Corporate Board of Directors

Duties

—board manages or directs corporation’s business affairs and authorizes officers and employees to exercise corporation powers

Composition requirements

1. Number of directors—default is one or more members; COI or bylaws can alter

2. Director qualifications—natural person (not another corporation); generally not required to be stockholder

Selection of directors

Selection of directors—selected by stockholders at annual stockholders’ meeting by straight or cumulative voting and by one or more stock classes; Unocal standard used to address situations in which directors make decisions that have clear implication for their continued control

Term of directors - Term

Term—directors (usually) serve one-year term; may serve longer than one year if terms are staggard; limits impact of cumulative voting

Holdover director

Holdover director—director whose term has expired but continues to serve until replacement selected

Director resignation

Director resignation—directors may resign at any time by delivering written notice to board, its chair or corporation

Director removal

Director removal—director may be removed (no cause required) by majority of shares entitled to vote at director elections unless (1) board is classified (requires cause) or (2) only part of board is being removed and votes against removal would be enough to elect that director (cumulative voting only)

Replacement or new director

Replacement or new director—majority vote of directors in office may fill vacancy

Compensation of directors

—compensation allowed for serving on board; amount fixed by board unless COI says otherwise; when directors make decisions about own compensation, decisions generally reviewed as self-dealing transaction under entire fairness standard

Meeting requirements - Meeting types

Meeting types—directors may hold regular and special meetings; no notice required for regular meetings; required notice of special meeting may be dictated by COI; notice may be waived by signed written waiver or by attendance (unless director promptly objects to lack of notice)

Meeting requirements - Presence

Presence—physical presence not required if meeting conducted through conference call or any means allowing each director to hear others

Action without meeting

Action without meeting—board may act without meeting by unanimous written consent

Voting requirements for Director’s Action- Quorum required

Rule: For the board of directors' acts to be valid, there must be a quorum of directors present at the meeting.  A majority of the total number of directors constitutes a quorum unless the certificate of incorporation or the bylaws require a greater or lesser number. Interested directors may be counted to determine the presence of a quorum at the meeting authorizing the act or transaction.

• Director presence—director must be present when vote occurs to be counted toward quorum; directors cannot vote by proxy

Voting requirements - Passage

—majority of directors present at time of vote (generally)

Voting requirements - Director dissent

Director dissent—may be jointly and severally liable for illegal or improper dividend, even if not present at meeting or did not vote for action; to avoid liability, director must: (1) if present, enter dissent into meeting minutes or (2) if absent, enter dissent into books immediately after notice of the action.

• If liable, director may seek contribution from other directors who voted for or concurred

Voting requirements - Deadlock

In Delaware, the Court of Chancery may appoint a custodian to resolve a deadlock. 

• The Court, upon the request of a stockholder, has discretion to appoint one or more persons to be custodians for the corporation when (1) at any meeting held for the election of the directors, the stockholders are so divided that they have failed to elect directors; (2) the business is suffering or is threatened with irreparable injury because the directors are so divided on managing the corporation that the board cannot take action and the stockholders cannot break the deadlock; or (3) the corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate, or distribute its assets. 

• The Court may determine the duration of the appointment as well as the specific powers to be conferred on the custodian.

Committees—board may act through one or more (Special) committees

The board may take action through a committee that consists of two or more directors.  Generally, a majority of directors must vote to create the committee and to appoint directors to the committee. 

• Committee Powers: The committee may exercise all of the powers and authority of the board in the management of the corporation's business and affairs, to the extent permitted by the bylaws or a board resolution.  However, a committee may not (1) approve, adopt, or recommend to the stockholders any action or matter, other than the election or removal of directors, expressly required to be submitted to the stockholders for approval or (2) adopt, amend, or repeal the bylaws.

Independent and disinterested—members should be independent or disinterested concerning transaction

A special committee should consist of members who are independent and disinterested regarding the transaction. Plaintiff has the burden of prove that the director lacks independence and is interested

• Disinterested: not party to transaction, no material interest in transaction, and no material relationship with someone having material interest

• A Material interest is: any actual or potential benefit that may impair director’s objective judgment

• A Material relationship : familial, financial, professional, employment, or other relationship that may impair director’s objective judgment

An “independent” Board of directors

Director is independent when:

• the director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences. 

• There is a presumption that directors are independent. 

To show that a director is not independent, a plaintiff must demonstrate that the director is beholden to the controlling party or so under the controller's influence that the director's discretion is sterilized. 

