Delaware Fiduciary Duty of Disclosure Explained by Chancery
In re Wayport, Inc. Litigation, Cons., C.A. No. 4167-VCL (Del. Ch. May 1, 2013).
Issues Addressed: Among the several issues addressed in this case, the most noteworthy is a fulsome discussion and restatement of the fiduciary duty of disclosure that directors and majority shareholders owe to other existing shareholders from whom they are purchasing or selling shares.
The procedural posture of this case was a post-trial opinion in connection with claims for breach of fiduciary duty and resulting damages arising out of the sales of stock in Wayport, Inc. involving insiders (insider trading). A prior Chancery decision dismissed in part many of the original claims. See Latesco, L.P. v. Wayport, Inc. (highlighted on these pages here), 2009 WL 2246793 (Del. Ch. July 24, 2009).
Highlights of Key Legal Principles Discussed
The plaintiffs alleged that the defendants owed them fiduciary duties that included a duty to disclose material information when they purchased the shares of the plaintiffs. The court explained that directors of a Delaware corporation owe two fiduciary duties: care and loyalty.
The court added that “the duty of disclosure is not an independent duty, but derives from the duty of care and loyalty…. The duty of disclosure arises because of the application in the specific context of the board’s fiduciary duties . . . Its scope and requirements depend on context; the duty does not exist in a vacuum.” Slip op. at 26 (citations omitted).
The court described the need to engage in a context specific analysis to determine the scope and requirements of a disclosure obligation. The court referred to several recurring scenarios in which these issues arise, and provided a discussion of four scenarios that it labeled as prominent in an analysis of the duty of disclosure. In other words, the duty of disclosure most often arises in four common contexts described below as scenarios.
The First Recurring Scenario
The court described the first recurring scenario as a classic, common law ratification in which directors seek approval for a transaction that does not otherwise require a stockholder vote under the DGCL. See Gantler v. Stephens, 965 A.2d 695, 713 (Del. 2009). See id. at n.54 (“The only species of claim that shareholder ratification can extinguish is a claim that the directors lack the authority to take action that was later ratified. Nothing herein should be read as altering the well established principle that void acts such as fraud, gift, waste and ultra vires acts cannot be ratified by a less than unanimous shareholder vote.”)
The second scenario involves a request for stockholder action when directors submit to the stockholders a transaction that requires stockholder approval, such as a merger or charter amendment. In such a transaction that is not otherwise interested, the directors have a duty to “exercise reasonable care to disclose all facts that are material to the stockholders’ consideration of a transaction or a matter, and that they can reasonably obtain from their position as directors.” See Stroud, 606 A.2d at 84. Failure to disclose material information in this context “may warrant an injunction against, or rescission of, the transaction, but will not provide a basis for damages from defendant directors absent proof of: (i) a culpable state of mind or non-exculpated gross negligence, (ii) reliance by the stockholders on the information that was not disclosed, and (iii) damages proximately caused by that failure. See Loudon v. Archer-Daniels-Midland Co., 700 A.2d 135, 146-47 (Del. 1997).
The third scenario involves a corporate fiduciary that speaks outside of the context of soliciting or recommending stockholder action such as: “public statements made to the market, statements informing shareholders about the affairs of the corporation, or public filings required by the federal securities laws. “ Malone v. Brincat, 722 A.2d 5, 11 (Del. 1998). In that context, directors owe a duty to stockholders not to speak falsely. Such a breach may result in a derivative claim or a cause of action for damages or equitable relief. Id. at 14.
The fourth scenario is when a corporate fiduciary buys shares directly from or sells shares directly to an existing outside stockholder. The Delaware Supreme Court adopted the “special facts doctrine” to address this scenario, in the case of Lank v. Steiner, 224 A.2d 242 (Del. 1966). Under that doctrine, a director has a fiduciary duty to disclose information in the context of a private stock sale “only when a director is possessed of special knowledge of future plans from secret resources and deliberately misleads a stockholder who is ignorant of them.” Id. at 244. If this standard is met, a duty to speak exists. If the standard is not met, then the director does not have a duty to speak and is liable only to the same degree as a non-fiduciary would be.
Importantly, this duty does not exist to purchases or sales in impersonal secondary markets. Transactions in the public markets are distinctly different.
The current case originally raised the second, third and fourth scenarios but only the fourth scenario remained at trial.
Three Rules (Majority View, Minority View and Delaware View)
The court discusses the three rules developed to address the duty of disclosure of a fiduciary in a direct purchase by a fiduciary. Among the scholarship cited by the court was an article by Professor Stephen M. Bainbridge entitled: Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189, 1219 (1995). The court also quotes extensively from an article by Professor Lawrence A. Hamermesh entitled: Calling Off the Lynch Mob: The Corporate Director’s Fiduciary Disclosure Duty, 49 Vand. L. Rev. 1087, 1099 (1996). Both professors are friends of this blog and among the most cited corporate scholars in Delaware opinions.
The court discussed the majority rule, the minority rule, and the compromise position known as the “special facts doctrine,” that the Delaware Supreme Court, in the words of this Chancery opinion, “appears to have adopted” based on the analysis of decisions of Delaware’s High Court discussed in this opinion. The conflict of viewpoints on this issue present different standards to determine the contours of the duty that a director owes to disclose to the selling stockholder material facts which are not known or available to the selling stockholder but are known or available to the director by virtue of his position as a director. See Slip op. at 31.
Special Facts Doctrine (the Delaware View)
In order to satisfy the special facts doctrine requirement, a plaintiff must “generally point to knowledge of a substantial transaction, such as an offer for the whole company. This may also include a third party offer to purchase a corporation’s stock at a multiple value.”
The court emphasized that the standard for finding “special facts” is lower than the standard of materiality.
The court explained that officers have the same fiduciary duties of disclosure. In footnote 3, the court noted that it is possible for a non-fiduciary to be liable for aiding and abetting a breach even if the board members are exculpated from a breach of their duty of care, and a non-fiduciary would not enjoy that same exculpation under DGCL Sections 102(b)(7) or 141(e).
Duty of the Corporate Entity
The court observed a nuance of corporate law not often addressed, and that is that the corporate entity itself does not owe fiduciary duties to its stockholders. See Slip op. at 44.
Duty to Speak
The court explained that in this context, a director would only have a duty to speak if he possessed special knowledge of future plans and deliberately misled a stockholder who is ignorant of those plans. In addition, a duty to speak can arise because of statements a party previously made, and then subsequently acquired information makes the previous statement untrue, or if the speaker knows that subsequently acquired information would make untrue a previous representation that when made was true. See Slip op. at 45.
Equitable Fraud and Common Law Fraud
The court described the difference between equitable fraud and common law fraud, the former sometimes referred to as “constructive fraud”. Equitable fraud differs from actual fraud based on the existence of a special relationship such as where the defendant is a fiduciary for the plaintiff.
Equitable fraud has also been described as a form of fraud having all the elements of common law fraud except the requirement of scienter. Equitable fraud has also been referred to as providing a remedy for negligent or innocent misrepresentations.