Independent Directors Mitigate Legal Risk

Delaware’s new supreme court chief justice on the cases that changed director liability.

 

In the face of the pandemic, the Delaware Supreme Court has stopped criminal trials altogether (no juries allowed). The Delaware Court of Chancery has shifted to Zoom hearings. It’s a good thing those hearings have continued, because the Court of Chancery has seen an uptick in cases.

Collins Seitz Jr., chief justice of the Delaware Supreme Court, says many of those are “busted deal cases.”

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“Some very high-profile, megabillion-dollar cases are working their way through the Court of Chancery now, and they’ll eventually work their way up to the Supreme Court,” he says. “At last count, 30 or 40 of them have been filed, and I think that’s just the tip of the iceberg on these cases, especially if the economy worsens.”

Seitz joined the Delaware Supreme Court as an associate justice in 2015 and became chief justice in the fall of 2019, replacing Leo Strine. The supreme court often sets corporate law precedent as two-thirds of Fortune 500 companies are incorporated in Delaware.

Chancery court cases involving private companies tend to be disputes over key documents like shareholder agreements or LLC operating agreements, the chief justice says. Such cases typically are harder to resolve by settlement than corporate cases such as merger disputes, so a lot of them are going to trial, he says.

Seitz says having independent board directors is a best practice for private companies:

“For public companies, Delaware law has put a lot of stock in the use of independent directors. I think it would be a treasured resource for private companies to also [have independent directors] to bounce things off of and to use when conflicts occur.”

In today’s economic and social environment, there is an increased need for outside perspective, the chief justice says.

“When a private or public company board shows that it’s a diverse board, I think you have a big leg up.”

This interview was part of the 2020 Private Company Governance Summit held online in September. Registration is still available to watch replays of the sessions. Register now…

A landmark Delaware chancery decision, In re Caremark International Inc. Derivative Litigation, highlighted public company boards’ obligation to make a good-faith effort to exercise their duty of care. Last year the same precedent was set for private companies through Marchand v. Barnhill, in which the Delaware Supreme Court found that the board of Blue Bell Creameries did not conduct adequate oversight or reporting. Seitz says it’s very difficult for a plaintiff to prevail in Caremark or Marchand cases.

“That’s because you’re holding directors personally liable for conduct, in many cases, which they weren’t even aware of,” Seitz says.

Boards must be able to demonstrate credibly that they’re thinking proactively about potential systemic risks, Seitz says.

“Delaware law requires that there be reporting systems in place, so that when a major corporate trauma occurs, there’s some path to the board so it can be addressed.”

While “boards aren’t held liable under Delaware law for simple negligence,” if risks are ignored or issues affecting a core operation of the business are treated as minimal, “it’s becoming harder to make the case that directors ought to be immune from liability,” the chief justice says.

In the Blue Bell Creameries case, customers died after eating contaminated ice cream. “There were no reporting systems in place to bring health and safety issues at the plants up to the board level where they could be addressed. You can see why the board could be viewed as asleep at the wheel,” Seitz says.

Seitz also emphasizes the importance of keeping minutes of board meetings — “and I’m not talking about minutes that are sanitized by lawyers, I’m talking about real minutes.

“If a corporate action has been taken but it hasn’t been documented, that’s when plaintiffs can get ahold of emails, and it almost turns into its own second lawsuit for companies,” Seitz says.

“But under Delaware law, if you have exercised proper corporate hygiene [and] you have board minutes that are kept that reflect [board discussions], and those are avail to be produced when info requests are made, you can avoid a lot of heartache.

“If directors do their job as directors and document their work, they don’t have a lot to fear under Delaware law.”

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