Lewis Lazarus opines on the question of representative directors, concluding that "Directors Designated By Investors Owe Fiduciary Duties to the Company as a Whole and Not to the Designating Investor."
Investors who make substantial investments often demand a seat on their company's board of directors. That is a reasonable request as it permits the investor to have a representative on the board of directors with a voice in management of the company. It is well-settled that directors elected by stockholders of a Delaware corporation owe fiduciary duties to the company and all its stockholders once they serve on the board. Thus, they may make decisions in the exercise of their fiduciary duty that are different than what is in the best interest of designating investor. ...
As stated in Phillips v. Insituform of N. Am., Inc., 1987 WL 16285, at *10 (Del. Ch. Aug. 27, 1987) the "law demands of directors ... fidelity to the corporation and all of its shareholders and does not recognize a special duty on the part of directors elected by a special class to the class electing them." ...
[Delaware] cases teach that directors designated by particular stockholders or investors owe duties generally to the company and all of its stockholders. Where the interests of the investor and the company and its common stockholders potentially diverge, the directors cannot favor the interests of the investor over those of the company and its common stockholders.
As a general rule, I think that's right. It's especially important when the sponsoring investor has a conflict of interest, such as where the sponsoring investor proposes a transaction with the corporation.
In some cases, however, a bright line rule might not make sense. Suppose a financially distressed company with a unionized work force negotiated give backs from the union. As a condition of those give backs, the union required representation on the corporation’s board of directors. My research on these cases suggests that board of director representation is a way of maximizing access to information and bonding its accuracy. The employee representatives will be able to verify that the original information about the firm’s precarious financial situation was accurate. Employee representatives on the board also are well-positioned to determine whether the firm’s prospects have improved sufficiently to justify an attempt to reverse prior concessions through a new round of bargaining.
The anticipated role of the union representative in such cases is almost certain to conflict with the duties of the director as set forth by Mr Lazarus. Suppose that as a condition of granting the concessions, the union insisted that its director be free to pass any information to the union. The board of directors agreed. Would it matter if the proposal was disclosed to the shareholders and the shareholders elected the union representative to the board, as opposed to the union representative being appointed by the board to fill a vacancy?
What if the union insisted that the union representative on the board be allowed to vote as s/he understands the interests of the union to demand? Should the board of directors (or the shareholders) be denied the power to agree where that is necessary to obtain concessions that might save the company?
To take another example, suppose a corporation has failed to pay dividends on preferred stock for a sufficient period of time that the holders of the preferred are now entitled to elect a majority of the board. Would Delaware courts really say that the board cannot prefer the interests of the preferred holders? Isn’t looking out for the interests of the preferred shareholders the very purpose of giving otherwise nonvoting preferred shares the right to elect a board in the event of failure to pay dividends?
As a final example, what about the case in which a dissident shareholder successfully wages a short slate proxy contest on a platform calling for, say, the sale of the company. Surely the sponsoring shareholder should surely be entitled to expect their nominees to pursue that goal. Indeed, the sponsor might reasonably expect the directors not just to "advocate" for the shareholder's position, but to vote for it and take other action.
Granted, I don't think the sponsor should be able to punish the directors for failing to do so. In the recent Airgas case, discussed by Lazarus, three directors sponsored by a takeover bidder declined to support the bidder's demand that the target's poison pill be lifted. If the bidder doesn't like that result, it should have picked people with a greater sense of loyalty. On the other hand, I wouldn't necessarily fauly directors who had been elected on the basis of a campaign to sell the company from insisting that the pil be dropped.
So I think we have to take these cases contextually.
