How many masters can a director serve? A look at the tensions facing constituency directors

Business Lawyer

Volumn 63, Issue 3, 2008, Pages 761-775

  Veasey, E Norman ^a,b   Di Guglielmo, Christine T ^a  

^a Weil Gotshal and Manges LLP   (United States)

^b Weil Gotshal and Manges LLP   (United States)

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EID: 49449095641     PISSN: 00076899     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (47)

1. See, e.g., In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 697 (Del. Ch. 2005) ("Unlike ideals of corporate governance, a fiduciary's duties do not change over time"), aff'd, 906 A.2d 27 (Del. 2006); cf. E. Norman Veasey with Christine T. Di Guglielmo, What Happened in Delaware Corporate Law and Governance from 1992-2004? A Retrospective on Some Key Developments, 153 U. PA. L. REV. 1399, 1405 (2005) (distinguishing standards of conduct from standards of review and stating that "[t]he expectations for director conduct evolve over time as business mores evolve, with courts applying the evolving expectations in a common law process in deciding the proper standard of review to apply in specific circumstances" and that "[t]here has been no change in Delaware law of the time-honored business judgment rule, which remains alive and well").
2. See, e.g., Disney, 907 A.2d at 697-98 ("How we understand those duties may evolve and become refined, but the duties themselves have not changed .... Fiduciaries who act faithfully and honestly on behalf of those whose interests they represent are indeed granted wide latitude in their efforts to maximize shareholders' investment. Times may change, but fiduciary duties do not.").
3. See Veasey & Di Guglielmo, supra note 1, at 1436-39 (discussing the "evolving expectations" of directors); see also Disney, 907 A.2d at 760 n.487 (hinting that post-Disney there might be a higher bar for good faith as a result of the Disney decision itself).
4. See, e.g., Cyril Moscow, The Representative Director Problem, INSIGHTS, June 2002, at 6 (noting many of these categories of representative directors); cf. also Terence Woolf, Note, The Venture Capitalist's Corporate Opportunity Problem, 2001 COLUM. BUS. L. REV. 473, 473 (suggesting that application of the traditional duty of loyalty rubric and corporate opportunity test in the venture capital context "has the potential to harm capital formation and business development" because they are based on an "anachronistic and ineffectual" "notion that directors and officers owe their undivided loyalty to a single company and its shareholders").
5. See Bayless Manning, Reflections and Practical Tips on Life in the Boardroom After Van Gorkom, 41 BUS. LAW. 1, 5-6 (1985) (comparing "enterprise issues" and "ownership claim issues").
6. To be sure, there will be some investors, including some hedge funds, whose time horizons are short, and whose investment strategy is to maximize their return quickly.
7. See Dodge v. Ford Motor Co., 170 N.W 668, 684 (Mich. 1919) (suggesting that duty is owed primarily to the stockholders, but the corporation is a proxy for the stockholders in most circumstances); cf. also Int'l Bhd. of Teamsters Gen. Fund v. Fleming Cos., Inc., No. CIV-96-1650-A, 1997 U.S. Dist. LEXIS 2979, at *2 (WD. Okla. Feb. 19, 1997) (stating that a corporation's stockholders "are, in fact, the corporation").
8. Compare, e.g., N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007) ("It is well settled that directors owe fiduciary duties to the corporation."); Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006) ("'[A] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest.'" (quoting Guttman v. Huang, 823 A.2d 492, 506 n.34 (Del. Ch. 2003))); Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (stating that the business judgment rule is a presumption that "in making a business decision the directors of a corporation acted ... in the best interests of the company"), with Gheewalla, 930 A.2d at 99 ("It is well established that the directors owe their fiduciary obligations to the corporation and its shareholders."); Mills Acquisition Co. v. MacMillan, Inc., 559 A.2d 1261, 1280 (Del. 1989) ("[T]he directors owe fiduciary duties of care and loyalty to the corporation and its shareholders ...."); Revlon, Inc. v. MacAndres & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1986) ("[T]he directors owe fiduciary duties of care and loyalty to the corporation and its shareholders.").
