What does Delaware want from corporations in the wake of
recent events? Permit a justice of its Supreme Court a few
thoughts on the subject.
While there can be no serious quarrel about whether
judges simply interpret the law according to legislative
will or shape the law through the interaction of substance
and procedure, the following comments assume three major
premises:
These three premises are not revelations. They do, however,
bear consideration when people look to the courts to remedy
corporate injustices, whether it be to punish individual
corporate wrongdoers, to halt business transactions ranging
from the fraudulent to the ill advised, or to reshape the
governance relationship between investors and
management.
Generally, as is well known, the concept of directors' duty
to those whom they serve flows from the law of trusts and
recognizes that "
by accepting of a trust of this
sort, a person is obliged to execute it with fidelity and
reasonable diligence." While the typical lawyer may
not recognize these words as the lord chancellor's from
1742, it can nevertheless be said that the standard of
personal conduct described 260 years ago remains — in
Delaware at least — the foundation of a director's
duty today.
Exercise care in acting for and on behalf of others. Do so
without regard to your own interests and be faithful to
those for whom you act. Those bearing these responsibilities
must carry out both those fairly self-evident obligations in
good faith, recognizing that the Delaware courts examining
an individual's conduct will do so in the context of the
"Business Judgment Rule." That rule mandates that
the actions of disinterested and independent directors
— who after reasonable investigation — adopt a
course of action that they, in good faith, honestly and
reasonably believe will benefit the corporation will not be
"second guessed," on the merits of that
decision.
The Business Judgment Rule also can shield the deserving
director from money damages as well as operate doctrinally
to protect or salvage a particular transaction.
Courts in Delaware have long adopted the Business Judgment
Rule as the "all things being equal,"
"default" tool of judicial review of corporate
actions.
When complainants launch an attack on directors' decisions
or their process for making those decisions, they often
strike at the underpinnings of the Business Judgment Rule in
an attempt to persuade the court, after initial motion
practice, discovery and ultimately trial, that they have
alleged and then proved sufficient facts to create doubt
that the decision made was, in fact, a
"business
decision."
A
"business decision" is one where a
majority of directors acted disinterestedly (that is, had no
interests that conflicted with those for whom they acted or
the corporation's interest itself), where the directors
possessed the information that reasonably prudent people
ordinarily would have in the particular business environment
or want or need to have, where the directors took the time
to review it if it were available, or in the case of a
recommendation to shareholders for their action, disclosed
all the information to shareholders that the reasonably
prudent shareholder would need to review in order to act
intelligently on the directors' information.
With that background in mind, how do the Delaware courts
reconcile the simplicity of the concept of fiduciary duty
with the seemingly tolerant tool of judicial review embodied
in the Business Judgment Rule and even then be subject to
criticism for inconsistent or unpredictable results? And
when those criticisms fairly lie, how can corporate decision
makers act with confidence and in anticipation that
transactions they believe are in the best interests of the
corporation and its shareholders will survive judicial
scrutiny?
Even more important, given public perception and awareness
of corporate scandal today, widespread stock ownership,
increased militancy of institutional investors and
legislative limelighting in the wake of Enron, Tyco, TXU and
WorldCom, will courts entertain a sea change in approach
toward what some believe to be an overly complaisant tool of
judicial review?
A recent article from an academic setting in effect demanded
to know what Delaware was going to do in light of recent
events, legislatively and judicially, to demonstrate our
disdain for an arguable tear in the fabric of corporate
governance. (Robert B. Thompson and H. Sole,
"Securities Fraud and Corporate Governance: Reflections
Upon Delaware," 56,
Vand. L. Rev. 2003.) The
article seemed to suggest that, if Delaware did not react
publicly and forcefully, it would lose its pre-eminence in
corporate governance.
Parenthetically, the enormous growth of alternative business
organizations, especially LLCs, and the raging debate over
whether corporate fiduciary duty principles should be
applied to at least some unincorporated entities, suggest a
retreat from the corporate form and arguably from corporate
governance principles.
