Comparison of the State of Delaware and The Jurisdiction of Barbados.

David Dean Ellis LL.M MBA BA

Introduction

Corporate governance as a social concept has its roots in the development of capitalism and the rise of productivity in a post industrial revolution era.[1] Corporate governance defines the range of activities and policies which are involved in the control and management of a corporation. These activities may involve the appointment of boards, the determination of officer appointments and compensations and operational decisions which shape the strategic policies involved in running a company.

At the heart of good corporate governance is a capable Board of Directors entrusted with the responsibility of managing the corporation. It is the Board of Directors which determines the ultimate vision of the company through their choice of appointments and terminations. A 2014 report published by the Institute of Corporate Directors for the Canadian Society cited the “enhancing” of shareholder value as the raison d’etre of all corporate boards.[2] This view of shareholder primacy is most important in the formation of companies as the shareholders represent the legitimate ownership of the corporation.

This paper will focus on the specific duties of the board of directors with respect to the ways in which corporate governance has developed in the state of Delaware as well as in the British based jurisdiction of Barbados. An examination of the two jurisdictions will reveal the importance of having a developed body of case law from which jurists can develop more complex rules concerning corporate governance in practice.

The Delaware Jurisdiction and the duty of Loyalty

Delaware General Corporation Law (DGCL)[3] constitutes one of the most active jurisdictions in the United States (US) owing to its historical “corporation friendly” legal environment. The specific tenets regarding the fiduciary duty of loyalty however was largely developed through case law and can be traced initially back to Guth v Loft[4] which determined that corporate directors should use their position to safeguard the interests of the corporation above and beyond their own interests. The dicta in this case is interesting because director’s responsibility was viewed as,

“A public policy, existing through the years and derived from a profound knowledge of human characteristics”[5]

This framing of the source of director’s duty of loyalty tends to suggest that it was a social norm which developed into public policy rather than a rule developed strictly from case law. Briefly stated, Delaware considers the duty of loyalty of a director to be derived from the director’s obligation to serve the best interests of his corporation in all circumstances above and beyond his own self interests.

Directors therefore should theoretically avoid situations where there is an inherent conflict of interest or where they stand to benefit substantially at the detriment of the corporation. In Aronson V Lewis[6] for example the court maintained that directors should not have interests in both sides of a transaction and neither can they hope to extract personal financial benefit.

Under the Delaware Law, litigation where the Director is self interested is subjected to the “entire fairness doctrine”[7] which attempts to determine whether the proposed transaction is fair to the entire body of shareholders. In such instances the burden of proof falls on the defendants (usually the self- interested directors) to prove that the transaction in question benefits the corporation as a whole.

Loyalty as an abstract concept gives rise to further derivations in law. Principal among those is the duty of Good Faith which up until 2006 constituted a separate aspect of a triad of duties which defined a director’s obligations in the state of Delaware[8] reversing the position taken in Cede & Co. V Technicolor, Inc.[9] which emphasized good faith as a separate duty. Delaware defines good faith as a director acting in the best interest of the corporation as a custodian of its value and a protector from all risks which the corporation may face. A Director acting in Good Faith therefore is not apt to be wasteful with the corporation’s resources or deliberately commit actions which would jeopardize its interests.

This duty is of particular importance in Delaware as section 102(b)(7)[10] of the Delaware code provides that directors cannot be protected from liability if found to have acted in bad faith. It is important here to note that Delaware affords substantial protection to the directors of corporations both in the authorization of corporations to include provisions for eliminating director’s liability in section 102(b)(7)[11] and also through the provision of insurance and indemnification for Directors in the event of law suits. This exception to the protections afforded by law to directors is a testament of the importance of good faith conduct in the Delaware Jurisdiction.

The duty of confidentiality is yet another derivative of the duty of loyalty which is often cited in Delaware cases and it states quite simply that a director should not disclose confidential or sensitive information belonging to the company to any third party especially when such information may not be in the best interests of the corporation.  In Shocking Technologies V Michael[12] for example the court held a board director liable for contacting a third party who was interested in acquiring stock options in a corporation and advising them not to exercise those options as the corporation in question was in financial difficulty and further encouraging the third party to exercise leverage over the corporation to exact a better price from the board of directors. This was directly in breach of his duties as a board member and in direct violation of his fiduciary duty of loyalty. Despite the director’s defense that his actions were aimed at securing changes in the corporate governance of the corporation, the court ruled that the methods used to secure these results were in definite breach of his duties as a director.