9. See, e.g., ALI PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS § 2.01 cmt. f (1994) ("Activity that entails a short-run cost to achieve an appropriately greater long-run profit is therefore not a departure from the economic objective. An orientation toward lawful, ethical, and public-spirited activity will normally fall within this description."); ABA SECTION OF BUS. LAW, COMM. ON CORPORATE LAWS, CORPORATE DIRECTOR'S GUIDEBOOK 31 (5th ed. 2007), in 62 BUS. LAW. 1482 (2007) ("Compliance with environmental standards ... is particularly important, because violations can in many cases have a material financial effect on the corporation .... Global warming and being a 'green company' are other examples of environmental issues that can affect business reputation, culture, and morale."); Ira M. Millstein, Holly J. Gregory & Rebecca C. Grapsas, Rethinking Board and Shareholder Engagement in 2008, Weil Gotshal & Manges Corporate Governance Advisory Memorandum (Jan. 2008), http://www.weil.com/news/ pubdetail.aspx?pub=6382 ("Shareholders have legitimate interests in information about corporate policies and practices with respect to social and environmental issues such as climate change, sustainability, labor relations and political contributions. These issues ... bear on the company's reputation as a good corporate citizen and consequently, the perceived integrity of management and the board."); see also Kelly v. Bell, 266 A.2d 878, 879 (Del. 1970) (noting that when directors decided to cause corporation to make voluntary "tax" payments they "believed with good reason that [the corporation] would derive substantial benefit therefrom - a belief which has apparently proven justified").
10. The business judgment rule "is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson, 473 A.2d at 812. Where the business judgment rule presumption applies, a board's decision "will be upheld unless it cannot be 'attributed to any rational business purpose.'" Disney, 906 A.2d at 74.
11. See generally Veasey & Di Guglielmo, supra note 1, at 1506 (discussing trends in best practices and explaining that "counseling directors to 'do the right thing' is a proper function of the courts as well as counsel"); CORPORATE DIRECTOR'S GUIDEBOOK, supra note 9, at 3 (noting the link between conscientious conduct by directors and reduced risk of liability).
12. N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 99 (Del. 2007) (holding that creditors of a corporation in the zone of insolvency may not assert direct claims for breach of fiduciary duty because they are protected by contract terms, fraudulent conveyance law, and other law, while fiduciary duties exist to protect stockholders). But see cases cited supra note 8 (reciting that directors' fiduciary duties run "to the corporation.").
13. Cf. ABA Section of Bus. Law, Comm. on Corporate Laws, Guidelines for the Unaffiliated Director of the Controlled Corporation, 45 BUS. LAW. 429, 430 (1989) (evaluating the roles of "affiliated" as compared with "unaffiliated" directors of a controlled corporation and stating that "[a]ll directors have the same duties to the corporation and to all of its shareholders"); cf. also Phillips v. Insituform of N. Am., Inc., Civ. A. No. 9173, 1987 Del. Ch. LEXIS 474, at *30 (Aug. 27, 1987) ("[T]he law demands of directors ... fidelity to the corporation and all of its shareholders and does not recognize a special duty on the part of directors elected by a special class to the class electing them ....").
14. See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985) ("[O]ur analysis begins with the basic principle that corporate directors have a fiduciary duty to act in the best interests of the corporation's stockholders.").
