In Schoon v. Smith, 2008 WL 375826 (Del. Feb. 12, 2008), the Delaware Supreme Court “decline[d] to enlarge” the standing requirement for plaintiffs in stockholder derivative actions, holding that non-stockholding directors lack standing to bring a derivative suit.  Although the court expressly reserved the power to grant “equitable standing” — standing that has not been formally granted by statute, but can be granted at the discretion of the court — it refused to make such a grant to non-stockholding directors.  Finding that there was no “failure of justice” sufficient to warrant an expansion of the equitable standing doctrine, the court concluded that the rights of the stockholders could best be protected by the stockholders themselves and not a non-stockholding board member.  This decision from Delaware’s highest court confirms that Delaware courts are unlikely to expand derivative standing to those who lack a personal financial stake in the corporation.

The case involved the Troy Company, a privately held Delaware corporation.  Under Troy’s corporate charter, holders of Series A shares were entitled to elect four of the five Troy directors.  Daryl Smith held a majority of Series A stock and appointed himself and three others to the board of directors.  Plaintiff Richard Schoon was the only director not elected to the board at Smith’s discretion.  Although he was a member of Troy’s board of directors, he owned no shares of Troy stock.  Schoon eventually came to believe that the three board members appointed by Smith were “beholden” to Smith, and that these directors took action to “entrench” Smith in power while “thwart[ing] potential value maximizing transactions for the benefit of Troy and its stockholders.”  Schoon filed a derivative action on behalf of Troy alleging that this conduct by his fellow directors constituted a breach of their fiduciary duties.  Because Schoon was not a stockholder, he argued that the court should grant him equitable standing to pursue the derivative remedy in order to “promote the core Delaware public policy of protecting against misconduct by faithless fiduciaries.”

The court declined this invitation.  While the court expressly reserved the right to create equitable standing for non-stockholders based on exigent circumstances — as the court had done a year earlier in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007), granting creditors equitable standing to bring derivative actions against directors of insolvent corporations — the court refused to craft such standing for non-stockholding board members.  Instead, the court held that equitable standing could only be expanded in the face of significant “exigency.”  A court must be convinced that, in not granting a plaintiff standing, there would be a “failure of justice on behalf of the corporation” where “stockholders would be without any immediate and certain remedy.”

Based upon the facts before it, the court found it unlikely that a “failure of justice” would occur if Schoon were prevented from bringing suit.  Observing that a stockholder “aligned with” Schoon already was litigating against Troy in other matters, the court concluded that “a stockholder derivative action would fully and adequately redress any injuries” to the company that were suffered due to a breach of fiduciary duties by the board.  Schoon’s suit presented “no new exigencies” that would require an extension of equitable standing to non-stockholding directors.

The decision in Schoon suggests that Delaware courts are unlikely to expand standing to those who lack a direct financial interest in a corporation.  Although the same court had granted standing to non-stockholding creditors in Gheewalla, the court took pains to distinguish it from Schoon, observing that the lesson of Gheewalla was merely that courts could “substitute[] creditors for shareholders” who “no longer have a financial interest” in an insolvent corporation.  While the court observed that a handful of jurisdictions and the American Law Institute had expanded standing to encompass non-shareholding board members, it expressed little enthusiasm for adopting such a standard in the future.  Though not entirely foreclosing on the possibility of expanding equitable standing to encompass non-shareholding board members in the future, the court did little to suggest such an expansion will be forthcoming.  “Given the absence of statutory authority” for such an expansion, and given the absence of evidence that such standing would be necessary to “prevent a complete failure of justice,” the court concluded that a stockholder derivative action, and not a non-stockholder board member action, was the better way to redress any injury resulting from a breach of fiduciary duty by a corporate board.

For further information, please contact John Stigi at (213) 617-5589.