Vedder Thinking | Articles Delaware Supreme Court Clarifies When a Friendship Could Compromise a Director’s Independence
When can a close personal friendship potentially interfere with a director's independence? The Supreme Court of Delaware recently addressed the issue in Delaware County Employees Retirement Fund, et al. v. Sanchez. The Sanchez case involved a complicated transaction between Sanchez Resources, LLC, a private company that is wholly owned by the family of A.R. Sanchez, Jr. (the "Private Sanchez Company"), and Sanchez Energy Company, a public company in which the Sanchez family is the largest shareholder and which depends upon the Private Sanchez Company for its management services (the "Public Sanchez Company"). Among other matters, the transaction included significant cash payments from the Public Sanchez Company to the Private Sanchez Company in exchange for the purchase of certain properties.
Without first making a demand upon the Board, certain shareholders initiated a derivative action alleging that the Public Sanchez Company grossly overpaid and unfairly benefited the Private Sanchez Company. The shareholders also claimed that demand was excused because a majority of the Board's directors were not sufficiently independent and disinterested to evaluate a demand. The parties stipulated that, of the five members on the Public Sanchez Company's board of directors (the "Board"), Mr. Sanchez and his son were not disinterested board members. The parties disagreed, however, as to whether a third director, Alan Jackson, was independent from Mr. Sanchez.
According to the plaintiffs, Mr. Jackson was not an independent and disinterested director because:
- Mr. Jackson was a close personal friend of Mr. Sanchez for over 50 years. To that end, Mr. Jackson personally donated $12,500 to Mr. Sanchez's gubernatorial campaign in 2012;
- Mr. Jackson and his brother are executives at an insurance agency at which they are responsible for the Private Sanchez Company and Public Sanchez Company accounts. Moreover, the insurance company employing Mr. Jackson and his brother is wholly owned by a company in which Mr. Sanchez is the largest stockholder and a non-independent director.
- The $165,000 paid to Mr. Jackson for his role as a director of the Public Sanchez Company represented approximately 30-40% of his total income in 2012.
Upon the defendants' motion, the Court of Chancery dismissed the shareholders' complaint, finding that the plaintiffs' allegations did not rebut the presumption that Mr. Jackson was an independent and disinterested director. As a result, the court held that the plaintiffs did not sufficiently plead demand futility under Aronson v. Lewis, 473 A.2d 805 (Del. 1984).
The Supreme Court of Delaware reversed the Court of Chancery's dismissal, holding that the lower court improperly considered Mr. Jackson's close friendship with Mr. Sanchez separate and apart from Mr. Jackson's business and financial ties to Mr. Sanchez. The Court held that, when considered in their totality and in a light most favorable to the plaintiffs, the plaintiffs' allegations supported a pleading inference that Mr. Jackson could not act independently of Mr. Sanchez. As such, the Court held that the plaintiffs sufficiently alleged that the majority of the Board lacked independence.
In its ruling, the Delaware Supreme Court noted that it can be a close and difficult decision when determining "whether a plaintiff has pled facts supporting an inference that a director cannot act independently of an interested director for purposes of demand excusal." In this respect, the Court was careful to note the distinction between allegations of a long-term friendship and those of a more casual, undeveloped relationship. Ultimately, the totality of the plaintiffs' allegations—including the substantial payments to the Private Sanchez Company, Mr. Jackson's considerable business and financial ties to Mr. Sanchez and his longstanding and continued friendship with Mr. Sanchez, tilted the scale in favor of the plaintiffs. Notwithstanding the unique facts alleged in this case, shareholders will likely rely on the Sanchez decision in support of future derivative actions in which a director has any personal relationship with an insider.
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