BGC Partners, Inc. Derivative Litigation (Sept. 20, 2021) involved a merger between entities that were controlled by the same person, Howard Lutnick, through his control of Cantor Fitzgerald, L.P. ("Cantor"). Lutnick had a far larger economic interest in the target company, Berkeley Point Financial LLC ("Berkeley Point"), than in the acquiring company, BGC Partners, Inc. ("BGC"). The plaintiffs claimed that he therefore caused BGC to overpay for Berkeley Point (receiving himself 42% of the alleged overpayment, which amounted to $125 million, at the expense of the other BGC stockholders). The transaction was approved by a special committee of BGC's four outside directors, after months of negotiation with BGC. (BGC's minority stockholders did not vote on the transaction.) The plaintiffs sued Lutnick, Cantor, and BGC's directors for breach of fiduciary duties in improperly approving the related-party transaction.
The court found, despite evidence that it characterized as "not overwhelming," that two of the outside directors may not have been independent of Lutnick. As a result, the court held that: (i) the plaintiffs were excused from not having made a litigation demand on the board to bring the litigation (as demand would have been futile); (ii) the burden of proof under entire fairness review would not shift to the plaintiffs (as the transaction was not approved by a special committee comprised of a majority of independent directors); and (iii) the plaintiffs had validly pled a non-exculpated fiduciary claim against one of the nonindependent directors (as that director may have taken actions that furthered Lutnick's self-interest, violating the duty of loyalty).
- With respect to director independence from a company's controller, the decision highlights that: (i) there can be significant, negative impacts (particularly in the context of a related-party deal) from a judicial finding that one or more purportedly independent directors were not independent of the controller; (ii) the standard is low at the pleading stage of litigation for a finding of non-independence; and (iii) it is not only a director's close personal or business ties with the controller that can lead to a finding of non-independence. In this case, the court found one director to be non-independent based solely on the high percentage of his total income that his directorship compensation represented; and found another director to be non-independent based solely on the fact that he had highly praised the controller.
- With respect to fiduciary claims against directors, the decision highlights that, at least with respect to a director who the court deems to have been non-independent of the controller, there is the potential for seemingly minor actions to be interpreted as having advanced the controller's self-interest (and therefore constituting a breach of the duty of loyalty). In this case, the court found that the co-Chair of the special committee (who the court found may not have been independent of the controller) may have acted to advance the controller's self-interest when he was "mindful" of the controller's preferences for selecting advisors to the Special Committee and setting the timetable, he communicated directly with the controller about the process several times, and, perhaps most critically, his understanding of the controller's role was that he "could negotiate for BGC with himself as Cantor."
Background. The $850 million acquisition of Berkeley Point by BGC from Cantor Commercial Real Estate, L.P. ("CCRE") was approved by a Special Committee comprised of BGC's four outside directors-- Linda Bell, Stephen Curwood, William Moran, and John Dalton. Bell and Curwood were co-Chairs of the Committee. (Dalton ceased to be a director prior to this litigation being brought.) The Committee met nineteen times and engaged in months of negotiations with BGC, with several offers and counteroffers exchanged. At the early pleading stage of the litigation, then-Chancellor Andre Bouchard held that the plaintiffs had pled sufficient facts (a) to create a reasonable doubt as to the independence of a majority of the board that would have received a litigation demand and (b) to state non-exculpated claims against Lutnick and the outside directors. Following discovery, the defendants filed a motion for summary judgment on these issues, seeking dismissal of the suit. In this latest decision, on the summary judgment motion, Vice Chancellor Lori Will found that Curwood and Moran may not have been independent of Lutnick, and that Moran may have acted to further the self-interest of Lutnick rather than the interests of BGC and its stockholders. Therefore, the court excused demand by the plaintiffs; refused to shift the burden of proof to the plaintiffs under the entire fairness review; and refused to dismiss the fiduciary claim against Curwood.
Independence of the directors has relevance for a number of critical issues decided at the pleading stage of litigation:
- Demand futility. Demand on the board to itself bring litigation derivatively against directors is excused if the demand would have been "futile" because a majority of the directors who would have considered it could not have been impartial in making the decision. The court held in BGC that demand was excused because there were genuine questions of material fact as to whether a majority of the demand board was independent of Lutnick and therefore whether they could have been impartial in deciding whether to bring a suit against him.
- Burden shift (and MFW). In a conflicted controller transaction, under MFW, business judgment will be the judicial standard of review if the transaction was approved by both a special committee of independent directors and a majority of the minority stockholders. If MFW does not apply, then the more stringent entire fairness standard applies. When entire fairness applies, the burden of proof will shift, from the defendants (to prove the transaction was entirely fair) to the plaintiffs (to prove the transaction was not entirely fair), if the transaction was approved by either a special committee of independent directors or a majority of the minority stockholders. In BGC, MFW clearly did not apply because the minority stockholders did not approve the transaction. The court held that the burden of proof under entire fairness would not shift given that a majority of the directors serving on the special committee may not have been independent of Lutnick.
