Responsibilities of Officers and Directors under Texas and ...

Responsibilities of Officers and Directors under Texas and Delaware Law

By Byron F. Egan, Dallas, TX*

I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

II. Fiduciary Duties Generally . . . . . . . . . . . . . . . . . . . . . 7

A. General Principles . . . . . . . . . . . . . . . . . . . . . . . . . . 7

B. Applicable Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

C. Fiduciary Duties in Texas Cases . . . . . . . . . . . . 12

1. Loyalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

a. Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . 13

b. Self-Dealing Transactions. . . . . . . . . . . . 13

c. Oversight . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

2. Care (including business judgment rule) . 14

3. Other (obedience) . . . . . . . . . . . . . . . . . . . . . . . . 17

D. Fiduciary Duties in Delaware Cases . . . . . . . . 17

1. Loyalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

a. Conflicts of Interest . . . . . . . . . . . . . . . . . . 17

b. Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . 19

c. Oversight/Caremark . . . . . . . . . . . . . . . . . 21

2. Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

a. Informed Action; Gross Negligence . . . 32

b. Inaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

c. DGCL ? 141(e) Reliance on Reports

and Records . . . . . . . . . . . . . . . . . . . . . . . . . 33

* Copyright 2007 by Byron F. Egan. All rights reserved. Byron F. Egan is a partner of Jackson Walker L.L.P. in Dallas,

Texas. Mr. Egan is a Vice-Chair of the ABA Business Law Section's Negotiated Acquisitions Committee and former Co-Chair of its Asset Acquisition Agreement Task Force, which published the ABA Model Asset Purchase Agreement with Commentary (2001). He is also a member of the American Law Institute. Mr. Egan is a former Chairman of the Texas Business Law Foundation and is also former Chairman of the Business Law Section of the State Bar of Texas and of that Section's Corporation Law Committee.

The author wishes to acknowledge the contributions of the following in preparing this paper: Michael L. Kaufman, Michael L. Laussade, Monica L. Pace and Michael E. Taten of Jackson Walker, L.L.P. in Dallas, Texas; Mark A. Morton of Potter, Anderson & Corroon LLP of Wilmington, Delaware; and Val D. Ricks, Professor of Law at South Texas College of Law in Houston, Texas.

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d. DGCL ? 102(b)(7) Limitation on

Director Liability . . . . . . . . . . . . . . . . . . . . 33

E. Fiduciary Duties of Officers . . . . . . . . . . . . . . . . . 36

F. Derivative Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

G. Effect of Sarbanes-Oxley Act of 2002 on

Common Law Fiduciary Duties . . . . . . . . . . . . . 41

1. Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

2. Shareholder Causes of Action . . . . . . . . . . . 43

3. Director Independence . . . . . . . . . . . . . . . . . . . 43

a. Power to Independent Directors . . . . . . 43

b. Audit Committee Member

Independence . . . . . . . . . . . . . . . . . . . . . . . . 51

c. Nominating Committee Member

Independence . . . . . . . . . . . . . . . . . . . . . . . . 56

d. Compensation Committee Member

Independence . . . . . . . . . . . . . . . . . . . . . . . . 57

e. State Law . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

4. Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

a. Prohibition on Loans to Directors or

Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

b. Stock Exchange Requirements . . . . . . . 68

c. Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . 69

5. Related Party Transactions . . . . . . . . . . . . . . 69

a. Stock Exchanges . . . . . . . . . . . . . . . . . . . . . 69

b. Interested Director Transactions --

TBOC ? 21.418; TBCA Art. 2.35-1;

