Director Reliability, Board Independence and the Delaware Courts: In re Goldman Sachs (The Exception for Business Relationships; Part 2)
We are discussing In re Goldman Sachs and the exceptions carved out of the definition of director independence by the Delaware courts. These exceptions permit the designation of candidates who, while characterized as "independent," are in fact likely to be "reliable" supporters of management's policies. See Essay: Neutralizing the Board of Directors and the Impact on Diversity
Boards of public companies at one time consisted mostly of insiders and other persons with material financial relationships with the company (suppliers, lawyers, customers, etc). These directors could be counted on to reliably support the CEO. As the need for board independence grew, however, these categories of directors gradually disappeared. While the definition of independent director evolved, the central theme was that it did not include directors who had significant economic ties to the company.
In re Goldman, however, provided an avenue for the return to the board of these directors. the court did so by simply finding that the significant relationships did not impair director independence.
One of the Goldman directors served as chairman and CEO of ArcelorMittal, a large integrated stell and mining company. Plaintiffs alleged that “Goldman has arranged or provided billions of euros in financing to [this director's] company” and that “[d]uring 2007 and 2008 alone, [Goldman] had made loans to ArcelorMittal [sic] in the aggregate amount of 464 million euros.” By any standards, the relationship looked significant. Nonetheless, the court concluded that the business relationtionship was not sufficient to cast a "reasonable doubt" about the independence of the director.
- Goldman is an investment bank. The fact “[t]hat it provided financing to large . . . companies should come as no shock to anyone. Yet this is all that the plaintiffs allege.” The Plaintiffs fail to plead facts that show anything other than a series of market transactions occurred between AcelorMittal and Goldman. For instance, the Plaintiffs have not alleged that AcelorMittal is receiving a discounted interest rate on the loans from Goldman, that Mittal was unable to receive financing from any other lender, or that loans from Goldman compose a substantial part of ArcelorMittal’s funding.
In other words, the court considered the size of the loan largely irrelevant. Independence would be lost if plaintiffs could allege at the pleading stage that the loans was made on favorable terms (presumably more favorable than would have been given by other lenders) or that it was a "substantial part" of the overall funding of the company (irrespective of the company's particular need for funding).
The ability to show that a loan was more favorable was, in most cases, an impossible standard at the pleading stage. Any "discount" on the interest rate would not be apparent from the actual rate charged by Goldman. Even if the company obtained a loan at the market rate of interest, the rate could still have been discounted if the company had a higher risk profile. Only by knowning the actual considerations used by Goldman to price the loan could a plaintiff determine whether the terms were excessively favorable. That kind of information at the pleading stage would not likely be available.
More importantly, however, the analysis ignored the obvious reality. ArcelorMittal would presumably not have borrowed the money from Goldman unless it was on the most favorable terms possible. In other words, if ArcelorMittal could have gotten the loan from another lender on better terms, it presumably would have done so. Thus, at the pleading stage, when plaintiffs only must show a reasonable doubt about independence, the presumption ought to be that ArcelorMittal in fact received a loan from Goldman on the most favorable terms possible. That ought to be enough to establish reasonable doubt, with discovery ultimately available to determine whether the loan was as favorable or more favorable than what other lenders would have provided.
The Delaware court has essentially stepped back in time. The court has allowed directors to be treated as independent despite these substantial business relationships. In other words, they are treating as independent the very class of directors that the definition of independence was largely designed to eliminate.
Primary materials, including the decision in the case, can be found at the DU Corporate Governance web site.