Proposed legislation in California would expressly provide that directors may consider the interests of specific corporate constituencies in addition to the shareholders. This legislation seeks to promote corporate social responsibility by removing the threat of shareholder lawsuits against directors who consider the interests of certain constituencies which may be inconsistent with the interests of the corporation’s shareholders. The bill further seeks to clarify the directors’ standard of care in connection with acquisitions. However, the bill is ambiguous as to whether it applies only to corporations formed under the laws of California or also applies to so-called "quasi-California corporations," corporations with significant ties to California.
Under existing California law, a director of a corporation is required to perform his duties in good faith, in a manner he believes to be in the best interests of the corporation and its shareholders, and with the care (including reasonable inquiry) of an ordinarily prudent person. The proposed legislation seeks to modify Section 309 of the California Corporations Code to expressly grant directors the ability to consider factors in addition to the interests of shareholders in making business decisions. The bill provides that, in considering the best interests of the corporation, directors may consider, without limitation, the long-term and short-term interests of the corporation and its shareholders, as well as the long-term or short-term effects that the corporation’s actions may have on:
- the prospects for potential growth, development, productivity and profitability of the corporation;
- the economy of the state and the nation;
- the corporation’s employees, suppliers, customers and creditors;
- community and societal considerations; and
- the environment.
The bill also provides that directors shall be presumed to be acting in the corporation’s best interests absent a showing of a breach of fiduciary duty, lack of good faith, or self-dealing. In particular, any act of the directors relating to an acquisition of control that is approved by a majority of the disinterested directors shall be presumed to satisfy this standard of care, unless it is proven by clear and convincing evidence that the disinterested directors did not assent in good faith after reasonable investigation.
Proponents of the bill believe that its passage would lead to greater social responsibility by removing the threat of shareholder lawsuits against directors who consider the interests of constituencies other than the corporation’s shareholders. Proponents also believe that the bill would attract innovative businesses to California because it reduces liability for companies that espouse socially responsible positions, including sustainability.
Opponents of the bill contend that:
- The bill would undermine director accountability to shareholders by permitting directors to make business decisions for reasons unrelated to the best interests of the shareholders. As a result, opponents believe that the bill would lead to less responsive corporate governance and, ultimately, less socially responsible corporate behavior.
- The bill would negatively affect the profitability of the corporation because it would divert management’s focus away from the value of the shareholders’ investment. As a result, opponents argue that the bill would make it more difficult and expensive for corporations to attract investment and may lead entrepreneurs to incorporate in states more favorable to shareholders.
- By burdening directors with the need to consider the interests of multiple constituencies, and thereby confusing rather than clarifying the question of what actions directors should take to fulfill their fiduciary duty, the bill would deter qualified candidates from serving as directors.
- The interests of the constituencies listed in the bill would be better protected by legislation that deals specifically with the interests of employees, suppliers, customers, creditors, the community, and the environment.
As to the acquisition of control provisions, opponents argue that the bill changes the standard of review for evaluating director actions and thereby impairs the shareholders’ ability to protect their interests. In making it more difficult for shareholders to challenge director actions related to a sale of control, opponents assert that the bill departs from the trend in Delaware and other states toward imposing greater scrutiny on board actions taken in connection with an acquisition of control.
Section 2115 of the California Corporations Code provides that certain provisions of California law, including Section 309 (directors’ standard of care), should apply to a corporation incorporated under the laws of another state if the average of the property, payroll and sales factors defined in the California statutes indicate that more than half of the corporation’s business is conducted in California and if more than half of its voting securities are held by shareholders having addresses in California. Although Section 2115 makes Section 309 applicable to so-called quasi-California corporations, the bill itself refers only to "domestic corporations" in those sections that grant directors the ability to consider factors in addition to the interests of shareholders, and refers to a "corporation" when discussing the standard of care in acquisitions. Thus, it is unclear whether the bill intends to remove Section 309 from the scope of Section 2115 in all cases or only in the case of corporate actions other than acquisitions, or whether the reference to "domestic corporations" was inadvertent.
The assistance of John Hynes in the presentation of this article is greatfully acknowledged.
For further information, please contact Peter M. Menard at (213) 617-5483.