15. See, e.g., Unocal, 493 A.2d at 955 (stating that in responding to a takeover bid, directors may consider, among other things, "the impact on 'constituencies' other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally"); Eric J. Gouvin, Resolving the Subsidiary Director's Dilemma, 47 HASTINGS L.J. 287, 297 (1996) ("Two celebrated Delaware cases support the discretion of directors under the business judgment rule to make the best decision for the corporation, even if the shareholders would have preferred other action.");
16. Robert A. McCormick, Union Representatives as Corporate Directors: The Challenge to the Adversarial Model of Labor Relations, 15 U. MICH. J.L. REFORM 219, 247 n.132 (1982) ("There is a division of authority regarding whether a corporate officer's fiduciary duty runs to the corporation as an entity, or to the shareholders themselves. The weight of authority, however, holds that a director's duty runs to the corporation. As a result, a majority of courts will not void a board decision that is fair and reasonable to the corporation, merely because a director with an outside interest participated in making the decision." (citations omitted)); cf. Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998) ("The directors of Delaware corporations stand in a fiduciary relationship not only to the stockholders but also to the corporations upon whose boards they serve.... Although the fiduciary duty of a Delaware director is unremitting, the exact course of conduct that must be charted to properly discharge that responsibility will change in the specific context of the action the director is taking with regard to either the corporation or its shareholders."). In some states, corporation law statutes explicitly require or permit directors to take into account the interests of non-stockholder constituencies when considering a takeover.
17. See Roberta Romano, A Guide to Takeovers: Theory, Evidence, and Regulation, 9 YALE J. ON REG. 119, 171-73 (1992) (providing an overview of such "other constituency" statutes).
18. See Gheewalla, 930 A.2d at 101 ("Delaware corporate law provides for a separation of control and ownership. The directors of Delaware corporations have 'the legal responsibility to manage the business of a corporation for the benefit of its shareholders owners.' Accordingly, fiduciary duties are imposed upon the directors to regulate their conduct when they perform that function." (footnotes omitted)).
19. See, e.g., id. at 99 ("While shareholders rely on directors acting as fiduciaries to protect their interests, creditors are afforded protection through contractual agreements, fraud and fraudulent conveyance law, implied covenants of good faith and fair dealing, bankruptcy law, general commercial law and other sources of creditor rights.").
20. ALI PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS § 2.01 cmt. f (1994).
21. See, e.g., Gheewalla, 930 A.2d at 103 (describing the fiduciary duties of directors of an insolvent corporation as a "duty to maximize the value of the insolvent corporation for the benefit of all those having an interest in it"); Unocal, 493 A.2d at 954 ("[T]the board's power to act derives from its fundamental duty and obligation to protect the corporate enterprise, which includes stockholders ...."); Gouvin, supra note 15, at 294-95 ("Well-established law in Delaware and other jurisdictions holds that the directors of corporations owe fiduciary duties to both the corporation and its shareholders. The Delaware Supreme Court has recently stated that these two duties are 'of equal and independent significance,' but case law reveals that the directors' duty to the corporation as an entity usually predominates over their duty to the shareholders." (footnotes omitted) (quoting Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 367 (Del. 1993))); see also E. Norman Veasey, Counseling the Board of Directors of the Company in Distress, AM. BANKR. INST. J. (forthcoming 2008).
22. Cf. CORPORATE DIRECTOR'S GUIDEBOOK, supra note 9, at 2 ("In some cases, a board may even make a decision, in good faith, knowing that a substantial percentage of shareholders might disagree with that decision.").
23. Moscow, supra note 4, at 4 (discussing insistence of union president on Chrysler Corporation's board that the proxy statement disclose that he was joining the board to represent labor interests).
24. Cf. Paramount Commc'ns Inc. v. QVC Network Inc., 637 A.2d 34, 51 (Del. 1994) (explaining that fiduciary duties may not be limited or defined by contract); R. Franklin Balotti & A. Gilchrist Sparks, III, Deal-Protection Measures and the Merger Recommendation, 96 NW. U. L. REV. 467 (2002) (exploring the juxtaposition of contract and fiduciary principles in light of QVC and Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985)). Consider also that preferred stockholders' rights may be grounded in a blend of contract and fiduciary principles. Cf. Kaiser Aluminum Corp. v. Matheson, 681 A.2d 392 (Del. 1996).
