Directors faced uncertain times in 2009 due to the global financial crisis. Many companies put deals on hold, abandoned them altogether or in some cases tried to get out after the deal closed. That turmoil was reflected in the litigation before the Delaware courts in 2009 and “director oversight” became the watchword.
One of the most notable cases in 2009 was In re Citigroup Shareholder Derivative Litigation, where the Court of Chancery found no director liability for oversight or Caremark-type duties for Citigroup’s losses resulting from substantial exposure to subprime debt. The Court noted that “to establish oversight liability a plaintiff must show that the directors knew that they were not discharging their fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as by failing to act in the face of a known duty to act.” In addition, “a showing of bad faith is a necessary condition to director oversight liability.” No liability resulted in this case because Citigroup had procedures and controls in place that were designed to monitor risk and the plaintiffs did not contest these standards. And even if there were warning signs or “red flags‘ as the plaintiffs claimed, the Court stated that they are not evidence that the directors consciously disregarded their duties or otherwise acted in bad faith but may only be evidence that the directors made bad business decisions.
Kevin F. Brady and Francis G.X. Pileggi co-authored this post.
In Lyondell Chemical Company, et al. v. Ryan, the Delaware Supreme Court addressed director’s duties as to “Revlon” or “deal protection” claims in the $13 billion sale of Lyondell. In this case, the Court made clear that Revlon duties arise not because a company is “in play” (such as in this case where there was a Schedule 13D filing), but rather when the company “embarks on a transaction – on its own initiative or in response to an unsolicited offer – that will result in a change of control.” The Court further noted that “there are no legally prescribed steps that directors must follow to satisfy their Revlon duties” and that the Lyondell directors’ failure to take any specific steps during the sale process could not have demonstrated a “conscious disregard of their duties.” Finally, the Court stated that instead of questioning whether disinterested, independent directors did everything that they (arguably) should have done to obtain the best sale price, “the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.”
In In re Nymex Shareholder Litigation, an action involving challenges to a consummated mixed cash/stock acquisition, the Court of Chancery dismissed allegations against directors regarding breaches of fiduciary duties of loyalty, due care and candor in the sale of NYMEX. In doing so, the Court reaffirmed the considerable deference Delaware law provides to an independent board facing a change of control situation post-Lyondell. The Court did not address the threshold Revlon applicability issue in a mixed cash/stock deal because NYMEX’s Certificate of Incorporation contained an exculpatory clause authorized by 8 Del. C. § 102(b)(7) that protected the NYMEX directors from personal monetary liability for breaches of the duty of care. If the Plaintiffs failed to show that the either a majority of the directors were interested, lacked independence or failed to act loyally or in good faith, then their only remaining claim would be a breach of a duty of care which is addressed by §102(b)(7). Thus, even if Revlon applied, application of the §102(b) (7) exculpatory clause would lead to dismissal “unless the Plaintiffs have successfully pleaded a failure to act loyally (or in good faith), which would preclude reliance on the Section 102(b) (7) provision.”
In In re John Q. Hammons Hotels Inc. Shareholder Litigation, the Court of Chancery discussed what standard should apply — entire fairness or business judgment — in reviewing this merger. In this case, the Court stated that the majority shareholder neither stood “on both sides of the transaction” nor made the offer to the minority stockholders; an unrelated party, Elian, made the offer. Elian negotiated separately with the minority shareholders, who were represented by the disinterested and independent special committee and the majority shareholder “who had a right to sell (or refuse to sell) his shares.” However, in order to invoke the business judgment standard, “it is paramount . . . – that there be robust procedural protections in place to ensure that the minority stockholders have sufficient bargaining power and the ability to make an informed choice of whether to accept the third-party’s offer for their shares.” Here the Court found that the procedures in place (where the special committee could waive the vote of the minority stockholders and required the approval of only the majority of the voting minority shareholders), were not sufficient to warrant business judgment protection. Importantly, the Court stated that the minority vote serves as a complement to, and a check on, the special committee. It also noted that “[a]n effective special committee, unlike disaggregate stockholders who face a collective action problem, has bargaining power to extract the highest price available for the minority stockholders. The majority of the minority vote, however, provided the stockholders with an important opportunity to approve or disapprove of the work of the special committee and to stop a transaction they believed was not in their best interests. Thus, to provide sufficient protection to the minority stockholders, the majority of the minority vote must be nonwaivable, even by the special committee.”
Finally, in Gantler v. Stephens, the Delaware Supreme Court clarified what had been presumed for years by finding that “officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty…and the fiduciary duties of officers are the same of directors.”
Kevin F. Brady is a partner and co-chair of the Business Law Group of the Wilmington, Del., office of Connolly Bove Lodge & Hutz LLP. His practice includes corporate and commercial litigation in the Delaware Court of Chancery. He can be reached at KBrady@cblh.com.
Francis G.X. Pileggi is the founding partner of the Wilmington, Delaware, office of Fox Rothschild LLP, an AmLaw 200 firm. He started a blog in 2005 at www.delawarelitigation.com that summarizes all the key decisions on corporate and commercial law from the Delaware Court of Chancery and Delaware Supreme Court, and includes posts on legal ethics and related topics. His e-mail address is: fpileggi@foxrothschild.com.