- Non-exculpated claims. Claims that would be exculpable under the company's charter (as permitted under DGCL Section 102(b)(7)) (i.e., duty of care claims) are dismissible at the pleading or summary judgment stages of litigation under the Cornerstone doctrine. One basis on which a plaintiff may validly plead a non-exculpable claim (i.e., a duty of loyalty claim) is by showing that the director may have acted to advance the interest of a self-interested controller from whom the director could not be presumed to act independently. The court held in BGC that the plaintiffs had pled a valid duty of loyalty claim against Moran (the Special Committee's cochair) as he may have taken actions to advance Lutnick's self-interest rather than the interests of BGC and its stockholders.
The standard, at the pleading stage, for a finding of possible non-independence is low. The court acknowledged that "the evidence [was] not overwhelming" with respect to the non-independence of any of the BGC directors, but emphasized that it does need to be. Rather, the standard at the pleading stage is merely whether it was "reasonably conceivable" that directors were non-independent, while making all reasonable inferences arising from the alleged facts in favor of the plaintiffs and leaving any "genuine issues of material fact" to be addressed at trial. The court noted that independence is rarely established at the pleading stage as it requires a facts-intensive inquiry best addressed at trial.
The court determined that Curwood may not have been independent--due solely to his household income level. It is well-established that, given that a controller can unilaterally remove a director, a director may be deemed to be non-independent of the controller if the compensation the director receives for serving on the board is material to the director from a personal financial view. Curwood was a journalist and environmentalist and hosted a public radio show on environmental issues. He joined the BGC board in 2009; and served on no other boards of companies affiliated with Cantor. He received $164,500 per year as compensation for this directorship during that period, which represented 52.4% of his total household income. His only other interaction with Lutnick was that they had served together on the Haverford Board of Managers for 12 years (including on one committee that focused on fundraising). The court found that Curwood may have been non-independent from Lutnick given that the compensation he received for serving as a BGC director represented "a majority" of his total household income.
The court noted that it was "mindful of the public policy concerns at play when wealth is used as a factor in analyzing independence"--however, the court emphasized, when director compensation is "personally material" to the director it may compromise his independence from the company's controller. Curwood's compensation represented "a majority" of his income; and Curwood had testified that this compensation allowed him to pursue his passion of a career in public radio and still be able to "feed his family." It would be "difficult to imagine more personally motivating factors," the court commented. The defendants argued that Curwood was not actually dependent on the compensation from this directorship as he had "many other options" to earn income. The court concluded that whether that was true, and Curwood's "subjective belief" about it, were facts-intensive matters to be addressed at trial.
The court determined that Moran may not have been independent--due solely to his high praise for Lutnick. According to the court, Moran had a "largely professional" relationship with Lutnick. He had been a senior executive at JP Morgan Chase from 1975-2005. He joined the BGC board in 2013 and served on the boards of three other Cantor-affiliated companies (one, which was BGC's predecessor, for six years; one for four years; and one for one year). His compensation from these directorships was $135,655 per year from 2013-2017, which represented 11.5% of his total household income during that period. Moreover, Moran had a net worth of about $20 million and an annual pension of almost $1 million. Over their "20-year relationship," Moran and Lutnick had attended only "a handful" of social, charitable or political events together. However, the court found that Moran may have been non-independent given his "respect" for Lutnick, which was "considerable." Moran called Lutnick an "inspiration" and stated that he might get "teary-eyed" speaking about what a "wonderful human being" Lutnick was and how proud he was to be associated with him.
The court stated that there is a reasonable inference that "reverence" for a person might color a director's judgment as to matters involving that person. The defendants argued that Moran's high praise for Lutnick was related to Lutnick's various charitable responses to the loss of lives of many Cantor Fitzgerald employees in the 9/11 disaster, and that his comments should be considered in light of the emotionally charged nature of that event. The court reasoned that whether Moran's views about Lutnick would have affected his impartiality in evaluating a litigation demand, and whether Moran actually bargained for the benefit of the company and its stockholders despite his reverence for Lutnick, were facts-intensive issues to be addressed at trial.
The court determined that Bell was independent. Bell, a Professor of Economics, joined BGC as a director in 2013; and had served on the board of another Cantor affiliate from 2009-2013. From these board positions, she earned an average of $119,000 per year from 2010-2017, which represented 7.6% of her total household income during that period. She had been a faculty member and then Provost at Haverford College, from which Lutnick had graduated and where he was a longtime member of the Board of Managers and a major donor. Bell left Haverford in 2012 to become the Provost at Barnard College, after which her limited contact with Lutnick outside BGC involved his introducing her to a wealthy family whose child was interested in Barnard; her occasionally recommending students to him to be interviewed for employment; and her finding a tutor for Lutnick's son and occasionally advising the son regarding his academic path.
