Litigation: Disloyal director conduct doesn’t always constitute bad faith

Recent decision shows that Delaware courts continue to carefully guard stockholder voting rights.

In 2006, in Stone v. Ritter, the Delaware Supreme Court held that the duty of good faith was not an independent fiduciary duty, but was instead a subsidiary of the duty of loyalty.

The rationale is that a director who acts in bad faith cannot simultaneously be loyal to the corporation. But if all bad faith acts constitute disloyalty, do all disloyal acts constitute bad faith? The answer is “no,” according to a recent decision by the Delaware Court of Chancery.

When tailored for review of director action affecting a stockholder vote, enhanced scrutiny requires that:

  1. The defendant fiduciaries persuade the court that their motivations were proper and not selfish
  2. That they neither precluded stockholders from voting nor coerced to them to vote a certain way
  3. That the fiduciaries’ actions were reasonably related to a legitimate objective

When the fit between the means and the end are not reasonable, the defendant fiduciaries fail to carry their burden. When the stockholder vote at issue involves a director election or touches on matters of corporate control, the defendant directors then face Delaware’s most stringent test for director conduct and they must establish that their decisions are supported by a “compelling justification.”


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John Reed

John Reed is a partner the Delaware office of DLA Piper, where he concentrates his practice on corporate litigation and counseling. He can be contacted...

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