DealLawyers.com Blog

This Sidley memo explores some of the issues associated with the rise of “fraud on the board” claims in Delaware, including the potential culpability of the defrauded directors. This excerpt explains:

Are the directors who have been deceived by an uncandid colleague simply victims, or have they breached their fiduciary duty for failure to anticipate and deal with a lack of candor caused by a conflict of interest? The answer “yes” is what the plaintiffs in Haley asserted explicitly. In that case, the plaintiffs argued that the uncandid CEO/director’s fellow directors “… breached their fiduciary duties by failing to oversee [the CEO’s] negotiations.” 235 A.3d at 715. Similarly, the Court of Chancery in PLX, after declaring that the uncandid director breached his fiduciary duty, added “… and induced the other directors to breach theirs.” 2018 WL 5018535, at *47.

This approach of victim-at-fault echoes the holding and language of the Rural Metro case. While that case related to a financial advisor’s undisclosed conflict of interest, the language of the opinion was broader in scope. “Another part of providing active and direct oversight [of a sales process] is acting reasonably to learn about actual and potential conflicts faced by directors, management, and their advisors.” In re Rural Metro Corp. S’holders Litig., 88 A.3d 54, 90 (Del. Ch. 2014).

The authors suggest that the board can protect itself by learning from Rural Metro and engaging in some degree of investigation and heightened oversight of potential conflicts involving fiduciaries, particularly in situations where an independent director has certain attributes that make conflict or lack of candor somewhat likely.  Examples of these include when the director is a representative of a hedge fund or other evidence suggests a short-term bias, and when the director has a close relationship with another director who is clearly conflicted.

– John Jenkins