LAW IN RELATION TO PUBLIC COMPANIES IN USA : STANDARDS OF LIABILITY FOR DIRECTORS : (a) A director shall not be liable to the corporation or its shareholders for any decision to take or not to take action, or any failure to take any action, as a director, unless the party asserting liability in a proceeding establishes that: (1) no defense interposed by the director based on (i) any provision in the articles of incorporation authorized by section 2.02(b)(4) or, (ii) the protection afforded by section 8.61 (for action taken in compliance with section 8.62 or section 8.63), or (iii) the protection afforded by section 8.70, precludes liability; and (2) the challenged conduct consisted or was the result of: (i) action not in good faith; or (ii) a decision (A) which the director did not reasonably believe to be in the best interests of the corporation, or (B) as to which the director was not informed to an extent the director reasonably believed appropriate in the circumstances; or (iii) a lack of objectivity due to the director’s familial, financial or business relationship with, or a lack of independence due to the director’s domination or control by, another person having a material interest in the challenged conduct (A) which relationship or which domination or control could reasonably be expected to have affected the director’s judgment respecting the challenged conduct in a manner adverse to the corporation, and (B) after a reasonable expectation to such effect has been established, the director shall not have established that the challenged conduct was reasonably believed by the director to be in the best interests of the corporation; or (iv) a sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation, or a failure to devote timely attention, by making (or causing to be made) appropriate inquiry, when particular facts and circumstances of significant concern materialize that would alert a reasonably attentive director to the need therefore; or (v) receipt of a financial benefit to which the director was not entitled or any other breach of the director’s duties to deal fairly with the corporation and its shareholders that is actionable under applicable law. (b) The party seeking to hold the director liable: (1) for money damages, shall also have the burden of establishing that: (i) harm to the corporation or its shareholders has been suffered, and (ii) the harm suffered was proximately caused by the director’s challenged conduct; or (2) for other money payment under a legal remedy, such as compensation for the unauthorized use of corporate assets, shall also have whatever persuasion burden may be called for to establish that the payment sought is appropriate in the circumstances; or (3) for other money payment under an equitable remedy, such as profit recovery by or disgorgement to the corporation, shall also have whatever persuasion burden may be called for to establish that the equitable remedy sought is appropriate in the circumstances. (c) Nothing contained in this section shall (1) in any instance where fairness is at issue, such as consideration of the fairness of a transaction to the corporation under section 8.61(b)(3), alter the burden of proving the fact or lack of fairness otherwise applicable, (2) alter the fact or lack of liability of a director under another section of this Act, such as the provisions governing the consequences of an unlawful distribution under section 8.33 or a transactional interest under section 8.61, or (3) affect any rights to which the corporation or a shareholder may be entitled under another statute of this state or the United States. Subsections (a) and (b) of section 8.30 establish standards of conduct that are central to the role of directors. Section 8.30(b)’s standard of conduct is frequently referred to as a director’s duty of care. The employment of the concept of ‘‘care,’’ if considered in the abstract, suggests a tort-law/negligence-based analysis looking toward a finding of fault and damage recovery where the duty of care has not been properly observed and loss has been suffered. But the Model Act’s desired level of director performance, with its objectively-based standard of conduct (‘‘the care that a person in a like position would reasonably believe appropriate under similar circumstances’’), does not carry with it the same type of result-oriented liability analysis. The courts recognize that boards of directors and corporate managers make numerous decisions that involve the balancing of risks and benefits for the enterprise. Although some decisions turn out to be unwise or the result of a mistake of judgment, it is not reasonable to reexamine an unsuccessful decision with the benefit of hindsight. As observed in Joy v. North, 692 F.2d 880, 885 (2d Cir. 1982): ‘‘Whereas an automobile driver who makes a mistake in judgment as to speed or distance injuring a pedestrian will likely be called upon to respond in damages, a corporate [director or] officer who makes a mistake in judgment as to economic conditions, consumer tastes or production line efficiency will rarely, if ever, be found liable for damages suffered by the corporation.’’ Therefore, as a general rule, a director is not exposed to personal liability for injury or damage caused by an unwise decision. While a director is not personally responsible for unwise decisions or mistakes of judgment—and conduct conforming with the standards of section 8.30 will almost always be protected—a director can be held liable for misfeasance or nonfeasance in performing the duties of a director. And while a director whose performance meets the standards of section 8.30 should have no liability, the fact that a director’s performance fails to reach that level does not automatically establish personal liability for damages that the corporation may have suffered as a consequence. A director’s financial risk exposure (e.g., in a lawsuit for money damages suffered by the corporation or its shareholders claimed to have resulted from misfeasance or nonfeasance in connection with the performance of the director’s duties) can be analyzed as follows: 1. Articles of incorporation limitation. If the corporation’s articles of incorporation contain a provision eliminating its directors’ liability to the corporation or its shareholders for money damages, adopted pursuant to section 2.02(b)(4), there is no liability unless the director’s conduct involves one of the prescribed exceptions that preclude the elimination of liability. See section 2.02 and its Official Comment. 2. Director’s conflicting interest transaction safe harbor. If the matter at issue involves a director’s conflicting interest transaction (as defined in section 8.60(2)) and a safe harbor procedure under section 8.61 involving action taken in compliance with section 8.62 or 8.63 has been properly implemented, there is no liability for the interested director arising out of the transaction. See subchapter F of this chapter 8. 3. Business opportunities safe harbor. Similarly, if the matter involves a director’s taking of a business opportunity and a safe harbor procedure under section 8.70 has been properly implemented, there is no liability for the director arising out of the taking of the business opportunity. See subchapter G of this chapter 8. 4. Business judgment rule. If an articles of incorporation provision adopted pursuant to section 2.02 or a safe harbor procedure under section 8.61 does not shield the director’s conduct from liability, this standard of judicial review for director conduct— deeply rooted in the case law—presumes that, absent self-dealing or other breach of the duty of loyalty, directors’ decision-making satisfies the applicable legal requirements. A plaintiff challenging the director’s conduct in connection with a corporate decision, and asserting liability by reason thereof, encounters certain procedural barriers. In the first instance, many jurisdictions have special pleading requirements that condition the ability to pursue the challenge on the plaintiff’s bringing forward specific factual allegations that put in question the availability of the business judg ment presumption. Assuming the suit survives a motion to dismiss for failure to state (in satisfaction of such a condition) an actionable claim, the plaintiff has the burden of overcoming that presumption of regularity. 5. Damages and proximate cause. If the business judgment rule does not shield the directors’ decision-making from liability, as a general rule it must be established that money damages were suffered by the corporation or its shareholders and those damages resulted from and were legally caused by the challenged act or omission of the director. 6. Other liability for money payment. Aside from a claim for damages, the director may be liable to reimburse the corporation pursuant to a claim under quantum meruit (the reasonable value of services) or quantum valebant (the reasonable value of goods and materials) if corporate resources have been used without proper authorization. In addition, the corporation may be entitled to short-swing profit recovery, stemming from the director’s trading in its securities, under § 16(b) of the Securities Exchange Act of 1934. 7. Equitable profit recovery or disgorgement. An equitable remedy compelling the disgorgement of the director’s improper financial gain or entitling the corporation to profit recovery, where directors’ duties have been breached, may require the payment of money by the director to the corporation. 8. Corporate indemnification. If the court determines that the director is liable, the director may be indemnified by the corporation for any payments made and expenses incurred, depending upon the circumstances, if a third-party suit is involved. If the proceeding is by or in the right of the corporation, the director may be reimbursed for reasonable expenses incurred in connection with the proceeding if ordered by a court under section 8.54(a)(3). 9. Insurance. To the extent that corporate indemnification is not available, the director may be reimbursed for the money damages for which the director is accountable, together with proceeding- related expenses, if the claim/grounds for liability come within the coverage under directors’ and officers’ liability insurance that has been purchased by the corporation pursuant to section 8.57. Section 8.31 includes steps (1) through (6) in the analysis of a director’s liability exposure set forth in the above Note. In establishing general standards of director liability under the Model Act, the section also serves the important purpose of providing clarification that the general standards of conduct set forth in section 8.30 are not intended to codify the business judgment rule— a point as to which there has been confusion on the part of some courts (notwithstanding a disclaimer of that purpose and effect in the prior Official Comment to section 8.30). For example, one court viewed the standard of care set forth in Washington’s business corporation act (a provision based upon and almost identical to the prior section 8.30(a)—which read ‘‘A director shall discharge his duties as a director . . . : (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner he reasonably believes to be in the best interests of the corporation’’) as having codified the business judgment rule. See Seafirst Corp. v. Jenkins, 644 F. Supp. 1152, 1159 (W.D. Wash. 1986). (A later court characterized this view as a mistaken assumption and recognized the disclaimer made in section 8.30’s Official Comment. See Shinn v. Thrust IV Inc., 786 P. 2d 285, 290 n.1 (Wash. App. 1990).) Another court declared ‘‘Section 309 [a standard of conduct almost identical to the prior section 8.30(a)] codifies California’s business judgment rule.’’ See Gaillard v. Natomas Co., 208 Cal. App. 3d 1250, 1264 (1989). The Court of Appeals of New York referred to that state’s statutory standard of care for directors, a formulation set forth in NYBCL § 717 that is similar to the prior section 8.30(a), as ‘‘New York’s business judgment rule.’’ See Lindner Fund, Inc. v. Waldbaum, Inc., 624 N.E. 2d 160, 161 (1993). In contrast, another court considering New York’s conduct standard observed: A board member’s obligation to a corporation and its shareholders has two prongs, generally characterized as the duty of care and the duty of loyalty. The duty of care refers to the responsibility of a corporate fiduciary to exercise, in the performance of his tasks, the care that a reasonably prudent person in a similar position would use under similar circumstances. See NYBCL § 717. In evaluating a manager’s compliance with the duty of care, New York courts adhere to the business judgment rule, which ‘‘bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.’’ Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 264 (2d Cir. 1984) [quoting Auerbach v. Bennett, 47 N.Y. 2d 619, 629 (1979)]. Sections 8.30 and 8.31 adopt the approach to director conduct and director liability taken in the Norlin decision. See section 8.30 and its Official Comment with respect to the standards of conduct for directors. For a detailed analysis of how and why standards of conduct and standards of liability diverge in corporate law, see Melvin A. Eisenberg, The Divergence of Standards of Conduct and Standards of Review in Corporate Law, 62 Fordham L. Rev. 437 (1993). The Model Act does not undertake to prescribe detailed litigation procedures. However, it does deal with requirements applicable to shareholder derivative suits (see sections 7.40–7.47) and section 8.31 builds on those requirements. If any of (i) a liability-eliminating provision included in the corporation’s articles of incorporation, pursuant to section 2.02(b)(4), (ii) protection for a director’s conflicting interest transaction afforded by section 8.61(b)(1) or section 8.61(b)(2), or (iii) protection for a disclaimer of the corporation’s interest in a business opportunity afforded by section 8.70 is interposed by a defendant director as a bar to the challenge of his or her conduct, the plaintiff’s role in satisfying the requirement of subsection (a)(1)—i.e., establishing that the articles of incorporation provision or the safe harbor provision interposed does not apply—would be governed by the court’s procedural rules. Parenthetically, where fairness of a director’s conflicting interest transaction can be established, protection from liability is also afforded by section 8.61(b)(3). If it is asserted by a defendant director as a defense, it is important to note that subsection (a)(2)(v) rather than subsection (a)(1) would be implicated and the burden of establishing that the transaction was fair to the corporation—and, therefore, no improper financial benefit was received—is placed on the interested director under section 8.61(b)(3). Similarly, the local pleading and other rules would govern the plaintiff’s effort to satisfy subsection (a)(2)’s requirements. Consistent with the general rules of civil procedure, the plaintiff generally has the burden under subsection (b) of proving that the director’s deficient conduct caused harm resulting in monetary damage or calls for monetary reimbursement; in the alternative, the circumstances may justify or require an equitable remedy. If a provision in the corporation’s articles of incorporation (adopted pursuant to section 2.02(b)(4)) shelters the director from liability for money damages, or if a safe harbor provision, under subsection (b)(1) or (b)(2) of section 8.61 or section 8.70, shelters the director’s conduct in connection with a conflicting interest transaction or the taking of a business opportunity, and such defense applies to all claims in plaintiff’s complaint, there is no need to consider further the application of section 8.31’s standards of liability. In that event, the court would presumably grant the defendant director’s motion for dismissal or summary judgment (or the equivalent) and the proceeding would be ended. If the defense applies to some but not all of plaintiff’s claims, defendant is entitled to dismissal or summary judgment with respect to those claims. Termination of the proceeding or dismissal of claims on the basis of an articles of incorporation provision or safe harbor will not automatically follow, however, if the party challenging the director’s conduct can assert any of the valid bases for contesting the availability of the liability shelter. Absent such a challenge, the relevant shelter provision is self-executing and the individual director’s exoneration from liability is automatic. Further, under both section 8.61 and section 8.70, the directors approving the conflicting interest transaction or the director’s taking of the business opportunity will presumably be protected as well, for