A plaintiff must also meet a materiality standard, in which the court must conclude that the director's material ties to the controlling party are sufficiently substantial that the director's fiduciary duties cannot be objectively fulfilled.

General rules regarding Director's’ duties in DE

In Delaware, a director owes three basic duties to the corporation: (1) a duty of care, (2) a duty of good faith, and (3) a duty of loyalty. 

• A breach of a fiduciary duty is an equitable tort in Delaware and falls under the jurisdiction of the Court of Chancery.

Duty of care—refrain from gross negligence (extreme departure from ordinary care)

In Delaware, a director's duty of care is to refrain from gross negligence.  Gross negligence is a higher level of negligence representing an extreme departure from the ordinary standard of care, and generally requires directors and officers to fail to fully inform themselves in a deliberate manner before voting on a significant transaction.

• A board cannot be found to have breached the duty of care unless the directors individually and the board collectively have failed to inform themselves fully and in a deliberate manner before voting as a board upon a significant transaction.

• Business judgment rule (BJR) - see definition next

Business judgment rule (BJR)

Directors owe a duty of care to the corporation. 

• At the outset, the court conducts a director-by-director analysis.  If the board was not comprised of a majority of disinterested and independent members, then the court applies the EFT.

• Business judgment rule (BJR)—rebuttable presumption that directors acted in good faith and with honest belief that actions were in corporation’s best interests.

• This rule can be rebutted when a plaintiff sufficiently alleges that the board was interested in the outcome of the transaction or lacked the independence to consider objectively whether the transaction was in the corporation's and stockholders' best interests. 

• When the presumption for the BJR has been rebutted, the board's action is examined under the entire fairness standard (the most onerous standard of review) and burden shifts to defendants to show action was fair to corporation and shareholders

Duty of good faith

—encompasses all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders

• Board or committee members fully protected when performing duties if acting in good faith and relying on reasonably reliable information (e.g., reports, expert opinions);

• Good-faith presumption overcome if challenger shows fraud, dereliction of duty, condoning illegal conduct, or a conflict of interest

Bad Faith

—(1) subjective bad faith (conduct motivated by intent to harm), (2) fiduciary action constituting gross negligence, or (3) intentional dereliction of duty (conscious disregard for responsibilities)

Section 102(b)(7) permits exculpation

• The exculpation clause should be included in the COI before filing to avoid having to amend the COI. ​​​​​​​And including such a provision in the bylaws would not be effective because exculpatory provisions must be in the COI.

• A COI may limit or eliminate a director's personal liability to the corporation or its stockholders for monetary damages for breaching the fiduciary duty of care.

102(b)(7) COI exculpatory provisions

COI exculpatory provisions—may eliminate or limit director or officer liability, but cannot eliminate or limit liability for (1) breach of loyalty, (2) acts not in good faith, intentional misconduct, or knowing violation of law, (3) unlawful payment of dividend, stock purchase, or redemption, (4) deriving personal benefit from transaction, or (5) an officer in an action by or for the corporation

Duty of loyalty

—requires an undivided and unselfish loyalty to the corporation and no conflict between duty and self-interests

• Self-dealing: —Typically, a director breaches this duty by placing his own interests before those of the corporation, or engages in conflict-of-interest transaction with own corporation or profits at corporation’s expense. If so, director violates duty of loyalty unless protected by safeharbor rule. BJR does not apply.

• Conflict of interest transaction: is a transaction (not including controlling shareholder) involving corporation or subsidiary on one side, and on the other side (1) director or officer, or (2) any other entity in which the director or officer is involved financially

Safe-harbors for conflict-of-interest transactions: Protection against a breach of duty of loyalty

o (1) Disclosure of material facts—the court looks at the director or officer relationship to transaction; majority of disinterested directors or committee must approve in good faith and without gross negligence

o (2) Ratification—the transaction was ratified by informed, uncoerced, affirmative vote of majority of votes cast by disinterested stockholders.

o (3) Fairness—to corporation and stockholders when the transaction was authorized; consistent with entire fairness test

o Effect of defense—directors and officers are not subject to claims for equitable relief or damages

Controlling stockholder transactions

Controlling stockholder transactions—between corporation and controlling stockholder or from which controlling stockholder receives special benefit

• Safe-harbors depend on whether a going private transaction is involved:

  • No going private transaction

  • Going private transaction

Safe-harbors - When the corporation is not going private transaction

No going private transaction—cleansed if: (1) disclosure of all material facts and approval by disinterested directors, (2) conditioned on approval and receives approval by informed, uncoerced, majority of votes by disinterested stockholders, or (3) transaction is fair to corporation and stockholders

