A Brief Look At Delaware Law - Limitation Of Director's Liability

Since there's no episode of The Verdict on tonight, I have instead a brief write-up on the provisions of Delaware corporate law (found in Title 8, Chapter 1 of the Delaware Code) that apply to limitation of directors' liability at the time of incorporation. If you're interested, section 102, subsection (b), (3) has a provision for pre-emptive rights to subscribe for additional shares, provided that all shares of the same class have that right, to be included in the certificate of incorporation. In other words, it has a provision that allows for a poison pill to be put into the certificate of incorporation, provided that all shares of the same class have the same right to the "one-time-only-bargain" issuance and sale of new shares.

The part of sect. 102 that's relevant to limitation of directors' liability is found in subsection (b), (7): the corporation, upon incorporating, can limit the liability of its directors for their actions as directors, except for: “any breach of the director's duty of loyalty to the corporation or its stockholders”; or, for “acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law;" or “under [section] 174 of this title”; or, “for any transaction from which the director derived an improper personal benefit.”

Section 174 deals with the board improperly declaring a dividend (s. 173) or directors violating section 160. The latter section governs the right of a Delaware corporation to sell and buy its own shares. Subsection (c) of it requires that any corporation that owns a majority of its own stock, or a holding company that itself is owned by that same corporation, be forbidden from voting those shares or for using them for “quorum purposes.” No loop-de-loop, where corp. B holds a majority of shares in corp. A and corp. A holds majority control in corp. B. (or a circular chain with more than two links in it,) is allowed to get around this provision.

(Interestingly enough, this part of subsec. (c) does not apply to "pyramids of control." The snake has to bite its own tail for this part to nullify the voting rights.)

Subsec. (c) ends with: “Nothing in this section shall be construed as limiting the right of any corporation to vote stock, including but not limited to its own stock, held by it in a fiduciary capacity.” In other words, even if there is a control loop as described in the paragraph two above this one, the nullification of directors' liability does not kick in if corp. B., or whichever, holds the shares of corp A., or vice-versa and if the holder corporation in question uses the associated rights in conformance with the standard of fiduciary duty. If the latter condition applies, then directors' liability provisions aren't nullified by Delaware law, even though a circular-control set-up exists.

Section 102, subsection (b), (7) (ii) is broken up into three separate conditions; violation of any one of them gets rid of the directors' liability limitation with respect to any act that breaches any of those three conditions. To quote verbatim, they are: "for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law."

It's nice to see the logical "or" in there, as well as the separation of those three conditions into independent clauses. Otherwise, a gang of bank robbers could set up a Delaware corporation and include a provision that limits directors' liability for "any violation of law committed by any director strictly in the capacity of directorial duties, and for which the obligation of directors' duty of loyalty and duty of fairness are strictly adhered to." Once set up, the robbers could then: make each of themselves directors, as well as employees of said corporation; bring along a counter of the proceeds of each "score" they make; build up a paper trail that certifies that they didn't spend any of the proceeds of any robbery on the way to deposting it in the corporation's bank account; and, show that they only collected, for each of their personal benefits, the salaries and directors' fees to which their positions in the corporation entitle them.

This is why you will never see a gang of that sort showing up in the Delaware Court of Chancery asking for an injunction preventing them from being arrested for bank robbery. You'll never hear, "But, Yer Honor, Louie was around to make sure that we took care of the dough by depositing all of it in the corporation's bank account, and we only spent what we was entitled to draw from the account as directors, as well as employees, and we collected the funds due the corporation as directors, too, as well as finding the funds due to the corporation as directors; it says so in this paperwork here. Hence, the directors' liability is guaranteed us because of our duty of care and duty of loyalty were fulfilled all rightly and properly, Yer Honor. So, we deserve an injuction against being arrested in so capricious and ignorant a fashion as these officers of the law want to do to us." The logical independence of each of these three clauses means that such a criminal gang cannot use limitation of directors' liability as an injunctive shield against any criminal conviction, under any circumstances.

(Even if they somehow could, I doubt very much if the Delaware Chancery Court has the scope to influence the exercise of the criminal law anyway. If any gang of crooks tried something like that, I suspect that the resultant Chancery Court opinion would be a very short one: "Beyond our jurisdiction. Now gitouttahere, and Louie's going with you".)


If you're interested, the firm of Morrison and Forester, LLP, has a Web sheet that defines the terms "duty of loyalty," "duty of care," and other basic terms relating to corporate law, including to Delaware corporate law. Footnote 2 cites a 2003 decision by the Delaware Chancery Court. No "Louieisms," though.