10. BA Corporate Litigation

A board member is accused of violating her duty of loyalty by entering into a self-dealing transaction with the corporation. The self-dealing transaction sells an asset to the director, allegedly at a deep discount.

Is the lawsuit direct or derivative?

A. Direct because selling the asset at too low of a price directly harms shareholders by lowering the value of their shares.

B. Derivative because it is the corporation that is harmed and the corporation would receive the recovery.

B. Derivative because it is the corporation that is harmed and the corporation would receive the recovery.

Good answer! For this purpose, any breach of fiduciary duty by a director or officer is considered harm to the corporation. We might say that the duty was owed first and foremost to the corporation and only indirectly to the shareholders.

If a majority of directors are named in a lawsuit challenging a transaction, demand is excused.

True

False

False

Right. What we need for demand to be excused is a majority of the board to have an interest in the challenged transaction (or to face substantial likelihood of liability or to be under control of wrongdoers).

If a majority of directors approved a transaction being challenged in a lawsuit, demand is excused.

True

False

False

We're still looking for a majority of the board to have a financial or material interest in the challenged transaction (or to face substantial likelihood of liability or to be under control of wrongdoers). E.g., demand would be excused if a majority of the board got a cut of a self-dealing transaction that a shareholder now wanted to challenge.

Demand is excused if a majority of directors are employed by a controlling shareholder who enters into a transaction with the company that shareholders challenge in a lawsuit.

True

False

True

Here we go. A majority of directors aren't independent from the wrongdoer (the controlling shareholder).

If a plaintiff can somehow plead facts showing that the board approved a $100 billion transaction based on an incoherent 30 minute presentation from the company’s CEO, demand is excused for a lawsuit challenging that transaction.

True

False

True

Right. It doesn't sound like a valid exercise of business judgment so there is a substantial likelihood of liability due to the challenged conduct.

A corporation has a board that consists of the company's CEO and three outside directors who have no relationship to the company or the CEO. At a board meeting, the full board approves a rich compensation package to the CEO. Prior to approving the compensation package, the board reviewed full versions of the agreements, conferred extensively with the company's compensation consultant, and suggested many modifications to the original proposed documentation.

In a lawsuit against the board alleging breach of fiduciary duty for approving the CEO compensation package, would demand be excused?

A. Yes because the CEO participated in deliberations and has a material financial interest in the transaction.

B. Yes because a majority of the board voted for the compensation package and is named in the lawsuit.

C. No because a majority of the board is disinterested (for this purpose) and exercised valid business judgment.

D. No because the three independent directors constitute a special litigation committee.

C. No because a majority of the board is disinterested (for this purpose) and exercised valid business judgment.

Right! Only the CEO has a material financial interest in the transaction. Believe it or not, it's not enough that a majority of the board approved the compensation and is named in the lawsuit.

A corporation has a board that consists of the company's CEO and three outside directors who have no relationship to the company or the CEO. At a board meeting, the full board approves a rich compensation package for the outside directors. Prior to approving the compensation package, the board reviewed full versions of the agreements and conferred extensively with the company's compensation consultant.

In a lawsuit against the board alleging breach of fiduciary duty for approving the director compensation package, would demand be excused?

A. No because a majority of the board is independent.

B. No because it is not enough that a majority of the board is named in the lawsuit.

C. Yes because this is not an exercise of valid business judgment.

D. Yes because a majority of the board has a financial interest in the challenged transaction.

D. Yes because a majority of the board has a financial interest in the challenged transaction.

Right! A majority of board members are voting on their own compensation.

Same facts as last question. Because demand is excused, the plaintiffs bring the lawsuit without making demand on the board. Nonetheless, the company finds two new directors and asks them to independently assess whether the lawsuit has merit and is in the best interests of the company to pursue. The committee is provided a significant budget to hire a law firm and its own compensation consultant. In a 100-page report, they detail how the director compensation at issue is in fact below the median compensation for public company directors, and how the publicity from the lawsuit is having a concrete adverse effect on the ability of the company to recruit talented board members. The committee recommends that the lawsuit be dismissed.

