Delaware Supreme Court Confirms Equivalent Duties of Officers and Directors – Gantler v. Stephens, 965 A.2d 695 (Del. 2009)
By: MATTHEW T. BOOS
In Gantler v. Stephens, 965 A.2d 695 (Del. 2009), the plaintiff-shareholders of First Niles Financial, Inc. (First Niles or the Company) sued certain Company officers and directors for, among other things, breaches of fiduciary duty relating to their rejection of a valuable opportunity to sell the company. The case is important because, in its decision, the Delaware Supreme Court affirmed a corporate law principle that had been implied in prior decisions; namely, that officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors. Id. at 708-709. The en banc Court reversed and remanded the Court of Chancery’s dismissal of claims against the defendant officers and directors. The Delaware Supreme Court found that the complaint sufficiently pled breaches of the duty of loyalty and duty of care in connection with the rejection of a merger and a subsequent decision to reclassify the Company’s shares and take the Company private.
The dispute in Gantler arose out of the Company’s solicitation of potential purchasers. Three potential buyers presented offers that the Company’s financial adviser deemed to be within the range suggested by its financial models. The financial adviser had also noted that accepting the stock based offers would be superior to retaining First Nile’s shares. The defendant board chair and CEO, Stephens (CEO), allegedly neglected to provide due diligence materials to one of the potential buyers after he had indicated he would do so. He also allegedly failed to inform the board fully until after that potential buyer withdrew its bid. At a special board meeting to discuss an offer by the second potential buyer, the CEO circulated a memorandum from the Company’s financial adviser that spoke favorably about the offer. After the board voted 4 to 1 to reject the offer without any discussion or deliberation (the plaintiff-director voted for the proposal), the CEO discussed management’s privatization plan and instructed legal counsel to investigate that option further. Five weeks later, the CEO circulated to the board members a document describing the proposed privatization plan.
Under management’s proposal to take the Company private, holders of 300 or fewer shares of the common stock would have their shares reclassified into a special class of preferred stock with limited voting rights. The board eventually voted to proceed with the reclassification; plaintiff-director voted against the proposal and resigned. Because the reclassification required an amendment to the Certificate of Incorporation requiring shareholder approval, ultimately First Niles prepared a proxy statement disclosing the abandoned sale process. The proxy statement also disclosed the fact that each of the directors and officers had a conflict of interest with respect to the share reclassification. Nonetheless, the shareholders approved the reclassification.
Gantler and others filed suit alleging breach of fiduciary duty relating to the board’s rejection of the merger offer, approval of the reclassification, and the making of false and misleading statements in the proxy materials. In particular, they claimed defendants had breached their duties of loyalty and care as directors and officers by (i) sabotaging the due diligence aspect of the sale process; (ii) rejecting an offer to sell; and (iii) terminating the sale process, all for the purpose of retaining the benefits of continued incumbency. Id. at 704. The Court of Chancery dismissed the lawsuit, holding that the facts as pled were insufficient to defeat the presumption of the business judgment rule1 with regard to the board’s actions.2 The Delaware Supreme Court reversed and remanded on each of the plaintiffs’ claims.
The Court analyzed the breach of fiduciary duty claim under the business judgment rule. It first addressed the disloyalty claims against the defendants in their capacity as directors. The Court explained that the fact that the directors would lose their jobs in a merger was insufficient to support a breach of loyalty claim. The Court held, however, that not only did plaintiffs plead a motive to retain corporate control, but they alleged additional facts that the directors acted disloyally; namely, that three of the four directors who voted against the merger (a majority) were disloyal to the Company. One of the directors never responded to a due diligence request from one of the potential buyers, causing it to withdraw its bid; the other two directors owned outside businesses that provided services to the Company, and thus a sale of the Company would harm the directors to the extent their outside businesses would lose a client (the Company) in the event that it was sold.
Of particular interest, the Court separately addressed the disloyalty claim against the defendant officers. The Court stated that what had been implied in prior cases was now made explicit: corporate officers owe the same duties of care and loyalty as corporate directors. The Court then explained that the allegations in the present case supported an inference that the officers had breached their duty of loyalty to the Company. In particular, the officers (like the directors), allegedly acted disloyally in rejecting the merger proposal because they were financially motivated to maintain the status quo. Beyond this, the Court noted that the CEO failed to respond to due diligence requests from the first potential buyer – a buyer that stated its intention to terminate the incumbent board. This allegedly caused the potential buyer to drop out of the sales process. The CEO (as well as the defendant Vice President and Treasurer) was responsible for preparing due diligence materials for the three firms expressing an interest in buying First Niles. The Court also found plaintiffs’ allegations sufficient with respect to the Treasurer insofar as he depended upon the CEO’s continued goodwill to retain his job and the associated benefits. Because he was in no position to act independently of the CEO, it could be reasonably inferred that by assisting the CEO to “sabotage” the due diligence process, the Treasurer breached his duty of loyalty. Id. at 709.
Conclusion and Recommendation to Officers
The Gantler decision leaves no doubt that officers have the same fiduciary duties of care and loyalty as do directors. What does this mean for officers? Officers, unlike directors, are not eligible for exculpation for monetary damages for breach of the fiduciary duty of care. Such “raincoat” provisions under the corporate laws purport to eliminate personal liability of directors from money damages for breach of their fiduciary duty of care (not, however, for breaches of the duty of loyalty). The Gantler decision may inspire more plaintiffs to assert breach of fiduciary duty claims against officers, not just directors. Thus, it is critically important that officers – who must look to indemnification provisions in the corporation’s charter documents or in stand-alone indemnification agreements and directors and officers liability insurance policies – should review and understand their level of protection from lawsuits. Officers are well advised to ensure adequate protection through corporate charter documents, indemnification agreements and director and officer insurance.
1 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 interest of the company.” See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).