September 8, 2020

Conflicts of Interest: Chancery Highlights Limits of Directors’ Abstention Defense

When I was a young lawyer, a senior labor partner in my my firm kept what he called a “Pontius Pilate Kit” on prominent display in his office.  It consisted of a bottle of water, a towel & a basin, which he used to symbolically “wash his hands” of some of the more unsavory tactics used by the contending parties in labor disputes.

It’s probably unfair, but I can’t help thinking about that guy’s Pontius Pilate Kit whenever the idea of addressing director conflicts through recusal has come up.  There are all sorts of good reasons for conflicted directors to recuse themselves & abstain from voting on a deal in which the director has a direct or indirect interest – but the Delaware Chancery Court’s recent decision in In re Coty, Inc. Stockholder Litigation, (Del. Ch.; 8/20), makes it clear that the abstention defense has its limits.

The case involved allegations that the controller and the director defendants breached their fiduciary duties in connection with tender offer in which the controller increased its holdings from 40% to 60% allegedly at an unfair price and through an unfair process. Four of the nine director defendants had ties to the controlling stockholder & recused themselves from the board vote to authorize the transaction.

Chancellor Bouchard reviewed Delaware precedent on the abstention defense, and noted that it required a director to completely avoid any participation in the transaction:

Over twenty-five years ago, then Vice Chancellor Jacobs explained in In re Tri-Star Pictures, Inc. that “Delaware law clearly prescribes that a director who plays no role in the process of deciding whether to approve a challenged transaction cannot be held liable on a claim that the board’s decision to approve that transaction was wrongful.”  As this court more recently stated the principle, a “director can avoid liability for an interested transaction by totally abstaining from any participation in the transaction.”

The Chancellor noted that determining whether a director totally abstained can be a difficult determination to make at the motion to dismiss stage, since there are often factual nuances that need to be developed through discovery.  In this case, he pointed out the fact that the disclosure document provided to shareholders indicated that the conflicted directors attended the key board meeting at which the transaction was approved, and expressed their support for it before they recused themselves from the vote and left the meeting.

John Jenkins