25. Cf. Equity-Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1042 (Del. Ch. 1997) ("While the facts out of which this dispute arises indisputably entail the imposition by the board of (or continuation of) economic risks upon the preferred stock which the holders of the preferred did not want, and while this board action was taken for the benefit largely of the common stock, those facts do not constitute a breach of duty"). While the BioMed scenario is based on the facts in Equity-Linked, the discussion in Equity-Linked of the duty of the directors to the common stockholders vis-à-vis the preferred stockholders is dicta. The plaintiff-preferred stockholders in Equity-Linked, perhaps recognizing the principle that directors of a corporation generally do not owe fiduciary duties to preferred stockholders, brought a claim under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1985). In that claim, the plaintiffs contended that the financing transaction in that case constituted a change of control transaction in which the directors owed a duty to the stockholders to obtain the best price reasonably available. The decision does not suggest that the preferred stockholders had any representatives on the board.
26. See Equity-Linked, 705 A.2d at 1042 ("[T]he board in these circumstances could have made a different business judgment ...."). But cf. id. ("The special protections offered to the preferred are contractual in nature. The corporation is, of course, required to respect those legal rights. But, aside from the insolvency point just alluded to, generally it will be the duty of the board, where discretionary judgment is to be exercised, to prefer the interests of common stock - as the good faith judgment of the board sees them to be - to the interests created by the special rights, preferences, etc., of preferred stock, where there is a conflict." (citation omitted)).
27. But cf. Orban v. Field, Civ. A. No. 12820, 1997 Del. Ch. LEXIS 48, at *28-29 (Apr. 1, 1997) (assuming that the business judgment rule did not apply to a board's "authoriz[ation of] a non-pro-rata redemption of preferred shares for the purpose of funding the exercise by holders of preferred stock of Warrants to buy common stock" in order to facilitate a merger in which the merger proceeds covered part of the value of the preferred stockholders' contractual preferences but left the common stockholders with nothing and stating that "[a] board may certainly deploy corporate power against its own shareholders in some circumstances - the greater good justifying the action - but when it does, it should be required to demonstrate that it acted both in good faith and reasonably").
28. Cf. id. at *32-33 (holding that directors did not breach a duty of loyalty by choosing a transaction that gave effect to the "existing legal preferences" of preferred stockholders because the common stockholders had "no legal right to a portion of the merger consideration under Delaware law or the corporate charter" and the transaction "appeared reasonably to be the best available transaction").
29. See, e.g., Thorpe ex rel. Castleman v. CERBCO, Inc., 676 A.2d 436, 443 n.9 (Del. 1996) ("The premise of the entire fairness test is that the business judgment rule is inapplicable where self-interest may have colored directors' actions."); Nixon v. Blackwell, 626 A.2d 1366, 1376 (Del. 1993) (explaining that when a business decision is made by an interested or non-independent decision maker, the decision will be subject to entire fairness review).
30. Note the recent imbroglio reported in the Wall Street Journal involving the board of the Hershey company when its largest stockholder, the Hershey Trust, asserted rights to appoint or remove five of the corporation's six directors and effectively replaced with its own nominees the company directors with whom the Trust disagreed. See Julie Jargon, Matthew Kamitschnig & Joann S. Lublin, How Hershey Went Sour, WALL ST. J., Feb. 23, 2008, at B1.
31. Cf. MODEL BUS. CORP. ACT § 7.32 (2005) (authorizing shareholder agreements, approved by all shareholders, that modify default rules governing, for example, "the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation").
32. See Moscow, supra note 4, at 6 ("The basic assumption should be that most close corporation directors are representatives. At that extreme, self interested actions can be bounded by a fairness doctrine which would monitor conduct that reflects an abuse of power that is not within the expected range of the bargain of the shareholders.").
33. Contrast the board involvement in the suggested situation with usurpation of a corporate opportunity without disclosure to the board.
34. DEL. CODE ANN. tit. 8, § 122(17) (2001).
35. DEL. CODE ANN. tit. 8, § 141(a) (2001); see also Nixon v. Blackwell, 626 A.2d 1366, 1379-80 (Del. 1993) (observing that a purchasing minority stockholder may bargain for "definitive provisions of self-ordering" or other agreements to protect his or her position).
