Conflicts: Disinterested and Independents

A conflict is when a fiduciary is either:

• Not disinterested (direct interest) or

• Not independent (indirect interest)

If there is a conflict, the fiduciary will face entire fairness review.

Interested fiduciaries

Delaware typically defers to the business decisions of the fiduciaries. But what if the fiduciary is on both sides of a transaction? It wouldn’t make sense to presume good behavior in the situation where they are most likely to cheat. A director or officer is “interested” if they “receive a personal financial benefit from a transaction that is not equally shared by the Stockholders.” In re Trados, 73 A.3d 17, 45 (Del. 2023). This benefit must be “of a sufficiently material importance, in the context of the director’s economic circumstances, as to have made it improbable that the director could perform her fiduciary duties ... without being influenced by her overriding personal interest.” Id. In other words, we look for some personal financial benefit that would make it improbable that the fiduciary is not influenced.

Note that we're talking about the specific fiduciary, not whether the amount was material in the abstract or when applied to some imaginary “reasonable fiduciary.” We look at the actual fiduciary and that fiduciary's bank account. What are the chances this amount of money would corrupt this fiduciary? A $50,000 gain is going to mean a lot more to me than it would to the CEO of Amazon. So if we both faced the same conflict, the court may find that I'm interested but Amazon's CEO is not.

For example, a director in the Trados case received over $2 million from the challenged transaction and a new job earning $60,000 per year. The director’s net wealth was $5 - 10 million. The court held that the $60,000 salary alone would not be material to that director, but with the additional $2 million benefit the amount was material to the director, so the director was interested. In re Trados, 73 A.3d 17 (Del. 2023). You have to consider the specific financial situation of the fiduciary.

Independent fiduciaries

What if the conflict isn't financial? What if it's a decision involving a close family member? Sometimes relationships are enough to question whether directors are going to act in line with their duties. When the conflict is based on a relationship, we call it a lack of independence.

A director lacks independence if the fiduciary is “dominated or controlled” by someone that is interested in the transaction. Benihana of Tokyo, Inc. v. Benihana, Inc., 891 A.2d 150, 174-75 (Del. Ch. 2005). You show domination and control by showing that “through personal or other relationships the directors are beholden to the controlling person or so under their influence that their discretion would be sterilized.” Id. (internal citations and quotations omitted). You can show this by showing “financial ties, familial affinity, a particularly close or intimate personal or business affinity or . . . evidence that in the past the relationship caused the director to act nonindependently.” Beam v. Stewart, 845 A.2d 1040, 1051 (Del. 2004). You need to show that the director or officer would “be more willing to risk his or her reputation than risk the relationship” with the interested person. Id. at 1052.

Just like in the disinterested analysis, we look at the actual person, rather than some imaginary “reasonable person” when determining whether they are independent.

This is a high standard that usually requires more than past social or business dealings. For example, Martha Stewart owned 94% of the voting power of Martha Stewart Living Omnimedia, Inc. Arthur Martinez sat on the board of the company. He had an incredible resume: former CEO of Sears, former director at Saks Fifth Avenue, current director at PepsiCo and Liz Claiborne and the chairman of the federal reserve bank of Chicago. He had been a dear friend of Martha for many years, and they ran in the same social circles. In a transaction with his friend Martha, is Arthur independent?

Arthur is independent in this transaction. He may be dear friends with Martha, but friendship alone isn’t enough to make him controlled or dominated. And given his many high profile positions, it’s unlikely he’d risk his reputation for her. Beam v. Stewart, 845 A.2d 1040 (Del. 2004).

Let’s contrast that with In re Carvana, 2022 WL 2352457 (Del. Ch. 2022). There, the CEO and his father owned a majority of the company, and the CEO was involved in some interested transactions. One director was a long time colleague of the father. The father was convicted for a business related felony. But the director/friend stood by the father, and the father made this director the CEO of his next venture. The director later violated NYSE rules to protect the father, and the two have worked together on numerous business deals ever since. Is that director independent?

At the motion to dismiss stage, a court said he wasn’t independent. This director was more than a social friend who went to the same parties; this directors career was entangled with the the father, so much so that he had violated the rules before to protect the father. That was enough to find domination or control at the motion to dismiss stage.