We are discussing In re InfoUSA. The primary materials for the case, including the opinion, can be found at the DU Corporate Governance web site. For a paper that goes into this topic in greater detail, Disloyalty without Limits: "Independent Directors" and the Elimination of the Duty of Loyalty, go here.
One of the most flagrant inconsistencies in connection with the definition of director independence has been the application to directors fees. Despite the exponential growth in fees (some outside directors can receive annual compensation in excess of $400,000, for examples, go here and here), the Delaware courts have something approaching a categorical exception for fees.
The Delaware courts purport to use a materiality standard for determining when a payment from the company to the director will result in a loss of independence. Moreover, the test is a subjective one. As a result, a large payment to Bill Gates will not be material. The use of a subjective test, in addition to making the lack of independence much harder to show at the pleading stage (plaintiffs have to know the relative net worth of the director to assess the materiality of the payment, a fact often not in the public domain), results in large payments to wealthy directors being deemed immaterial.
Whatever the merits of the approach, the subjective test would also seem to compel the conclusion that even modest fees could be material where the director has only a modest income. In these circumstances, however, the Delaware courts have simply ignored their own materiality test. This occurred in Disney, an opinion written by the author of the opinion in In re InfoUSA. As discussed in far greater length in my paper, Disloyalty without Limits, plaintiffs challenged the independence of a director who was a principal of an elementary school, alleging that the fees she received were material. Ignoring the materiality analysis, the court found the director independent because of his concern that to do otherwise would banish "regular folks" from the board.
- Furthermore, to do so would be to discourage the membership on corporate boards of people of less-than extraordinary means. Such "regular folks" would face allegations of being dominated by other board members, merely because of the relatively substantial compensation provided by the board membership compared to their outside salaries. I am especially unwilling to facilitate such a result. Without more, Plaintiffs have failed to allege facts that lead to a reasonable doubt as to the independence of Bowers.
731 A.2d 342, 360 (Del. Ch. 1998), rev'd on other grounds, 746 A.2d 244 (Del. 2000). Putting aside that the court ignored its own analysis, the ostensible desire to protected "regular folk" was misguided. The finding that a director was not independent because of fees would not automatically compel "banishment." Such a director would probably still be independent under the rules of the stock exchange (the only place that affirmatively imposes an obligation to have a minimum number of independent directors) and, even if not under state law, could still serve. Delaware merely provides advantages where a board has a majority of independent directors, leaving plenty of room for non-independent ones to serve.
Anyway, we are discussing this because it came up again in In re InfoUSA. The plaintiffs alleged that one of the directors, a professor, had lost his independence because of the receipt of a material payment from the company in the form of fees. Plaintiffs alleged that the director received approximately $450,000 in compensation from his university over a four year period and $399,000 from the company (excluding the value of stock options) during the same period.
The court disregarded the allegations, noting that the payment of directors fees "without more" would not result in a lost of independence. That of course completely ignores the fact that plaintiffs did not just plead the payment of fees but produced evidence that the fees were material to the recipient. The court went on to note that to find otherwise would result in the exclusion from the board of "regular folks."
- "Such 'regular folks' would face allegations of being dominated by other board members, merely because of the relatively substantial compensation provided by the board membership compared to their outside salaries. I am especially unwilling to facilitate such a result. My concern about this issue has not diminished.
It is an odd place to suddenly evince concern for regular folks and the composition of the board, something not traditionally carrying much interest for the Delaware courts (It took SOX to more or less compel the inclusion on the board of someone with the requisite financial expertise). Moreover, this unusual concern flies in the face of the established analysis for director independence. Finally, as we have already discussed, a company has plenty of room to include "regular folks" on the board even if they are not treated as independent under Delaware law.
All of this shows that the test for director independence in Delaware is applied in a result oriented fashion. The subjective materiality test is used to make it harder on plaintiffs to plead a lack of independence and to allow courts to disregard the payment of large fees to directors. At the same time, the subjective materiality analysis is entirely ignored when it would result in directors of modest means losing their independence because of the payment of a modest amount of fees. With analysis like this, it makes absolutely clear that at least some boards considered to have a "majority" of independent directors by the Delaware courts in fact do not.