The directors of a corporation owe a duty of loyalty to the corporation’s shareholders, which requires them to act only in the interest of the corporation and avoid self-dealing. Claims alleging a breach of this duty range from the relatively benign, such as a failure to disclose a conflict of interest, to overt acts of bad faith. A recent decision from the Delaware Court of Chancery addressed a claim of bad-faith breach, which the court noted is very difficult to prove. In re Chelsea Therapeutics Int’l Ltd. Stockholders Litig., No. 9640-VCG, mem. op. (Del. Ct. Chanc., May 20, 2016). A group of shareholders alleged that certain directors breached the duty of loyalty by disregarding higher financial projections before recommending the sale of the company. The court found that the plaintiffs had failed to establish that the defendants acted egregiously enough to meet the legal standard for bad faith. It described a situation that would constitute bad faith under the duty of loyalty as a rara avis, a “rare bird.”
Directors and officers are obligated to direct their efforts toward the interests of the corporation and its shareholders. The mere existence of a conflict of interest, however, does not automatically breach the duty of loyalty. A director with a conflict of interest, such as a personal financial stake in a board decision, must make a full disclosure to the other directors and the shareholders. Any related transaction requires majority approval from the disinterested directors or shareholders. A breach of the duty of loyalty could result in civil liability to the corporation, or to some or all shareholders.
Typically, it is in the corporation’s interest, and the interests of its shareholders, to maximize profits and minimize expenses, but this is not always the case. If a corporation is currently the subject of negotiations incident to a proposed merger or acquisition, for example, obtaining the best possible price is generally considered the top priority for the directors. This was the situation in the Chelsea case.