Fiduciary Duty, Shareholder Litigation, and The Business Judgement Rule

Fiduciary Duties

(1) Care (2) Loyalty (3) Candor (4) Good Faith

Two Ways to Bring a BJR Claim

(1) From a board decision that results from a board decision that results in a loss because the decision that results in a loss because that decision was ill advised or negligent (Most Common) (2) Liability to the corporation for a loss may be said to arise from an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss. (Caremark Type/ Very challenging claim)

Two Standards In Sinclair

(1) Sinclair received nothing from the Subsidiary to the exclusion of the minority shareholders the BJR applies to evaluate the dividends issue and expansion. (2) However, since the majority received something at the exclusion of the intrinsic fairness rule applies.

Sale's Framework for Thinking Through this chapter

(1) Who has the burden of proof (2) What is the court looking at?

Proving a lack of Duty of Loyalty

(1) corporate opportunity; (2) conflicting interests and self-dealing; OR (3) good faith

The corporate opportunity doctrine (ALI Northeast Harbor Test)

(1) requires a strict requirement of full disclosure prior to taking advantage of any corporate opportunity (if fails to offer she violated the FD) (2) The corporation must formally reject (3) She may then argue that it was not corporate opportunity (Broad Definition) : closely relates to a business in the corporation is engaged In Harbor it is a problem that she operates in secret!

The Guth Test (DE) for Corporate Opportunities. The Director May Not Take the Opportunity if:

(1) the corporation is financially able to exploit the opportunity. (2) the opportunity is within the corporation's line of business. (Broz: While it was within the line of business it is not equally clear that CIS had a cognizable interest or expectancy in the license.) (3) the corporation has an interest or expectancy in the opportunity (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation

The Guth Test (DE) for Corporate Opportunities. The Director May Take the Opportunity if:

(1) the opportunity is presented to the director in his individual and not his corporate capacity (Broz: the director heard about the opportunity to acquire the cell company in individual capacity) (2) the opportunity is not essential to the corporation (3) the corporation holds no interest or expectancy in the opportunity (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity

What are the necessary conditions for director's oversight liability?

(a) the directors utterly failed to implement any reporting or information system or controls; or (b) Having implemented such a system or controls , consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. (Caremark)

Proving a lack of Duty of Care

1) gross negligence- using care, but not enough; (2) lack of candor- disclosure); OR (3) abrogate duties -failed to do what was required

How can a conflicted interest transaction be made arms length?

1. Informed Vote of the Shareholders 2. Be forthright with the board, for example in Globe woolen if Maynard came forward and told the board about the crazy requirements in the deal it would be better. 3. Create a committee pursuant to 141 4. Recuse the interested party.

What is Demand in Derivative Suits?

A plaintiff must ask the corporation for permission to sue, exist as the threshold, first to insure that the stockholder exhausts his intra-corporate remedies and make sure directors run the business management. The Board Could → Reject, Internally Investigate (Only in Derivative Suits)

What is the principal of Good Faith Claims we learn from Caremark?

Absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's behalf. (Bad Outcome is not the same as Bad Faith)

In order to show that demand is futile what test is used?

Aronson Test: (1) Majority of directors disinterested & independent Plaintiff wants to show that the directors lack independence OR that they are interested. (2) (2) OR challenged transaction was otherwise the product of a valid exercise of business judgment (Good Faith and Reasonably Inform) (Need to Tag the Majority of the Board or Half if it is an even board) (Limited)

BJR at the Trial Stage

At Trial BJR: Not just pleading but proving actual breach of fiduciary duty

What is backdating?

Backdating: Issue employee stock options at the date of the lowest price, instead of the date of issuance. (Gifford) Backdating in itself is not really a problem (Only a problem when not disclosed): Must be Fair Market Value at the date of issuance so have to go by the bylaws. Backdating can of course be voted on and "ok"ed by the shareholders.

Broadly what is the Business Judgement Rule?

Business Judgement Rule is absent fraud, or gross overreaching to achieve expansion through the medium of its subsidiaries the court will trust the company

Duty of Candor

Candor: Times you must speak and is enforceable by securities law for publicly held companies

Corporate Governance § 5.05(b)(1)(A)

Corporate opportunity comes up and person offering expects it to be offered to corporation. Agency theory

What is the statutory basis for allowing the board to create an independent committee?

