The courts have repeatedly told potential plaintiffs that if they want to bring a derivative securities lawsuit, they must have owned shares in the company when the alleged misdeeds took place.
Now the Delaware Supreme Court has shut the door on any corporate directors who think that standard doesn’t apply to them.
The recent decision, Schoon v. Smith et al, addresses the admittedly odd scenario of a board director who owns no shares in the company. The case involved Richard Schoon, a director of Troy Corp., an industrial manufacturer. He had filed a derivative action in the Delaware Chancery Court on behalf of Troy, alleging breaches of fiduciary duties by his fellow directors.
Schoon argued that his role as a fiduciary should permit him to have the same standing as a stockholder has to bring a derivative action. Schoon also insisted a director can bring a derivative action for the same reasons that equity has traditionally granted stockholders the right to do so. He also contended that an extension of standing to a director will promote Delaware public policy.
The Delaware Chancery Court, however, dismissed his complaint. And several weeks ago the Delaware Supreme Court affirmed the dismissal.
“Because a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action,” the Supreme Court wrote. It stressed that Schoon did not cite a single case permitting a director, who does not own stock, to sue derivatively.
Kaizer
“This is entirely consistent with precedent,” says Andrew Kaizer a partner in the law firm of McDermott Will & Emery.
The unusual dispute stems from Troy’s three-tier ownership structure. Daryl Smith, the company’s chairman and CEO, owned a majority of Series A shares and used them to vote four of Troy’s five directors onto the board. Series B shareholders have the right to elect the fifth member of the board. Another privately held Delaware corporation, Steel Corp., owns a majority of Series B shares, which it voted to put Schoon onto the board. (Series C shares have no voting rights.)
Schoon alleged that shortly after he became a director, he discovered that the other three board members were “beholden to Smith,” which allowed Smith to dominate and control the board. Schoon alleged that Smith took actions on several occasions designed to entrench himself and, in turn, thwart potential value-maximizing transactions for the benefit of Troy and its stockholders.
Schoon claimed in his complaint that none of the directors, other than him, was able to exercise independent judgment regarding Smith or Troy. Schoon also alleged that Troy is being injured by the actions of his fellow directors, and that his own attempts to save the company from their breaches of fiduciary duty were thwarted by Smith.
Smith, the other three directors, and Troy moved to dismiss Schoon’s complaint for lack of standing. The reason: Schoon did not own any shares of the company. The courts agreed.
DENIED
The following excerpt from Richard Schoon v. Smith et al Supreme Court of Delaware Decision relates to the American Law Institute position on director standing.
In arguing that a grant of standing to directors will further the policy of
protecting against misconduct by fiduciaries, Schoon urges us to adopt the 1994
proposal of the American Law Institute (“ALI”) that relates to director standing.
Section 7.02(c) of the ALI Principles provides: “A director of a corporation
has standing to commence and maintain a derivative action unless the court finds
that the director is unable to represent fairly and adequately the interests of the
shareholders.” The commentary to this provision recognizes that this is a
“special right” because “most directors will already have standing to sue as
shareholders.”
... Schoon cites no case permitting a director, who does not own stock, to
sue derivatively. We recognize, as did the ALI, that New York provides by statute
that a director can sue other directors on behalf of the corporation derivatively.
We regard the New York statute as confirming the prerogative of a legislature to
confer standing upon a director by statute. To date, the Delaware General
Assembly has not chosen to do so.
… Given the absence of statutory authority for his standing to sue as a director,
Schoon’s argument must succeed or fail on the merits of extending the doctrine of
equitable standing judicially. We have explained the rationale for this equitable
doctrine and decline to enlarge it by embracing a policy that will divert the
doctrine from its original purpose: to prevent a complete failure of justice.
Schoon has not shown that a complete failure of justice will occur unless he is granted
standing to sue as a director. A stockholder derivative action would fully and
adequately redress any injuries to Troy resulting from a breach of fiduciary duty by
its board. Accordingly, we decline to extend equitable standing to Schoon to sue
derivatively in his capacity as a director.
CONCLUSION: The judgment of the Court of the Chancery dismissing Schoon’s complaint for lack of standing is AFFIRMED.
Source
Supreme Court of Delaware Decision (Feb. 12, 2008).
“Given the well-established duties of a director and the ability and the right of Steel Corp. as a stockholder to bring a derivative action if Steel deems it necessary, we perceive no new exigencies that require an extension of equitable standing to Schoon as a director,” the Court wrote.
In fact, the Court pointed out that Steel, which had appointed Schoon to the Troy’s board, is litigating other matters involving Troy before the Chancery Court. It has already sought the books and records from Troy “to value its shares and facilitate the sale of its stock to a third party,” to which Troy agreed if Steel executed a confidentiality agreement, according to the ruling.
“Part of the court’s argument is that the people responsible for making Schoon a director are shareholders who could have done the derivate suit,” Kaizer says.
Laster
Travis Laster, partner with Abrams & Laster, which represented Schoon, says the ruling “is significant in principle but likely not to have much impact in practice,” since almost all directors either own shares themselves or are closely affiliated with investors who do have the standing to file a derivative suit.
But Laster adds that the ruling has created a somewhat gray area if a director only owned options or does not have an affiliated stockholder who can sue, and the director perceives serious misconduct at the company.
The Court also rejected Schoon’s call for Delaware to adopt the 1994 proposal of the American Law Institute that would also provide derivative standing to directors. The Court noted that only Pennsylvania’s Supreme Court had blanket adopted that provision so far.
It did recognize that New York provides by statute that a director can sue other directors on behalf of the corporation derivatively. However, the Supreme Court stated: “We regard the New York statute as confirming the prerogative of a legislature to confer standing upon a director by statute. To date, the Delaware General Assembly has not chosen to do so.”
This is not the only recent decision that rejected a plaintiff’s right to sue if he or she did not own stock.
In Grosset v. Wenaas et al, a shareholder derivative suit involving JNI Corp., the plaintiff sought to recover damages for breach of fiduciary duty and insider trading. The San Diego Superior Court allowed the case to proceed, but it was dismissed through a special litigation committee’s investigation and motion to dismiss, according to the law firm DLA Piper.
Hurd
The law firm notes that the Court of Appeals in California dismissed the appeal because the plaintiff sold his stock in a cash merger of JNI into another company. The California Supreme Court later affirmed that bringing a derivative suit requires a plaintiff to own stock in the company continuously throughout the litigation. So, the plaintiff lost standing when the stock was sold.
“These cases reaffirm what the law is,” says Susan Hurd, a partner with the law firm Alston & Bird “It is not an expansion of the law.”
No comments yet