Corporate Directors, Even Though Acting in Subjective Good Faith, May Breach Fiduciary Duties to the Corporation, According to Delaware Court

310102_6457.jpgA Delaware court found that a corporate director breached the fiduciary duty of loyalty, despite the director’s subjective good faith, in Shocking Technologies, Inc. v. Michael, C.A. No. 7164-VCN (Del. Ch., Sept. 28, 2012). The plaintiff company filed suit against one of its directors, who was also an equity owner of a shareholder. Although this may have created some conflict for the defendant himself, the court held that his duty to the company as director were clear. Even though the defendant believed he was acting in the company’s best interest, the court found that he breached his fiduciary duty of loyalty largely because of the risk his actions posed to the company.

The defendant, Simon J. Michael, was the manager of Balch Hill Capital, LLC (BHC). BHC, in turn, was the general partner of Balch Hill Partners, L.P. (BHP). Both BHC and BHP are named as defendants in the case as well. Michael, through BHP, made three separate investments in the plaintiff, Shocking Technologies, Inc. Michael also became BHP’s designee to the board of directors.

Although the bylaws allowed for six directors, Shocking only had four during the summer of 2011. One of the directors was also the founder, president, and chief executive officer of the corporation, and the other two were shareholder-directors. Michael, as the fourth director, allegedly felt that the other directors were acting in concert and not in the company’s best interests. Communications between the other three directors and Michael broke down, according to the court’s ruling, leading to the alleged acts that formed the basis of Shocking’s lawsuit.

Littelfuse, a Series C investor, had granted several intellectual property licenses to Shocking along with its $3 million investment, and it held warrants allowing it to invest at least $3 million more. Michael allegedly advised Littelfuse that it should exercise the warrants, which expired in December 2011, unless it could get better terms from Shocking, including the right to designate a director. He allegedly told Littelfuse that it was Shocking’s only potential funding source at the time, which Shocking considered to be confidential information. Although Littelfuse decided to exercise the warrants, it did not invest any additional funds until April 2012.

Shocking filed suit against Michael, BHP, and BHC, alleging that Michael breached his fiduciary duty of loyalty, and that his actions were motivated by a desire to gain control of the board of directors and the company. Michael countered that he believed that, by attempting to improve corporate governance, he was acting in the company’s best interest.

The Delaware Court of Chancery ruled in Shocking’s favor, but did not award it any damages. The court agreed that shareholder-directors have the right to seek changes in corporate governance, but found that Michael’s actions directly threatened key corporate interests, such as solvency. It also noted the stark similarity between Michael’s claimed vision of the company’s best interest and Michael’s increased influence on the board of directors. Because Littelfuse exercised its options and the company remained solvent, however, the court did not award damages.

The business attorneys at Samuel C. Berger, PC offer fixed-fee packages of legal services to businesses and entrepreneurs who want to do business in New York and northern New Jersey. To speak to a member of our skilled legal team, contact us today online or at (212) 380-8117.

Web Resources:

Memorandum Opinion (PDF file), Shocking Technologies, Inc. v. Michael, et al, Case No. 7164-VCN, Delaware Court of Chancery, September 28, 2012
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