In a bench ruling issued February 6, 2013 in In re Puda Coal, Inc. Stockholders Litig., C.A. No. 6476-CS (Del. Ch.), the Delaware Court of Chancery refused to dismiss claims of a breach of the fiduciary duty of loyalty against the U.S. independent directors of a Delaware company with assets and operations solely abroad. Directors of Delaware corporations have a fiduciary duty of loyalty to act in good faith in exercising reasonable oversight of management and operations of a corporation. Traditionally, Delaware courts have imposed a high standard for plaintiffs to demonstrate a breach of such duty, finding that only a “sustained or systematic failure of the board to exercise oversight” constitutes a breach. In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 971 (1996).
Puda Coal, Inc. (“Puda Coal”) was a publicly-held Delaware company with operations in China. In 2011, the audit committee of the board of directors began conducting an internal investigation, which found that the company’s chairman had inappropriately transferred the primary operating subsidiary to himself. The Securities and Exchange Commission suspended trading of Puda Coal’s stock, and the independent directors resigned due to an alleged lack of cooperation by the company. In subsequent derivative litigation, the plaintiffs alleged that the directors acted in bad faith by failing to adequately monitor Puda Coal.
The Court denied the defendants’ motion to dismiss for failure to state a claim, which claim stated that the independent directors breached their duty of loyalty by failing to discharge oversight of the company. According to the Court, “independent directors who step into these situations involving essentially the fiduciary oversight of assets in other parts of the world have a duty not to be dummy directors.” The Court explained that directors cannot allow themselves to be appointed to their positions without making any serious effort to fulfill their duties. The Court also found that the resignation of Puda Coal’s independent directors could constitute a breach of the duty of loyalty, since they constituted a majority of the company’s board of directors and such resignations would not cure prior failings, but instead left the company controlled by the errant chairman.
While Puda Coal is a bench ruling, it serves as a warning for independent directors of foreign-headquartered companies incorporated in Delaware. Such directors need to maintain a system of internal controls, exercise adequate oversight of management and possess the language skills necessary to navigate the environment in which their company operates. Directors should also carefully consider the current state of operations of a company before resigning, as they may have a duty to remain in their positions and assist in solving existing problems.