider whether they have a conflict of interest in a matter that comes before the board, or may lack independence with respect to the matter at hand, because of a particular interest held by their stockholder opposed to or different from the interests of all stockholders. As the Delaware Chancery Court explained:

[A] disabling “interest,” as defined by Delaware common law, exists in two instances. The first is when (1) a director personally receives a benefit (or suffers a detriment), (2) as a result of, or from, the challenged transaction, (3) which is not generally shared with (or suffered by) the other shareholders of his corporation, and (4) that benefit (or detriment) is of such subjective material significance to that particular director that it is reasonable to question whether that director objectively considered the advisability of the challenged transaction to the corporation and its shareholders. The second instance is when a director stands on both sides of the challenged transaction ....

“Independence” does not involve a question of whether the challenged director derives a benefit from the transaction that is not generally shared with the other shareholders. Rather, it involves an inquiry into whether the director’s decision resulted from that director being controlled by another. A director can be controlled by another if in fact he is dominated by that other party, whether through close personal or familial relationship or through force of will. A director can also be controlled by another if the challenged director is beholden to the allegedly controlling entity. A director may be considered beholden to (and thus controlled by) another when the allegedly controlling entity has the unilateral power (whether direct or indirect through control over other decision makers), to decide whether the challenged director continues to receive a benefit, financial or otherwise, upon which the challenged director is so dependent or is of such subjective material importance to him that the threatened loss of that benefit might create a reason to question whether the controlled director is able to consider the corporate merits of the challenged transaction objectively.[12]

What types of relationships might give rise to either a conflict of interest or a lack of independence? First, and foremost, the Delaware Supreme Court has made clear that “it is not enough to charge that a director was nominated by or elected at the behest of those controlling the outcome of a corporate election. That is the usual way a person becomes a corporate director.”[13] Thus, the mere fact that a director was elected by virtue of a significant stockholder is insufficient evidence to suggest either a conflict of interest or a lack of independence.

What relationships or benefits might then suggest either a lack of independence or a conflict of interest for a constituency director? An example of a personal conflict of interest that could arise in the relationship between a director and the stockholder might be a payment, like a bonus, triggered by consummation of a particular transaction desired by the stockholder and being considered by the board. This payment would be a benefit conferred on the director, not enjoyed by all stockholders. An example of influence that might impact the constituency director’s independent judgment on the issue before the board might be the director’s full-time employment relationship with the stockholder or its affiliate, which would suggest that the director is “beholden to” the stockholder. Family relationships could also raise the issue of influence. Or perhaps the director has been placed on more than one board by the stockholder, and is receiving compensation from those directorships.

Allegations of past personal or business relationships, without more, will not raise an independence issue, but the Delaware Chancery Court has explained that:

Although mere recitation of the fact of past business or personal relationships will not make the Court automatically question the independence of a challenged director, it may be possible to plead additional facts concerning the length, nature or extent of those previous relationships that would put in issue that director’s ability to objectively consider the challenged transaction.[14]

Thus, the courts would need to review whether a person who serves as director for a stockholder in multiple companies received benefits from those directorships, and has a relationship with the stockholder that would prevent him or her from being able to consider decisions regarding the stockholder objectively. “Independence means that a director’s decision is on the merits of the subject before the board rather than extraneous considerations or influences.”[15]

Once a benefit or influence is identified, the next question is whether the benefit or influence is material to the director. As the Delaware Chancery Court explained:

The key issue is not simply whether a particular director receives a benefit from a challenged transaction not shared with the other shareholders, or solely whether another person or entity has the ability to take some benefit away from a particular director, but whether the possibility of gaining some benefit or the fear of losing a benefit is likely to be of such importance to that director that it is reasonable for the Court to question whether valid business judgment or selfish considerations animated that director’s vote on the challenged transaction.[16]

Keep in mind that the need for an analysis of a constituency director’s conflicts or independence arises where the director is also aware that the stockholder has a material interest different from other stockholders with respect to some matter being considered by the board. As noted above, in most cases, the interests of all stockholders will be aligned. In some cases, though, a particular stockholder might have a special interest, different from all stockholders, in a transaction before the board. Obvious examples of transactions raising a special interest of the stockholder are where a corporation is evaluating a real estate or other commercial transaction with the stockholder or one of its affiliates, or where the stockholder or its affiliate is making an investment in the company. Similarly, if the stockholder is an owner of a company that the corporation is considering for an acquisition, or which is making a proposal to buy the corporation, the stockholder has an interest different from other stockholders.