36. See, e.g., DEL. CODE ANN. tit. 6, § 18-1101(c) (2005) (permitting an LLC agreement to expand, restrict, or eliminate the fiduciary duties of a member, manager, or other person otherwise owing fiduciary duties to an LLC or a member, manager, or other person bound to an LLC agreement); DEL. CODE ANN. tit. 6, § 17-1101(d) (2005) (same in limited partnership context).
37. CORPORATE DIRECTOR'S GUIDEBOOK, supra note 9, at 1487.
38. See Aronson v. Lewis, 473 A.2d 805, 812, 814 (Del. 1984); cf. also DEL. CODE ANN. tit. 8, § 144 (2001).
39. CORPORATE DIRECTOR'S GUIDEBOOK, supra note 9, at 1487; cf. also In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 748 (Del. Ch. 2005) (noting the recent understanding in Delaware case law that director liability determinations must be made on a director-by-director basis), aff'd, 906 A.2d 27 (Del. 2006).
40. Posting of Joseph Hinsey to the Harvard Law School Corporate Governance Blog, http://blogs.law.harvard.edu/corpgov/2008/01/14/the-constituency-director (Jan. 14, 2008, 15:26 EST) ("The Constituency Director"); see also Moscow, supra note 4, at 2 ("The problem arises under the corporate norm when expected advocacy by a representative director evolves into action of the director, whether in considering transactions with the sponsor, a veto of a corporate action, information sharing or other actions that may benefit the sponsor.").
41. See Moscow, supra note 4, at 4 (discussing proxy disclosures of Chrysler Corporation regarding role of UAW's representative on the Chrysler board).
42. See, e.g., DEL. CODE ANN. tit. 8, § 144(a) (2001) (providing that an interested director transaction shall not be void or voidable solely because the interested director participates in the decision-making process or votes in favor of the transaction, if the director's interest is disclosed to the board and a majority of the disinterested directors approve the transaction); Aronson, 473 A.2d at 812 ("[I]f such director interest is present, and the transaction is not approved by a majority consisting of the disinterested directors, then the business judgment rule has no application whatever in determining demand futility"); id. at 814 (holding that demand will be futile and therefore excused under Court of Chancery Rule 23.1 if a majority of the board approving a challenged transaction was interested in the transaction).
43. See, e.g., Beam v. Stewart, 845 A.2d 1040 (Del. 2004).
44. For cases outlining the parameters of directors' duty to protect confidential information, see, for example, Malone v. Brincat, 722 A.2d 5, 12 (Del. 1998); Stroud v. Grace, 606 A.2d 75, 89 (Del. 1992); In re Oracle Corp. Derivative Litigation, Civ. A. No. 18751, 2004 Del. Ch. LEXIS 173, at *90 (Nov. 24, 2004); Lazard Debt Recovery GP, LLC v. Weinstock, Civ. A. No. 19053, 2004 Del. Ch. LEXIS 109 (Aug. 6, 2004); Hollinger International v. Black, 844 A.2d 1022, 1061-62 (Del. Ch. 2004); and Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949).
45. See, e.g., Moscow, supra note 4, at 5, 7 (describing the duty of loyalty standard as "rigid" and stating that "the standard corporate model is simplistic and unworkable as a rigid guide").
46. See, e.g., Woolf, supra note 4, at 473 (suggesting that application of the traditional fiduciary duty standards in the venture capital context "has the potential to harm capital formation and business development" because the standards are based on an "anachronistic and ineffectual" "notion that directors and officers owe their undivided loyalty to a single company and its shareholders").
47. Cf. Beam v. Stewart, 845 A.2d 1040, 1049 (Del. 2004) ("The primary basis upon which a director's independence must be measured is whether the director's decision is based on the corporate merits of the subject before the board, rather than extraneous considerations or influences.").