In contrast the duty of disclosure requires Board directors to act with complete transparency with the company’s shareholders and especially in the cases of a merger or acquisition. Delaware law requires directors to divulge relevant information to shareholders especially when the information is needed to inform their voting rights. In Lynch v. Vickers Energy Corp[13]., the defendant (Vickers) a subsidiary of Esmark, also a defendant in the case, owned a majority of the shares in TransOcean and also acquired an additional 4,228,000 shares of TransOcean stock at $12 a share. The issue in this case was that Vickers failed to disclose that a qualified petroleum engineer, who was a member of the TransOcean Management had calculated the net asset value of the shares as significantly above the tender offer price and that Vickers had authorized the purchasing of these shares for bids of up to $15 per share. This in essence deprived the corporation of an opportunity to maximize the value of the shares in question. The shareholders sued as a class and was granted a reversal of the original decision in the Delaware Supreme court against the defendants. On the subject of disclosure, the court commented,

“We conclude, therefore, that it was a breach of the fiduciary duty of candor for defendants to fail to disclose the Harrell estimate to those persons to whom they owed the duty and whose stock Vickers was attempting to acquire.”[14]

The duty of Care in the Delaware

Similar to the duty of Loyalty, the duty of care demands that directors and officers of a corporation exercise due diligence when utilizing the powers of their office. This broadly means that directors should avail themselves of all material facts of a situation before making decisions in the corporation’s interest. The efforts to gain material information may be diverse but can come under the following methods:

1. Through the hiring of suitably qualified third party experts such as lawyers and accountants who are external to the corporation.
2. By reliance on internal committees and subcommittees entrusted with information gathering.
3. By putting in place structural procedures for information gathering and feedback which can keep the board abreast of the state of a corporation in real-time.[15]

In addition, directors should take into counsel the information they receive from these sources and ensure that information is obtained well in advance of important decisions concerning the corporation and use of its assets and resources.

Delaware case law views breeches of the duty of care within the standard of gross negligence which is a,

“…reckless indifference to or a deliberate disregard of the whole body of stockholders or actions which are without the bounds of reason”[16]

This standard is reminiscent of the wording of the law of tort which require that reasonable care and attention be exercised so as not to commit harm or wrong to others. In this instance a Director by virtue of the power he exercises within his capacity can in all probability create economic “harm” to shareholders. This situation was proven to be the case in Smith V Van Gorkom[17] where the defendant (Van Gorkom) neglected to consult with any outside financial experts and failed to disclose information to the board of TransUnion during a proposed leverage buy-out merger by the Marmon group. The defendant arbitrarily decided on a price for the shares of the company upon consultation with the Chief Financial Officer of the company without making a valuation of the company as a whole and further failed to disclose to the Board of Director’s previous objections by management to his valuation and methods. The Board in light of the lack of information approved the proposal.

The court in turn found the Board of Directors grossly negligent in their duties to the shareholders for their lack of attention to the process of approving this merger.

This decision became important in Delaware law as it highlighted the importance of the duty of care which directors owed to their shareholders as well as the consequences inherent in breeching this duty.

Subsequently however Delaware law has sought to soften the effects of the Van Gorkom decision by various means. Lubben and Darnell[18] make a case that the duty of care in Delaware law has been diluted through the enactment of section 102 (b) (7) which absolves Directors of monetary charges less than a year after the Van Gorkom decision. They also argue that Delaware law now attempts to irrationally compartmentalize liability cases involving directors into breeches of the duty of loyalty or analysis based on a transactional model to prove or disprove director loyalty. Regardless the duty of care still remains a fundamental principal in Delaware Corporation Law.

The Barbados Jurisdiction

Unlike Delaware the jurisdiction of Barbados neither has developed case law nor the statutory amendments necessary to ensure most eventualities involving corporate liability. Barbadian legislation is an admixture of Canadian, English and Australian law and as such will draw on elements from all these jurisdictions. Most of the act concerning Director’s duties is encapsulated within section 95 of the Barbados Companies Act[19] and is very brief in its mandates.

Director’s Duty to manage

Division D section 58[20] of the act requires managers to “exercise the powers of the company directly or indirectly through employees and agents of the company” and also to “direct and mange the business and affairs of the company”. This seemingly obvious statement is then qualified in section 2 and 3 with the disclaimer that directors should ensure that the secretary of the company which is meant to be an administrator should be suitably qualified for the position and makes suggestions as to who may be suitably qualified. This is interesting in that there is a specific emphasis placed on who the managers of a Barbados corporation should hire as assistant administrators which suggests that part of their duties require “care” as to the quality of their support staff.

