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BNA, INC.
SECURITIES!
REGULATION & LAW
REPORT
Reproduced with permission from Securities Regulation & Law Report, 41 SRLR 622, 4/6/2009. Copyright
姝 2009 by The Bureau of National Affairs, Inc. (800372-1033) http://www.bna.com
C O R P O R AT E G O V E R N A N C E
The Applicability of the Business Judgment Rule
To Corporate Officers After Gantler v. Stephens
BY DOUGLAS H. FLAUM
AND
SHAHZEB LARI
he Delaware Supreme Court’s recent decision in
Gantler v. Stephens clarified a previously murky
area of Delaware law, i.e., whether corporate officers owe fiduciary duties, analogous to those owed by
corporate directors, to the company they are employed
by and the shareholders they serve.1 There is general
consensus that Gantler, by answering that question in
T
1
No. 132-2008, 2009 Del. LEXIS 33 (Del. Jan. 27, 2009).
Gantler also elaborated upon another previously ambiguous
topic, the appropriate scope of Delaware’s common-law shareholder ratification doctrine. With respect to that issue, a comprehensive discussion of which is beyond the ambit of this article, the Delaware Supreme Court held that the doctrine is
limited ‘‘to circumstances where a fully informed shareholder
vote approves director action that does not legally require
shareholder approval in order to become legally effective’’ and
that the effect of such shareholder approval is simply ‘‘to subject the challenged director action to business judgment re-
Douglas H. Flaum is a partner, and Shahzeb
Lari is an associate, in the litigation department of Fried, Frank, Harris, Shriver and
Jacobson LLP. Christen Furka, an associate at
the firm, assisted in the preparation of this
article.
COPYRIGHT 姝 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC.
the affirmative, increases officers’ potential exposure to
liability. Given that fact, the standards applicable to officers’ conduct in determining whether they have fulfilled their fiduciary duties — most significantly,
whether officers are protected by the business judgment rule — are more important than ever. However,
neither Gantler nor prior Delaware precedent provide a
definitive answer to that question. This article discusses
the current state of the law regarding the applicability
of the business judgment rule to the conduct of corporate officers and the need for further clarification from
the Delaware courts.
The Gantler Decision. Gantler involved breach of fiduciary duty claims brought by shareholders of First Niles
Financial, Inc. against the company’s officers and directors.2 In brief, the plaintiff shareholders asserted three
separate claims for breach of fiduciary duty, asserting
that the defendants (i) improperly rejected a third-party
offer to purchase the company, (ii) reclassified the company’s shares in order to benefit themselves, and (iii)
distributed a materially misleading proxy statement to
shareholders in order to gain approval of the reclassification.3 The Delaware Chancery Court had dismissed
the plaintiffs’ complaint; the Delaware Supreme Court
view, as opposed to ‘extinguishing’ the claim altogether.’’ Id. at
**42-46.
2
Id. at **2-13.
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2
reversed the dismissal, finding that the complaint adequately stated claims for breach of fiduciary duty with
respect to all three of the challenged actions.4
In doing so, the Delaware Supreme Court expressly
held — for the first time—that corporate officers owe fiduciary duties to the corporation and its shareholders
identical to those owed by corporate directors:
The Court of Chancery has held, and the parties do not dispute, that corporate officers owe fiduciary duties that are
identical to those owed by corporate directors. That issue —
whether or not officers owe fiduciary duties identical to
those of directors — has been characterized as a matter of
first impression for this Court. In the past, we have implied
that officers of Delaware corporations, like directors, owe
fiduciary duties of care and loyalty, and that the fiduciary
duties of officers are the same as those of directors. We
now explicitly so hold.5
The fiduciary duties of directors are, of course, well
known: ‘‘[i]n discharging their management function,
‘directors owe fiduciary duties of care and loyalty to the
corporation and its shareholders.’ ’’6 That is, directors
must act with the care that an ordinarily prudent person
would exercise in similar circumstances and in a manner they reasonably believe to be in the best interests of
the company and its shareholders.7 Under Gantler,
those duties are now equally shared by corporate officers.