Safe-harbors - When Corp. is going private transaction

Going private transaction—cleansed if: (1) approved by committee and disinterested stockholders, or (2) transaction is fair to corporation and stockholders

Usurpation of corporate opportunity

A director may violate the duty of loyalty by usurping a corporate opportunity before first offering the opportunity to the corporation.  Delaware courts consider several factors in determining whether an opportunity must be disclosed. The director may:

• Not take opportunity

• Take opportunity

• Take opportunity is corporation has rejected it

Director May Not take opportunity

if: (1) corporation financially able to take opportunity, (2) opportunity is within corporation’s line of business, (3) corporation has interest or expectancy in opportunity, and (4) taking opportunity puts fiduciary in position adverse to personal corporate duties

Director May Take opportunity

if: (1) presented to director or officer in her individual (not corporate) capacity, (2) not essential to corporation, (3) corporation holds no interest or expectancy in opportunity, and (4) fiduciary has not wrongfully employed corporation resources in pursuing or exploiting opportunity

Duty to disclose - Material information

Directors have a fiduciary duty to disclose fully and fairly all material information within the board's control when they seek stockholder action and to avoid misleading partial disclosures.  A fact is material if there is a substantial likelihood that a reasonable stockholder would consider it important in deciding how to vote. 

• A board can breach the duty of disclosure by making a materially false statement, by omitting a material fact, or by making a partial disclosure that is materially misleading.

Duty to disclose - Confidential agreements (privately held corporations)

In general, it is reasonable for the execution of a confidentiality agreement in a privately held corporation to be a prerequisite to disclosure of confidential information to stockholders. 

• If the board subsequently withholds material information from stockholders, it would have to show that (1) the withheld information was confidential and (2) the board only withheld the information from stockholders who, even though given notice and opportunity, failed to execute a reasonable confidential agreement. 

• The court will look at whether the confidentiality policy was reasonable in its conception and application.

Duty not to commit waste

To recover on a claim of corporate waste, plaintiffs must prove that the exchange was so one-sided that no businessperson of ordinary, sound judgment could conclude that the corporation has received adequate consideration.  A claim of waste will arise only in the rare, unconscionable case where directors irrationally squander or give away corporate assets.  Committing waste is an act of bad faith.

Duty of oversight (Caremark)

—directors must act in good faith to oversee company operations. A Caremark claim is a lawsuit against a corporation's directors or officers for failing to fulfill this duty. Plaintiff must show:

(1) Directors failed to set up any systems to monitor business or legal risks; or

(2) Systems were in place but directors knowingly failed to monitor them leaving them unaware of risks or issues requiring attention

 In either case, liability requires a showing that the directors knew that they were not discharging their fiduciary duties.  Thus, to satisfy this duty, the directors must make a good-faith effort to implement an oversight system and then monitor it.

Fiduciary duties to preferred stockholders

—none owed when considering whether corporate action might impact contractual rights; but are owed when special contractual rights are not involved and right at issues is equally shared with common stock

Breach of fiduciary duties

• Standard of conduct—what directors are expected to do; defined by duties of loyalty and care

• Standard of review—three test applied to evaluate whether directors met standard of conduct; review tiers: (1) BJR, (2) enhanced scrutiny, and (3) entire fairness

• BJR (default standard)—can be rebutted by plaintiff showing board was interested or lacked independence

Enhanced scrutiny (intermediate standard)

—applies to specific, recurring, and readily identifiable situation involving potential conflicts of interest where decision making of independent or disinterested directors could be undermined

o Rule: Defendants must show (1) their motivations were proper (not selfish) and (2) actions were reasonable in relation to legitimate objective

Unocal Standard: a form of enhanced judicial scrutiny

The Unocal standard is a form of enhanced scrutiny that applies to a board adopting defensive measures against a takeover. The Court has held that the Unocal standard should be used to address situations in which the directors make decisions that have clear implications for their continued control.

Applies when the board adopts a defensive measures in response to a perceived threat to corporate control or policy: Apply in the following scenarios:

1. Hostile Takeover: when the Board takes action to resist an unsolicited acquisition or buyout offer

2. Shareholder activism: when the board adopts measures intended to thwart activist investors

3. Interference with voting/elections: when a board enacts bylaws or maneuvers to delay shareholder meetings, impede proxy contests, or disenfranchise stockholders.