Corporations are entitled to create independent committees: Controlled 141a (Business Judgement) and 141c (Committees) 8 Del. C § 144: Permits it seems clear that the Delaware

What are the jurisdictional differences in demand?

Delaware Law: Demand unless futile → goes straight to court, but they are all bad news Model Business Corporation Act: MUST always Demand

What is the controlling statute for indemnification under DE Law?

Don't have to pay your defense up front/ if you are a bad actor you pay back § 145

Red Flags

Even if you have a framework, red Flags cannot be ignore (put on notice). (Miller:Miller's dual role as director and officer (President, Chairman, and CEO of USF, director to Royal Ahold magnifies the importance of the duties he owed and alleged violated) Ex of Red Flags : "Big Newspaper Reports and Internal Investigation"- SALE If the board did nothing while federal investigation, Bad if you failed to act: (But wicked hard to survive)

Brehmer v. Eisner

First Disney Case about the waste doctrine. The stockholders feel like the gave Ovitz too good of a deal, it was more lucrative for him to quit than leave. The board took enough procedural due care the court will not look into substantive due care.

What did we learn in Gifford?

Gifford Where the Bylaws required that price was fair market value, and the board backdated could not be an exercise of business judgement. (i.e second prong of Aronson)

Why was Gifford not a Rales Scenario?

Gifford was not a Rales scenario. The compensation committee approved option grants and half of the board members on that committee are still on the board. (Remember Half is enough for an even board)

Zapata Corp v. Maldonado

Gives the Zapata Rule for Independent committees Maldonado instituted a derivative action in DE Chancery Court against ten officers and/or the directors of Zapata for breach of fiduciary duty. four if the defendant-directors were no longer on the board. The board created an "Independent Investigation Committee" composed solely of the two new directors, to investigate Maldonado's actions, as well as a similar should continue any or all of the litigation. The Committee decided to dismiss the case.

What does a party who has "fingers in both pies" do?

If a party has fingers in both pies, or feet on both sides of the transaction, the party must take steps to cleanse the transaction pursuant to § 144

Malpiede Rule

If a plaintiff brings a claim for breach of duty of care, must plead it intertwined with another fiduciary duty (ie. loyalty, or good faith) to survive the Motion to Dismiss. Through 102(b)(7) Delaware may have closed a door but they've opened a window through intertwined claims. Sometimes this is a high bar because DE does not allow for discovery while the MoD is pending.

Why does the Court adopt the Zapata Test

In Creating the Test court attempts to balance: (1) Corporations can consistently wrest bona fide derivative action away from well-meaning derivative plaintiffs through the use of the committee mechanism and (2) meritless or harmful litigation and strike suits, the derivative action, cared to benefit the corporation, will produce the opposite, unintended result.

In Van Grokom, how should Van Gorkom have approached Pritziker when discussing the sale of the company?

In Van Gorkom, the court prescribes what would have been a better practice. When approaching a buyer will an ideal price first ask whether they are interested before beginning with a price. For example when he went up to Pritizer and told him the price we wanted to sell for instead of asking if he was interested.

If a conflicted deal is grossly inequitable, will a court uphold the deal simply because it was cleansed?

Justice Cardozo suggests that the court will likely not uphold it. In Globe Woolen, he looks at the fact the deal was grossly inequitable.

Duty of Loyalty

Loyalty: a director must favor the corporation's interests over her own whenever those interest conflict.

What is mandatory indemnification?

Mandatory Indemnification: Indemnification Must Occur for defense expenses occurs when the director is successful on the merits.

What are some examples of Directors lacking independence?

Material Compensation: Consider percentage/importance (Limited) Donations to the President of a University (Limited) Beholden state of mind (More than simply about CASH!) "You must make your director look like a bad actor"- sale

Can a board rely on information from industry experts?

Members of the board of directors, or member of any committee designated by the board of the director is fully protected in relying in good faith upon the records of the corporation, other person's professional, or expert competence who has been selected with reasonable care pursuant to § 141e

Cornerstone Rule

Must have something on ALL of the directors to sue all of them

Intrinsic Fairness

Need both (1) Fair Dealing and (1) Fair Price with a thumb on the scale of fair price.

What is permissive indemnification?