Are the committee's conclusions likely to be given any weight by a court?

A. No because demand was excused so the shareholders get to make decisions about the suit.

B. No because bad publicity is an inappropriate reason to drop a case.

C. Yes because the business judgment rule applies to special litigation committee recommendations pursuant to the second step of Zapata.

D. Yes because the special litigation committee likely has found compelling reasons to dismiss the suit.

D. Yes because the special litigation committee likely has found compelling reasons to dismiss the suit.

Right! Of course the court will take a hard look at the committee and will exercise its own judgement. But it looks good for the SLC so far based on these facts.

Which of the following might be a valid reason for a special litigation committee to recommend that a derivative suit be dropped?

A. The suit just doesn't seem to have any merit.

B. Bad publicity from the suit would seriously damage the company.

C. The suit is of a type that would be extremely expensive to pursue, such that it would unlikely result in a net recovery.

D. All of the above.

D. All of the above.

In considering a recommendation of a special committee, a court may consider whether it is in the public's interest (rather than just the corporation's interest) to see a suit continue.

True

False

True

First, let's brush up on some material from prior modules. Assume that Waltuch (from Waltuch v. Conti) finishes up his suspension by the CFTC and becomes a vice president and one of three members of the board of directors of Silver Lining Investments, Inc. ("Silver Lining"), a company that advises clients on silver trades. Waltuch wants to start a gold trading business on the side, starting with his current Silver Lining clients. Shareholders of Silver Lining bring a suit alleging that Waltuch has violated his fiduciary duties to the corporation.

What standard of review/level of scrutiny will apply when the court considers whether Waltuch violated his fiduciary duties?

A. Business judgment rule

B. Fairness review

C. Enhanced/intermediate scrutiny

D. The Broz 4-part test

D. The Broz 4-part test

This is a corporate opportunity fact pattern.

Let's try another one from a prior module. Same facts as last question. Assume all directors sign off on Waltuch opening the gold trading business on the side. Shareholders sue Waltuch and the rest of the board for breach of fiduciary duties to the corporation.

Is demand required?

A. No because a majority of the board is named in the law suit.

B. Yes because a majority of the board can be trusted to consider the demand under Aronson.

C. No because a majority of the board approved the transaction.

D. No because there are no compelling reasons to dismiss the suit.

B. Yes because a majority of the board can be trusted to consider the demand under Aronson.

Same facts. When Waltuch joined Silver Lining, he negotiated an indemnification agreement that says the corporation shall indemnify him to the full extent permitted under the DGCL. The case is dismissed pursuant to a settlement agreement under which Waltuchagrees to pay to the corporation the $50K of profit he has made so far in the gold business

Is he entitled to indemnification?

1. Yes under 145(c)

2. Yes under 145(a) plus the agreement

3. Yes under 145(b) plus the agreement, but only for expenses and only if he acted in good faith

4. No answer text provided.

3. Yes under 145(b) plus the agreement, but only for expenses and only if he acted in good faith

   Right! 145(b) allows for indemnification for the expenses in reaching settlement such as lawyer fees. Through the agreement, the corporation commits to exercising its discretion in favor of making the permitted indemnity. Still, keep in mind that 145(b) does not allow for indemnification for the $50K settlement amount.

When does the Delaware indemnification statute require a corporation to advance a director litigation expenses?

A. When the director acts in good faith.

B. When the director is successful on the merits.

C. Never

D. When the director is not adjudged liable

C. Never

Right! The only way a corporation can be bound to advance expenses is through an agreement, bylaws, or articles. The statute never requires it.

Which of the following is the best synonym for "indemnification"?

A. Reimburse

B. Absolve

C. Loan

D. Sue

A. Reimburse