Summary Judgment Affirmed on Claims Challenging Restatement; Directors Shielded by Reliance on Advisors
Erica Smith | Bloomberg Law
In an unpublished opinion, the California Court of Appeal affirmed that directors of Nara Bancorp, Inc., a Delaware corporation that is the holding company for Nara Bank, were entitled to summary judgment on claims of breach of duty and corporate waste. Applying Delaware law, the court found that the directors were shielded from liability based on their good faith reliance on competent advisors.
Directors Raise Shield of Business Judgment Rule and Statutory Protections
From 2002 to 2003, plaintiff Thomas Chung was the chairman of Nara’s board of directors. In late 2002, the board and then-CEO Benjamin Hong executed a letter providing that Hong would forfeit half of the profit share due to him in 2003 and 2004 in exchange for future compensation. This enabled Nara’s earnings per share to avoid falling short of analyst expectations. Nara’s 2002 financial statements did not include an obligation for the unpaid monies.
In 2005, Nara’s audit committee commenced an investigation of the letter. A law firm (Fulbright & Jaworski LLP) was hired to conduct the investigation, with assistance from Navigant Consulting, Inc., a forensic accounting company. Fulbright and Navigant ultimately recommended that Nara restate its 2002 financial statements to reflect the obligation to Hong, as did Crowe Chizek & Company LLC, Nara’s independent auditor. The board of directors issued a restatement.
Nara subsequently initiated arbitration against Hong, claiming damages from the restatement. Hong counterclaimed for recovery of bonus monies. The arbitration panel found in favor of Hong and concluded that the restatement of the 2002 financial statements had been unnecessary. In 2008, despite the outcome of the arbitration, the board chose not to sue its advisors or revise the 2002 restatement. The board also issued a Form 8-K disclosing, without stating reasons, that it had lost the arbitration.
Chung filed suit, alleging breach of fiduciary duties and corporate waste by the individuals who served on Nara’s board in 2005 and 2008 (respectively, the 2005 Directors and the 2008 Directors). He claimed the 2005 Directors breached their duties by hiring the advisors to “reach the predetermined conclusion” that a restatement was necessary, issuing a false and misleading Form 8-K, and failing to sue the advisors for negligence. As for the 2008 Directors, Chung asserted that they should have sued the advisors and the 2005 Directors, disclosed the arbitration findings, and restated the company’s restated financial statements. The defendants moved for summary judgment based on the business judgment rule and the statutory protections of Sections 102(b)(7) and 141(e) of the Delaware General Corporation Law (DGCL). The superior court granted the motion, and the plaintiff appealed.
Delaware Law Defenses
The court provided an overview of the Delaware law defenses invoked by the defendants. The business judgment rule presumes that when the board of directors acts, it is well informed and honestly believes it is promoting the best interests of the corporation and the shareholders. The presumption of business judgment shields directors from liability unless evidence of fraud, bad faith, or self-dealing is shown, or the board’s decision cannot be attributed to any rational business purpose. The court observed that when evaluating whether directors were adequately informed in reaching a business judgment, “gross negligence” is the proper standard to apply. Further, the business judgment inquiry focuses on whether the process employed by the directors was rational or a good faith effort to serve corporate interests, and is not an opportunity to critique the decision in hindsight.
DGCL Section 102(b)(7) authorizes a corporation, in its certificate of incorporation, to eliminate or limit a director’s personal liability to the corporation or its stockholders for monetary damages based on a breach of fiduciary duty. However, such exculpation is not available with respect to (1) breach of the duty of loyalty, (2) acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law, (3) unlawful payment of a dividend or unlawful stock purchase or redemption, or (4) transactions conferring an improper personal benefit on the director. DGCL Section 141(e) protects a director who relies in good faith upon, among other things, the advice of others in matters within their professional or expert competence.
The court observed that a failure to act in good faith exists “where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating conscious disregard for his duties.” Chung at 9 (citing In re Walt Disney Co. Derivative Litig., 906 A.2d 27 (Del. 2006)). Noting that gross negligence alone does not constitute bad faith, the court concluded that the statutory defenses served as a stronger shield from liability than the business judgment rule, since a grossly negligent decision may not be protected by the business judgment rule but might be under a statutory defense.
Good Faith Reliance on Advisors Protects 2005 Directors
The court found no triable issue regarding whether the 2005 Directors relied in good faith on their advisors. The defendants provided declarations stating that when they decided to restate the 2002 financial statements, they relied in good faith on the opinions, statements, and reports provided by Fulbright, Navigant, and Crowe Chizek. The parties did not dispute the qualifications of Fulbright and Navigant to conduct the investigation, or that they were selected with reasonable care.
The plaintiff offered two expert declarations addressing the 2005 Directors’ alleged gross negligence. However, the court noted that neither expert opined that the 2005 Directors acted in bad faith. In addition, two cases cited by the plaintiff were distinguishable by their facts and did not support his assertion that the 2005 Directors “acted in bad faith because they were inattentive or uninformed as to the reasoning and findings of their advisors; because they relied on their advisors without question; and, in the alternative, they did not rely on anyone’s advice.” Id. at 12. Finally, the plaintiff’s claim that a showing of gross negligence would also demonstrate bad faith failed because “the law of Delaware establishes the opposite.” Id. at 13. Based on the foregoing, the court concluded that DGCL Section 141(e) protected the 2005 Directors from liability.
2008 Directors Also Off the Hook
With respect to the plaintiff’s contention that triable issues also existed with respect to the 2008 Directors’ conduct after the arbitration, the court noted that Nara’s certificate of incorporation contained an exculpatory provision pursuant to DGCL Section 102(b)(7). In addition, the defendants offered declarations that they “exercised their business judgment in making postarbitration decisions, and that they relied on management and legal counsel to make all legally necessary public disclosures about the arbitration.” Id. at 13-14. The court found these statements sufficient to implicate the protections of Sections 102(b)(7) and 141(e). Since the plaintiff merely asserted that the protection of the business judgment rule was not warranted and failed to address the statutory defenses, the court found that he waived the argument.
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