Directors Ignore Majority-Shareholder Malfeasance at their Peril

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.