Monday, November 25, 2019

What if . . . . Delaware and Mrs. Pritchard

Many of us teach Francis v. United Jersey Bank, 432 A. 2d 814 (N.J. 1981), in Business Associations courses as an example of a substantive duty of care case.  The case involves a deceased woman, Lillian Pritchard, who, in her lifetime, did nothing as a corporate director to curb her sons' conversions of corporate funds.  The court finds she has breached her duty of care to the corporation, stating that:

Mrs. Pritchard was charged with the obligation of basic knowledge and supervision of the business of Pritchard & Baird. Under the circumstances, this obligation included reading and understanding financial statements, and making reasonable attempts at detection and prevention of the illegal conduct of other officers and directors. She had a duty to protect the clients of Pritchard & Baird against policies and practices that would result in the misappropriation of money they had entrusted to the corporation. She breached that duty.

Id. at 826.  In sum:

by virtue of her office, Mrs. Pritchard had the power to prevent the losses sustained by the clients of Pritchard & Baird. With power comes responsibility. She had a duty to deter the depredation of the other insiders, her sons. She breached that duty and caused plaintiffs to sustain damages.

Id. at 829.

Francis is followed in our text by a number of additional fiduciary duty law cases, including Delaware's now infamous Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), Stone v. Ritter, 911 A.2d 362 (Del. 2006), and In re Walt Disney Derivative Litigation, 907 A 2d 693 (Del. 2005).  In covering these cases and discussing them with students during office hours, I became focused on the following passage from the Disney case:

The business judgment rule . . . is a presumption that "in making a business decision the directors of a corporation acted on an informed basis, . . . and in the honest belief that the action taken was in the best interests of the company [and its shareholders]." . . . .

This presumption can be rebutted by a showing that the board violated one of its fiduciary duties in connection with the challenged transaction. In that event, the burden shifts to the director defendants to demonstrate that the challenged transaction was "entirely fair" to the corporation and its shareholders.

In re Walt Disney Co. Derivative Litigation, 907 A.2d 693, 746-47 (Del. Ch. 2005).  I have some significant questions about the application of the "entire fairness" standard of review in certain types of cases.  In thinking those through with some of my colleagues (including a few of my co-bloggers), I realized I was curious about the answer to a related question: How would the Francis case be pleaded, proven, and decided as a breach of duty action under Delaware law?  

I have my own ideas.  But before I share them, I want yours.  How would you categorize/label the breach(es) of duty as a matter of Delaware law?  What standard of conduct and liability would you expect a Delaware court to apply as a matter of Delaware law?  And what standard of review would you expect that court to use?  Leave your ideas on any or all of the foregoing in the comments, please!

Business Associations, Delaware, Family, Family Business, Joan Heminway | Permalink


I have always wondered about how Caremark applies to closely held corporations. At one time, I would have answered your question by saying that the cause of action in Delaware is breach of the duty of care in the oversight setting, and the standard of liability would be gross negligence. But Caremark strikes me as something different than a gross negligence standard. If the Caremark standard is violated, would Delaware then apply an entire fairness analysis? Is Delaware trying to set up a doctrine where gross negligence is the standard of conduct, but Caremark is the standard of liability? And if Caremark is really a duty of loyalty claim, then what?

Posted by: Doug | Nov 26, 2019 8:09:14 AM

Doug, thanks for all these thoughts. I love the fact that you highlighted the closely held corporation angle--one that I also love to explore. One question I have about that is whether the doctrine of independent legal significance/equal dignity would be used by the Delaware courts to conclude that a closely held Delaware corporation should not be held to a different standard unless it is organized as a Delaware statutory close corporation (under subchapter XIV of the Delaware General Corporation Law) and has adjusted its structural and liability norms accordingly. I would be interested in your views on that (and those of others, too) . . . .

The portion of your comment focusing on the duty of care also interests me. As I read Stone v. Ritter, a bad faith claim in the oversight context (i.e., a Caremark claim) should be styled as a duty of loyalty claim in Delaware, rather than a duty of care claim (although prior to Stone v. Ritter, I had always assumed and advised that oversight was a care question). You allude to this issue at the end of your comment. The bad faith standard of liability under In re. Disney is certainly harder to meet than the gross negligence standard of liability under Smith v. Van Gorkom.

And do we both assume that the business judgment rule would apply here, absent conflicting interests or other facts invoking a higher-order standard of review?

Posted by: joanheminway | Nov 26, 2019 7:19:02 PM

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