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Concluding the Case for Allowing Corporations to Limit Directors’ Personal Liability

By Dan Parlow (posts)

This is the fourth and final post in a series of posts on this subject. The full version of the article was published by the Institute of Corporate Directors in its Journal and and as a web resource.

Bad Faith and Self-Dealing

I would not allow corporations to exonerate directors in the event of bad faith, self-dealing or other instances of non-loyalty.

In the event the directors’ action is challenged, it will be the court’s job to determine whether the board’s decision was in fact taken disloyally.  This may involve review of the substance of a business decision made by an apparently well motivated board for the limited purpose of assessing whether that decision is so far beyond the bound of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.  Delaware law shows that the courts are capable of making a reasoned distinction.

In the event of a conflict of interest, directors’ approval of a transaction can be set aside even where it had been subsequently approved by the shareholders after the conflicts of interest were disclosed.  Directors in such a case would be obliged to prove that the shareholders were fully informed and that the process was transparent in all respects.

As discussed in the Delaware Disney litigation involving its former president, Michael Ovitz, a “failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.”

A good example of a gross negligence claim without a bad faith component is seen in the proposed sale of the Lear Corporation: Lear Corporate Shareholder Litigation. A deal was struck with a potential suitor under which he would increase his offer by some $90,000,000 on the condition that the company pay him a $25,000,000 termination fee if the shareholders voted “no”. After the deal was rejected and the termination fee was paid, the plaintiffs alleged that the transaction was entered into in bad faith in that it had been a virtual certainty that the offer would be rejected by shareholders.  The Court once against struck the lawsuit because there were no facts indicating that the directors consciously acted in a manner contrary to the interests of Lear and its stockholders.

In another recent business sale case of Ryan v Lyndell, the lower court pointed to a number of factors including the lack of an independent valuation, the speed with which the transaction was approved, the lack of board involvement in the negotiations and the adoption of deal protection measures tending to dissuade potential competitive bids, all of which contributed to the possibility that the “board’s failure to engage in a more proactive sale process may constitute a breach of the good faith component of the duty of loyalty … and thus potentially falls outside the exculpation.”  However, the Supreme Court of Delaware disagreed, holding that the directors were disinterested and independent; that they were generally aware of the company’s value and its prospects; and that they considered the offer, under the time constraints imposed by the buyer, with the assistance of financial and legal advisors. In the absence of evidence from which to infer that the directors knowingly ignore their responsibilities, thereby breaching their duty of loyalty, the case was dismissed summarily.

Conclusion

Corporations in Canada should have the right, through their charter, to eliminate or restrict the personal liability of directors for monetary damages arising from a failure in the exercise of the duty to exercise “care, diligence and skill”. Implementation of the Charter Option in appropriate cases will serve both to attract competent directors and to discourage them from being risk averse when making decisions in the best interest of the corporation.

The language of amendments to Canadian corporations’ laws should reflect the Canadian separation between the director’s fiduciary duty and the duty of care, diligence and skill.

This measure would not, and should not, restrict shareholder rights and remedies in cases of bad faith, self-dealing or other statutory breaches.

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