The directors of a corporation owe a duty of loyalty to the corporation’s shareholders, which requires them to act only in the interest of the corporation and avoid self-dealing. Claims alleging a breach of this duty range from the relatively benign, such as a failure to disclose a conflict of interest, to overt acts of bad faith. A recent decision from the Delaware Court of Chancery addressed a claim of bad-faith breach, which the court noted is very difficult to prove. In re Chelsea Therapeutics Int’l Ltd. Stockholders Litig., No. 9640-VCG, mem. op. (Del. Ct. Chanc., May 20, 2016). A group of shareholders alleged that certain directors breached the duty of loyalty by disregarding higher financial projections before recommending the sale of the company. The court found that the plaintiffs had failed to establish that the defendants acted egregiously enough to meet the legal standard for bad faith. It described a situation that would constitute bad faith under the duty of loyalty as a rara avis, a “rare bird.”
Directors and officers are obligated to direct their efforts toward the interests of the corporation and its shareholders. The mere existence of a conflict of interest, however, does not automatically breach the duty of loyalty. A director with a conflict of interest, such as a personal financial stake in a board decision, must make a full disclosure to the other directors and the shareholders. Any related transaction requires majority approval from the disinterested directors or shareholders. A breach of the duty of loyalty could result in civil liability to the corporation, or to some or all shareholders.
Typically, it is in the corporation’s interest, and the interests of its shareholders, to maximize profits and minimize expenses, but this is not always the case. If a corporation is currently the subject of negotiations incident to a proposed merger or acquisition, for example, obtaining the best possible price is generally considered the top priority for the directors. This was the situation in the Chelsea case.
The corporation at issue in Chelsea is a pharmaceutical manufacturer that makes a drug used to treat neurogenic orthostatic hypotension (NOH). The drug received approval from the U.S. Food and Drug Administration (FDA) in early 2014. At around the same time, the FDA had suggested it might take the drug’s chief competitor off the market, making its status highly uncertain and making Chelsea’s prospects look good.
Also at around the same time, the corporation received a tender offer to acquire the company. The board of directors ultimately recommended that the shareholders approve the tender offer. In making this recommendation, however, they disregarded two sets of financial projections that showed a higher standalone value for the company.
The plaintiffs filed suit, alleging that the defendant directors excluded this information in a bad-faith breach of the duty of loyalty. The court held that this was not an act of bad faith. Both sets of projections, the court found, were based on hypothetical factors that were beyond the company’s control, such as the FDA’s possible removal of the competing drug from the market. The projections were speculative enough that disregarding them was a reasonable action and did not meet the legal standard for bad faith.
New York and New Jersey business transactions attorney Samuel C. Berger represents businesses, business owners, and entrepreneurs, offering fixed-fee packages of legal services that cover a broad array of issues for our clients. To schedule a confidential consultation with a skilled and knowledgeable business advocate, contact us today online, at (201) 587-1500, or at (212) 380-8117.
More Blog Posts:
In Claim for Breach of Employee’s Duty of Loyalty, New Jersey Supreme Court Allows Disgorgement of Salary Even Without Evidence of Economic Loss, New York & New Jersey Business Lawyer Blog, November 19, 2015
When Might a Corporate Officer Owe a Fiduciary Duty to a Corporate Creditor? – Workforce Solutions v. Urban Services of America, New York & New Jersey Business Lawyer Blog, January 11, 2013
Corporate Directors, Even Though Acting in Subjective Good Faith, May Breach Fiduciary Duties to the Corporation, According to Delaware Court, New York & New Jersey Business Lawyer Blog, December 28, 2012