However, Gantler did not address the standard to be
used in assessing whether officers have complied with
their fiduciary obligations. It is axiomatic that, in determining whether directors have complied with their fiduciary duties, directorial decisions are typically subject
to the business judgment rule: ‘‘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.’’8 Although the Gantler court expressly found that the plaintiffs’ allegations were sufficient to rebut the business
judgment rule with respect to the director defendants,
due to a combination of factual and procedural quirks,
the court did not discuss whether any of the officer defendants’ actions were subject to the business judgment
rule. Therefore, following Gantler, Delaware law is
clear that officers bear the same burdens— the duties of
loyalty and care—that directors labor under, but
Gantler provides no guidance as to whether officers are
entitled to the same protection (the business judgment
rule presumption) that attaches to directors.
Officers and The Business Judgment Rule: Existing Delaware Precedent. Prior Delaware precedent does not provide a definitive answer either. Indeed, there is a surprising lack of Delaware case law directly addressing
the applicability of the business judgment rule to decisions made by officers as officers (as opposed to deci3
Id.
Id. at *2.
Id. at *30.
6
Schoon v. Smith, 953 A.2d 196, 206 (Del. 2008) (quoting
Mills Acq’n Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del.
1988)).
7
See, e.g., Smith v. Van Gorkom, 488 A.2d 858, 893 (Del.
1982), overruled on other grounds byGantler, 2009 Del. LEXIS
33; Guth v. Loft, 5 A.2d 503, 510 (Del. 1939).
8
Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
4
5
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sions made by directors or officer-directors in their directorial capacity). While many Delaware cases imply
that the business judgment rule applies to officers, few
deal with the issue directly.
For example, several years ago (and before Gantler),
the Third Circuit held that, under Delaware law, the
business judgment rule applies equally to officers and
that officers, like directors, are entitled to the presumption that their decisions were made in good faith and on
an informed basis because directors and officers are
‘‘comparable fiduciaries’’ and should be judged under
the same theories of liability.9 Although the Third Circuit cited opinions by the Delaware Court of Chancery
in ruling that the business judgment rule applied to
non-director officers, none of the cited cases actually
applied the rule to non-director officers.10 Rather, the
cited cases simply stated the general rule that ‘‘in the
absence of facts showing self-dealing or improper motive, a corporate officer or director is not legally responsible to the corporation for losses that may be suffered
as a result of a decision that an officer made or that directors authorized in good faith.’’11
Indeed, Delaware state court decisions expressly discussing the relationship between officer conduct and
the business judgment rule are rare and dated. For example, in Kelly v. Bell, a case involving a shareholder
challenge to a board of directors’ tacit acquiescence to
a decision by a company’s officers (who were also directors) to pay certain machinery taxes even though the
corporation had no legal obligation to do so, the Delaware Supreme Court held that the decision was protected by the business judgment rule.12 Similarly, in
Kaplan v. Centex Corp., the Delaware Chancery Court
addressed a derivative claim brought by a stockholder
to challenge the propriety of transactions initiated by
officers and subsequently acquiesced to by directors (in
particular, the plaintiffs claimed that the company had
transferred certain equity interests for inadequate consideration and paid excessive amounts in settlement of
a dispute).13 The court cited Kelly for the principle that
‘‘the decision of executive officers may also come
within the [business judgment] rule,’’ and found that ‘‘it
probably does here, in the absence of any divided loy9
Stanziale v. Nachtomi (In re Tower Air), 416 F.3d 229, 238
& n.12 (3d Cir. 2005). Of course, the Third Circuit’s perspective on matters of Delaware state law are not conclusive.
10
See id. at 238 (citing Arnold v. Soc’y for Sav. Bancorp,
Inc., 678 A.2d 533, 539 (Del. 1996), Gagliardi v. Trifoods Int’l,
Inc., 683 A.2d 1049, 1053 (Del. Ch. 1996), and In re Caremark
Int’l Inc. Derivative Litig., 698 A.3d 959, 967-70 (Del. Ch.
1996)).
11
Gagliardi, 683 A.2d at 1053. This formulation of the business judgment rule — which arguably supports its applicability to officers— has been employed by a number of Delaware
cases. See, e.g., Cinerama, Inc. v. Technicolor, Inc., 663 A.2d
1156, 1162 (Del. 1995) (citing Cede & Co. v. Technicolor, Inc.,
634 A.2d 345, 361 (Del. 1993)); Pogostin v. Rice, No. 6235, 1983
Del. Ch. LEXIS 437, at *8 (Del. Ch. Aug. 12, 1983), aff’d, 480
A.2d 619 (Del. 1984), partially overruled on other grounds by
Brehm v. Eisner, 2000 Del. LEXIS 51, 746 A.2d 244, 254 (Del.