Some of the issues where attention should be directed
include:
Relaxation of the demand rule in derivative cases;
excusing the requirement that shareholders make demand on
the board of directors for action or establishing futility
of demand before filing suit. What will be the effect of
federal definitions of an independent director on state case
law? Do we move to inflexible codification and away from the
flexibility of common law?
A call for a shift in emphasis in the so-called "gray
director" area and for a more liberal view of factual
situations that prohibit directors from entanglements that
taint their independence. Should there be no shift in
emphasis, will the new standard for delineating an
independent director be set by federal statute, federal
regulatory pronouncement or other rules?
Readdress Section 102(b)(7) of the Delaware General
Corporation Law that exculpates directors from damages for
breach of the fiduciary duty of care — even though
shareholders routinely endorse the concept by amendment to
corporate charters in order to encourage directors to take
"reasonable risks for profit."
We recognize that there will be proposals to amend our
corporation code to strengthen our ability to reach
corporate officers in litigation. Why? Because few
corporations' principal offices are physically located in
Delaware and, therefore, their officers cannot be reached
for service of process under current law. As the federal
government and others press for more "independent"
directors on boards, fewer corporate officers, other than
perhaps CEOs, will be found among potential director
defendants.
All of the above have been suggested despite that (1) none
of the current corporate scoundrels prompting early calls
for reform involved Delaware corporations; and (2) Enron, an
Oregon corporation, operated under the Model Business
Corporation Act, and had in place an updated
"model" code of ethics for officers and directors.
The Securities and Exchange Commission, using the federal
securities law and rules of disclosure, is attempting to
chart or at least delineate inflexible definitions and a
standard of conduct with penalties for noncompliance.
Delaware corporations, despite the guidance of Delaware case
law, are not immune from potential transgressions. The
correct remedy lies in the availability of prompt definitive
litigation in the Delaware courts.
The Delaware courts' traditional approach is to create
incentives for good things to happen, not to punish except
through public embarrassment and occasional money damages
for egregious conduct. That is why the doctrinal flexibility
expressed in Delaware case law stresses shareholder action
and approval after recommendation from the directors; the
importance of full, fair disclosure; an untainted
shareholder franchise; independent committee action by
disinterested directors; burden shifting and emphasis on
entire fairness in certain transactions; and a
reasonableness test for defensive actions in compelling
circumstances.
The cases emphasizing these responses by the courts to
claims of breach of fiduciary duty are, of course,
transaction specific and based on facts established by the
parties. Only in the narrowest terms do they suggest
deviation from the still valid 1742 standard of fidelity and
careful attention to detail. Pronouncements from the cases
may at times seem overbroad, but they are meant to be
aspirational, not dictatorial. Although Delaware judges are
constrained to "contextually specific teachings under
our common law," one can make the case that the
Delaware approach serves to encourage people with integrity
and a strong work ethic to continue to serve on boards.
What Delaware judges expect from corporate officers and
directors when reviewing their conduct retrospectively is a
scrupulous adherence to a process of decision making that
reflects fidelity to the institution and investors that they
serve. Their conduct must also show a dedication to spending
the time necessary to educate themselves about the business
and the facts surrounding a decision that will lead the
court to have confidence that the ultimate course of action
adopted was the product of a rational and careful decision-
making process made in good faith.
Despite retrospective court scrutiny of their decisions and
decision-making process, directors and officers of Delaware
corporations who adhere to the basic, intuitive principles
of loyalty and due care and who make a careful factual
record supporting their adherence to those duties need not
fear personal liability, personal disparagement nor the
unraveling of transactions made in the best interest of the
institution and investors they serve.
At the same time, the Delaware courts will continue to be
open and available to redress corporate wrongs by those who
seek to abuse or betray the trust they accept when they
accept corporate office. In my opinion, Delaware will and
should remain the first state contemplated as the forum for
business litigation.
Justice Steele is a member of the Delaware Supreme Court.
This article is based on remarks to New York University's
Stern Executive Program in November, 2002. His e-mail is
msteele@state.de.us.
