Francis Pileggi brings news of an interesting Posner opinion in CDX Liquidating Trust v. Venrock Associates, (7th Cir. March 29, 2011), a case decided under Delaware law. As Mr. Pileggi notes, the case held, among other things, that disclosure of a conflict of a director’s interest may “insulate the agreement from attack, but does not, per se, protect the director from a claim for breach of fiduciary duty.” This is an established principle, but benefits from Judge Posner’s clear articulation. The case also raises some interesting procedural issues.
The case involved a VC’s (Venrock) bridge loan which provided for a substantial payment to the lender in the event of liquidation that would leave nothing left for the shareholders. As Posner says, “[t]he disinterested directors of Cadant [the borrower] * * * who voted for the loan were engineers without financial acumen, and because they didn’t think to retain their own financial advisor they were at the mercy of the financial advice they received from Copeland [who was a director both of the VC and the borrower] and the other conflicted directors.”
The borrower’s board approved a sale of assets for enough to pay off the creditors and preferred (including the VC) but not the common. The sale was approved by a simple majority of both common and preferred voting together and the preferred voting separately. The question is whether the bridge loans were a breach of the VC’s fiduciary duty. Here’s Posner:
The accusation is that the directors were disloyal. They persuaded the district judge that disclosure of a conflict of interest excuses a breach of fiduciary duty. It does not. It just excuses the conflict. * * *
To have a conflict and to be motivated by it to breach a duty of loyalty are two different things—the first a factor increasing the likelihood of a wrong, the second the wrong itself. Thus a disloyal act is actionable even when a conflict of interest is not—one difference being that the conflict is disclosed, the disloyal act is not. A director may tell his fellow directors that he has a conflict of interest but that he will not allow it to influence his actions as director; he will not tell them he plans to screw them. If having been informed of the conflict the disinterested directors decide to continue to trust and rely on the interested ones, it is because they think that despite the conflict of interest those directors will continue to serve the corporation loyally.
I agree that disclosure of the conflict was not enough to eliminate the breach of fiduciary duty issue. But should it be enough for liability to show that the disinterested directors relied on the interested one?
I don't buy Posner's analysis. Posner's trying to be his usual clever self, but the analysis simply makes no sense. In oder for disclosure to cure a conflict of interest, there must be full disclosure of all material facts relating to both the transactions and the director's conflict of interest. If the interested director failed to disclose that "he plans to screw them," neither the conflict nor the disloyal act has been excused.