October 21, 2006
Disney and Individual vs. Collective Director Liability
Posted by Darian Ibrahim

When the Delaware Supreme Court issued its most recent opinion in Disney, Lisa posted on two very interesting aspects of the case: first, that the Supreme Court punted on whether a director’s fiduciary duty breach should be assessed individually or collectively; and second, that the Supreme Court, like the Chancery Court, distinguished between a board’s best practices and its acceptable practices. In my next two posts, I’ll revisit those issues.

First, should director liability in fiduciary duty suits be assessed individually or collectively? This is a question that few courts or academics have explicitly addressed. However, in looking at the case law, it’s clear that courts analyze duty of loyalty breaches individually, meaning that a disloyal director may be liable even if all other directors complied with their fiduciary duties. On the other hand, although it’s less clear, courts have tended to analyze duty of care breaches collectively, meaning that one director’s carelessness is legally excused if the remaining directors have met their duties. Although my initial thinking was that collective liability might operate as a collective sanction, punishing non-breachers (as well as the breacher) for lax monitoring, courts don’t appear to use it in this way. Instead, they shield the breacher so as not to punish the non-breachers.

In a work-in-progress, I argue that an individual/collective focus that shifts based on fiduciary duty type is desirable on corporate governance policy grounds because it strikes the right balance between a board’s authority and its accountability. (Both Gordon and Stephen Bainbridge have discussed the importance of this balance, and I draw heavily on their work.) In short, self-dealing is intentional wrongdoing, typically by inside directors, and can therefore taint the board’s process in a meaningfully way even if only one director does it. To preserve a functioning board, courts must favor accountability over authority in these situations. Conversely, negligence (even gross negligence) is unintentional wrongdoing, typically by outside directors, and is therefore less likely to meaningfully impact the board’s functioning if there's only one culprit. The board can still function adequately, if not perfectly, with an absentee director (either in body or in mind), so courts should favor authority over accountability in these situations.

In its current form, my paper argues that this duty-based answer to the individual/collective question is both descriptively accurate and normatively desirable. As I continue to work through the implications of this framework, I hope to illustrate how it would be used in concrete cases; e.g., in derivative suits over stock option backdating. Also, I’m less clear on how relevant the issue is to the early stages of litigation – discovery, demand, etc. – as opposed to the trial stage, which is the paper’s focus. I welcome your comments, either publicly or privately.

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