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Director Standing qua Director to Sue Derivatively

Francis Pileggi alerts us to a new Delaware supreme court decision, Schoon v. Smith, which Pileggi explains held that “a director qua director may not sue fellow directors of a corporation derivatively.”

Plieggi links to a commentary by Steven Haas, who opines that:

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “because a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

In my Corporation Law and Economics treatise, I waffled:

Assume an injury to the corporation giving rise to a claim belonging to the corporation. Obviously, the board of directors, acting collectively, could authorize the corporation’s agents to bring the lawsuit in question. Suppose, however, the board has not acted. An individual director who is also a shareholder obviously could bring a derivative cause of action in the latter capacity. But does a director qua director have standing? The logical answer is no, although that answer is based on the implications of several distinct principles rather than a single statement of doctrine. First, both MBCA § 7.41 and Federal Rule 23.1 speak only of shareholders. As we have seen, other corporate constituents (such as creditors) lack standing. Second, under AGENCY RESTATEMENT § 14 C, an individual director is not an agent of the corporation. Indeed, comment b to that section states that the individual director “has no power of his own to act on the corporation’s behalf, but only as one of the body of directors acting as a board.” Taken together, these principles logically suggest that a director acting alone has no standing to sue qua director.

A few states, most notably New York, confer standing by statute on individual directors to bring derivative proceedings.  A director may not initiate a derivative action after leaving office, but neither removal nor expiration of the director’s term of office extinguishes the director’s standing to continue a previously filed suit.  ALI PRINCIPLES § 7.02(c) adopted the same rule.

Although director standing remains very much the minority position, it has a certain attraction. Recall the basic tenet of this text; namely, that shareholders do not own the corporation. Instead, they are merely one of many corporate constituencies bound together by a complex web of explicit and implicit contracts. To be sure, by virtue of their contractual status as residual claimants, shareholders ought to have standing to pursue suits that lower the value of that claim. If we view the directors as the corporation’s Platonic guardians, however, perhaps the directors ought to have prior standing to litigate injuries to the corporation. On the other hand, given the strong efficiency justifications for corporate law’s emphasis on the board as a collective, perhaps we ought to discourage directors from acting as lone rangers.

You’ll have to buy the book to get the benefit of the footnotes!