compliance with the relevant standards of conduct under section 8.30 is important for their action to be effective and, as noted above, conduct meeting section 8.30’s standards will almost always be protected. If a claim of liability arising out of a challenged act or omission of a director is not resolved and disposed of under subsection (a)(1), subsection (a)(2) provides the basis for evaluating whether the conduct in question can be challenged. Over the years, the courts have developed a broad common law concept geared to business judgment. In basic principle, a board of directors enjoys a presumption of sound business judgment and its decisions will not be disturbed (by a court substituting its own notions of what is or is not sound business judgment) if they can be attributed to any rational business purpose. See Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971). Relatedly, it is presumed that, in making a business decision, directors act in good faith, on an informed basis, and in the honest belief that the action taken is in the best interests of the corporation. See Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1983). When applied, this principle operates both as a procedural rule of evidence and a substantive rule of law, in that if the plaintiff fails to rebut the presumption that the directors acted in good faith, in the corporation’s best interest and on an informed basis, the business judgment standard protects both the directors and the decisions they make. See Citron v. Fairchild Camera & Instrument Corp., 569 A. 2d 53, 64 (Del. 1989). Some have suggested that, within the business judgment standard’s broad ambit, a distinction might usefully be drawn between that part which protects directors from personal liability for the decision they make and the part which protects the decision itself from attack. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A. 2d 173, 180 n.10 (Del. 1986). While these two objects of the business judgment standard’s protection are different, and judicial review might result in the decision being enjoined but no personal liability (or vice versa), their operative elements are identical (i.e., good faith, disinterest, informed judgment and ‘‘best interests’’). As a consequence, the courts have not observed any distinction in terminology and have generally followed the practice of referring only to the business judgment rule, whether dealing with personal liability issues or transactional justification matters. While, in substance, the operative elements of the standard of judicial review commonly referred to as the business judgment rule have been widely recognized, courts have used a number of different word formulations to articulate the concept. The formulation adopted in § 4.01(c) of The American Law Institute’s PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS (1994) provides that a director who makes a business judgment in good faith (an obvious prerequisite) fulfills the duty of care standard if the director: (1) is not interested [as defined] in the subject of the business judgment; (2) is informed with respect to the subject of the business judgment to the extent the director . . . reasonably believes to be appropriate under the circumstances; and (3) rationally believes that the business judgment is in the best interests of the corporation. Referring to clause (2) above, the decision-making process is to be reviewed on a basis that is to a large extent individualized in nature (‘‘informed . . . to the extent the director . . . reasonably believes to be appropriate under the circumstances’’)—as contrasted with the traditional objectively-based duty-of-care standard (e.g., the prior section 8.30(a)’s ‘‘care . . . an ordinarily prudent person . . . would exercise’’). An ‘‘ordinarily prudent person’’ might do more to become better informed, but if a director believes, in good faith, that the director can make a sufficiently informed business judgment, the director will be protected so long as that belief is within the bounds of reason. Referring to clause (3) above, the phrase ‘‘rationally believes’’ is stated in the PRINCIPLES to be a term having ‘‘both an objective and subjective content. A director . . . must actually believe that the business judgment is in the best interests of the corporation and that belief must be rational,’’ 1 PRINCIPLES, at 179. Others see that aspect to be primarily geared to the process employed by a director in making the decision as opposed to the substantive content of the board decision made. See Aronson v. Lewis, supra, at 812 (‘‘The business judgment rule is . . . a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. . . . Absent an abuse of discretion, that judgment will be respected by the courts.’’) In practical application, an irrational belief would in all likelihood constitute an abuse of discretion. Compare In re Caremark International Inc. Derivative Litigation (September 25, 1996) (1996 Del. Ch. LEXIS 125 at p. 27: ‘‘whether a judge or jury considering the matter after the fact . . . believes a decision substantively wrong, or degrees of wrong extending through ‘‘stupid’’ to ‘‘egregious’’ or ‘‘irrational’’, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests . . . the business judgment rule is process oriented and informed by a deep respect for all good faith board decisions.’’) Section 8.31 does not codify the business judgment rule as a whole. The section recognizes the common law doctrine and provides guidance as to its application in dealing with director liability claims. Because the elements of the business