Corporate Governance

Hampshire Group, Limited v. Kuttner: A Tee Hee Analysis (The Inevitable Solution)

By J Robert Brown Jr.

This case imposed liability on officers for breach of their fiduiciary duties.  To the extent that this happens on a recurring basis, officers (particularly the CEO) may begin to view Delaware as insufficiently management friendly and consider reincorporating elsewhere.  After all, companies select Delaware because the state increases board discretion, minimizes officer and director liability, and facilitates job retention (aka entrenchment).  (These factors are discussed in The Irrelevance of State Corporate Law in the Governance of Public Companies). 

Such an approach would threaten Delaware's preeminence in the corporate law area (and, collaterally, the revenue stream produced by these corporations).  The race to the bottom predicts that Delaware will one way or another minimize this risk of liability. 

There are two possible ways this might come about. 

First, despite the conclusion by the Delaware Supreme Court that officers and directors have the same fiduciary obligations, differences may emerge.  A hint of this possibility is contained in Hampshire Group.  As the Vice Chancellor noted:  

• There are important and interesting questions about the extent to which officers and employees should be more or less exposed to liability for breach of fiduciary duty than corporate directors. The parties in this case have not delved into any of those issues, and I see no justifiable reason for me to do so myself.

To the extent that fiduciary duties for officers and directors vary, the path is open for a judicial approach that minimizes the obligations imposed on officers.  Thus, for example, this case involved allegations against two officers who were subordinate to the CEO.  Perhaps the duty of loyalty will become less rigorous in the context of subordinates, at least where the alleged breach of fiduciary obligations is mostly explained by the behavior of the superior.

Second, the legislature can step in and alter the waiver of liability provision in Section 102(b)(7).  The provision was originally adopted in the aftermath of Van Gorkom (although the stated purpose was to deal with the D&O insurance crisis, see Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom).  There was in fact no real need for the provision but the "crisis" provided an opportunity for the complete elimination of liability for the duty of care. 

Only in drafting the provision, it was not extended to officers.  The provision applies only to "the personal liability of a director."  This omission can be remedied through an amendment to Section 102(b)(7) that would add officers to the category of persons subject to waiver of liability.  The explanation will be the need to conform with other jurisdictions (see, e.g. La. R.S. 12:24(C)(4)("A provision eliminating or limiting the personal liability of a director or officer to the corporation")). 

An amendment to Section 102(b)(7) that merely adds officers will not fully accomplish the task of eliminating officer liability.  In Hampshire Group, the behavior was alleged to have been a violation of the duty of loyalty, something not covered by Section 102(b)(7).  The legislature could add the right to waive the duty of loyalty to the section.  Alternatively, the courts could interpret fiduciary obligations for officers in a way that eliminates most claims for breach of the duty of loyalty.

Neither of these steps have been taken.  Perhaps this time, the state will allow for the development of  meaningful fiduciary standards, albeit for officers and not seek to minimize officer liability.  Only time will tell.

The opinion in Hampshire Group Limited v. Kuttner is posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on August 16, 2010 (boomark / email).