In a bench ruling issued this month in In re Puda Coal, Inc. Stockholders Litig., the Delaware Court of Chancery declined to dismiss breach of loyalty claims against the U.S. independent directors of a Delaware company with assets and operations solely in China. In this Davis Polk Client Newsflash that I recently received, the firm says while the pleaded facts here are extreme, the decision serves as a reminder that independent directors of Delaware-incorporated companies must take all necessary steps to satisfy their fiduciary duties, even when faced with the obvious challenges of a company whose assets and operations are primarily outside the U.S. Here is an excerpt:
Directors of Delaware corporations have a fiduciary duty to act in good faith to exercise reasonable oversight over the management and operations of the corporation. Traditionally, though, the Delaware courts have imposed a high standard for plaintiffs to demonstrate that directors’ failure to oversee management constitutes a breach of their fiduciary duties. Indeed, only a “sustained or systematic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.” In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d at 959, 971 (1996).
In Puda Coal, the Court ruled that, as applied to Delaware companies with primarily foreign operations and assets (particularly companies such as this one, which accessed the U.S. public securities market through a reverse merger with a Delaware shell), Caremark requires directors to be active, present and conversant in the environment in which the company operates. As applied to this situation, the Court said:
“if you’re going to have a company domiciled for purposes of its relations with its investors in Delaware and the assets and operations of that company are situated in China that, in order for you to meet your obligation of good faith, you better have your physical body in China an awful lot.”
Directors must make reasonable and “proportional” efforts to ensure that the company complies with the law and has in place adequate systems of control to manage and oversee its assets and operations, including “having the language skills to navigate the environment in which the company is operating.” In short, independent directors “have a duty not to be dummy directors.”
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