Facebook’s D&O Lesson

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Just like in life, directors must sometimes decide between taking what seems to be an unnecessarily formal route, or simply reaching the inevitable conclusion.  Anyone who has spent an entire day putting together IKEA furniture only to finish with a few “leftover” screws can certainly understand that completion is often more important than the path it took to get there.  However, the Delaware Chancery Court has made clear that when it comes to director liability, “no harm, no foul” is not the rule of law.

In Espinoza v. Zuckerberg, a Facebook shareholder brought a derivative suit against the company’s board of directors for a compensation increase that the shareholder alleges was a breach of fiduciary duties, unjust enrichment and a waste of corporate assets.  In its Motion for Summary Judgment, the Board admitted that under normal circumstances, giving itself a raise would be a self-dealing transaction subject to the entire fairness standard of review.  However, the Board argued that subsequent statements and affidavits from disinterested majority shareholder Mark Zuckerberg constituted an informal ratification that changes the standard of review to the more generous business judgment rule. The Board concluded that because Zuckerberg’s approval alone overrides any dissension from the minority shareholders, a formal vote or written notice under Delaware General Corporate Law is unnecessary.

In rejecting this position, the Chancery Court noted that formalities exist for a reason, even if the end result is inevitable.  In this case, the policy behind the ratification requirements includes avoiding ambiguities and misinterpretation, precision in decision-making and promoting transparency.  Each of these reasons, the Court said, benefits minority and majority shareholders alike.  The Chancery Court then held that although Zuckerberg could have unilaterally ratified the decision, his failure to follow the formal procedures nullifies his approval and the entire fairness doctrine is applicable.

This ruling is equally informative for directors of both large and small entities.  Bylaws and other corporate documents are often established long before it is discovered how certain actions will actually work out in practice.  As time progresses, it therefore becomes tempting to disregard seemingly unnecessary procedures.  This temptation becomes even greater when, as in Espinoza, the formalities have no bearing on the ultimate conclusion.  Nevertheless, directors and officers should be sure to stay informed of any rules governing their decision-making and abide by them closely.  An ounce of prevention is worth a pound of cure, and therefore directors should be sure to take the extra time to follow the rules now rather than undergo extensive litigation later because “it wouldn’t have mattered anyway.”