Monday, April 14, 2014
Delaware, like most states, has a provision in its corporate statutes allowing corporations to limit directors’ liability for breaches of fiduciary duty. Delaware section 102(b)(7) allows corporations to include in their charter “a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages" for certain breaches of fiduciary duty.
A recent Delaware case plows a huge hole through the protection provided by a section 102(b)(7) charter provision. In the Rural Metro case [In Re Rural Metro Corp. Stockholders Litigation, 2014 WL 971718 (Del. Ch. Mar. 7, 2014)], the Delaware Court of Chancery held that a 102(b)(7) provision does not protect against claims that non-directors aided and abetted a duty-of-care violation by directors, even when the directors themselves are protected.
The Chancery Court’s reasoning is sound. Section 102(b)(7), and the associated charter provision, don’t say there’s no breach of fiduciary duty, just that directors aren’t personally liable for damages. The underlying conduct by the directors is still a breach of fiduciary duty, and injunctive relief is still available, just no money damages.Since there’s still a breach of duty, and the statute says nothing about the liability of aiders and abettors, the court concluded that aiders and abettors can still be liable if: (1) the directors breached their fiduciary duties; (2) the third party knew the directors were breaching their fiduciary duties; and (3) the third party participated in the breach.
The court ultimately held that RBC Capital Markets, LLC was liable for aiding and abetting. I can't do justice to the facts in the space available here; I highly recommend a reading of this important opinion.
The real question is whether the Delaware legislature will let this holding stand. The Chancery Court’s statutory reasoning is sound, but that doesn’t mean the result is necessarily good policy. Investment bankers, brokers, accounting firms, and other third party providers, perhaps even lawyers in some cases, are exposed to the risk of liability under this holding. Even if they ultimately win on the merits, as I suspect many will, the litigation itself will be costly. That cost will, of course, be passed on to the corporations using the services of those third parties.
There’s a possible gain associated with that cost, of course: the possible increased deterrence of breaches of fiduciary duty by corporate directors. But the Delaware legislature, in adopting section 102(b)(7), has already decided that other considerations outweigh the deterrent effect of imposing liability on the directors themselves.
Two Legislative Options
Plugging the Rural Metro hole is easy. A simple amendment to 102(b)(7) would do the trick. But how the Delaware legislature chooses to amend the statute (if it does) is important.
One way would be to authorize corporations to include provisions in their charters protecting not only directors, but also people who aid and abet violations by the directors. If that's all the Delaware legislature did, the protection from liability would not be automatic. Companies with 102(b)(7) exculpation provisions would have to amend their charters to protect aiders and abettors.
A simpler, neater solution would make the protection of aiders and abettors automatic. The legislature could just add a sentence at the end of 102(b)(7) providing that aiders and abettors are not liable when the directors themselves are protected from liability. Something like the following would work: “Unless otherwise specified in the certificate of incorporation, no person shall be liable for money damages for aiding and abetting an action protected by such a provision.” If the legislature did this, no further corporate action would be needed to make this protection effective. Only companies that did not want aiders and abettors protected would have to amend their charters.
Stay tuned to see what, if anything, the Delaware legislature does.