Delaware is often cited as the favored state of incorporation for businesses. It prides itself on its advanced and well-developed corporate law and ability to resolve corporate disputes. It also has the reputation as being less strict on officers and directors of corporations, so an officer and director of a Delaware corporation may face less risk from shareholder claims than a non-Delaware corporation.
This has gradually changed and some Delaware cases have come down on the side of shareholders in disputes with a corporation's officers and directors. This is illustrated by the recent Delaware Supreme Court case of Gantler vs. Stephens (C.A. No. 2392). Interestingly, the case has generated several articles and commentaries, discussing different aspects of the case.
First Niles is a Delaware corporation headquartered in Niles, Ohio. Its sole purpose is to own and operate Home Federal Savings and Loan Association of Niles. In late 2003, faced with a depressed local economy, the Board decided that First Niles should be sold. The Board did not pass a competing proposal to take First Niles private, with the current officers and directors as potential owners.
Three potential purchasers showed up and all offered slight premiums over First Niles' share price. One purchaser was not pursued when it made clear it would replace the existing board. One purchaser quit in frustration when First Niles' management failed to provide some critical information. The final purchaser was rejected by the Board without deliberation or discussion. First Niles' management then pursued its "privatization" proposal, asking for shareholder approval. By a small margin, the shareholders approved.
But Gantler, another minority shareholder, claimed the Board and the corporate officers had breached their fiduciary duties to shareholders by rejecting one possible purchaser without discussion and sabotaging the other purchasers. They also claimed that the Board misled minority shareholders in presenting information on the "privatization" proposal, which could potentially enrich the Board members and officers. The lower court in Delaware dismissed the claim. But the Delaware Supreme Court found that there was enough information for the minority shareholders to continue their claim against the officers and directors.
Two aspects in the Delaware Supreme Court opinion are getting attention. First is the Court's view of shareholder ratification. Usually, shareholder approval is given great weight, almost a "cleansing" effect on the board's decisions. But the Court distinguished situations where shareholder approval was not legally required, but obtained anyway. This, said the Court, is true "ratification." But, in the First Niles case, where shareholder approval was legally required, the shareholder approval of the board decision will carry less weight, meaning the court will more closely scrutinize the board's decision. So the ability of directors to protect themselves through shareholder ratification has been narrowed.
Second, the Court held, for the first time, that officers of a corporation owe "fiduciary" duties (a very high level of responsibility) to the corporation, just as directors do. This aspect of the decision was not a surprise, as other courts in Delaware had said as much. But the Delaware Supreme Court took this opportunity to explicitly impose this duty on officers as well as directors.
The result in Gantler v. Stephens has implications for other companies. The recession may have had an influence. As is the case with almost any recession, adverse economic conditions will expose fraud, misconduct, and malfeasance more than the most skilled investigator. Delaware courts are less likely to pass on questionable conduct in this climate. Second, management and boards may not be able to rely on shareholder votes as assurance that their decisions will not be questioned. Third, officers of corporations (especially public corporations) must be concerned about personal liability arising from shareholder claims.