September 4, 2019 / 4:07 PM / 14 days ago

Court battles may loom after U.S. business heads widen corporate objectives

NEW YORK(Thomson Reuters Regulatory Intelligence) - A pledge by an influential forum of top U.S. business leaders to consider the interests of a broad range of stakeholders and social issues in addition to shareholder earnings may lead to more legal disputes over board decisions. And many of those disputes would likely be heard in the state of Delaware, the legal home to many U.S. corporations.

A United Nations flag is seen in a boardroom in the Secretariat building during the U.N. General Assembly at U.N. Headquarters in New York September 25, 2013.

Legal experts have begun to consider various scenarios that might emerge in Delaware courts after the surprise announcement last week by the Business Roundtable{here}, led by JPMorgan chief executive Jamie Dimon. Among them is whether directors of U.S. firms will continue to be shielded by the so-called “business judgment rule” which protects them from liability as long as they’re deemed to have acted in the corporation’s interest. By opening the door to other corporate objectives, some wonder whether new fiduciary claims might be on the horizon in Delaware.

“The atmosphere in Delaware may be ripe for more fiduciary claims in light of the recent Marchand v. Barnhill decision and other recent Delaware law developments,” Betty Moy Huber, co-head of the Environmental, Social & Corporate Governance group at Davis Polk, told Regulatory Intelligence.

In the case of Marchand v. Barnhill, the Delaware Supreme Court in June found that the board of Blue Bell Creameries USA Inc. failed to provide adequate oversight of a key risk area and thus breached its “duty of loyalty,” which some observers viewed as an indication of the potential widening scope for where directors could be sued for breach of fiduciary duty. The case arose out of a listeria outbreak in ice cream made by the company that sickened many consumers, caused three deaths and resulted in a total product recall.

“While directors are generally shielded from liability by the business judgment rule, it will be interesting to see if novel theories of law develop if directors aggressively and affirmatively take into account employees, communities, suppliers and stakeholders, and not just shareholder value, in their decision-making process,” Huber added.

The Business Roundtable statement last week, signed by 181 leading executives including Dimon and the heads of other financial firms, committed to:

—delivering value to customers;

—investing in employees;

—dealing fairly and ethically with suppliers;

—supporting their communities; and

—generating long-term value for shareholders.

Among other things, the statement upends nearly 50 years of U.S. corporate fidelity to the sole objective of maximizing shareholder value. But with widening social and political pressure in areas such as corporate governance, the environment and what many see as a failure of capitalism to serve the broader needs of society, the statement is what some believe is a reflection of the current business environment.

“I think this is a smart move by business heads who have come under inordinate public pressure,” said a partner at a large Washington D.C. law firm. “Whether they can execute on these objectives remains to be seen, and there might be some cause for concern in terms of director liability.”

CORPORATIONS MAY NEED TO TREAD CAREFULLY

Under current Delaware law, directors of U.S. corporations owe their fiduciary duties to the corporation and its stockholders. Unlike some other states, Delaware lacks what legal experts refer to as a “permissive constituency statute,” which allows directors to consider the interests of other constituencies, such as employees. Even then such a provision typically applies only in a merger and acquisition context, according to the law firm Sullivan & Cromwell.

But despite the narrow focus of Delaware’s statute, experts say companies should be able to take account the interests of other stakeholders and still be protected under the business judgement rule – that is, provided the interests of the firm remain paramount.

“We believe that a board’s decision based on such an evaluation, if made on an informed basis, would be fully protected by the business judgment rule,” said Sullivan & Cromwell in a note to clients.

“We also believe, however, that a decision by a board that is not grounded in the best interests of the corporation and its stockholders likely would not be protected by the business judgment rule under the current state of the law. Further, it is unclear how a court applying Delaware law would think about factors other than shareholder value in evaluating a board’s fulfillment of its duties under Delaware cases,” the firm added.

WHAT IS “STOCKHOLDER WELFARE?”

Many experts have pointed to Delaware’s chief justice Leo Strine’s past guidance as a point of departure on the business judgement rule. Strine, who is stepping down from the bench later this year, has argued that “[w]ithin the limits of their discretion, directors must make stockholder welfare their sole end.” In a widely-cited 2015 paper, Strine added: “Other interests may be taken into consideration only as a means of promoting stockholder welfare.”

Some see this as a major hurdle for boards to expand the definition of what constitutes “stockholder welfare.” But other experts believe that the state’s law doesn’t preclude companies from taking account of other stakeholder interests. What is critical is for directors to be able to clearly link their actions with their fiduciary obligations.

“To be clear, Delaware law does not enshrine a principle of shareholder primacy or preclude a board of directors from considering the interests of other stakeholders,” the law firm Wachtell, Lipton, Rosen & Katz said in a client memo.

“The fiduciary duty of the board is to promote the value of the corporation. In fulfilling that duty, directors must exercise their business judgment in considering and reconciling the interests of various stakeholders – including shareholders, employees, customers, suppliers, the environment and communities,” the firm said.

Still others argue there is ample evidence that a company's longer-term focus on multiple stakeholders provides investors with greater returns. "Managing for multiple stakeholders and related environmental and social issues leads to innovation, operational efficiency, lower risk, employee retention and other benefits that translate into improved corporate financials," writes Tensie Whelan, director at NYU's Stern Center for Sustainable Business, in a new article{here}, citing research that found a significant return on so-called "sustainability investment."

(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence.)

This article was produced by Thomson Reuters Regulatory Intelligence - bit.ly/TR-RegIntel - and initially posted on Aug 28. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters

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