judgment rule and the circumstances for its application are continuing to be developed by the courts, it would not be desirable to freeze the concept in a statute. For example, in recent years the Delaware Supreme Court has established novel applications of the concept to various transactional justification matters, such as the role of special litigation committees and change-of-control situations. See Zapata Corporation v. Maldonado, 430 A. 2d 779 (1981), and Unocal Corp. v. Mesa Petroleum Co., 493 A. 2d 946 (1985), respectively. Under Zapata, a rule that applies where there is no disinterested majority on the board appointing the special litigation committee, there is no presumption of regularity and the corporation must bear the burden of proving the independence of the committee, the reasonableness of its investigation, and the reasonableness of the bases of its determination that dismissal of the derivative litigation is in the best interests of the corporation. Under Unocal, the board must first establish reasonable grounds for believing an unsolicited takeover bid poses a danger to corporate policy and effectiveness, and a reasonable relationship of defensive measures taken to the threat posed, before the board’s action will be entitled to the business judgment presumptions. The business judgment concept has been employed in countless legal decisions and is a topic that has received a great deal of scholarly attention. For an exhaustive treatment of the subject, see D. Block, N. Barton & S. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors (4th ed. 1993 & Supp. 1995). While codification of the business judgment rule in section 8.31 is expressly disclaimed, its principal elements, relating to personal liability issues, are embedded in subsection (a)(2). The expectation that a director’s conduct will be in good faith is an overarching element of his or her baseline duties. Relevant thereto, it has been stated that a lack of good faith is presented where a board ‘‘lacked an actual intention to advance corporate welfare’’ and ‘‘bad faith’’ is presented where ‘‘a transaction . . . is authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of applicable positive law.’’ See Gagliardi v. TriFoods Int’l Inc., 683 A.2d 1049 (Del. Ch. 1996). If a director’s conduct can be successfully challenged pursuant to other clauses of subsection (a)(2), there is a substantial likelihood that the conduct in question will also present an issue of good faith implicating clause 2(i). Conduct involving knowingly illegal conduct that exposes the corporation to harm will constitute action not in good faith, and belief that decisions made (in connection with such conduct) were in the best interests of the corporation will be subject to challenge as well. If subsection (a)(2) included only clause 2(i), much of the conduct with which the other clauses are concerned could still be considered pursuant to the subsection, on the basis that such conduct evidenced the actor’s lack of good faith. Accordingly, the canon of construction known as eiusdem generis has substantial relevance in understanding the broad overlap of the good faith element with the various other subsection (a)(2) clauses. Where conduct has not been found deficient on other grounds, decisionmaking outside the bounds of reasonable judgment—an abuse of discretion perhaps explicable on no other basis—can give rise to an inference of bad faith. That form of conduct (characterized by the court as ‘‘constructive fraud’’ or ‘‘reckless indifference’’ or ‘‘deliberate disregard’’ in the relatively few case precedents) giving rise to an inference of bad faith will also raise a serious question whether the director could have reasonably believed that the best interests of the corporation would be served. If a director’s conflicting interest transaction is determined to be manifestly unfavorable to the corporation, giving rise to an inference of bad faith tainting the directors’ action approving the transaction under section 8.62, the safe harbor protection afforded by section 8.61 for both the transaction and the conflicted director would be in jeopardy. See the Official Comment to section 8.61. Depending on the facts and circumstances, the directors who approve a director’s conflicting interest transaction that is manifestly unfavorable to the corporation may be at risk under clause (2)(i). A director should reasonably believe that his or her decision will be in the best interests of the corporation and a director should become sufficiently informed, with respect to any action taken or not taken, to the extent he or she reasonably believes appropriate in the circumstances. In each case, the director’s reasonable belief calls for a subjective belief and, so long as it is his or her honest and good faith belief, a director has wide discretion. However, in the rare case where a decision respecting the corporation’s best interests is so removed from the realm of reason (e.g., corporate waste), or a belief as to the sufficiency of the director’s preparation to make an informed judgment is so unreasonable as to fall outside the permissible bounds of sound discretion (e.g., a clear case is presented if the director has undertaken no preparation and is woefully uninformed), the director’s judgment will not be sustained. If a director has a familial, financial or business relationship with another person having a material interest in a transaction or other conduct involving the corporation, or if the director is dominated or controlled by another person having such a material interest, there is a