#11132 - Fiduciary Duties - Corporations

Fiduciary Duties

1. In General

   1. Requires directors to act in the corporation's best interests and to exercise reasonable care in making decisions and overseeing the corporation's affairs.

   2. The business judgment rule is an acknowledgment of the managerial prerogatives of Delaware directors under DGCL § 141(a). Aronson v. Lewis

   3. The Business Judgement Rule creates "a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in honest belief that the action taken was in the best interests of the company." Aronson v. Lewis

   4. The burden is on the party challenging the decision to establish facts rebutting the presumption. Aronson v. Lewis

      1. Aside: MBCA § 8.30 provides for Standards of Conduct while Standards of Liability are provided for in MBCA § 8.31

         • MBCA § 8.30(a) provides that "[e]ach member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation."

   5. Duty of Care: The duty of care requires a director to act in the corporation's best interests and to exercise reasonable care in overseeing the corporation's affairs and in making business decisions.

      1. Breach of the Duty of Care: To rebut the BJR and show a breach of the duty of care, the plaintiff must show "gross negligence"

         • (1) "[G]ross negligence is conduct that constitutes reckless indifference or actions that are without the bounds of reason." McPadden v. Sidhu

           • This is essentially the duty not to make stupid decisions

         • MBCA § 8.30(b) calls on directors to "discharge their duties with the care that a reasonable person in a like position would reasonably believe for appropriate under similar circumstances."

           • "[A] director is held to the standard of that degree of care that an ordinary prudent director would use under the circumstances." Francis v. United Jersey Bank

           • McPadden v. Sidhu was a case of misfeasance (rather than nonfeasance). In that context, it is much more likely that the breach would be simply gross negligence and not a breach of the duty of good faith, under the duty of loyalty. In that case, the court determined that the directors were grossly negligent, but that there was no bad faith, where (1) the directors put Director Dubreville in charge of the sale of a subsidiary when they knew he was personally interested in the transaction, (2) the directors engaged in little or no oversight of the process, (3) the directors knew that the sale was going forward with only a half-hearted attempt to get competing bids (even from a company that had previously bid significantly higher than the ultimate sale price, (4) the directors knew that the valuation of the subsidiary was prepared at the direction of Dubreville, and (5) the board agreed to the sale at the low end of the range within the valuation.

             • The reason that this was not found to be bad faith, but only "reckless indifference or actions that are without the bounds of reason" is that the board at least followed a process. Where a process is at least in place and followed, it is unlikely to be bad faith. See McPadden v. Sidhu

               • Thus, in the malfeasance context, it is much more likely to be a breach of the duty of care than a breach of the duty of loyalty

         • (2) Waste

           • "[W]aste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade." Lewis v. Vogelstein

         • (3) Duty to be Informed (Also likely a breach of duty of loyalty for failure to monitor)

           • Acting based on inadequate information

             • The test is whether the directors have informed themselves "prior to making a business decision, of all material information reasonably available to them." Smith v. Van Gorkom

               • "The issue of whether the directors reached an informed decision . . . must be determined only upon the basis of the information then reasonably available to the directors and relevant to their decision . . . ." Smith v. Van Gorkom

               • Under DGCL § 141(e), "directors are fully protected in relying in good faith on reports made by officers." See also, MBCA § 8.30(d) (providing that the board is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, prepared or presented by officers, public accountants, committees, and legal counsel)

                 • The term "report" has been liberally construed to include reports of informal personal investigations by corporate officers. Smith v. Van Gorkom

                 • At a minimum for a report to enjoy the status conferred by § 141(e), it must be pertinent to the subject matter upon which a board is called to act, and otherwise be entitled to good faith, not blind, reliance. Smith v. Van Gorkom

               • In Smith, the court determined that the directors were grossly negligent and therefore breached their duty of care as the directors (1) not adequately inform themselves as to the Chairman and CEO Van Gorkom's role in forcing the sale of the company and in establishing the per share purchase price, (2) were uninformed as to the intrinsic value of the company, and (3) given the circumstances the directors were grossly negligent in approving the sale of the company upon two hours consideration, without prior notice, and without exigency of the crisis or emergency.

                 • Thus, the factors to consider re duty to be informed is (1) role of other directors in influencing the sale, (2) whether informed with respect to the value of the company, (3) time frame upon which the board considered the transaction and whether there was notice of what would be considered at the meeting and whether there was emergency or exigency.

         • Where the BJR rule is rebutted, the burden shifts to the defendants to show the entire fairness. CDX Liquidating Trust v. Venrock Associates

           • Entire Fairness Standard

             • Fairness has two basic aspects:

               • (1) Fair Dealing: "embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained." Weinberger v. UOP

                 • Some Courts have held that failure to make full disclosure constitutes per se unfairness. See State ex rel. Hayes Oyster Co. v. Keypoint Oyster Co.

               • (2) Fair Price: "relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock." Weinberger v. UOP

                 • Traditional concept of Fair Price: the range of values that two independent parties might agree to in an arms-length transaction

             • However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness. Weinberger v. UOP

             • "[I]n a non-fraudulent transaction we recognize that price may be the preponderant consideration outweighing other features of the merger." Weinberger v. UOP, Inc. - pg. 881

             • "Part of fair dealing is the obvious duty of candor." Weinberger v. UOP, Inc. - pg. 881

   6. Duty of Loyalty: The duty of loyalty requires a director to place the best interests of the corporation above his or her personal interests.

      1. Breach of the Duty of Loyalty: The BJR rule can be rebutted by:

         • (1) Conflict of Interest

           • DGCL

             • Where one or more directors or officers have a financial interest in a transaction, the duty of loyalty is implicated and we look to DGCL § 144.

               • Interested: (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 OR the director stands on both sides of the challenged transaction. Orman v. Cullman - pg. 752

               • e.g. self-dealing

               • BUT, the mere threat of personal liability is insufficient to render a director interested in a transaction. In re InfoUSA, Inc. Shareholders Litigation

               • Under DGCL § 144(a), where it has been shown that one or more of the directors or officers have a financial interest, such a conflict of interest transaction is not void or voidable solely because of the director or officer's financial interest if the defendants can show:

                 • (1) the transaction is approved by a majority of the disinterested directors, of whom are fully informed of all material facts, even if the disinterested directors be less than a quorum;

                 • Although the statute doesn't specifically require independence as well, over time the distinction between disinterested and independent under Delaware Law has been blurred. Although I will not superimpose the requirement that the directors also be "independent," it is certainly a stronger case if they are.

                 • "An omitted fact is material if there is a substantial likelihood that a reasonable [directors] would consider it important in deciding how to vote." See TSC Industries, Inc. v. Northway, Inc. - pg. 558

                 • (2) the transaction is ratified by a majority of the disinterested stockholders, of whom are fully informed of all material facts; OR

                 • Even though the statute does not...