The transaction might however not be with the stockholder directly, but the stockholder might still have a special interest not shared by all stockholders. For example, such a director employed by the stockholder may know that the stockholder has a particular time horizon for its investment. Imagine a situation where a director is reviewing a proposed merger. The director may recognize that the merger proposal does not adequately value the company based on its business and prospects, but may also understand that it could be closed quickly and provides the particular stockholder with sufficient cash to allow it to meet some pressing current debt obligations. In this example, assume that the director’s constituent stockholder does not care that the company is being sold at a discount to its fair value, because current liquidity needs outweigh its own interest in getting the best price and terms for the company. But what about the other stockholders? In this type of situation, the constituency director should recognize that his stockholders’ interests may be different from the interests of all of the stockholders.[17]

An issue like this also arises for a director designated or appointed by preferred stockholders, where the goal for such stockholders might be simply to obtain their liquidation preference. These preferred holders may be indifferent to maximizing the value of the corporation, whether because their return is fixed, and additional return doesn’t benefit them, or because they have a different time horizon than the common stockholders. Directors are required to strive to “maximize the value of the corporation for the benefit of its residual claimants, the ultimate beneficiaries of the firm’s value, and not for the benefit of its contractual claimants [the preferred stockholders].”[18] Thus, a director who is beholden to a preferred stockholder should recognize that the interest of his or her constituent stockholder in some cases may not be aligned with the interests of the residual stockholder, creating a potential conflict of interest for that director. “[T]he VC firms’ ability to receive their liquidation preference could give the VC directors a divergent interest in the Merger that conflicted with the interests of the common stock.”[19]

Another example might be a sale of a subsidiary by a parent corporation with minority stockholders.[20] In one case dealing with this type of conflict, Atlantic Richfield owned 80 percent of ARCO Chemical.[21] The parent wanted to sell the subsidiary, and could have vetoed any transaction it had not approved. The court affirmed the right of the majority stockholder to sell or vote its shares without regard for the minority. Nonetheless the court held that the subsidiary’s directors owed a duty of loyalty to all of its stockholders. The directors were obligated “to make an informed and deliberate judgment, in good faith, about whether the sale proposed by the majority shareholder will result in maximization of value for the minority shareholders.”[22] The board could not abdicate its duty by simply deferring to the judgment of the controlling stockholder. The court held that the board, comprised primarily of employees of the parent, was required to use a special committee to make an independent judgment as to whether the transaction maximized value for all stockholders.

What must a director do in a case where he or she knows that there is a conflict of interest or a relationship that might prevent him or her from exercising independent judgment on a transaction where the constituent stockholder has an interest different from other stockholders? The constituency director has a duty to disclose to the board any potential conflict of interest that arises as a result of the director’s relationship with the stockholder, and which may impact the director’s independent judgment or impair his or her ability to act in the best interests of all the stockholders. Other directors should also be alert to those potential conflicts.

In such cases, the board may ask the director to recuse himself from the deliberations. The Delaware courts have expressed concerns where an interested director is present during the decision-making process.[23] One court observed, “[T]he single flaw in the non-affiliated directors’ decision-making process was their failure to insist that [two conflicted directors] absent themselves entirely from that process.”[24] Thus, the directors who do not have the conflict of interest will be well-served to deliberate without the conflicted director present to avoid any taint of undue influence from the conflicted director.