potential for that conflicted interest or divided loyalty to affect the director’s judgment. If the matter at issue involves a director’s transactional interest, such as a ‘‘director’s conflicting interest transaction’’ (see section 8.60(2)) in which a ‘‘related person’’ (see section 8.60(3)) is involved, it will be governed by section 8.61; otherwise, the lack of objectivity due to a relationship’s influence on the director’s judgment will be evaluated, in the context of the pending conduct challenge, under section 8.31. If the matter at issue involves lack of independence, the proof of domination or control and its influence on the director’s judgment will typically entail different (and perhaps more convincing) evidence than what may be involved in a lack of objectivity case. The variables are manifold, and the facts must be sorted out and weighed on a case-by-case basis. If that other person is the director’s spouse or employer, the concern that the director’s judgment might be improperly influenced would be substantially greater than if that person is the spouse of the director’s step-grandchild or the director’s partner in a vacation time-share. When the party challenging the director’s conduct can establish that the relationship or the domination or control in question could reasonably be expected to affect the director’s judgment respecting the matter at issue in a manner adverse to the corporation, the director will then have the opportunity to establish that the action taken by him or her was reasonably believed to be in the best interests of the corporation. The reasonableness of the director’s belief as to the corporation’s best interests, in respect of the action taken, should be evaluated on the basis of not only the director’s honest and good faith belief but also on considerations bearing on the fairness to the corporation of the transaction or other conduct involving the corporation that is at issue. Subchapter F of chapter 8 of the Model Act deals in detail with directors’ transactional interests. Its coverage of those interests is exclusive and its safe harbor procedures for directors’ conflicting interest transactions (as defined)—providing shelter from legal challenges based on interest conflicts, when properly observed— will establish a director’s entitlement to any financial benefit gained from the transactional event. A director’s conflicting interest transaction that is not protected by the fairness standard set forth in section 8.61(b)(3), pursuant to which the conflicted director may establish the transaction to have been fair to the corporation, would often involve receipt of a financial benefit to which the director was not entitled (i.e., the transaction was not ‘‘fair’’ to the corporation). Unauthorized use of corporate assets, such as aircraft or hotel suites, would also provide a basis for the proper challenge of a director’s conduct. There can be other forms of improper financial benefit not involving a transaction with the corporation or use of its facilities, such as where a director profits from unauthorized use of proprietary information. A director is expected to observe an obligation of undivided loyalty to the corporation and, while the law will not concern itself with trifling deviations (de minimis non curat lex), there is no materiality threshold that applies to a financial benefit to which a director is not properly entitled. The Model Act observes this principle in several places (e.g., the exception to liability elimination prescribed in section 2.02(b)(4)(A) and the indemnification restriction in section 8.51(d)(2), as well as the liability standard in subsection (a)(2)(v)). In contrast, there is a materiality threshold for the interest of another in a transaction or conduct where a director’s lack of objectivity or lack of independence has been asserted under subsection (a)(2)(iii). In the typical case, analysis of another’s interest would first consider the materiality of the transaction or conduct at issue—in most cases, any transaction or other action involving the attention of the board or one of its committees will cross the materiality threshold, but not always— and would then consider the materiality of that person’s interest therein. The possibility that another’s interest in a transaction or conduct that is not material, or that an immaterial interest of another in a transaction or conduct, would adversely affect a director’s judgment is sufficiently remote that it should not be made subject to judicial review. The director’s role involves two fundamental components: the decision-making function and the oversight function. In contrast with the decision-making function, which generally involves action taken at a point in time, the oversight function under section 8.01(b) involves ongoing monitoring of the corporation’s business and affairs over a period of time. This involves the duty of ongoing attention, when actual knowledge of particular facts and circumstances arouse suspicions which indicate a need to make inquiry. As observed by the Supreme Court of New Jersey in Francis v. United Jersey Bank, 432 A.2d 814, 822 (Sup. Ct. 1981): Directors are under a continuing obligation to keep informed about the activities of the corporation. . . . Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty to look. The sentinel asleep at his post contributes nothing to the enterprise he is charged to protect. . . . Directorial management does not require a detailed inspection of day-today activities, but rather a general monitoring of corporate affairs and policies. While the facts will be outcome-determinative, deficient conduct involving a sustained failure to exercise oversight—where found actionable—has typically been characterized by the courts in terms of abdication and continued neglect of a director’s duty of attention, not a brief distraction or temporary interruption. However, embedded in the oversight function is the need to inquire when suspicions are aroused. This duty is not a component of ongoing oversight, and does not entail proactive vigilance, but arises when, and only when, particular facts and circumstances of material concern (e.g., evidence of embezzlement at a high level or the discovery of significant inventory shortages) suddenly surface. Subsection (a)(2)(v) is, in part, a catchall provision that implements the intention to make section 8.31 a generally inclusive provision but, at the same time, to recognize the existence of other breaches of common-law duties that can give rise to liability for directors. As developed in the case law, these actionable breaches include unauthorized use of corporate property or information, unfair competition with the corporation and taking of a corporate opportunity. In the latter case, the director is alleged to have wrongfully diverted a business opportunity as to which the corporation had a prior right. Section 8.70 provides a safe harbor mechanism for a director who wishes to take advantage of a business opportunity, regardless of whether such opportunity would be characterized as a ‘‘corporate opportunity’’ under existing case law. Note that section 8.70(b) provides that the fact that a director did not employ the safe harbor provisions of section 8.70 does not create an inference that the opportunity should have first been presented to the corporation or alter the burden of proof otherwise applicable to establish a breach of the director’s duty to the corporation. Pursuant to section 8.61(b)(3), an interested director (or the corporation, if it chooses) can gain protection for a director’s conflicting interest transaction by establishing that it was fair to the corporation. (The concept of ‘‘fair’’ and ‘‘fairness,’’ in this and various other contexts, can take into account both fair price and fair dealing on the part of the interested director. See the Official Comment to section 8.61.) Under case law, personal liability as well as transactional justification issues will be subject to a fairness standard of judicial review if the plaintiff makes out a credible claim of breach of the duty of loyalty or if the presumptions of the business judgment standard (e.g., an informed judgment) are overcome, with the burden of proof shifting from the plaintiff to the defendant. In this respect, the issue of fairness is relevant to both subsection (a) and subsection (b). Within the ambit of subsection (a)(2), a director can often respond to the challenge that his or her conduct was deficient by establishing that the transaction or conduct at issue was fair to the corporation. See Kahn v. Lynch Communications Systems, Inc. 669 A.2d 79 (Del. 1995). Cf. Cede & Co. v. Technicolor Inc., 634 A.2d 345 (Del. 1993) (when the business judgment rule is rebutted—procedurally— the burden shifts to the defendant directors to prove the ‘‘entire fairness’’ of the challenged transaction). It is to be noted, however, that fairness may not be relevant to the matter at issue (see, e.g., clause (iv) of subsection (a)(2)). If the director is successful in establishing fairness, where the issue of fairness is relevant, then it is unlikely that the complainant can establish legal liability or the appropriateness of an equitable remedy under subsection (b). Subsection (a)(2) deals, throughout, with a director’s action that is taken or not taken. To the extent that the director’s conduct involves a breach of his or her duty of care or duty of attention within the context of collegial action by the board or one of its committees, proper performance of the relevant duty through the action taken by the director’s colleagues can overcome the consequences of his or her deficient conduct. For example, where a director’s conduct can be challenged under subsection (a)(2)(ii)(B) by reason of having been uninformed about the decision— he or she did not read the merger materials distributed prior to the meeting, arrived late at the board meeting just in time for the vote but, nonetheless, voted for the merger solely because the others were in favor—the favorable action by a quorum of properly informed directors would ordinarily protect the director against liability. When the director’s conduct involves the duty of fair dealing within the context of action taken by the board or one of its committees, the wiser choice will usually be for the director not to participate in the collegial action. That is to say, where a director may have a conflicting interest or a divided loyalty, or even where there may be grounds for the issue to be raised, the better course to follow is usually for the director to disclose the conduct-related facts and circumstances posing the possible compromise of his or her independence or objectivity, and then to withdraw from the meeting (or, in the alternative, to abstain from the deliberations and voting). The board members free of any possible taint can then take appropriate action as contemplated by section 8.30. (If a director’s conflicting interest transaction is involved, it will be governed by subchapter F of this chapter and the directors’ action will be taken pursuant to section 8.62 (or the board can refer the matter for shareholder’s action respecting the