Permissive Indemnification: Indemnification May Occur, if the corporation so chooses for defense expenses, for the costs imposed on directors who have been determined to have acted in Good Faith (The Requirement of Good Faith may not be waived)

In Re Caremark International, Inc Derivative Litigation (DE 1996)

Post 102b7 Case. Medical Care company finds out it is out of compliance and had guidelines they repeatedly updated and did internal audits. DOJ investigates 2 officers and a doctor criminally charged. Had operations in place not the best. Bottom line they had procedural due care.

What does § 102b7 do?

Protects directors from monetary damages due to the breach of care. Doesn't protect from injunctive relief All corporations will have this in either their charter or articles to stop the shareholders for attempting to change it. Directors must bring as a affirmative defense or else the defense will be waived.

What is the Rales Test?

Rales Test: (1) Where the challenged transaction was not a decision of the board upon which the plaintiff must seek demand or (2) where the subject of the derivative suit is not a business decision of the board or (3) a board of a different company, plaintiff must "create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgement in responding to a demand

For what reasons would a corporation want to create an independent committee?

Reasons Why: The board has the power to choose not to pursue litigation when demand is made upon it, so long as the decision is not wrongful.

In Re Walt Disney Company Derivative Litigation (DE 2006)

Second Disney Case. Reaffirms took enough care. Suggests more the company should do like spreadsheets, research, better experts. "Not so tidy"

Owens Corning v. National Union Fire Insurance Co

Significant because about permissive indemnification. National Union denied payment to compensate Owens Corning for indemnifying its directors and officers who paid money to settle a 1991 shareholder class action. Settled for a load of money. Good Faith provision of indemnification cannot be waived

Northeast Harbor v Harris (ME 1995)

Significant because of the ALI Test for the Corporate Opportunity doctrine. Harris was president of the Golf Club. The Board had the possibility of raising money for development. Suminsby told Harris that he listed some land that he thought the club might be interested in and contacted Harris for her connections to the Club. She slowly bought land and proceeded to build on it

Stone v. Ritter

Significant because solid definitions of good faith. It shows use the importance of having proper channels. There was a ponzi scheme going on inside the bank. But they were not ignoring red flags.

Standard for Waste Claims

So inadequate in value that no person of ordinary, sound business judgement would deem it worth what the corporation had paid."Almost a never going to win on a waste claim because the bar is so high to get there, but you might as well throw it in"-Sale

Examples where demand is not futile

Stock ownership is not enough Selected, dominated and controls them → all boards are picked similarly because they are buddies → If so it would always be futile Board would have to sue themselves for waste and not capable of suing themselves → again argue in any case.

Under the fair price prong of the intrinsic fairness rule, is just any premium enough?

Substantial Premium: Just because the price is a substantial premium, doesn't mean the price was fair. What we are looking for is the RIGHT premium. (Van Gorkom)

What is the difference between substantive due care and procedural?

Substantive Due Care: What plaintiffs claim. the Substance behind the decisions Procedural Due Care: Don't have the process in place to have due care (This is the one courts WILL take action on.) However, it doesn't have to be the best system in place.

How did the Board Breach Their Duty of Care in Smith v. Van Gorkom?

The Board did not do enough research on the best price. They held only 20 minute meetings with the board. Remember the board is only liable here because 102b7 was not enacted yet.

Broz v. Cellular Information Systems, Inc

The Delaware approach for the Corporate Opportunity Doctrine. Broz is the president and sole stockholder of RFB Cellular (DE Corp) that is a cell phone service provided in the mid-west. He was also a member of the board of the directors of (CIS). Broz purchased a cellular telephone service license for RFB. Mackinac arranged a brokerage firm to compile a list of prospects. CIS was not among the list, they had just come out of Bankruptcy. No breach because he became aware in the individual capacity and the other company was not among the list

Globe Woolen Co v Utica Gas and Electric Co. (1918)

The Plaintiff is the owner of a worsted and a woolen mill. The Defendant owns a light and power plant. Maynard is the president and chief stockholder of the mill and also a director of the of the power plant with a property interest. Maynard and Defendant negiotate a deal that is completely unfavorable to the electric company. Even if the common member on the board doesn't vote he can still influence conflicted interest transactions.

How does the the Business Judgement Rule work at the dismissal stage for self dealing?

The Plaintiffs rebutt the presumption that the board did not make the decision (1) Good Faith (2) Informed with all material information. And it must be a business judgement. If the plaintiffs successfully rebut it switches to intrinsic fairness with the burden of proof on the defendant.

