Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty

Abstract:     
In discussing independent directors, most of the focus has been on the definitions employed by the stock exchanges. It is the Delaware definition, however, that is the more important one. Delaware provides that, in non-controlling shareholder cases, conflict of interest transactions approved by a board consisting of a majority of "independent" directors will receive the presumption of the business judgment rule. The result is to eliminate any judicial consideration of fairness in reviewing the transaction.

A number of problems exist with the approach. First, the requirement of a majority means that the business judgment rule applies despite the presence of a minority of interested or non-independent directors in the decision making process. They may participate in the debate and vote on the matter without altering the standard of review. Second, the definition of independent is inconsistently applied and does not insure that boards will in fact consist of a majority of independent directors. Third, the Delaware courts have used all but impossible pleading standards to dismiss challenges to director independence at the motion to dismiss stage, terminating any ability to use discovery to resolve the issue.

The result is that conflict of interest transactions receive business judgment protection despite approval by a majority of directors who are in fact not independent. No real substantive limits exist, therefore, on conflict of interest transactions. The result is predictable, with executive compensation and other conflict of interest transactions subject to no significant legal limits.

Number of Pages in PDF File: 55

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