Where there is a controlling or majority stockholder, the participation in the deliberations by a constituency director, particularly one closely affiliated, such as an employee or partner, may give rise to an inference that the controlling stockholder dictated the result of those deliberations. In cases where independent directors not affiliated with the controlling stockholder comprise less than a majority of the directors, the board may set up a special committee of independent directors so that there is an independent board committee making the decision.[25] Where no special committee is used but a majority of the directors are interested, the courts will apply an entire fairness standard, and the interested directors have a risk of being found to have breached their duty of loyalty.[26]

Confidentiality and Information Sharing

Directors who have relationships with stockholders face some additional issues relating to the information directors receive in the ordinary course. Directors often receive information that if prematurely disclosed outside the corporation may adversely affect the corporation, including confidential information about strategy, customers and suppliers, contract negotiations, sensitive personnel matters, compliance matters and financial results.

Under the umbrella of the duty of loyalty also comes the obligation that a director maintain the confidential nature of the information the director receives in connection with his or her duties.[27] Constituency directors, like other directors, must be careful not to disclose confidential information in a way that might harm the corporation, breaching their fiduciary duty.[28] The Chancery Court has explained:

A director may not harm the corporation by, for example, interfering with crucial financing efforts in an effort to further [his own] objectives. Moreover, he may not use confidential information, especially information gleaned because of his board membership, to aid a third party which has a position necessarily adverse to that of the corporation.”[29]

A corporation can seek a remedy from a director who provides information to individuals who are adverse to the corporation or not entitled to the information for the breach of the director’s fiduciary duty.[30] Courts have held that a confidentiality agreement is unnecessary for directors because the obligation to keep sensitive, confidential information safe and undisclosed is already included within the directors’ duty of loyalty to the corporation.[31]

The flip side of the duty to maintain confidentiality is the desire of constituency directors to share information with constituent stockholders who have a vested interest in the company. Directors affiliated with venture capital and private equity funds regularly report to the funds about their portfolio companies. Investors in publicly held corporations may not wish to receive confidential information to permit active trading, but some may have longer investment horizons and seek reports on the status of the company, although this type of reporting must be carefully restricted to prevent further dissemination or misuse of the information.

Information sharing is permitted under Delaware law.[32] In a recent case, the Chancery Court explained: “When a director serves as the designee of a stockholder on the board, and when it is understood that the director acts as the stockholder’s representative, then the stockholder is generally entitled to the same information as the director.”[33] The courts’ position with respect to information sharing is a practical accommodation to the reality of the business world. One could imagine that if a bright-line rule prohibited information sharing, either the rule would be observed “in the breach” or investors would stop investing.

Care should be taken by the director, however, to avoid any risk of harm to the corporation from such information sharing. Indeed, the rule assumes that the stockholder’s interest is aligned with the corporation and that the stockholder is not, for example, a competitor. It is best practice to have a confidentiality agreement in place between the corporation and the stockholder, as is the case in most private company information rights agreements.

Having such an agreement in place protects both the director and the corporation. Even without that restriction, the stockholder will be viewed as an insider for purposes of insider trading. Directors should be aware that the corporation could have a claim against both the stockholder and the director for any harm that comes from the disclosure.

Conclusion

A constituency director owes the same duties as all other directors, including an undivided duty of loyalty, to act in the best interests of the corporation and all of its stockholders. This means the director cannot simply defer to the wishes of his or her stockholder, but rather must exercise independent judgment on the matters that come before the board of directors.

If a director has a conflict of interest arising with regard to a matter involving the stockholder, because of a personal benefit not available to all stockholders, or the director is not able to make an independent judgment on the matter relating to the stockholder due to his or her relationship with the stockholder or its affiliates, then the director must disclose this conflict of interest or influence, and should recuse himself from the deliberations to avoid the risk that his participation taints the board’s decision.

Directors owe a duty of confidentiality regarding all confidential information they receive in their fiduciary capacity. Directors will be permitted to share information with constituents who have a stake in the corporation and whose interests are not opposed to the corporation, so long as the corporation can assure that the information will be kept confidential.

