In 1985, most businessmen were troubled by the outcome of Smith versus Van Gorkom. This was a case involving a cash merger of TransUnion for a substantial premium to the market price of that publicly traded stock.
Nevertheless, in a Ruling 3-2, the Delaware Supreme Court found that the Court of Chancery erred in dismissing the fiduciary action against TransUnion’s directors. The parties ended up settling the case for $23.5 million, which was $13.5 million more than the company’s A&D insurance policy.
Admittedly, the file reflects hasty decision-making on the part of the council. Nevertheless, a post-Van Gorkom the concern was whether this decision would cause business people to be reluctant to sit on boards of directors.
Although public reports indicate that the individual the administrators indeed did not end up paying the entire settlement being personally due to the benevolence of the purchaser, the threat of personal financial liability was all too real.
The Delaware legislature reacted quickly to the threat of losing capable administrators. In 1986, Section 102(b)(7) of the Delaware General Corporations Act was in place.
As originally built, DGCL Section 102(b)(7) allows Delaware corporations to include in their certificates of incorporation a provision that significantly reduces the possibility of a director being personally financially liable for violations of fiduciary dutyincluding the duty of care.
While the Van Gorkom the matter was a direct suit, the provisions of Section 102(b)(7) for directors apply to both derived costumes.
Called “exemption provisions,” section 102(b)(7) is not a pass for administrators. Directors can always be held personally liable for breaches of their duty of loyalty and good faith (i.e. Caremark Claims), willful misconduct or knowing violation of law, transactions involving improper personal benefits, and Section 174 violations regarding legal dividends, share buybacks and refunds.
Applicant Bar Innovation
When plaintiffs have attempted to bring duty of care suits against directors, exculpatory provisions have allowed corporations and their directors to quickly and effectively win their impeachment suits. This, as expected, discouraged plaintiff’s Bar from pursuing these lawsuits.
However, as plaintiff’s Bar is aware, corporate officers have the same fiduciary duties as directors, as clarified in a 2009 Delaware Supreme Court decision (Gantler v. Stephens). Recognizing this, the Plaintiff Bar has pursued a strategy of bringing legal action against the officers, knowing that Section 102(b)(7) does not protect them.
Amendments to the Delaware General Corporations Act
Amendments to section 102(b)(7) allow corporations to protect certain officers from personal monetary liability for shareholder claims related to breach of duty of care. The Delaware legislature has given corporations the ability to extend exculpatory provisions to certain senior officers such as:
- Chief executive officer
- Financial director
- Legal council
- Head of Accounting
- Top-earning executives as identified by public SEC filings
- Persons who consent to be identified as an officer
The exculpation for corporate officers has the same limitations as the exculpation provision for directors, ensuring that executives don’t get a pass either. In addition, and unlike the case of corporate directors, exculpation of officers only applies to direct suits and not to derivative suits.
Similar to the situation of corporate directors, senior corporate officers can only benefit from the new exoneration provisions if the company takes the positive step of putting these provisions in its certificate of incorporation.
Such an approach will be relatively easy for companies in the process of being created. Officer exculpatory provisions will become as ubiquitous as director exculpatory provisions over time.
Existing private companies will want to ask their shareholders to vote to approve executive exoneration provisions after their boards meet and confirm that they want to make such a change to their certificates of incorporation.
Existing public companies can also ask shareholders to vote to approve changes to the executive exoneration provision to their certificates of incorporation. It could be a good thing to put on the agenda of the next annual meeting of shareholders.
Of course, public companies should consider whether proxy advisory firms like ISS and Glass Lewis will recommend that their clients vote to approve these changes. As of this writing, neither has released a position on the matter.
It is good practice for both public and private boards to take the time to discuss and record in the formal minutes of board meetings the reasons for adopting executive exoneration provisions.
There are, of course, all the typical reasons why companies promise to protect directors and officers, such as a desire to recruit and retain the best talent as well as concern that directors and officers can make decisions without fear of personal financial liability due to unsubstantiated claims.
An additional reason is that while D&O insurance is a good safety net to address financial liability concerns, it can be expensive, may not always be available, and cannot remedy the time lost in frivolous litigation. Additionally, a law firm notes that exonerating officers is permitted in some other states. Finally, the addition of the exculpation of officers at least partially addresses the inconsistent treatment of directors and officers, both of whom have fiduciary duties.