Before coverage of the Nacchio trial began (it continues on the link to the left), we were doing posts on Delaware's definition of independent director, particularly as it applied to friendship.  Using the Disney case as an example, we discussed how Delaware essentially excluded friendship as a basis for depriving a director of his or her independence.  We do one last post in this series, although it is a topic that will be revisited.  Essentially Delaware gives great deference to decisions by independent boards but the courts use excessively high pleading standards and inconsistent tests to find boards independent, even where evidence suggests that they are not.  

In Disney, the courts came close to espousing a categorical rule that these types of relationships would not deprive directors of their independence. The approach defied common sense and had a result oriented appearance.

The Delaware Supreme Court ultimately decided otherwise in a case involving Martha Stewart. See Beam v. Stewart, 845 A.2d 1040 (Del. 2004). Stewart served as the CEO and chairman of Omnimedia and owned of 94% of the stock. In a derivative suit against the board of Omnimedia, Plaintiffs challenged the independence of several directors who served on the board, focusing in one case on Stewart’s friendship with Darla Moore.

The Delaware Supreme Court took the opportunity to discuss the affect of outside personal relationships on director independence. The Court acknowledged that “a variety of motivations” could impair independence, “including friendship.” The Court made no effort to reconcile these observations with the holding in Disney a few years before that suggested otherwise.

Friendship, however, was not enough. Instead, plaintiffs had to show that “the non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.” The opinion discounted relationships that arose from a “structural bias,” that is “professional and social relationships that naturally develop among members of a board impede independent decision making, whether before or after joining the board.”

Applying the new test to the facts at issue, the Court concluded that plaintiffs had not presented “reasonable doubt” that the director was not independent because of the friendship with Stewart.

There are many many things wrong with this opinion, not the least of which is that it makes it almost impossible to meet the test at the pleading stage. To demonstrate that a director would elevate friendship above personal reputation is a highly individual, subjective determination (even assuming one knows how to do it at all). The Court gave no hint how this might be done on the pleadings, a particularly important issue given its frequent use of high pleading standards to terminate examination of director independence. 

Nor did it explain how a plaintiff could produce the requisite amount of subjective information about a friendship at the pleading stage.  In fact, look at the amount of information presented by plaintiffs in Stewart.  They asserted that Moore was a longstanding friend of Stewart’s and, for support, pointed to a wedding reception hosted by Stewart’s attorney (the reception was for the attorney's daughter) that both attended, an article in Fortune Magazine highlighting “Moore’s close personal relationship” with Stewart (the author of the Article describes the women as “best buddies”), and that Moore was elected to replace Charlotte Beers, who plaintiffs described as a “longtime friend and confidante” of Stewart’s.  Finally, with 94% of the company’s shares, Stewart had absolute authority to determine who got on the board.

Plaintiffs only needed to show enough about the friendship to raise reasonable doubt.  Unusually, they were able to find information in the public domain that suggested a close friendship.  For the Delaware Supreme Court, however, the evidence was not enough.   As the Court concluded: “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.”

As a practical matter, therefore, the burden is going to be impossible to meet. Between the high pleading standards, the subjective nature of the analysis, and the difficult test, the case largely stands for the proposition that friendships categorically do not result in the loss of independence. In other words, the decision is no different than Disney, only less obviously embarrassing in its approach.