Information Rights of Conflicted Directors

Amy Simmerman and Brad Sorrels are partners and Nate Emeritz is of counsel at Wilson Sonsini Goodrich & Rosati. This post is based on a Wilson Sonsini memorandum by Ms. Simmerman, Mr. Sorrels, Mr. Emeritz, David Berger, Bradley Finkelstein, Douglas Schnell, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

The Delaware Court of Chancery recently addressed important issues concerning the information rights of directors designated by a significant stockholder, as well as a board committee’s ability to withhold information from certain directors. These types of issues frequently arise in practice when there are competing factions of directors or other types of governance disputes within a company. In a short letter decision during the discovery phase of the contentious In re CBS Corporation Litigation[1] Chancellor Andre Bouchard reinforced previous guidance from Delaware in holding that (1) directors could not access certain categories of information as to which adversity existed between the company and the stockholder that designated those directors, but (2) the designating stockholder also would not otherwise be prevented from seeing information to which its designated directors were entitled.

Background

This litigation pits two factions of the board of CBS Corporation (CBS) against each other: directors affiliated with controlling stockholders of CBS (including members of the Redstone family) versus CBS directors unaffiliated with the controlling stockholders. [2] When the controlling stockholders proposed in 2016 and again in 2018 a merger of CBS with Viacom (another company that those stockholders controlled), the CBS board of directors each time formed a special committee of independent directors to consider the proposed transaction. In 2016, the transaction talks ceased, only to resume again in 2018. In 2018, the special committee ultimately determined that the proposed transaction was not in the best interests of CBS’s minority stockholders. In addition, the special committee, citing prior conduct of the controlling stockholders that was of concern to the committee, recommended that the CBS board consider issuing a stock dividend (subject to judicial approval) that would dilute the controlling stockholders from 80 percent of CBS’s voting power to 20 percent. On the day before the board meeting at which the dividend was to be considered, the controlling stockholders acted by stockholder written consent to amend CBS’s bylaws to require that any dividend receive the approval of 90 percent of the directors then in office at two separate meetings held at least 20 business days apart. This provision, if effective, would give the directors affiliated with the controlling stockholders the ability to block the dividend. A trial is scheduled for October 2018 on these issues.

The Decision

This letter decision arose from a discovery-related motion to compel brought by the directors affiliated with the controlling stockholders, seeking production of two categories of privileged materials from 2005 forward:

  • Communications between company counsel to CBS (i.e., in-house and outside counsel to the company) and CBS’s officers and directors
  • Communications between special committee members and such company counsel

The current special committee members sought to withhold these materials on four bases: (1) that CBS and the controlling stockholders had been adverse with respect to the stockholders’ use of their control since CBS became a standalone public entity in 2005; (2) that CBS and the controlling stockholders had been adverse with respect to the proposed combination of CBS and Viacom since 2016; (3) that the special committee had its own privilege that it could assert against the directors affiliated with the controlling stockholders and had been explicitly authorized in its formational resolutions to work with and to direct the company’s directors, officers, employees, and agents, which would include company counsel; and (4) that even if the directors affiliated with the controllers were themselves entitled to certain of the materials in question, the controlling stockholders lacked contractual rights to those materials.

The court relied heavily on previous case law guidance provided by Vice Chancellor J. Travis Laster [3] and former Justice (then-Vice Chancellor) Jack B. Jacobs [4] in stating that, although a director’s right to information is “essentially unfettered” and is generally coequal to the rights of all other board members, a director’s ability to access privileged information may be limited in three ways: (1) by an agreement before the fact; (2) by formation of a committee that properly excludes that director; or (3) when “sufficient adversity exists between the director and the corporation such that the director could no longer have a reasonable expectation that he was a client of the board’s counsel.” With respect to the third basis for limiting information rights, the court here elaborated that, when “a director’s interests come into conflict with the interests of the corporation on a given issue, the board is entitled to deliberate—and receive legal advice—in confidence and without having to share that advice with the director whose interests are adverse, so long as the board employs appropriate governance procedures.”

