"It is understandable that investors, and others, want to find someone to hold responsible for these losses, and it is often difficult to distinguish between a desire to blame someone and a desire to force those responsible to account for their wrongdoing. Our law, fortunately, provides guidance for precisely these situations in the form of doctrines governing the duties owed by officers and directors of Delaware corporations. This law has been refined over hundreds of years, which no doubt includes many crises, as we must not let our desire to blame someone for our losses make us lose sight of the purpose of our law."
C. A. No. 3338-CC, *58, Del. Ch. Feb. 24, 2009
Chancellor Chandler
Yesterday, the Court of Chancery rejected - at least for now - the attempt by Citigoup's shareholders to blame its Board of Directors for its massive losses and the ensuing plunge in its share price. There will undoubtedly be more pronouncements from the Court on this topic in the upcoming weeks and months, as Citigroup is in good company with Bank of America, and other financial giants recently sued in the Delaware Courts alleging broad-ranging breaches of fiduciary duty, lack of oversight and corporate waste.
Citigroup's shareholders sued the board of directors, alleging that the Board wrongfully permitted it to engage in subprime lending, loading up its balance sheet with inflated loan assets that ultimately required billions in asset write-downs. The Complaint alleged that the Board breached its fiduciary duties by (1) failing to adequately oversee and manage Citigroup's exposure to the problems in the subprime mortgage market, even in the face of "red flags" and (2) failing to ensure that the Company's financial reporting and other disclosures were thorough and accurate. In In re Citigroup Shareholder Derivative Litigation, Chancellor Chandler issued a 58-page opinion dismissing the Complaint for failure to make a demand upon the Board to cause the company to bring the action itself, because, under Delaware law, the decision whether to initiate or pursue a lawsuit on behalf of the corporation generally belongs to its board of directors. 8 Del. C. § 141(a).
Demand Requirement
Chancellor Chandler's decision hinged on application of Court of Chancery Rule 23.1 which requires shareholders to allege with particularity the efforts, if any, made by the shareholders to make a demand on the board prior to initiating any action to enforce corporate rights or the reasons for the failure to make such a demand. Rule 23.1 ensures that it is the board in the first instance who enjoys the right and ability to decide whether the company will bring legal claims belonging to the corporation. Plaintiffs argued that the demand requirement of Rule 23.1 should be excused because the director defendants were not "disinterested." According to the plaintiffs, the directors would be unable to exercise disinterested business judgment in deciding whether a lawsuit should be brought because their conduct - the alleged failure of oversight -- subjects them to a substantial likelihood of personal liability.
The Court, following established Delaware law, recognized that the mere fact that a board faced a decision as to whether to sue itself does not pose a conflict sufficient to excuse the demand requirement. Otherwise, the demand requirement would be rendered meaningless. Rather, other facts must be present showing a particularized interest of a more egregious character on its face before a suit may proceed absent a demand and a refusal. No such circumstances were alleged in this case.
Lack of Oversight Allegations
The Court next found that to establish oversight liability, the plaintiffs must show that the directors knew they were not discharging their fiduciary obligations or that directors consciously disregarded their responsibilities. For instance, oversight liability might attach where a board failed to act in the face of a known duty to act. Again, this standard tracks established Delaware law rooted in concepts of bad faith - the necessary element to survive both the motion to dismiss raising demand concerns and to establish director oversight liability. Again, the Court finds that Plaintiffs missed the mark; "plaintiff's theory essentially amounts to a claim that the director defendants should be personally liable to the Company because they failed to fully recognize the risk posed by subprime securities." The Court went on to analogize that "[w]hen one looks past the lofty allegations of duties of oversight and red flags use to dress up these claims, what is left appears to be plaintiff shareholders attempting to hold the director defendants personally liable for making (or allowing to be made) business decisions that, in hindsight, turned out poorly for the Company." *26. Hence, Plaintiffs failed to sustain their burden of overcoming the business judgment rule - and the Court will not impose a hindsight evaluation of the reasonableness or prudence of directors' business decision.
Disclosure Allegations
Plaintiffs also argued that demand should be excused because defendant directors were facing personal liability for violating their duty of disclosure by failing to properly disclose the value of or existence of certain complex financial instruments, some of which were accounted for off the balance sheet. Again, this allegation fell wide of the established disclosure standards applied in Delaware. Typically, the duty of disclosure is implicated when there is a shareholder action about to take place. In the absence of a request for information, plaintiffs must demonstrate that the directors "deliberately misinformed shareholders about the business of the corporation either directly or by a public statement." *43. The plaintiffs missed the mark on the pleading requirement by failing to allege with factual particularity the actual misstatement or omissions that constituted a violation of the board's duty to disclose.
Waste Allegations
Plaintiffs also invoke corporate waste allegations for (1) approving a letter agreement between Citigroup and Defendant Charles Prince, the former CEO; (2) allowing the company to purchase over $2.7 billion in subprime loans; (3) approving a buy-back of over $645 million worth of company's shares at a dated price; and (4) investing in assets that were unable to pay off maturing debt. The Court analyzed each component separately with respect to the demand requirement. Respecting stock repurchase, subprime loan purchase and investment decisions, the Court found that mere allegations of red flags is insufficient to overcome the business judgment rule. The executive compensation question, however, led to a different analysis - primarily based on the facts and the details of the package received by former CEO Prince. As the Delaware Supreme Court articulated, directors discretion in setting executive compensation is not unlimited, and there is a point at which the compensation is so disproportionately large as to be unconscionable and constitute waste. Here, Prince was to receive $68 million upon his departure, an office, an administrative assistant, and a car with a driver for the lesser of five years or until he commences full time employment with another employer. In exchange for this multi-million dollar goody bag, Prince signed a non-compete agreement, a non-disparagement agreement, a non-solicitation agreement, and a release of claims against the company. The Court appears to be clearly puzzled, at best, skeptical, at worst at the propriety of the package. Thus, Chancellor Chandler found that "[w]ithout more information, and taking, as [he] is required, plaintiffs' well pleaded allegations as true, there is reasonable doubt as to whether the letter agreement awarded compensation that is beyond the outer limit of reason. The Court denied the motion to dismiss that portion of the waste claim that pertained to executive compensation of Prince.
The Citigroup decision forges no revolutionary ground in its application of the demand requirement. However, it contains glimpses of a changing landscape especially with respect to the volatile question of executive compensation. It also provides some limited guidance for future claimants who wish to avoid the demand requirement.
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