This is particularly important as many failed business decisions and may have their root in a lack or inadequate information provided by support staff to the directors of a company.

As an example, a director who needs to make a time sensitive decision about the hiring of a new Chief Executive Officer may rely on his administrative staff to do research and provide details about the applicant. The administrator failing in their duty to do this research may in all eventuality overlook or completely miss that the proposed applicant has had a record of corporate fraud and been convicted of such a crime. The directors seeking to fill the position may then hire the applicant on the basis of the applicant’s education and experience alone. The resultant fall-out from this decision could not only lower the value of the company in the eyes of investors who may be privy to the missing information but may result in disaster should the new CEO choose to defraud the company. Under Barbados law the fault would be both on the administrator who failed in their duty and ultimately on the board of directors for not ensuring that their information was correct before making the decision, since the onus was on them to hire an administrator who was properly trained to carry out background checks.

Duty of Loyalty and Care

Division D section 95 (1)[21] of the Barbados Companies Act states that every director and officer of a company must ,

• Act honestly and in good faith with a view to the best interests of the company and…
• Exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.[22]

This combining of what can be seen as two distinct subject matters is interesting in that it suggests that Barbadian legislators regard both loyalty and care as extensions of the other. In paragraph (a) emphasis is placed on good faith and honesty and the rest of the section does not elaborate on what exactly is meant by good faith except to point out in section 2 that the best interests of the company extends to the company’s employees as well as to its shareholders.

This inclusion suggests that legislators would want to discourage the practice of benefit to the shareholders at the expense of employee health and well-being as in the case of a corporation whose directors attempt to maximize profits for their shareholders by reducing the number of staff and extending the working hours of the remaining staff to their detriment while paying them minimal remuneration for the extended hours. This practice of employee exploitation has been prevalent particularly in the developing world and national legislators have developed methods of curbing this trend by the inclusion of such clauses in their laws.[23]

Section (3) makes the addition that the duties aforementioned in section 2 is owed to the company alone and is enforceable. This clause makes it clear, although not expressly stated that a certain amount of loyalty to the corporation is required as a director or officer of a corporation and in addition that this loyalty is enforceable by law,

“in the same way as any other fiduciary duty owed to a company by its directors[24]”

Section 4 reiterates that directors should comply with the clauses of the act as well as any unanimous shareholder agreement relating to the company and section 5 states follows that no inclusion of any clause in the company by-laws or any contractual obligation relieves the director of the duties stated under the Companies Act. This is most likely to ensure that directors do not seek to subvert the spirit of the act with loophole clauses included in their articles of incorporation.

As can be seen there is no fundamental separation of the duty of care and loyalty in Barbadian law although the act makes it clear that Loyalty and prudence are expected from directors.

Comparative approach of the two jurisdictions concerning the duties of directors

Duty to Manage

The duty to manage as a statutory statement is worded very differently between the two jurisdictions and as such provides some insight as to the differences in experience and background between the two.  Delaware’s statute 141 (a)[25] states that,

“the business and affairs of every corporation organized under this chapter shall be managed by or under a board of directors except as may be otherwise provided in this chapter or in its certificate of incorporation.”,

then details in clauses (b) through (k) a list of all the requirements concerning the composition and formalities of the board. Indeed, section 142[26] which follows on from this and which comes under the heading of “officer’s duties, titles, selection” continues the list of requirements without an direct expression of duty to manage.

This duty however is clearly expressed in the Barbados Companies act and goes further to detail specifics of how proper governance should be pursued. This in all probability has a lot to do with the age and development of Delaware case law which already has a long tradition and developed case law concerning the concepts of management style. Delaware statutes are clearly more concerned with “form” in terms of the specifics of the organization of the board as opposed to the detailing of the specifics of how the board should govern.

Section 58[27] of the Barbados Companies Act seems less prescriptive as to the specific formalities of the Board and concentrates on the “how” of corporate governance laying out specifics of the minimum requirements of good management by the Board of Directors under the law and making a specific reservation for the employees of the company. As with all Legislation, corporate governance has been adapted to suit the needs of the population and its particular challenges.

