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Is there room for liability — and thus judicial involvement — in corporate decision-making, outside of self-dealing? Applying the business judgment rule, Delaware courts hardly ever sanction managers and boards absent self-dealing. Nor do other states’ courts. In a well-known case, the New York Supreme Court absolved American Express's board of liability even though they had forgone an $80 million tax benefit (in today's money) without any convincing countervailing benefit. Some have called this area of the law the “law of director non-liability.”
This raises two questions: Why no liability? And if there truly is no liability, why not say so outright and save the expense and distraction of litigation?
Importantly, the cases in this area still involve conflicts of interest, albeit of a subtler kind than the outright financial or similarly strong conflicts giving rise to claims of self-dealing. Boards' and managers' interests diverge from shareholders' interests at least inasmuch as the former have to do all the work but surrender most of the benefits to the latter, incentive compensation notwithstanding. As you read the cases, you should be on the lookout for more specific conflicts.EDIT PLAYLIST INFORMATION DELETE PLAYLIST
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|1||Show/Hide More||Smith v. Van Gorkom (Del. 1985)|
This is the one case where Delaware courts imposed monetary liability on disinterested directors for breach of the duty of care. It caused a storm. Liability insurance rates for directors skyrocketed. The Delaware legislature intervened by enacting DGCL 102(b)(7), which allows exculpatory charter provisions to eliminate damages for breaches of the duty of care. Such charter provisions are now standard. Even without them, however, it is unlikely that a Delaware court would impose liability on these facts today. The courts seem to have retrenched — not in their doctrine but in how they apply it. Cf. Disney below.
You should, therefore, read the case not as an exemplary application of the duty of care, but as a policy experiment: why is the corporate world so opposed to monetary damages on these facts?
The case involves the acquisition of the Trans Union Corporation by Marmon Group, Inc. As is typical, the acquisition is structured as a merger. The acquired corporation (the “target”) merges with the acquiror (the “buyer”) or one of the buyer's subsidiaries. In the merger, shares in the target are extinguished. In exchange, target shareholders receive cash or other consideration (usually shares in the buyer).
Under most U.S. statutes such as DGCL 251, the merger generally requires a merger agreement between the buyer and the target to be approved by the boards and a majority of the shareholders of each corporation. This entails two important consequences.
First, the board controls the process because only the board can have the corporation enter into the merger agreement. This is one example of why it is at least misleading to call shareholders the “owners of the corporation.”
Two, in public corporations, the requirement of shareholder approval means that several months will pass between signing the merger agreement and completion of the merger. This is the time it takes to convene the shareholder meeting and solicit proxies in accordance with the applicable corporate law and SEC proxy rules. Of course, many things can happen during this time. In particular, other potential buyers may appear on the scene.
1. According to the majority opinion, what did the directors do wrong? In other words, what should the directors have done differently? Why did the business judgment rule not apply?
2. What are the dissenters’ counter-arguments?
3. How do you think directors in other companies reacted to this decision — what, if anything, did they most likely do differently after Van Gorkom?
|2||Show/Hide More||In re Walt Disney Co. Derivative Litigation (Del. 2006)|
After Smith v. Van Gorkom, Disney is the closest Delaware courts have come to imposing monetary liability on disinterested directors. The litigation was heavily colored by Disney's 102(b)(7) waiver, which Disney and most other large corporations had adopted after Van Gorkom. The Delaware Supreme Court, however, chose first to make an affirmative finding that the defendants met even the default standard of due care. As you read that part of the opinion (chiefly IV.A.1), ask yourself why the court reached the opposite result from Van Gorkom:
1. Did the court apply different law, i.e., did it overrule Van Gorkom, explicitly or implicitly?
2. Did the case present materially different facts? The Disney court certainly paints a more favorable picture of the board process than the Van Gorkom court. But were the processes substantively different? Imagine you are the plaintiffs' lawyer (or a judge in the Van Gorkom majority) and try to recast the Disney facts in a light less favorable to the defendants.
The Disney court next addresses “good faith,” which is a necessary condition for liability protection under DGCL 102(b)(7) (as well as for indemnification under DGCL 145(a) and (b)).
1. How does the court interpret “good faith”?
2. How does “good faith” relate to the duty of care and the duty of loyalty?
3. Was addressing both “good faith” and the default standard of due care necessary for the court’s decision of the case? If not, why did it?
|3||Show/Hide More||Stone v. Ritter (Del. 2006)|
The business judgment rule, as authoritatively stated in Aronson and applied in Disney, should provide comfort to directors and officers even in the absence of a 102(b)(7) waiver (which does not cover officers). For a long time, however, directors and officers might have been worried by the following passage from Aronson:
“However, it should be noted that the business judgment rule operates only in the context of director action. Technically speaking, it has no role where directors have either abdicated their functions, or absent a conscious decision, failed to act.”
Aronson v. Lewis, 473 A.2d 805, at 813 (Del. 1984).
To be sure, Aronson continued that “a conscious decision to refrain from acting may nonetheless be a valid exercise of business judgment and enjoy the protections of the rule” and acknowledged in a footnote to the quoted paragraph that “questions of director liability in such cases have [nevertheless] been adjudicated upon concepts of business judgment” (emphasis added). Doubts remained, however, and were only amplified by Chancellor Allen’s famous 1996 Caremark decision, which mused that the absence of a reporting system could give rise to liability. Stone addressed this question.
1. What is the rule of Stone: what is the liability standard for oversight failures?
2. How does the rule compare to the business judgment rule – is it more or less lenient for defendants, doctrinally speaking?
3. Do you think the doctrinal difference matters in practice?
4. What is the role of DGCL 102(b)(7) in this case?
December 07, 2017
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