Approach to Unocal Standard

If there is one or above scenario, then the court must apply UNOCAL standard first and if the Board’s action SATISFIED the UNOCAL then their actions are protected by BJR. If they fail the UNOCAL standard, then the court must review the ENTIRE FAIRNESS STANDARD.

Unocal Standard

Rule: Under Unocal, the Board must prove that (1) the Board had reasonable grounds for believing that a danger to corporate policy and effectiveness existed and (2) the defensive response was reasonable in relation to the threat posed. 

• Directors satisfy the first prong by demonstrating good faith and a reasonable investigation, and they must articulate some legitimate threat. 

• To address the second factor, the court first asks whether the Board's actions were preclusive or coercive. 

• If not, then the court must determine whether the defensive response fell within a range of reasonable measures by whether the board tailored its response to what is necessary to counter the threat.  If these issues are proven, an adoption of a defensive measure will be protected by the BJR.

Business Judgement Rule (BJR)— Section 141(a)

The BJR is the default standard of review applied to determine if directors have breached their fiduciary duties.

Rule: BJR is a rebuttable presumption that a director acted in good faith and in the honest belief that the action taken was in the best interests of the company. 

• This rule can be rebutted when a plaintiff sufficiently alleges that the board was interested in the outcome of the transaction or lacked the independence to consider objectively whether the transaction was in the corporation's and stockholders' best interests. 

• When the presumption for the BJR has been rebutted, the board's action is examined under the entire fairness standard (the most onerous standard of review) and the burden of the defendant to show that the transaction was a product of fair price and fair dealing.

Section 141(e) - Essentially a safe harbor

Where to look: (1) in the COI; (2) initial By law; or an amendment adopted by a vote of the stockholders. This section shields directors from liability (a form of BJR):

1. Directors are protected when relying in good faith on corporate records and expert advice.

2. Board and committee actions may be taken by a unanimous written consent without a meeting.

Entire fairness (highest standard)

—applies when BJR presumption has been rebutted and the board’s action is examined under the entire fairness standard.

Whether entire fairness test applies

whether enough sufficiently informed, disinterested individuals (acting in good faith) comprised board majority when action taken (director-by-director review):

• If board not comprised of majority of disinterested or independent board members, entire fairness standard used, but

• If (1) directors’ conflicting interests known and (2) committee of directors consisting of two or more disinterested directors approve action (with no gross negligence), BJR applies instead

When entire fairness test applies:

• Defendants (generally) has the burden of proof that transaction was product of fair dealing and fair price

• A different scenerio: However, Plaintiffs bear burden of showing unfairness if transaction approved by committee of independent or disinterested directors

• ALSO If the special committee's approval is sufficient to invoke the BJR from the outset, then the plaintiff bears the burden of rebutting the presumption that the directors acted in good faith, with due care, and in the best interests of the corporation.

Fair dealing factors

the court looks at—(1) when transaction timed, (2) how transaction initiated, structured, negotiated, disclosed to directors, and (3) how board and stockholder approvals obtained

Fair price factors

the court looks at the—(1) economic and financial considerations of the action (e.g., assets, market value) and (2) any other element that impacts company’s stock value.

• The transaction must be objectively fair regardless of the board's beliefs.

Indemnification and insurance

—directors or officers may seek expense or adverse award indemnification from corporation if involved in legal action caused by role as director

Mandatory Indemnification

—required to indemnify director for any reasonable expense actually incurred in successful defense of proceeding against director in corporate role

Permissive indemnification

—may indemnify director in unsuccessful defense of suit when (1) director acted in good faith with reasonable belief that conduct was in (or at least not opposed to) corporation’s best interests or (2) in criminal proceeding, director did not have reasonable cause to believe his conduct unlawful

Actions brought by or on corporation‘s behalf

—corporation may indemnify director, officer, employee, or agent for expenses actually and reasonably incurred in certain circumstances

Indemnification of others

—corporation may indemnify any other person (who is not present or former director or officer) against expenses actually and reasonably incurred to extent person has been successful on case merits, defense; person must have met applicable standard of conduct.

Inspection rights of directors

—directors entitled to inspect and copy corporate books, records, and other documents for any purpose related to performance of duty as director

Advance Litigation Expense: Director

A corporation may, upon a petition by the director, advance litigation expenses to the director.  The certificate of incorporation or the bylaws may even contain a specific provision making the advancement of expenses mandatory.  On termination of the action, the director must repay those expenses if it is determined that the person should not be indemnified by the corporation.