Raising the Supervisory Bar in the Boardroom: In re Rural Metro Corporation Stockholders Litigation (Part 5)
We are discussing In re Rural Metro Corporation Stockholders Litigation, CA No. 6350-VCL (Ch. Ct. March 7, 2014).
The case that went to trial only involved the alleged liability against the investment bank. The directors had already settled iwth plaintiffs. The court did analyze the underlying breach and, while purporting to avoid determining whether the behavior transgressed the duty of care or the duty of loyalty, mostly focused on the duty of care. See Id. ("Because this decision has not parsed whether the directors‘ conduct constituted a breach of the duty of loyalty, it assumes for purposes of the 'knowing participation' element that the directors breached only their duty of care."). In other words, the court deliberately declined to apply a duty of loyalty analysis to the board's behavior.
This was in part because the plaintiffs apparently did not ask the court to do so. Id. ("The plaintiffs do not contend that any director breached his duty of loyalty"). Nonetheless, there were facts that suggested a possible conflict of interest by some of the directors.
One example was that one of the board members was a managing director of a hedge fund that owned shares of Rural. The Fund owned 12.43% of Rural, a holding that equaled 22% of the Fund’s entire portfolio (“twice the target size for a core position”). Moreover, Rural was embarking on an investment strategy that conflicted with the Fund’s goals.
- [Rural's] growth plan conflicted with [the Fund’s] investment strategy, which favored companies with predictable cash flows. The fund told its investors that it avoided companies whose valuations relied on exceptional growth, was reluctant to buy into sizable growth initiatives, preferred a margin for safety based on modest organic growth assumptions, and often penalized companies for acquisitions.
Likewise, the Fund was in the process of raising capital. As the court noted: "A Rural transaction would be a coup for the young, activist hedge fund and could be used to market the fund to new investors.”
The court did not find that the director was interested or lacking in independence but certainly raised concerns. In general, independence in Delaware is not impaired even when directors represent large shareholders. In Beam, Martha Stewart owned 94% of Omnimedia yet the factor was considered irrelevent in connection with the determination of independence. See 845 A.2d. at 1051 ("Allegations that Stewart and the other directors moved in the same social circles, attended the same weddings, developed business relationships before joining the board, and described each other as “friends,” even when coupled with Stewart's 94% voting power, are insufficient, without more, to rebut the presumption of independence.").
This can be compared with the practice overseas. In the Combined Code in Britain, for example, determination of independence requires consideration as to whether the director "represents a significant shareholder". See Section A.3.1 of the Combined Code. In other words, the factor at least needs to be considered as a routine part of the independence analysis. Perhaps after this case, it will be.