June 2, 2022

Fiduciary Duty: Del. Chancery Says Charter Can’t Alter Standard of Review

In Totta v. CCSB Financial, (Del. Ch.; 6/22), the Delaware Chancery Court held that language in an antitakeover charter provision giving the board broad authority to construe its terms and providing that the board’s informed, good faith decisions would be “conclusive and binding” did not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.

The case arose out of a proxy contest in which an insurgent stockholder sought to obtain two out of seven seats on the company’s board. In response to that contest, the board invoked a provision in the company’s certificate of incorporation prohibiting a stockholder from exercising more than 10% of its voting power. The board also adopted an interpretation of its language that permitted aggregating the ownership of multiple stockholders if the board decided they were acting in concert. Accordingly, the board instructed the inspector of elections not to count any votes above the limit submitted by the insurgent stockholder, his nominees, and an entity affiliated with one of the nominees.

This instruction turned out to be outcome determinative, and the insurgents sued to invalidate the board’s instruction.  The company pointed to the language of the charter provision, which purported to render “conclusive and binding” on the company and its stockholders “any constructions, applications, or determinations made by the Board of Directors pursuant to this section in good faith and on the basis of such information and assistance as was then reasonably available.”  It argued that this language compelled the Court to apply the business judgment standard of review to the challenged actions.

Chancellor McCormick disagreed. She noted that the entity in question was a corporation, not an alternative entity, and that as such, it didn’t have the authority to establish or alter the standard of review that a court would apply to the fiduciary obligations of its directors:

The Company’s argument contravenes fundamental principles of Delaware corporate law. In essence, the Company asks the court to hold that a corporate charter may alter the directors’ fiduciary obligations and the attendant equitable standards a court will apply when enforcing those obligations. The Company would treat a corporate charter like the constitutive agreement that governs an alternative entity.

Fiduciary duties arise in equity and are a fundamental aspect of Delaware law. The constitutive agreements that govern an entity can only eliminate or modify fiduciary duties and the attendant judicial standards of review to the extent expressly permitted by an affirmative act of the Delaware General Assembly. The General Assembly has granted broad authorization to modify or eliminate fiduciary duties and attendant standards of review in some types of entities. The General Assembly has granted only limited authority to corporations.

The Chancellor ultimately concluded that because the voting limitation interfered with the exercise of the franchise, the board’s actions in issuing the challenged instruction to the inspector of elections should be evaluated under the Blasius standard of review, which required the directors to establish a “compelling justification” for their actions. She held that the board did not carry this burden.

Chancellor McCormick also concluded that the board’s interpretation of when stockholders are “acting in concert” was inappropriate.  In the course of making this latter determination, she engaged in an extended discussion of what it means to “act in concert” under Delaware law, so this case is worth bookmarking on that point as well.

John Jenkins