Duty of Care

The development of the duty of care has been a matter for the mountain of case law which has developed with respect to the Delaware supreme court. It must be noted here that Delaware General Corporation law (DGCL) has been in operation for over a hundred years and contains many precedent cases which inform the foundations of corporate laws all over the US. As such, the substance of Delaware’s treatment of the duty of care is to be found in the landmark decisions of the supreme court.  Holland describes a division of Delaware’s treatment of the duty of care as beginning with Smith V Van Gorkom[28] which affirmed that Directors of a company could be held liable for the breech of the duty of care irrespective of the deference to the business judgment rule which the court up until that time steadfastly adhered to. The subsequent passage of Statute 102 (b)(7)[29] the year after the Van Gorkom decision and the proliferation of “exculpatory clauses in accordance with this statute in companies’ charter of incorporation represent a reaction to the dangers posed by the new reality of Director liability which the Van Gorkom decision introduced. This clearly had implications for directors as well as the state which up until then had been the preferred state of incorporation specifically for its promotion of no liability for directors and its facile business rules for corporations.

Further, the Malpiede V Towsend[30] decision which saw the supreme court affirming that shareholder complaints concerning the duty of care solely could be dismissed outright in the event that statute 102 (b) (7) provision was properly invoked reaffirmed the protections which Directors of Delaware corporations had come to expect.

The result is as several writers have commented[31] a complete erosion of Delaware’s duty of care treatment in the supreme court. Plaintiffs could no longer expect to succeed on the basis of the duty of care alone but tried to find redress on the bases of the duties of loyalty or breeches of good faith or a combination of the three.

In contrast Barbadian, legislation treats the duty of care in very specific terms and impresses upon the directors the fact that their duty of care to the corporation also is owed to the employees of the corporation as well.

This is largely because the majority of Barbadian law is drafted from British corporate law which historically has treated this duty as a kind of tort.[32]

The Barbadian legislation condensed these fundamental “duties” and adapted them to suit their needs as a developing nation in order to protect their labor market, however the duty of care still remains a staple standalone duty which is owed by directors in this jurisdiction.

Duty of loyalty

Delaware’s treatment of the duty of loyalty also is derived from case law. Loyalty is one of the most seriously considered duties with respect to establishing Director liability. It is important to note here that whereas writers have thought of the duty of good faith conduct as a standalone duty, [33] Delaware treats this duty as an essential component in proving director breech of Loyalty. In Stone V Ritter[34] for example the plaintiff’s arguments were predicated upon the fact that directors failed to act in good faith as they failed to implement adequate monitoring systems to detect suspicious Banking activity which led to $50 million in fines for Am South Bank Institution and as a result failed in their duty of loyalty to the corporation.

It is important to note here that the claim by the plaintiffs was not based on a failure of the duty of care, which in most eventuality would not have succeeded since the Delaware Supreme court sets the standard for proving breech of this duty very high but on the basis of lack of good faith conduct leading to a breech of Loyalty to the corporation.

In any event the decision by the Delaware supreme Court (DSC) stated unequivocally that there must be a showing of,

“a lack of good faith as evidenced by a sustained or systematic failure of a director to exercise reasonable oversight”

 as well as

“an utter failure to implement any reporting information and controls”

On this basis the plaintiff’s claim of breech of loyalty was denied. However, the proliferation of cases in the DSC[35] which are based on the directors breech of loyalty and good faith suggests that the path available for plaintiffs hoping to overcome the default business judgment rule in order to be successful in their claims must necessarily involve claims of the breech of loyalty and good faith conduct.

The Barbadian Jurisdiction however explicitly states that Directors are to act honestly and in good faith with a view to the best interests of the “company”. The act which came into force in 1985 and has its latest amendments in 2002 has not developed a substantial body of cases with which to adequately define what constitutes honesty and good faith in a Barbadian context however the fact that the subject is expressly stated in the act is of importance to directors especially when combined with the mandate to act in the best interests of the employees as well. The issue here can be demonstrated in a sample case of the Barbadian Supreme court.

In Pelling et al v Pelling et al[36] Berger J. dismissed a shareholder claim for breach of fiduciary of loyalty on the grounds that

“there is no fiduciary obligation as between shareholders and no general fiduciary obligation owed by a director to shareholders. A director’s duty is to the company…”[37]

The duty of loyalty therefore in a Barbadian context must specifically fit within the context of harm done to the corporation as a separate unit from the shareholders. This adaptation of of the entire fairness doctrine approximates a “Caribbean version” of the Business judgment rule which removes the gray area in which shareholder may bring “tort-like” claims against directors. Harm to the company is seen as the test for a director’s failure to adhere to his fiduciary duties as opposed the shareholders.