[1] One ongoing controversy relates to a potential arrangement between an activist and a director nominee on the activist’s slate to compensate that director either upon election or during service by that director. Activists have sought to recruit independent directors with relevant industry experience to their slates. These arrangements are designed to induce a nominee with relevant business experience to run as part of the activist slate. The agreements may provide a payment to the activist upon election, and possibly an alternative payment if, for example, the shares of the company increase by a defined amount. Some public corporations have adopted bylaws prohibiting directors with such agreements from serving as directors of the corporation, and they have been criticized as “golden leashes.” Proxy advisory firms like ISS may recommend a vote against directors who approve such a bylaw without stockholder approval.

Governance commentators have raised the question of whether this type of arrangement creates a potential conflict for the director; some commentators have argued that it isn’t clear whether the purportedly independent director is working for the activist or for all shareholders. Other commentators suggest that these arrangements could create a risk to board cohesion because the director party to this type of arrangement would have different financial incentives than other board members. Other critics see these arrangements as encouraging short-term thinking in the management of a corporation. ISS has noted that these arrangements must be reviewed carefully, considering the size of the payment and whether they might incent the director to push riskier strategies. This type of arrangement must in any case be disclosed to stockholders in connection with the election contest if it is in effect at that time, and also should be disclosed post-election on an ongoing basis if such an agreement is in effect, if required under SEC rules. The bottom line question is whether these arrangements align the director with the interests of all shareholders.

Earlier this year, ISS announced its support for a contractual arrangement between Third Point and two sitting directors of Dow Chemical up for election at Dow’s annual meeting after the settlement of a proxy contest brought by Third Point; the Third Point arrangement based director payments on the performance of Dow shares over three and five years, assuming the directors are still on the board, regardless of whether Third Point continues to own Dow shares. 

[2] In re Trados S’holder Litig., 73 A.3rd 17, 48 (Del. Ch. 2013).

[3] In re Trados S’holder Litig., 73 A.3rd 17, 46 (Del. Ch. 2013), citing Weinberger v. UOP Inc., 457, 701, 710 (Del. 1983)(citations omitted).

[4] Id. at 48.

[5] Id. at 38 (citations omitted).

[6] Id., citing In re Lear Corp S’holder Litig., 967 A.2nd 640, 655 (Del. Ch. 2008)(“Directors are not thermometers, existing to register the ever-changing sentiments of stockholders ...”).

[7] Paramount Communs Inc. v. Time Inc., 1989 Del. Ch. LEXIS 77, 1989 WL 79880, at *30 (Del. Ch. 1989), aff’d in pertinent part, Time, 571 A.2nd 1140 , 1150 (1989); see also In re Lear Corp. S’holder Litig., 967 A.2d 640, 641 (Del. Ch. 2008).

[8] Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984).

[9] Air Products & Chemicals v. Airgas, 16 A.3rd 48 (Del. Ch. 2011).

[10] Chancellor Chandler explained: “[Air Products] ran a slate committed to taking an independent look and deciding for themselves afresh whether to accept the bid. The Air Products Nominees apparently ‘changed teams’ once elected to the Airgas board (I use that phrase loosely, recognizing that they joined the Airgas board on an ‘independent’ slate with no particular mandate other than to see if a deal could be done). Once elected, they got inside and saw for themselves why the Airgas board and its advisors have so passionately and consistently argued that Air Products’ offer is too low ... The incumbents now share in the rest of the board’s view that Air Products’ offer is inadequate — this is not a case where the insurgents want to redeem the pill but they are unable to convince the majority.” Id. at 128.

[11] Id. at 123 FN 487.

[12] Orman v. Culman, 794 A.2d 5, 25 n.50 (Del. Ch. 2002).

[13] Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984).

[14] Orman v. Cullman, 794 A.2d at 25 n.50

[15] Aronson, 473 A.2d at 816.

[16] Id.