2000).
12
266 A.2d 878, 879 (Del. 1970) (‘‘There is no evidence that
any director or officer was motivated by expectation of personal gain, by bad faith or by any consideration other than that
of doing what was best for Steel. . . . These acts are governed
by the ‘business judgment rule.’ ’’).
13
284 A.2d 119, 120-25 (Del. Ch. 1971).
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alty and in light of subsequent ratification by the board
of directors.’’14
Neither of these cases provides a definitive answer to
the question of whether the business judgment rule applies to officers acting in their capacity as officers. In
Kelly, the only claims were against the company’s directors (who, as noted, also functioned as officers).15 In
Kaplan, the court elected not to base its decision on the
broad applicability of the business judgment rule but on
its factual finding that the challenged payments were
proper.16
More recent Delaware cases also lack a clear pronouncement on this issue. Although a number of courts
have generically stated that the business judgment rule
applies to both officers and directors, they do not actually apply the rule to (or, in many instances, address the
liability of) officers acting as officers. In essence, Delaware law on this topic is parallel to Delaware law on the
question of officers’ fiduciary obligations prior to
Gantler. That is, the applicability of the business judgment rule to officers may be implied, but there is no definitive holding.
The Law Outside Delaware. The vast majority of courts
outside Delaware to have considered the issue—under
either the law of Delaware or of other states—have held
that the business judgment rule applies
to decisions made by officers acting within the scope
of their authority.17 There are, however, a few decisions
14
Id. at 124-25.
266 A.2d at 878.
16
284 A.2d at 124-29.
17
See, e.g., T.S.G. Water Res., Inc. v. D’Alba & Donovan
Certified Pub. Accountants, 366 F. Supp. 2d 1212, 1226 (S.D.
Ga. 2004) (‘‘Under the business judgment rule officers are presumed to have acted properly and in good faith, and may be liable for their actions only when they are shown to have engaged in fraud, bad faith or an abuse of discretion.’’) (internal
quotations omitted) (applying Georgia law); Grassmueck v.
Barnett, No. C03-122P, 2003 U.S. Dist. LEXIS 14767, at *10
(W.D. Wash. July 7, 2003) (‘‘The business judgment rule protects corporate officials from liability for breaches of the duty
of care so long as they act in good faith and without a corrupt
motive.’’) (applying Delaware and Washington law); In re
Fleet/Norstar Secs. Litig., 935 F. Supp. 99, 115 (D.R.I. 1996)
(business judgment rule would likely bar recovery on mismanagement claims against officers) (applying Rhode Island law);
Resolution Trust Corp. v. Gladstone, 895 F. Supp. 356, 369 (D.
Mass. 1995) (‘‘The Business Judgment Rule shields directors
and officers from liability for corporate decisions made in good
faith and after due care.’’) (citations omitted) (applying federal
common law); FDIC v. Stahl, 854 F. Supp. 1565, 1570 n.8 (S.D.
Fla. 1994), partially reversed on other grounds by 89 F.3d 1510
(11th Cir. 1996) (‘‘It is clear the business judgment rule applies
equally to both officers and directors.’’) (applying Florida law);
Potter v. Pohlad, 560 N.W.2d 389, 391-92 & n.1 (Minn. Ct. App.
1997) (business judgment rule applies to nondirector officers)
(applying Delaware law); Rosenfield v. Metals Selling Corp.,
643 A.2d 1253, 1261 n.16 (Conn. 1994) (‘‘Although the business judgment rule is usually defined in terms of the role of
corporate directors, it is equally applicable to corporate officers exercising their authority . . . .’’) (applying Connecticut
law); Selcke v. Bove, 629 N.E.2d 747, 750 (Ill. App. Ct. 1994)
(finding that plaintiff’s argument that business judgment rule
applies only to directors is ‘‘clearly contrary to the substantial
body of corporate case law which has developed on this issue’’) (applying Illinois law); Para-Med. Leasing, Inc. v. Hangen, 739 P.2d 717, 722 (Wash. App. 1987) (‘‘In considering the
actions of a corporate officer, however, the business judgment
rule rather than the standard of ordinary care applies. This
15
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finding that the business judgment rule does not apply
to officer conduct.
