The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 1)

Sometimes the Delaware courts issue decisions that are nothing more than a straight forward application of state law, breaking no new ground.  In these moments of clarity, they often demonstrate the degree to which Delaware law favors management at the expense of shareholders.  They demonstrate why, as the decades progress. more and more areas of state corporate law will be preempted.

In Teamsters Union 25 Health Services & Insurance v. Orbitz, the board of Orbitz negotiated a new agreement with Travelport Limited, a large, arguably controlling, shareholder. Shareholders filed a derivative suit alleging among other things that directors of Orbitz violated their fiduciary duties by approving the agreement.  The case, as many do in Delaware, turned on whether demand was excused.   

The court had to weigh the independence of the board, both for purposes of demand excusal and to determine the standard of review.  Shareholders alleged that five of the nine directors were not independent.  The court noted that for demand excusal and application of the business judgment rule, it was enough that there be a majority of independent directors.  As a result, the court did not examine the allegations with respect to all five directors, but did so with respect to only one.  That four other directors might not be independent was irrelevant to the court's analysis.  

Step back and examine what this means.  Boards can have a bare majority of independent directors and still get the benefit of the business judgment rule.  The business judgment rule, as we have often noted, is an over broad presumption designed to protect risk taking.  Directors not subject to a conflict of interest know that they will get the presumption and almost never be liable.  They can take risks without meaningful fear of liability.    

But the logic of the over broad protection breaks down in cases involving the duty of loyalty. The business judgment rule protects risk taking; it is not intended to protect decisions motivated by unfairness or favoritism. In those instances, therefore, the law has traditionally imposed on the board the burden of establishing fairness.  

Somewhere along the way (the "way" is explained in The Irrelevance of State Corporate Law in the Governance of Public Companies). the courts in Delaware extended the protections of the business judgment rule to boards that contained a sizeable number of interested directors, so long as a majority of independent directors remained.  It was as if the interested influence did not exist or have any capacity to influence the decisionmaking.  Interested directors could participate in the discussion and even vote.  The only thing that mattered was the number of independent directors.  

Pretending that the interested influence didn't exist was bad enough.  But with interested directors often members of management or under the control of management, these directors had the potential to significantly influence any decision.  Nonetheless, these boards were treated as if the interested influence did not exist and the board deserved the protections of the business judgment rule.     

So back to Orbitz.  As long as five of the nine directors were, based upon the allegations, independent, everything that followed was as if the entire board was independent.  The court only needed to reach the number five.  That there was the possibility that four of the nine directors were not independent had absolutely no relevance to the analysis that followed.