Delaware Court of Chancery again addresses a board’s duty of care

Steven D. Goldberg, Esq. Wilmington, DE
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In one of his final decisions before retiring from the Delaware Court of Chancery, Vice Chancellor Lamb revisits the board’s duty of care in the context of committee of a corporate board which was delegated authority to negotiate the terms of a debt offering.  (San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc., et al, CA 4446-VCL, May 12, 2009).  amylin

While this case arrose under the DGCL and not the LLC Act, the issues of stockholder voting franchise and fiduciary duties have equal impact on LLC’s and their company agreements, again unlsess those rights or duties have been reduced or eliminated by the agreement.

After many twists and turns, the plaintiff’s original claim seeking a judgment declaring the invalidity of a “poison put” contained within a continuing directors provision of the credit agreement was rendered moot as the outside investor group was no longer nominating a majority of the board. [The credit agreement contained a provision under which if the “Continuing Directors do not constitute a majority of the Company’s Board of Directors…”  the trustee could declare a non-monetary default and demand immediate payment of the notes at par. The notes were selling at a steep discount.  “Continuing Directors” were defined as the directors who at the issue date were directors and any new directors whose nomination was “approved” by at least a majority of the directors then still in office who were either directors at the issue date or whose nomination and election were previously approved.] Continuing director provisions are often found in loan agreements for public debt and syndications, they are problematical because of the potential to strip from the stockholder their franchise to exercise their voting rights to elect members of the board and the potential to entrench the board.

At that point the Vice Chancellor could have dismissed the remaining two counts (breach of duty of care of the defendant directors in approving the continuing director provision and a declaration that the board could “approve” dissident director candidates for the purpose of the continuing director requirement without endorsing or supporting their candidacy). The Vice Chancellor determined to not dismiss the two remaining counts and weighed in on the issues.

The board delegated to a “pricing committee” the authority to negotiate and approve the terms of the credit agreement. The plaintiff claimed that the board (acting through the pricing committee) breached its duty of care in the adoption of the loan agrement  insofar as the loan agreement contained the continuing director provision. The basis of the claim was that committee never discovered that loan agreement contained the provision.

In order to be actionable the board must have been “grossly negligent” in making the decision which is the subject of the action. The Vice Chancellor, citing Brehm v. Eisner, stated that the duty of care requires that:

in making business decisions, directors must consider all material information reasonably available, and that the directors’ process is actionable only if grossly negligent. . . . [T]he standard for judging the informational component of the directors’ decisionmaking does not mean that the Board must be informed of every fact. The Board is responsible for considering only material facts that are reasonably available, not those that are immaterial or out of the Board’s reasonable reach.

Notwithstanding the fact that the pricing committee was unaware of the provision, which one would be hard pressed not to consider “material”, the court concluded that the committee and thus the board was not “grossly negligent”. Here I will quote at length from the decision as it is instructive to both boards and counsel who represent them:

The board retained highly-qualified counsel. It sought advice from Amylin’s management and investment bankers as to the terms of the agreement. It asked its counsel if there was anything “unusual or not customary” in the terms of the Notes, and it was told there was not. Only then did the board approve the issuance of the Notes under the Indenture. This is not the sort of conduct generally imagined when considering the concept of gross negligence, typically defined as a substantial deviation from the standard of care.

The plaintiff argues that the board’s questioning if there was anything “unusual or not customary” in the Indenture was insufficient. But the way in which the board inquired into the material terms of the Indenture cannot be equated with gross negligence in failing to inform itself’s Certainly, no one suggests that the directors’ duty of care required them to review, discuss, and comprehend every word of the 98-page Indenture.

This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise. In the context of the negotiation of a debt instrument, this is particularly troubling, for two reasons. First, as a matter of course, there are few events which have the potential to be more catastrophic for a corporation than the triggering of an event of default under one of its debt agreements. Second, the board, when negotiating with rights that belong first and foremost to the stockholders (i.e., the stockholder franchise), must be especially solicitous to its duties both to the corporation and to its stockholders This is never more true than when negotiating with debtholders, whose interests at times may be directly adverse to those of the stockholders. Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests. Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board. In this way, the board will be able to exercise its fully informed business judgment. Finally the Vice Chancellor addressed the issue of whether the board could “approve” the dissident director slate while still opposing their election. The court concluded that they could. Black’s Law Dictionary defines “to approve” to mean “to give formal sanction to; to confirm authoritatively.” Citing the definition the Company argued that while endorsement or recommendation may necessarily imply approval, the reverse is not true. Further the Company claimed that the board may approve a slate of nominees for the purpose of the Indenture (i.e., sanctioning their nomination for election) without endorsing them, and may simultaneously recommend and endorse its own slate instead. The Court held that the Company’s reading of the Indenture was correct and that it could approve the slate of nominees.

Having determined that the Company had the power to approve the slate under the Indenture, the Court then focused on whether the board had properly exercised its power to do so. The Court, after reviewing the issues underlying approval, ultimately determined that on the record the issue was not ripe for adjudication. The factual record was not well developed and was not helpful to the board. The Court noted that the board had made negative public statements about the outside investor groups and their nominees. The court further observed that the approval of the nominees was made in exchange for a partial settlement with the plaintiffs which dismissed the personal claims against the directors which would not have been covered by D&O insurance and the Company’s indemnification powers. The court observed that “[t]hese circumstances at least raise a question whether the board’s decision to approve was made in a good faith exercise of its considered business judgment, or instead taken simply to avoid facing a suit for money damages against themselves personally.”

Ultimately the stockholder voted and both the Chairman of Amlin and the lead independent director were not re-elected and replace by the outside shareholder group. Two new independent directors were also elected.

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