and DGCL ? 144 . . . . . . . . . . . . . . . . . . . . . 70

III. Shifting Duties When Company on Penumbra of

Insolvency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

A. Insolvency Changes Relationships . . . . . . . . . . . 72

B. When is a Corporation Insolvent or in the

Vicinity of Insolvency? . . . . . . . . . . . . . . . . . . . . . . 76

C. Director Liabilities to Creditors . . . . . . . . . . . . . 77

D. Deepening Insolvency . . . . . . . . . . . . . . . . . . . . . . . 81

E. Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . 87

F. Fraudulent Transfers . . . . . . . . . . . . . . . . . . . . . . . 88

IV. Executive Compensation Process . . . . . . . . . . . . . . . . 88

A. Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

B. Specific Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

1. Walt Disney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

a. Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

b. May 28, 2003 Chancery Court

Opinion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

Responsibilities of Officers and Directors 3

c. September 10, 2004 Chancery Court

Opinion (Ovitz's Fiduciary Duties

Regarding His Employment

Agreement) . . . . . . . . . . . . . . . . . . . . . . . . . . 90

d. August 9, 2005 Chancery Court Post

Trial Opinion . . . . . . . . . . . . . . . . . . . . . . . . 91

e. June 8, 2006 Supreme Court

Opinion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

2. Integrated Health . . . . . . . . . . . . . . . . . . . . . . . 100

3. Sample v. Morgan . . . . . . . . . . . . . . . . . . . . . . . 104

4. Ryan v. Gifford . . . . . . . . . . . . . . . . . . . . . . . . . . 107

5. In re Tyson Foods, Inc. Consolidated

Shareholder Litigation . . . . . . . . . . . . . . . . . . 109

6. Desimone v. Barrows . . . . . . . . . . . . . . . . . . . . 113

7. Teachers' Retirement System of

Louisiana v. Aidinoff . . . . . . . . . . . . . . . . . . . . 116

8. Valeant Pharmaceuticals v. Jerney . . . . . . 116

C. Non-Profit Corporations . . . . . . . . . . . . . . . . . . . . . 119

V. Standards of Review in M&A Transactions . . . . . 123

A. Texas Standard of Review . . . . . . . . . . . . . . . . . . . 123

B. Delaware Standard of Review . . . . . . . . . . . . . . . 125

1. Business Judgment Rule . . . . . . . . . . . . . . . . 126

2. Enhanced Scrutiny . . . . . . . . . . . . . . . . . . . . . . 127

a. Defensive Measures . . . . . . . . . . . . . . . . . . 128

b. Sale of Control . . . . . . . . . . . . . . . . . . . . . . . 128

3. Entire Fairness . . . . . . . . . . . . . . . . . . . . . . . . . . 130

C. Action Without Bright Lines . . . . . . . . . . . . . . . . 131

VI. M&A Transaction Process . . . . . . . . . . . . . . . . . . . . . . . 132

A. Statutory Framework: Board and

Shareholder Action . . . . . . . . . . . . . . . . . . . . . . . . . . 132

B. Management's Immediate Response . . . . . . . . . 133

C. The Board's Consideration . . . . . . . . . . . . . . . . . . 134

1. Matters Considered. . . . . . . . . . . . . . . . . . . . . . 134

2. Being Adequately Informed . . . . . . . . . . . . . . 136

a. Investment Banking Advice . . . . . . . . . . 136

b. Value of Independent Directors,

Special Committees . . . . . . . . . . . . . . . . . . 138

c. Significant Recent Process Cases . . . . . 149

D. Value of Thorough Deliberation . . . . . . . . . . . . . 155

E. The Decision to Remain Independent . . . . . . . 157

1. Judicial Respect for Independence . . . . . . . 158

2. Defensive Measures . . . . . . . . . . . . . . . . . . . . . 161

F. The Pursuit of a Sale. . . . . . . . . . . . . . . . . . . . . . . . 162

1. Value to Stockholders . . . . . . . . . . . . . . . . . . . 162

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2. Ascertaining Value . . . . . . . . . . . . . . . . . . . . . . 163

3. Process Changes . . . . . . . . . . . . . . . . . . . . . . . . . 171

4. Disparate Treatment of Stockholders . . . . 179

5. Protecting the Merger . . . . . . . . . . . . . . . . . . . 183

a. No-Shops . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

b. Lock-Ups . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188

c. Break-Up Fees . . . . . . . . . . . . . . . . . . . . . . . 189

6. Specific Cases Where No-Shops, Lock-

Ups, and Break-Up Fees Have Been

Invalidated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

7. Specific Cases Where No-Shops, Lock-

Ups and Break-Up Fees Have Been

Upheld . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

G. Dealing with a Competing Acquiror . . . . . . . . . 196

1. Fiduciary Outs . . . . . . . . . . . . . . . . . . . . . . . . . . 197

a. Omnicare, Inc. v. NCS Healthcare,

Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198

b. Orman v. Cullman. . . . . . . . . . . . . . . . . . . 203

c. Energy Partners, Ltd. v. Stone

Energy Corp. . . . . . . . . . . . . . . . . . . . . . . . . 205

2. Level Playing Field . . . . . . . . . . . . . . . . . . . . . . 207

3. Best Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208

VII. Responses to Hostile Takeover Attempts . . . . . . . . 210

A. Certain Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210

B. Rights Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210

C. Business Combination Statutes . . . . . . . . . . . . . 214

1. DGCL ? 203 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214

2. Texas Business Combination Statutes . . . 216

VIII. Going Private Transactions . . . . . . . . . . . . . . . . . . . . . 217

A. In re Pure Resources Shareholders

Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

B. In re Emerging Communications, Inc.

Shareholders Litigation . . . . . . . . . . . . . . . . . . . . . 222

C. In re PNB Holding Co. Shareholders

Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

D. In re SS&C Technologies, Inc. Shareholder

Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228

E. In re Netsmart Technologies . . . . . . . . . . . . . . . . 229

F. In re Topps Company Shareholders

Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239

In re Lear Corporation Shareholder

Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

IX. Director Responsibilities and Liabilities . . . . . . . . . 249

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A. Enforceability of Contracts Violative of Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249

B. Director Consideration of Long-Term Interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252

C. Liability for Unlawful Distributions . . . . . . . . . 252

D. Reliance on Reports and Opinions . . . . . . . . . . . 254

E. Inspection of Records . . . . . . . . . . . . . . . . . . . . . . . . 254

F. Right to Resign. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254

X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256

I. INTRODUCTION

The conduct of directors and officers is subject to particular scrutiny in the context of executive compensation, business combinations, whether friendly or hostile, and when the corpo ration is charged with illegal conduct. The high profile stories of how much corporations are paying their chief executive of ficer ("CEO") and other executives, corporate scandals, bank ruptcies and related developments have further focused attention on how directors and officers discharge their duties, and have caused much reexamination of how corporations are governed and how they relate to their shareholders.

The individuals who serve in leadership roles for corpora tions are fiduciaries in relation to the corporation and its own ers. These times make it appropriate to focus upon the fiduciary and other duties of directors and officers, including their duties of care, loyalty and oversight. Increasingly the courts are applying principals articulated in cases involving mergers and acquisitions ("M&A") to cases involving executive compensation, perhaps because both areas often involve con flicts of interest and self-dealing or because in Delaware, where many of the cases are tried, the same judges are writing signifi cant opinions in both areas. Director and officer fiduciary du ties are generally owed to the corporation and its shareholders, but when the corporation is on the penumbra of insolvency, the beneficiaries of those duties may begin to expand to include the creditors.

The failure of Enron Corp. and other corporate debacles re sulted in renewed focus on how corporations should be governed and led to the Sarbanes-Oxley Act of 2002 (the "SOX")1, which

1. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified in several sections of 15 U.S.C.A.) ("SOX"); see Byron F. Egan, The Sarbanes-Oxley Act and Its Expanding Reach, 40 Texas Journal of Busi

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