January 19, 2010

Continued Oversight Deference to Directors: Delaware Dismisses Derivative Claims

Below is analysis of a recent decision from Brad Aronstam of Connolly Bove Lodge & Hutz:

Last week, Chancellor Chandler – in In re Dow Chemical Company Derivative Litigation – dismissed derivative claims that Dow’s officers and directors breached their fiduciary duties to the company in connection with Dow’s more than $18 billion acquisition of Rohm & Haas highlights the heavy deference afforded independent directors in the “Caremark” oversight setting and comprises the latest chapter in the Stone, Citigroup discourse.

Plaintiffs claimed, among other things, that Dow’s fiduciaries breached their duties by failing to detect and prevent a variety of alleged wrongs, including alleged bribes made by Dow to Kuwaiti officials in connection with a related – and failed – funding deal involving the Kuwaiti government. Relying on the standards adopted in Stone and Citigroup as to the duty of oversight, the Court went so far as to presume that bribery may have occurred, but still rejected plaintiffs’ argument that the Dow board of directors had cause for suspicion. Interestingly, the plaintiffs alleged that the board “should have known” because of similar bribery allegations that had arisen in the past in which Dow had paid a fine to the SEC. Noting that the previous bribery allegations occurred in a different country, involved different members of management, and concerned a different transaction, the Court found that there was no cause for suspicion (i.e., “red flags”) as to this particular issue vis-a-vis the Kuwaiti government.

Also of note is the reliance by the Court on Dow’s Code of Ethics. Specifically, the Court held that the plaintiffs failed to satisfy their heavy burden under Delaware law in light of Dow’s policies in dealing with third parties, expressly stating that the “[p]laintiffs cannot simultaneously argue that the Dow board ‘utterly failed’ to meet its oversight duties yet had ‘corporate governance procedures’ in place without alleging that the board deliberately failed to monitor its ethics policy or its internal procedures.” The decision thus provides yet another reason why clients should always have well-drafted policies in place — here, expressly linked to the standards of fiduciary liability under Delaware law.

The decision contains a number of helpful nuggets concerning other areas as well (including the demand futility calculus, independence standards, and the good faith inquiry post-Lyondell) and thus warrants careful review by M&A practitioners and those who counsel directors.