The Fiduciary Limits on "Special Interest" Directors: Shocking Technologies v. Michael
One of the complaints about giving shareholders greater ability to nominate (and elect) their own candidates to the board is that they will elect "special interest" directors. These are directors who are nominated by particular shareholders and who are expected to support the interests of the nominating shareholders rather than the interests of all shareholders.
There are many many problems with this concern. It ignores the need for the candidate to obtain support from other shareholders, something more difficult if the nominee looks like it won't represent the interests of all shareholders. It also ignores the fact that directors have fiduciary obligations to all shareholders, not just those who submitted the nomination.
Fiduciary obligations to all shareholders, however, arguably provide reduced comfort given their amorphous nature. Directors can favor almost any position (including those supported by the shareholder who submitted their nomination) and assert that it is consistent with fiduciary obligations. Thus, to some degree, fiduciary duties do not impose meaningful limits on the behavior of individual directors.
Shocking Technologies v. Michael, 2012 Del. Ch. LEXIS 224 (Del. Ch. Sept. 28, 2012), suggests that this may not be true. The case did not involve a special interest director but did, nonetheless, clarify that there are substantial limits on the unilateral behavior of individual directors.
In that case, the director at issue sat on the board of a start up. A shareholder had the right to exercise warrants. The exercise would, according to the court, provide the company with a much needed source of capital. As the court described, the director "attempted to keep [the shareholder] from exercising the warrants in accordance with their terms and to persuade [the shareholder] to negotiate an even better deal—whether in terms of price or in terms of an additional board seat—before it exercised the warrants or made additional investments in Shocking."
The director's "actions clearly demonstrated a desire to interfere with the Company's funding." The court viewed the behavior as disloyal. See Id. ("The best interests of the Company—finding enough cash to survive—were immediate and unmistakable. [The director], knowing the consequences if he was successful, acted against the Company's best interests. For that, he was disloyal."). The court went on to conclude that the company had not shown damages. In addition, the court declined to aware fees, finding an absence of bad faith.
The court did not discount the right of directors to disagree or to seek to "change corporate governance ambiance and board composition." Nonetheless, there were limits.
A director may not harm the corporation by, for example, interfering with crucial financing efforts in an effort to further such objectives. Moreover, he may not use confidential information, especially information gleaned because of his board membership, to aid a third party which has a position necessarily adverse to that of the corporation.
The case stands for the broad proposition that fiduciary obligations impose limits on the behavior and activities of individual directors and require that director remain loyal to the corporation.
In the context of "special interest" directors (not something present in this case), the decision suggests that directors nominated by a particular shareholder will be subject to claims of disloyal behavior if they overtly favor the nominating shareholder. This significantly weakens the argument that directors nominated by particular shareholders will act in a manner that favors the nominating shareholder at the expense of the other owners.