In Schoon v. Smith,1 the Delaware Supreme Court recently affirmed the Delaware Court of Chancery’s decision dismissing a derivative complaint brought by a director of a Delaware corporation for lack of standing. Specifically, the Court of Chancery dismissed the complaint for lack of standing because Delaware statutory law did not provide directors with the power and the authority to commence a derivative action, and the appeal followed. On appeal, the Supreme Court affirmed the decision of the Court of Chancery for different reasons, and held that directors of Delaware corporations generally do not have standing to commence derivative actions on behalf of the company. In so holding, the Supreme Court noted that under certain limited circumstances, a director might have standing to commence a derivative action on behalf of the company under the doctrine of equitable standing, but that those circumstances were not present in this action.
In this action, a derivative complaint was filed by Richard W. Schoon against Troy Corporation2 and four of its five directors asserting claims for breach of fiduciary duties. Schoon was a director, but was not a stockholder, of Troy. Troy’s Board of Directors (the “Board”) consisted of five members (including Schoon), one of whom was Troy’s Chief Executive Officer. In his complaint, Schoon alleged that shortly after he became a director of Troy, he discovered that, in addition to the CEO, the remaining three directors on the Board were “beholden to” the CEO, which enabled the CEO to control the Board. Schoon also alleged that the CEO had taken actions on several occasions that were intended to entrench himself in power and, in turn, thwart potential value-maximizing transactions that may have benefited Troy and its stockholders. Accordingly, Schoon claimed that he was the only director able to exercise independent business judgment regarding the CEO and Troy, and that Troy was injured by the actions of his fellow directors. In response to the complaint, the defendants moved to dismiss the complaint for a variety of reasons, which included an assertion that Schoon lacked the requisite standing to commence a derivative action on behalf of Troy.
The Court of Chancery concluded that “Delaware law does not recognize the right of a director, acting in that capacity, to sue on behalf of the corporation he or she served or on behalf of its stockholders.” The Court of Chancery held that a decision to alter this arrangement is properly left to the legislature. Consequently, the Court of Chancery dismissed the complaint. Schoon filed an appeal with the Delaware Supreme Court.
On appeal, Schoon argued that as a matter of equity and public policy, a director should be entitled to assert a derivative claim on behalf of the corporation for the same reasons that stockholders are permitted to assert a derivative claim. In rendering its decision, the Supreme Court thoroughly examined the origins and historical development of derivative and equitable standing. The Supreme Court noted that because there was an absence of statutory authority for a director’s standing to commence a derivative action, Schoon’s argument ultimately would rise or fall on the merits of whether the Supreme Court should extend the doctrine of equitable standing to directors. The Supreme Court explained that the rationale for the doctrine was “to prevent a complete failure of justice on behalf of the corporation.” The Supreme Court held that no such complete failure was presented in this action, and, therefore, the Supreme Court declined to enlarge the doctrine of equitable standing in this action.
Although declining to extend equitable standing to Schoon, the Supreme Court disagreed “with the Court of Chancery’s categorical conclusion that ‘any decision’ to extend equitable standing to a director is for the [legislature] to make[,]” because “the judiciary is empowered to make” such a decision. In this case, however, the Supreme Court held that it could not extend equitable standing to Schoon because this dispute involved an issue of standing that had been embodied in a statute – specifically, 8 Del. C. § 327, which provides standing to stockholders to commence derivative actions – and because nothing in the record reflected that the stockholders of Troy were not able to commence a derivative action that asserted the same claims as Schoon. Ultimately, the Supreme Court declined to extend the doctrine of equitable standing to a director in this action because stockholders were available to redress any breach of fiduciary duty, and the stockholder who elected Schoon to the Board could have commenced a derivative action against the defendants. Thus, the Supreme Court perceived “no new exigencies that require[d] an extension of equitable standing to Schoon, as a director.”