In this decision, the Court of Chancery again affirms it disinclination to stay proceedings in Delaware just because a federal securities case was filed first elsewhere. Some doubt about that issue may have existed after the Court did stay a Delaware case involving Bear Sterns in favor of federal litigation in New York. But as this opinion notes, the Bear Sterns case was unique.
Introduction
A recent Delaware Court of Chancery decision has generated much discussion over whether disinterested directors may be held liable for approving a transaction that appeared reasonable to them and their advisors. Indeed, by holding that the directors may have acted in “bad faith,” the decision seemed to some to be a threat to the core principles embodied in the business judgment rule. That rule protects directors from being second guessed by courts long after the business decision has been made. These concerns are overstated. This article will: (1) outline the background to the current controversy over “bad faith” in Delaware, (2) predict how the Delaware Supreme Court will clarify the Delaware law of “bad faith” and (3) suggest a possible solution to address lingering concerns over director liability for disinterested business decisions.
The “Problem”
For many years Delaware limited director liability for disinterested business decisions to those decisions properly held to be grossly negligent. This high standard seemed adequate to protect directors from inappropriate judicial second guessing. Then in 1985, Smith v. Van Gorkom held a board was grossly negligent. Many commentators felt Van Gorkom demonstrated the inability of courts to understand what should constitute gross negligence. The Delaware Legislature promptly responded to Van Gorkom by adopting Section 102(b)(7) of the Delaware General Corporation law. That new statute permitted Delaware corporations to include a provision in their certificate of incorporation that immunized directors for even grossly negligent decisions. Section 102(b)(7) has its exceptions, however. One of those is that actions “not in good faith” lose the statutory protection from liability.
As might be expected, if directors could not be successfully sued for actions “in good faith,” it was only a matter of time before plaintiffs filed claims alleging directors had acted in “bad faith”.
Bad Faith
Bad faith remained largely undefined until 2005. After much debate regarding whether good faith was an independent fiduciary duty and what exactly constitutes good (and bad) faith, Chancellor Chandler defined bad faith as an “intentional dereliction of duty, a conscious disregard for one’s responsibilities” and a “[d]eliberate indifference and inaction in the face of a duty to act.” The Delaware Supreme Court then set out three different categories of fiduciary behavior that might deserve the “bad faith pejorative label.” The first, fiduciary conduct motivated by an intent to do harm, was aptly labeled “subjective bad faith” The second category involves “fiduciary action taken solely by reason of gross negligence and without any malevolent intent,” a lack of due care. The court decided, however, that gross negligence without more does not constitute bad faith, and thus does not breach the duty of loyalty. The third category is the Chancellor’s definition of bad faith, as intentional dereliction of duty, a conscious disregard for one’s responsibilities. In Stone v. Ritter, the court further stated bad faith is a “fail[ure] to act in the face of a known duty to act, thereby demonstrating a conscious disregard for [one’s] responsibilities,” and thus not exculpated under § 102(b)(7).
Brian T. Olson v. O. Andreas Halvrosen, C.A. 1884-VCL (Del Ch. Oct. 22, 2008)
This decision invalidates a provision in an unsigned LLC agreement for violating the statute of frauds. The Delaware LLC Act permits an oral LLC agreement; however, when the promise in that oral agreement cannot be performed within a year, the promise must be in writing. Given the common existence of oral LLC agreements, this decision sounds a word of caution.
Kempski v. Toll Bros., Inc., 2008 WL 4642633 (D. Del. Oct. 21, 2008)
In this opinion, the District Court reinforced Delaware’s law that indemnity provisions that require one party to indemnify another party for the second party’s own negligence are void as against Delaware’s public policy. Here the Defendant, Toll Brothers, Inc., contracted with Delaware Heating and Air Conditioning Services, Inc. (“DHAC”), to perform HVAC work on Defendant’s housing developments. One of DHAC’s employees was injured while performing the work, and sued Defendant. Defendant sought indemnification from DHAC pursuant to their contract. Both Defendant and DHAC sought summary judgment on the indemnification claim. The Court found that under Delaware law, the contractual indemnification provision that Defendant sought to invoke was against Delaware public policy, and granted summary judgment for DHAC.
Continue Reading...In the Matter of Dow Chemical International Inc. of Delaware, C.A. 3972-CC (Del. Ch. Oct. 14, 2008)
This decision has a good outline of when the right to sue a Delaware corporation expires after it is dissolved. The basic rule is that after three years no suit may be filed. Exceptions may exist for entities that still have undistributed assets and when a receiver is appointed for those entities.
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For more information concerning any of these cases, contact Edward M. McNally at emcnally@morrisjames.com or 302.888.6880