For example, in Platt v. Richardson, the United States
District Court for the Middle District of Pennsylvania,
interpreting Delaware law, denied an officer defendant’s motion for summary judgment on a breach of fiduciary duty claim alleging the misappropriation of
funds.18 In doing so, the Platt court held that the ‘‘business judgment rule applies only to directors of a corporation and not to officers,’’ and noted that ‘‘[t]he defendant does not cite a single authority which extends the
presumption afforded by the business judgment rule to
officers of a corporation and we have found none.’’19
Likewise, in Gaillard v. Natomas Co., the California
Court of Appeals, reversing the grant of summary judgment to defendant officer-directors who had secured lucrative ‘‘golden parachute’’ arrangements for themselves, held that the business judgment rule is inapplicable to officers and to officer-directors acting in their
capacity as officers.20 It is unclear how persuasive either case would be to a Delaware court today. At least
one non-Delaware court has rejected Platt as contrary
to the weight of authority.21 Similarly, although Gaillard found that the application of the business judgment
rule to officers would be contrary to the purpose of the
rule, it dealt exclusively with California’s statutory codification of the business judgment rule, which, by its
terms, applies only to directors.22
Post-Gantler: Are Officers Entitled To Business Judgment
Protection? Notwithstanding the marginality of the
cases refusing to apply the business judgment rule to
officers, they do indicate that the application of the rule
to officers is not a foregone conclusion, particularly
when non-Delaware courts are called upon to interpret
Delaware law.
Moreover, Gantler itself recognized that officers and
directors may be subject to differing levels of accountability, noting that directors’ and officers’ equivalent fiduciary obligations ‘‘does not mean, however, that the
consequences of a fiduciary breach by directors or officers, respectively, would necessarily be the same.’’23
The Gantler court was specifically referring to the fact
that § 102(b)(7) of Delaware’s General Corporation
Law, while allowing companies to adopt provisions exculpating directors for breaches of their duty of care,
does not extend any similar protections to officers.24
Nonetheless, until this issue is definitively resolved,
there will be those who will continue to attempt to draw
a more general distinction between officers and directors in the area of fiduciary obligations and liabilities.
However, the weight of both precedent and commentary on the issue suggests that the business judgment
rule does, or at least should, apply to officers.25 Given
rule shields the corporate officer from liability so long as he
acts in good faith without a corrupt motive.’’) (applying Washington law).
18
No. 88-0144, 1989 U.S. Dist. LEXIS 7933, at *6 (M.D. Pa.
June 6, 1989).
19
Id.
20
256 Cal. Rptr. 702, 711-12 (Cal. Ct. App. 1989).
21
Selcke, 629 N.E.2d at 750.
22
256 Cal. Rptr. at 709-12.
23
Gantler, 2009 Del. LEXIS 33, at *30 n.37.
24
Id.
25
Both the American Law Institute and the American Bar
Association are in favor of applying the business judgment rule
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that fact, the real question might be the precise scope of
the rule’s application to officer conduct. As one court
has noted:
To a great extent, the rules governing liability are the same
whether the officer sued is a director or some other officer
such as the president, vice president, secretary. But an officer’s duties may be more expansive than those of a director
since directors may rely on the management decisions and
recommendations of officers. We believe that judicial inquiry into the level of fiduciary duty owed is necessarily afto non-director officers. See 1 Am. L. Inst., Principles of Corporate Governance: Analysis and recommendations § 4.01
cmt. a (1994) (‘‘Sound public policy points in the direction of
holding officers to the same duty of care and business judgment standards as directors, as does the little case authority
that exists on the applicability of the business judgment standard to officers, and the views of most commentators support
this position.’’); MODEL BUS. CORP. ACT § 8.42 cmt. (1999) (‘‘The
business judgment rule will normally apply to decisions within
an officer’s discretionary authority.’’).
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fected by the circumstances under which the dispute arises,
including whether the allegedly defective conduct was that
of an officer or a director.26
Does the business judgment rule protect officers who
are acting contrary to board directives or beyond the
scope of their direct authority? Would officers only be
liable for gross negligence and bad faith or would a less
deferential standard apply? These are questions that the
Delaware courts are going to have answer in the nearterm, particularly since Gantler’s explicit imposition of
fiduciary obligations on officers can be expected to increase the number of claims asserted against corporate
officers. Given the current economic climate, when corporate officers need clear advice in making what are often difficult and material decisions, the sooner that clarity is provided by the Delaware courts, the better for all
concerned.
26
Potter, 560 N.W.2d at 391 n.1 (internal quotations omit-
ted).
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