[17] It is worth noting that liquidity needs alone will not be deemed a differing interest, without additional facts showing a board decision driven by that interest to a judgment contrary to the interests of all stockholders. In In Re Synthes Inc. Shareholder Litigation, 50 A.3d 1022 (Del. Ch. Aug. 17, 2012), the-Chancellor Leo Strine rejected the general notion that a CEO stockholder breached his duty of loyalty simply because he was a large stockholder who allegedly had liquidity needs due to “retirement objectives” and wanted liquidity for his shares, which he could not achieve by selling blocs on the open market without adversely impacting the stock price. In Synthes, however, there were no allegations that the stockholder had pushed for a quick sale. The board, not the stockholder, determined to explore the sale of the company and the marketing of the company was pursued in a deliberate and thoughtful process. Compare the facts alleged in a case where the Chancery Court refused to dismiss a complaint in In Re Answers Corp. Shareholders Litigation, 2012 WL 1253072 (Del. Ch. 2012)(allegations that controlling stockholder allegedly pushed for a transaction before public stockholders knew of improved financial results, allegedly because controlling stockholders wanted liquidity quickly and believed a higher price would jeopardize a sale); however, the Chancery Court later granted motions for summary judgment by defendants. 2014 WL 463163 (Del. Ch. 2014). Absent facts suggesting a board process tainted by the large stockholder interest, in contrast to interests of all stockholders, Chancellor Strine explained in Synthes that “a fiduciary’s financial interest in a transaction as a stockholder (such as receiving liquidity value for [its] shares) does not establish a disabling conflict when the transaction treats all stockholders equally.”

[18] Id. at 41. at 64 and 76-77.

[19] Id. at 47.

[20] See Warshaw v. Calhoun, 221 A.2d 487, 492 (Del. 1966); Sinclair Oil Corp. v. Levien, 280 A.2d 717, 719 (Del. 1971).

[21] McMullin v. Beran, 765 A.2d 910 (Del. 2000).

[22] McMullin, 765 A.2d at 919.

[23] See Yucaipa Am. Alliance Fund II LP v. Riggio, 1 A.3rd 310, 326-27 (Del. Ch. 2010)(presence of founder/chairman interfered with deliberations); Emerald Partners v. Berlin, 2003 WL 21003437 (Del. Ch. 2003); aff’d 840 A.2d 641 (Del. 2003).

[24] Emerald Partners v. Berlin, 2003 WL 21003437, at *28; aff’d 840 A.2d 641 (Del. 2003)(“the single flaw in the non-affiliated directors’ decision-making process was their failure to insist that [two conflicted directors] absent themselves entirely from that process.”).

[25] See e.g., Kahn v. Lynch Communications Systems Inc., 638 A.2d 1110, 1117 (Del. 1994); Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997).

[26] In re Trados S’holder Litig., 73 A.3rd at 64 and 76-77. Vice Chancellor J. Travis Laster notes the danger of “conflict blindness” and “conflict denial” for venture directors, while ultimately concluding that the common holders would not have received any more if the transaction had a fair process.

[27] Henshaw v. American Cement Corp., 252 A.2d 125 (Del. Ch. 1969).

[28] Shocking Technologies v. Michael, 2012 WL 4482838 (Del. Ch. 2012)(director held to breach his fiduciary duty of loyalty by providing confidential information to investor; shared information about the company’s negotiating position and lack of competing bids with potential investor to discourage investment in order to increase leverage of his stockholder constituent).

[29] Id. at *9.

[30] Henshaw v. American Cement Corp., 252 A.2d at 129.

[31] Id. at 127 and 129.

[32] Kalisman v. Friedman, 2013 WL 1668205 (Del. Ch. 2013), Moore Business Forms Inc. v. Cordant Holdings Corp., 1996 WL 307444 (Del. Ch. 1996); AOC Ltd. Partnership v. Horsham Corp., 1992 WL 97220, at *1 (Del. Ch. 1992).

[33] Kalisman v. Friedman, 2013 WL1668205 at *6.

Read the Law360 article here.

Also of Interest