January 19, 2022

Director Independence: Delaware Law Nuances

Cleary Gottlieb is out with its “Selected Issues for Boards of Directors in 2022” – this year’s edition covers 16 topics over the course of 83 pages. One item that I found particularly useful was the summary of how Delaware courts are analyzing director independence & disinterest (pg. 28), which is almost always an important issue in derivative suits and any other challenges to potentially conflicted transactions.

The Cleary team notes that recent Delaware cases – United Food & Commercial Workers Union v. Zuckerberg and others – are showing that judges are closely analyzing both economic conflicts and personal relationships. Here are the takeaways:

– The independence analysis under Delaware law is distinct from, and more nuanced, than under stock exchange rules. While the Delaware courts have noted that independence for purposes of stock exchange rules is one factor they consider, the Delaware law analysis is more holistic and fact-specific and considers, in addition to the traditional financial factors, such things as personal friendships or other relationships of a “bias-producing nature.

– Independence of directors is critical under Delaware law in a number of situations, including when the board is sued in a shareholder derivative action or when the board is asked to consider a related-party transaction. The Delaware courts have developed doctrines, including the demand futility test announced in Zuckerberg and the “MFW test” – which requires the approval of an independent special committee of directors for obtaining business judgment review of controlling stockholder squeeze-outs and other conflicted controlling stockholder transactions – that place a premium on the independence of directors in managing litigation risk.

– In evaluating director independence, Delaware courts have not hesitated to scrutinize closely personal relationships, taking into account facts such as co-ownership of unique assets, personal admiration, longstanding and overlapping business network ties, and shared philanthropic contributions. Boards should give serious consideration to these factors when selecting new directors or constituting special committees for the purposes of potentially conflicted transactions. It is advisable to stay aware of potential independence issues raised by interconnected personal relationships as Delaware courts continue to focus on this issue.

Liz Dunshee