Directors Ignore Majority-Shareholder Malfeasance at their Peril

This post is by Robert Jackson, Harvard Law School.

In an opinion issued yesterday in ATR-Kim Eng Financial v. PMHI Holdings, Vice Chancellor Strine concludes that two directors breached their duty of loyalty to a minority shareholder by standing by silently while the majority shareholder essentially liquidated the corporation’s assets and placed them into entities controlled by his family. The court concludes that the directors, who “regarded themselves as mere employees of [the majority shareholder] and failed to take any steps” to stop the shareholder from “do[ing] whatever he wanted,” breached their obligation to protect the interests of the company and “all its stockholders” (emphasis mine). The directors could not seek refuge in the business-judgment rule, the court held, because permitting the majority shareholder to do as he wished was not “indicative of a good faith error in judgment,” but rather “reflects a conscious decision to approach one’s role in a faithless manner by acting as a tool of a particular stockholder.”

In crafting a remedy for the aggrieved minority shareholder, the court takes the unusual step of holding the directors jointly and severally liable for the judgment against the majority shareholder. And even though the court acknowledges that the majority shareholder was more culpable than his abettors on the board–and thus that the directors may be able to recoup any monies paid to the plaintiffs through an action against the majority shareholder–Delaware directors would do well to take note of footnote 129 of the opinion. There the Vice Chancellor indicates that, “when persons act as mere tools for malefactors and contribute to harm to others, public policy might limit their ability to seek indemnification from their ‘boss.'”

This “occupational hazard,” as the court describes it, should give directors pause whenever they consider a transaction proposed by a controlling stockholder at the expense of other shareholders–who, after all, the directors must also serve in a manner commensurate with the duty of loyalty.

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One Comment

  1. Posted Sunday, January 21, 2007 at 7:35 pm | Permalink

    Good! It is about time that the law in Delaware enshrines the concept that directors are responsible to all shareholders. Not only is this an important precedent for any controlled company, it is also important that directors of all public companies be reminded–again and again–that the ‘collegiality’ of the board room does not extend to condoning management activities clearly contrary to the interests of minority shareholders. While the definition of what falls within the “business judgment rule” will always escape precision, directors must be aware that it is possible to step over the line, and that merely going along with the chairman is not necessarily a bar to liability. Only when directors no longer feel that they work ‘for’ the chairman will governance be put on a solid footing.

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