The Delaware Supreme Court’s recent decision in Gantler v. Stephens, No. 132, 2008 (January 27, 2009), confirms that officers of Delaware corporations have the same fiduciary duties of loyalty and care as directors. This has important implications for non-director officers of Delaware corporations, in particular because, as the Court points out in a footnote, there is at present no statutory authorization for the exculpation of officers for monetary liability for breach of their duty of care. The Court also holds that a statutorily required shareholder vote, such as for the approval of a merger, does not constitute ratification of breaches of fiduciary duties. Delaware companies now need to revisit their internal processes and indemnification and insurance arrangements to be sure that their corporate officers are protected.

The Delaware Court of Chancery had dismissed a complaint challenging a board’s decision to take the company private after commencing a bidding process and rejecting the resulting proposals. The Supreme Court held that the plaintiffs had sufficiently alleged director self-interest and had rebutted the presumptions of the business judgment rule that in the normal situation protect a board’s decision to reject a merger proposal. It found that management had "sabotaged" the due diligence process.

All three counts of the complaint had been dismissed for failure to state a claim by the Court of Chancery, holding that the business judgment rule, rather than the heightened Unocal or entire fairness standards, applied to the board’s decision to abandon its sale process; that the subsequent proxy statement describing the proposed reclassification of shares that would in effect enable the company to "privatize" itself contained no material omissions or misstatements; and that the approval by a majority of the unaffiliated shares ratified the breaches of fiduciary duty.

The Supreme Court reversed. It found that the plaintiffs had plead facts to form a sufficient basis to conclude that a majority of the board acted disloyally and that the officer defendants should not have been dismissed. It found that the statement in the proxy that the board rejected the merger proposal after "careful deliberations" was materially misleading, noting the failure to discuss the defendants’ conflicts of interest and the board’s rejection of the merger proposal without any discussion. It found that the statutorily required stockholder vote to amend the company’s certificate of incorporation could not also operate to ratify the challenged conduct of the interested directors and that the vote could not have been fully informed as required for ratification because the proxy contained a material misrepresentation

Tucked in the middle of the Supreme Court’s opinion is the following:

That issue – whether or not officers owe fiduciary duties identical to those of directors – has been characterized as a matter of first impression for this Court.  In the past, we have implied 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. We now explicitly so hold.

Stephens, the Chairman, President and CEO, and Safarek, the Vice President and Treasurer (not a director) of the company, “sabotaged” the due diligence process initiated by the board of directors by thwarting  bidders’ attempt to obtain information to support their bids. Safarek was described as dependent on Stephens’ continued good will to retain his job and the benefits it generated. The Supreme Court wrote “[b]ecause Safarek was in no position to act independently of Stephens, it may be inferred that by assisting Stephens to “sabotage” the due diligence process, Safarek also breached his duty of loyalty. “

This formalizes what had been a long “articulated principle of Delaware law,” and footnote 37 puts a chilling fillip to the message:

That does not mean, however, that the consequences of a fiduciary breach by directors or officers, respectively, would necessarily be the same.  Under 8 Del. C. § 102(b)(7), a corporation may adopt a provision in its certificate of incorporation exculpating its directors from monetary liability for an adjudicated breach of their duty of care. Although legislatively possible, there currently is no statutory provision authorizing comparable exculpation of corporate officers.

In light of this warning and the current outcry over various corporate officers’ insensitivities to the issues of compensation, disclosure and deal-making, it is appropriate for Delaware corporations to take the following actions:

• Review the officer indemnification provisions in their by-laws and in the individual indemnification agreements with their officers, particularly in view of the recent Delaware decision that holds that by-law indemnification provisions can be altered to the detriment of former directors, and, most likely, former officers as well.
• Review the language in their Directors and Officers Liability Insurance policy to assure that it provides adequate protection for claims of officer breach of duties of loyalty and care.
• Institute robust policies in the due diligence and disclosure areas and assure that all affected officers are apprised of their fiduciary duties and the need to continuously assess potential conflicts of interests that, in hindsight, may create the appearance of a personal incentive to disregard, or breach, their fiduciary duties.

For further information, please contact John Mullan at (213) 617-5475.