transaction under section 8.63). In this connection, particular reference is made to the definition of ‘‘qualified director’’ in section 1.43.) If this course is followed, the director’s conduct respecting the matter in question will in all likelihood be beyond challenge. After satisfying the burden of establishing that the conduct of the director is challengeable under subsection (a), the plaintiff, in order to hold the director liable for money damages under clause (b)(1), has the further burden of establishing that: (i) harm (measurable in money damages) has been suffered by the corporation or its shareholders and (ii) the director’s challenged conduct was the proximate cause of that harm. The concept of ‘‘proximate cause’’ is a term of art that is basic to tort law, and the cases providing content to the phrase represent well-developed authority to which a court will undoubtedly refer. A useful approach for the concept’s application, for purposes of subsection (b)(1), would be that the challenged conduct must have been a ‘‘substantial factor in producing the harm.’’ See Francis v. United Jersey Bank, supra, 432 A.2d at 829. Similarly, the plaintiff has the burden of establishing money payment is due from the director pursuant to clause (b)(2). If, while challengeable, the conduct at issue caused no harm under clause (b)(1) or does not provide the basis for other legal remedy under clause (b)(2), but may provide the basis for an equitable remedy under clause (b)(3), the plaintiff must satisfy whatever further burden of persuasion may be indicated to establish that imposition of the remedy sought is appropriate in the circumstances. In Brophy v. Cities Service Co, 70 A.2d 5, 8 (Del. Ch. 1949), an employee was required to account for profits derived from the use of the corporation’s confidential plans to reacquire its securities through open-market purchases. Notwithstanding the fact that harm to the corporation had not been established, the Chancellor observed: ‘‘[p]ublic policy will not permit an employee occupying a position of trust and confidence toward his employer to abuse that relation to his own profit, regardless of whether his employer suffers a loss.’’ Once actionable conduct that provides the basis for an equitable remedy under clause (b)(3) has been established, its appropriateness will often be clear and, if so, no further advocacy on the part of the plaintiff will be required. While section 8.31 addresses director liability to the corporation or its shareholders under the Model Act—and related case law dealing with interpretation by the courts of their states’ business corporation acts or dealing with corporate governance concepts coming within the common law’s ambit—it does not limit any liabilities or foreclose any rights expressly provided for under other law. For example, directors can have liability (i) to shareholders (as well as former shareholders), who purchased their shares in a registered public offering, under § 11 of the Securities Act of 1933 and (ii) to the corporation, for short-swing profit recovery, under § 16(b) of the Securities Exchange Act of 1934. Subsection (c) merely acknowledges that those rights are unaffected by section 8.31. And directors can have liability to persons other than the corporation and its shareholders, such as (i) employee benefit plan participants and beneficiaries (who may or may not be shareholders), if the directors are determined to be fiduciaries under the Employee Retirement Income Security Act of 1974, 29 U.S.C. §§ 1001–1461 (1988 & Supp. IV 1992), (ii) government agencies for regulatory violations or (iii) individuals claiming damages for injury governed by tort-law concepts (e.g., libel or slander). As discussed above in the Official Comment to section 8.31(a), the concept of ‘‘fairness’’ is often relevant to whether a director will have liability if his or her conduct is challenged. Specifically, a director can successfully defend a financial interest in a transaction with the corporation by establishing that it was fair to the corporation. See section 8.61 and its Official Comment. More generally, the courts have resorted to a fairness standard of review where the business judgment rule has been inapplicable. See Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983). In the usual case, the defendant seeking to justify challenged conduct, on the basis of fairness, has the burden of proving that it was fair to the corporation. Subsection (c) expressly disclaims any intention to shift the burden of proof otherwise applicable where the question of the fairness of a transaction or other challenged conduct is at issue. Finally, the Model Act deals expressly with certain aspects of director liability in other sections. For example, a director has a duty to observe the limitations on shareholder distributions set forth in section 6.40 and, if a director votes for or assents to a distribution in violation thereof, the director has personal liability as provided in section 8.33. And section 8.61 channels all directors’ transactional interests into the exclusive treatment for directors’ conflicting interest transactions that is therein provided, rejecting an award of damages or other sanctions for interests that do not come within its conceptual framework. Subsection (c) expressly acknowledges that the liability standard provided in sec tion 8.33 and the exclusive treatment for directors’ transactional interests provided in section 8.61 are unaffected by section 8.31.
Posted on: Fri, 12 Sep 2014 12:42:03 +0000
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