More Legal Winds of Change – Chancellor Strine on Duties of US Directors With Overseas Operati
Delaware corporate lawyers and D & O lawyers are buzzing about Chancellor Strine’s recent ruling on D & O issues while denying a motion to dismiss in a derivate claim lawsuit arising from misdeeds in China. A February 27, 2013 post at D & O Diary collects links to some of the posts and to some of the case materials. The ruling is not a formal written opinion, and instead is a hearing transcript, so one might assume a bit of breadth of wording that would not end up in a more hand-crafted opinion. That said, the words are sweeping and Chancellor Strine no doubt knew the words would reach many. The key quotes of Chancellor Strine are as follows:
"On 12(b)(6), I am sorry. Even if it’s just purely looked at as a Caremark case, drawing reasonable, rational inferences in favor of the plaintiffs, as I must, I believe the inference – one possible inference you can draw from this complaint is that essentially somebody took hold of an American vehicle, filled it with assets, sold a large amount of stock to the American investing public that independent directors were willing to go on and be a vehicle and get payments without understanding the duties they were taking on.
If you’re going to have a company domiciled for purposes of its relations with investors in Delaware and the assets and operations of the company are situated in China that, in order for you to meet your obligation of good faith, you better have your physical body in China an awful lot. You better have in place a system of controls to make sure that you know that you actually own the assets. You better have the language skills to navigate the environment in which the company is operating. You better have retained accountants and lawyers who are fit to the task of maintaining a system of controls over a public company
This is a very troubling case in terms that, the use of a Delaware entity in something along these lines. Independent directors who step into these situations involving essentially the fiduciary oversight of assets in other parts of the world have a duty not to be dummy directors. I’m not mixing up care in the sense of negligence with loyalty here, in the sense of our duty of loyalty. I’m talking about the loyalty issue of understanding that if assets are in Russia, if they’re in Nigeria, if they’re in the Middle East, if they’re in China, that you’re not going to be able to sit in your home in the U.S. and do a conference call four times a year and discharge your duty of loyalty. That won’t cut it.
If it’s a situation where, frankly, all the flow of information is in the language that I don’t understand, in a culture where there’s, frankly, not legal strictures or structures or ethical mores yet that may be advanced to the level where I’m comfortable? It would be very difficult if I didn’t know the language, the tools. You better be careful there. You have a duty to think."
Against Chancellor Strine’s statements, consider how the McDonald’s system did business in China for at least 25 years. The system, as they call it, began utilizing operations in China for production of tens of millions of Happy Meal toys. The system recognized the risks – a bad batch of toys could hurt children and ruin McDonalds. So, the system put in rigorous quality control rules. But, knowing the rules were only on paper, the system also put numerous people inside the manufacturing plants to enforce the standards. They sampled. They watched. They acted. And the system did all that long before the Caremark opinion issued in 1996.
Chancellor Strine really is not asking so much. In a way, one might say he is simply asking for corporations to actually follow respected processes such as ISO 9000 and Six Sigma. Like Caremark duties and SOX, the processes of ISO and Six Sigma are sometimes criticized as wasteful. But then again, McDonalds, GE, and other process driven companies over the years created hundreds of billions of wealth. Maybe the ROI fell short of 40% and so stock prices were less than "optimal," but then again, maybe there’s more to good decision-making than short-term stock prices. Maybe there is a shareholder value myth.