Conclusion

The laws which surround corporate governance represent one of the most evolving areas of law and as such is subject to constant change to meet its environment. In The Delaware Jurisdiction there is a mountain of cases and judgments which inform jurists of predictable judgments and remedies. In addition, Delaware has adapted its laws specifically with the intention of attracting the incorporation of businesses within its jurisdiction to great effect as many of the larger corporations in the US are incorporated within the state. Director immunity from liability and the possibility of indemnification under Section 102 (B) (7) are powerful motivators for a corporation seeking incorporation in Delaware.

Barbadian corporate legal structure on the other hand has adapted its concept of corporate governance to reflect its historical origin under British rule while still allowing for innovations which address its particular challenges as a developing nation. It is important that in this jurisdiction there is a special emphasis on protecting the corporation as well as the employees of the corporation. This feature of Barbadian corporate governance has roots in a post colonial rationale which is against the exploitation of workers by their superiors and is a central theme which runs through the Barbadian legal system.

Corporate governance therefore is an ever evolving system, however the basic duties of a director with regard to the corporation remain the same. Care, Good Faith and Loyalty though subjective standards have yet to be supplanted as the foundation of good governance.

Bibliography

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Gatz Properties, LLC v. Auriga Capital Corp.

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Norton v. K- SeaTransp. Partners L.P.

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[1] Randall Morck and Lloyd Steiner, The global history of Corporate Governance: An introduction. University of Chicago Press 2005.

[2] Institute of Corporate Directors, Directors’ Responsibilities in Canada. Sixth Edition

 Toronto, 2014 Pg.13

[3] Delaware General Corporation Law. Title 8, Chapter 1

[4] Guth v. Loft (Del. 1939) [Pepsi]

[5] ibid

[6] Aronson v. Lewis (Del. 1984)

[7] Webb Hecker, Shareholder Duty of Loyalty: Entire Fairness or Business Judgment.’ [2014] (University of Kansas School of Law

[8] Randy Holland, “Delaware Directors Fiduciary Duties: The focus on Loyalty” (2009).

[9] Cede & Co. v. Technicolor, Inc. 542 A.2d 1182 (1988)

[10] DEL. CODE ANN. tit. 8, § 102(b)(7) (1983 & Supp. 1986)

[11] ibid

[12] Shocking Technologies, Inc. v. Michael, C.A. No. 7164-VCN (Del. Ch. Oct. 1, 2012) (Noble, V.C.)

[13] Lynch v. Vickers Energy Corp. 383 A.2d 278 (1977)

[14] ibid

[15] Stephen Lubben and Alana Darnell, “Delaware’s Duty Of Care” [2006] DJCL pg 593

[16] Smith v. Van Gorkom 488 A.2d 858 (Del. 1985)

[17] ibid

[18] Stephen Lubben and Alana Darnell, “Delaware’s Duty Of Care” [2006] DJCL pg 593

[19] Barbados Companies Act (Cap. 308 as amended up to Act No. 17 of 2007)

[20] ibid

[21] ibid

[22] ibid

[23] Drusilla Brown et al. The Effects of Multinational Production on Wages and Working Conditions in Developing Countries (2004). University of Chicago Press

[24] ibid

[25] 8 Del. C. § 141(a)

[26] 8 Del. C. § 142

[27] 308. Companies. L.R.O. 1997 4. SECTION. 58.

[28] Smith v. Van Gorkom 488 A.2d 858 (Del. 1985)

[29] DEL. CODE ANN. tit. 8, § 102(b)(7) (1983 & Supp. 1986)

[30] Malpiede v. Townson DE SJC, 2001

[31] Holland, Lubben and Darnell, Ridgely and Reid all point to the likelihood of a plaintiff’s claim being dismissed outright if founded on the basis of a breech of the duty of care solely.

[32] Caparo Industries plc v Dickman [1990] UKHL 2, (defendant Dickman was held was held liable for incorrectly stating the accounts on the basis of negligence)

[33] Holland, Lubben and Darnell argue for a “triad” of duties which originally constituted directors duties.

[34] Stone v. Ritter Case 911 A.2d 362 (Del. 2006)

[35] Gatz Properties, LLC v. Auriga Capital Corp., Brinckerhoff v. Enbridge Co., Inc., Norton v. K- Sea

Transp. Partners L.P., Gerber v. Enterprise Products Holdings, LLC as examples.

[36] Pellinget al V pelling et al (1981) B.C.S.C 130 D.L.R (3) 761

[37] ibid