The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 4)
We are discussing Teamsters Union 25 Health Services & Insurance v. Orbitz. For purposes of demand excusal and the application of the business judgment rule, the court only needed to find that five of the nine directors were independent. Since the shareholder only challenged the independence of five directors, the court only needed to find that the allegations were insufficient to establish reasonable doubt about the independence of one of the five directors.
The court also considered a claim by the plaintiff that the board had breached its fiduciary duties by incorrectly determining that three directors were independent. The shareholder brought the a direct claim for false disclosure and a derivative claim for breach of fiduciary duty because the directors "violate[d] regulations applicable to the company." The court, however, did not resolve the direct/derivative issue but instead held that the shareholder had "no standing" to raise a violation of a rule of the stock exchange.
The court first found that the fiduciary duty claim was the "functional equivalent of a claim to enforce the NYSE Rules." Having transformed a fiduciary duty claim into a claim for breach of the rules of the exchange, the court largely relied on federal case law finding that a private right of action did not exist for violations of the rules of the exchange. Id. ("I find this federal authority to be persuasive, and I likewise conclude that Plaintiff has no standing to prosecute a violation of the NYSE Rules.").
The court conceded that, under the duty of loyalty, directors could not violate positive law. Moreover, the court apparently conceded that the rules of the exchange constituted "positive law." Nonetheless, there could be no claim because "the Complaint does not allege that the NYSE, as a self-regulatory organization, has indicated that Orbitz violated the NYSE Rules and Plaintiff has no standing to assert or prove that Orbitz violated the NYSE Rules."
The reasoning is unfortunate and impossible to sustain. First, the plaintiff was not bringing a cause of action for violation of the NYSE rule. The complaint alleged that the board violated its fiduciary obligations. Equating the two was inappropriate. They have different elements. Merely establishing a violation of an exchange rule does not automatically mean that the board violated its fiduciary obligations.
Second, the holding was based on the absence of a private right of action. Plenty of "positive" requirements (particularly under the securities laws) do not give rise to a private right of action. In addition to the rules of the exchanges (the idea that there is never a private right of action, by the way, is over broad, particularly given the use of congressionally mandated listing standards since SOX), numerous sections of the securities laws do not give rise to a private right of action (Section 17 of the 1933 Act) for example. Apparently, boards apparently do not have a fiduciary obligation to adhere to these provisions since shareholders have no private right of action for enforcement.
Third, the court left open the possibility that shareholders could bring a claim for breach of an NYSE rule where the exchange "indicated" that a violation had occurred. In addition to providing shareholders with an incentive to bring any claim to the attention of the relevant regulators, the holding effectively found that fiduciary duties depended not on the conduct at the time of the alleged violation but on the subsequent characterization following the behavior. This is also inconsistent with the law with respect to fiduciary duties. Characterizations of behavior and subsequent consequences are generally viewed as irrelevant to an analysis of breach of fiduciary duty.
Shareholders are protected by the broad nature of fiduciary obligations. These duties apply to all actions by directors and ensure that the company is always managed in the best interests of shareholders. It is black letter law that as part of that a board's fiduciary duties, they must follow legal requirements. See In re Massey Energy, 2011 WL 2176479 (Del. Ch. May 31, 2011) ("For fiduciaries of Delaware corporations, there is no room to flout the law governing the corporation's affairs. If the fiduciaries of a Delaware corporation do not like the applicable law, they can lobby to get it changed. But until it is changed, they must act in good faith to ensure that the corporation tries to comply with its legal duties.").
Apparently not any longer, at least where there is no private right of action.