The court stated that this situation was different from cases where the court has found directors with ties to a university lacked independence from significant donors to the university. Bell's role as Provost involved little fundraising; she was "five years removed" from any association with Haverford (thus she would not benefit in any way from his donations to the school); and she did not have any "owingness" to Lutnick because he had not been associated with her rise in professional standing at Haverford. The court characterized Bell's contacts with Lutnick's son as mere "cordiality," lacking the "emotional depth" to suggest non-independence from Lutnick. Even if she had gone out of her way for the son, that would suggest a sense of owingness on Lutnick's part, not Bell's, the court stated.
The court explained that independence for demand futility purposes is not dispositive of the independence issue for purposes of determining if a non-exculpated (duty of loyalty) claim has been pled. The demand inquiry is "hypothetical"--the question is whether, with respect to a transaction in which the controller is self-interested, a director "could theoretically have exercised impartial judgment if confronted with a demand to sue the conflicted [controller]." A director's objectivity concerning a hypothetical demand could be compromised even if the director's actions in evaluating the transaction were beyond reproach, the court stated. The duty of loyalty inquiry, by contrast, is focused on the director's "real-world actions (or inactions) in the context of [the director's] lack of independence"--the question is whether the director actually took steps in furtherance of the controller's self-interest or acted only in the interests of the company and the stockholders. A director, even if having a very close relationship with the controller, may nonetheless actually have acted beyond reproach in evaluating the transaction. The court therefore reviewed, with respect to each director that it viewed as potentially selfinterested, whether the director actually may have acted to advance Lutnick's self-interest.
The court determined that Moran may have breached the duty of loyalty by acting to advance Lutnick's self-interest. The court concluded that there were no particularized facts pled relating to Bell (who, as discussed above, the court deemed to be independent for futility purposes) or Curwood (who the court deemed to be possibly non-independent for futility purposes) indicating that they actually took actions (or were inactive) in support of Lutnick's self-interest. The court therefore granted summary judgment to Bell and Curwood and dismissed the fiduciary claims against them. However, the court found that Moran (who the court deemed possibly non-independent for futility purposes) may have acted to advance Lutnick's self-interest during the negotiations. According to the court, Moran's understanding of Lutnick's role in the transaction was that "Lutnick could negotiate for BGC with himself as Cantor." Also, the court noted, it appeared that Moran may have taken Lutnick's views into consideration when engaging advisors to the special committee and setting the timetable, and that Moran "communicated directly with Lutnick about the deal process on several occasions." No facts were alleged as to the substance of those communications. The court concluded that, while it could turn out that Moran stood up to Lutnick and "engaged in hard-fought, arm's-length negotiations to benefit BGC and its stockholders," that could only be determined at trial.
- A controller should weigh the legal benefits of having truly independent directors on the board against the added flexibility non-independent directors may provide. In addition, if seeking to appoint independent directors, a careful effort should be made to ensure that the persons being selected will be deemed by the court to be independent. Not only a potential director's personal and business relationships with the controller, but also his or her financial situation (including income, net worth, pension, and the like) should be reviewed and a judgment reached whether the directorship compensation would be personally material.
- A controlled-company board might want to consider whether there are innovative approaches that might reduce the risk that the court would view a director's compensation as a basis for determining that the director is non-independent of the controller. When a controlled company seeks to have an independent board, it is of course particularly discouraging if one or more otherwise fully independent directors is deemed to be non-independent of the controller based solely on the directorship compensation being personally material. The risk is higher to the extent that a director does not have significant other income or wealth. A board might want to consider, for example, structuring director compensation so that it is paid over the full term even if the director is removed without cause. Such a structure might reduce the risk that the court would view it as reasonable to infer that, if the compensation constitutes a significant percentage of the director's income, the director's judgment may be clouded by a desire to retain the compensation. Further, generally, it should be kept in mind that excessive fees or unusual compensation for special committee members may raise issues regarding their independence.
- Directors of controlled companies should carefully consider their public comments, and testimony to the court, regarding the controller. Unreserved praise and admiration may be interpreted by the court as indicating a kind of "reverence" that would raise a reasonable inference that the director may not be independent of the controller. Also, directors should understand the role of a controller and of a special committee, including the inherent power and limitations of both. The onboarding process for new directors, and the company's guidelines for directors, should cover these points so that directors are aware of the issues.
- A special committee generally should not to be influenced by the controller's preferences with respect to selecting committee advisors or setting the timetable. The committee's consideration of and rationale for these and other decisions should be documented. Generally, members of the committee should not communicate with the controller without committee approval.