From there, the court reached several specific holdings. The court first held that the record regarding the documents created between 2005 and 2016 was too undeveloped with respect to the existence of adversity, and thus the court declined to rule on that aspect of the motion to compel. The court instead instructed the parties to “do what litigants normally do during discovery” and challenge specific assertions of privilege as they are made so that they can be considered on a more specific factual record. The court then denied the affiliated directors access to the materials prepared after the special committees were formed to consider the proposed transaction, at least with regard to materials that were in aid of the committees’ processes. In doing so, the court rejected the affiliated directors’ argument that the court should only recognize a privilege between the committee and separate committee counsel and that the affiliated directors, like the other directors, should be able to access communications between longstanding company counsel (as well as in-house counsel) and the committees. The court concluded that the controlling stockholders created sufficient adversity when they “placed themselves across the negotiating table” from CBS and that they, and the affiliated directors, would have been on notice of being segregated from the committees’ deliberative processes. In addition, the court found that the board’s initial authorization of the committee members to direct company officers, employees, and agents would “make no sense” if those persons were “only to expose to an adversary party what they shared with the Special Committees” and that it was “logical to expect” that the special committee members “may wish or may need to confer with the corporation’s in-house lawyers and outside counsel”—particularly where outside counsel “possessed extensive historical knowledge about CBS and its relationship with [the controlling stockholders] from having represented CBS virtually from the date it became a separate public company.” Furthermore, the court found that the affiliated directors “could not have had a reasonable expectation that they were clients of CBS Counsel insofar as CBS Counsel was acting in aid of the process undertaken by either of the Special Committees.”

Finally, the court held that as for other communications that were not in aid of the special committee’s processes, the affiliated directors were entitled to those materials and the court would not prevent the controlling stockholders and their counsel from accessing information obtained by the affiliated directors. Citing prior case law suggesting that director designees can share information with appointing stockholders, the court stated: “Given that Ms. Redstone is one of [the affiliated directors]…and, by all accounts, is the key decision-maker for [the controlling stockholders], it is simply not realistic or practical to believe that any information to which she may become privy as a result of this ruling could be segregated from her thought process as an adversary of CBS in this case.” [5] The court did point out, however, that the directors and controlling stockholders were bound by a confidentiality order governing the use of discovery in the case.

Takeaways

This decision should prove important when considering director information rights in the future. The decision affirms that director information rights are broad and further suggests that director designees may be able to share information in some circumstances with their appointing stockholders, absent other contractual arrangements. At the same time, the decision is an important statement as to when directors’ information rights can be limited. The decision also underscores the importance of carefully considering the initial authorization of a committee, as well as carefully approaching how committee information is handled. In all events, directors’ information rights should be carefully navigated and, as this case shows, can often be hotly contested.

Endnotes

1C.A. No. 2018-0342-AGB (Del. Ch. July 13, 2018).(go back)

2CBS has a dual-class stock structure. As a result, the controlling stockholders control approximately 80 percent of the voting power of CBS, while owning an economic stake of approximately 10 percent in the company.(go back)

3Kalisman v. Friedman, 2013 WL 1668205 (Del. Ch. Apr. 17, 2013).(go back)

4SBC Interactive, Inc. v. Corporate Media Partners, 1997 WL 770715 (Del. Ch. Dec. 9, 1997).(go back)

5Slip op. at 18-19 (citing Kalisman v. Friedman; Moore Business Forms, Inc. v. Cordant Holdings Corp., 1996 WL 307444 (Del. Ch. June 4, 1996); KLM v. Checchi, 1997 WL 525861 (Del. Ch. July 23, 1997); AOC Ltd. P’ship v. Horsham Corp., 1992 WL 97220 (Del. Ch. May 5, 1992)).(go back)

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