Corporate Directors and the Issue of Bias:
Finding Safe Harbor under Delaware Law
By Autumn L. Sharp
Today, corporate directors are increasingly careful with the transactions they approve. Their focus is not only on how the outcome of the transaction will affect shareholders, but also whether the board's approval process will be viewed as fair and disinterested, meaning no director stands to benefit personally from the transaction.
Navigating Potential Bias Among Directors
While at first blush it may appear that achieving impartiality should not be a difficult task, we live in a world where one individual may have ties to multiple corporations, and where that individual may even sit on both sides of a deal. Should proposed transactions involving an interested director automatically be thrown out for fear of a perception of bias, even if the transaction would otherwise be a beneficial one?
For Delaware corporations, which represent more than half of the publicly traded companies in the United States, the answer is no. Section 144 of the state’s General Corporation Law provides a safe harbor for so-called interested transactions. If the material facts surrounding an interested director's relationship to the transaction are made known to the board, and the board authorizes the transaction in good faith by a majority of the disinterested directors, then Delaware's business judgment rule applies to the transaction. That means if the transaction is challenged by a shareholder or dissenting board member, the court will apply a presumption that the directors acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company. Obviously, an effective and ethical board of directors will want the business judgment rule to apply to every transaction they consider.
Does this mean the interested directors cannot vote on the transaction? Not exactly. There must be an independent and disinterested board majority that has the power to consummate the transaction—without the vote of the interested director. Therefore, interested directors can vote, but effectively, their votes cannot count for purposes of reaching a board majority.
A Delaware Example
Benihana of Tokyo, Inc. v. Benihana, Inc., 906 A.2d 114, 120, is a good example of the business judgment rule in action. In this case, decided by the Delaware Supreme Court in August 2006, a member of Benihana’s board of directors also served on the board of BFC, a holding company that purchased new convertible stock being issued by Benihana. The interested director informed the other Benihana directors that BFC was the potential purchaser of the stock. The board went on to approve the transaction, but one of the directors subsequently challenged that decision. The court found that because the disinterested directors knew all of the material information and chose to approve the transaction, Section 144 was satisfied and the business judgment rule applied.
The lessons learned here are relatively simple. If a board of directors wants to come within the safe harbor of Delaware's Section 144, the board should make sure that the transaction can be approved by a majority of disinterested directors. This does not mean that interested directors cannot vote, simply that the transaction must be consummated by the votes of the other disinterested directors.
Autumn L. Sharp, an Associate in the firm’s Litigation & Dispute Resolution group, represents clients in a range of business and commercial disputes, including matters involving state and federal franchise law, federal securities and antitrust law, generally accepted accounting principles (GAAP), trade secrets, government contracts, product liability, breach of contract and breach of warranty. She also participates in all levels of the discovery process, has served as co-counsel of record for multiple administrative hearings and regularly represents clients in mediation and arbitration. Autumn can be reached at 312.521.2631 or asharp@muchshelist.com.
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