What does the Dodge Bro Case Show Us?

The dodge brothas asks for dividends from ford because ford had so much excess cash. Since Ford did not have a good reason for not awarded their stockholders dividends the court awarded the stockholders dividends. Hilary Sale thinks this court violated the company's BJR.

How can one bring a successful breach of duty of good faith claim?

The duty of good faith is a very high bar. 1. Where the fiduciary intentionally acts with a purpose other than that of the advancing the best interests of the corporation. 2. Fiduciary acts with the intent to violate applicable positive law 3. Fiduciary intentionally fails to act in the face of known duty to act, demonstrating a conscious disregard for his duties. (Stone v. Ritter)

Does a corporation have to use Best Practices

The framework just has to be okay. For example, Even though court in Disney found for the directors, they say if they used spreadsheets/documentation, there would be no issue.

Aronson v. Lewis (DE Supreme Court 1984)- 402

This case is significant because it gives us the Aronson test. The Meyers Shareholders think that Fink, the former officer and now consultant is being paid to much money for no work. They said demand is futile because he put them all on the board.

In Re The Limited, Inc. Shareholders Ligation (DE 2002)

This is a issue about independent directors under Aronson's first prong. There were 2 transactions done by the board (A dutch auction is a form of tender offer in which the selling stockholders, rather than the buyer determine the price to be paid for the shares purchased and redemption agreement for trust) that are though to be done for Wexner's benefit. Success under 1st prong: Wexner was interested. Many were not independent based on proportion of income and the president of university.

Gifford

This is significant because it is an issue under Aronson 2nd prong. That it was not a business judgement. Because the stock option plans required that "the exercise price of each option shall be not less than one hundred percent of the FMV of the stock." Board had no discretion to change it. Knowing and intentional violations of the stock option plans according to the plaintiff cannot be exercise of bj. Therefore demand is futile

What does Shelensky Show us?

This is the baseball case where the shareholders wanted to host night games. it is not the shareholder's decision to make choices for the company, that directors get the benefit that decision so long as it was formed in good faith and the best interest of the company

What is the Zapata 2 Prong Test

To find out if demand on an independent committee's dismissal of the case was wrongful. Good Faith/Independence(1) The court should inquire into the independence and good faith of committee and the bases supporting it conclusions (Burden Corp) (2) Court's Independent Judgment(2) The Court's independent business judgment is satisfied. the Court may proceed to grant the motion: could arise where committee can establish it independence and sound bases for it good faith decisions and still have the corporation's motion denied. This step to to insure that the corporation does not prematurely terminate a stockholder grievance deserving of further consideration in the corporation's interest.

Stakeholder Claim

Very Low Concern, yet still valid. The argument that the business decision may affect the surrounding neighborhood (Shelenksy) or that it will affect the employees.

Why do we have the business judgment rule?

We Trust the directors with the business management to balance the needs of the shareholders with needs of running the company. We don't want hindsight judgements

What is Self Dealing?

Where one person has a foot on both sides on a parent and subsidiary deal. The parent owes a subsidiary a fiduciary duty when there is a parent-subsidiary dealing. These transactions are normally given the Business Judgement Rule standard.

What is the key difference between the Delaware Guth Test and the ALI?

You don't have to present to the board the opportunity. But Safe Harbor: But if you do present, you get a safe harbor against breach. Hilary Sale "When in doubt present"!

Basics of the BJR with 102b7

You want to show the the directors breached a duty. More than care if you don't want to exculpated. If P's meet his burden, the burden then shifts to the D directors to rebut the presumption that they were not disinterested and independent, reasonably informed, and in good faith (The Limited case).

Waste Doctrine

allows courts to find directors liable where direct proof of lack of care or loyalty is lacking, but the substantive decision seems explainable only as a product of the director's failure to carry out their fiduciary responsibilities. High Bar! (Claim the plaintiffs tried to make in Disney about Ovitz Contract)

What does it mean to be an independent director?

director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences. Must plead particularized facts sufficient to overcome presumptions of independence and proper exercise of business judgment (Limited)

What is a derivative suit?

suing about a business decision on behalf of the corporation the plaintiff steps into the shoes of the corporation. Asking the corporation for permission to sue them also known as demand. Based on your rights as a shareholder.