The
Latest in Research!
This research
will review the accuracy of the claims made in the "Nevada vs.
Delaware" reported on many web sites in our industry. The issues
will be discussed in the order presented in the report. Specifically,
there are five areas wherein it is asserted that a specific act would
be protected under Nevada law, but that a corporate director or officer
would be exposed to liability in Delaware. Research reveals that the
report is quite accurate.
ACTS
OR OMISSIONS NOT IN GOOD FAITH
Before
it was amended effective June 15, 2001, Nevada Revised Statutes (NRS)
78.037(1) allowed a Nevada corporation's articles of incorporation to
contain:
A provision
eliminating or limiting the personal liability of a director or officeholder
to the corporation or its stockholders for damages for breach of fiduciary
duty as a director or officer[.]
However,
such protection was prohibited for "[a]cts or omissions which involve
intentional misconduct, fraud or a knowing violation of law[.]"
NRS 78.037(1)(a). [Repealed as of 6/15/01; the current version of NRS
78.037 allows corporate articles to contain any provision not prohibited
by law.]
Prior to
the change, this section was discussed in David Mace Roberts & Rob
Pivnick, "Tale of the Corporate Tape: Delaware, Nevada and Texas,"
52 Baylor L. Rev. 45 (2000). They wrote:
Without
doubt on this subject, Nevada is more director and officer friendly
than either Delaware or Texas . . . .
The NRS
seems to imply that a limitation of liability statement may exculpate
directors for a breach of the duty of loyalty, acts not in
good faith, and receiving improper benefits. If true, directors
may act contrary to the interests of the corporation by receiving
improper benefits or otherwise act in bad faith, without vicarious
liability, if the articles of incorporation eliminate director
liability for such acts.
Id. at
51 (footnotes omitted)(emphasis added).
Concurrent
with the change to NRS 78.037 came an amendment to NRS 78.138. Effective
June 15, 2001, a subsection (7) was added to the statute:
[A] director
or officer is not individually liable to the corporation or its stockholders
for any damages as a result of any act or failure to act in his capacity
as a director or officer unless it is proven that:
(a) His
act or failure to act constituted a breach of his fiduciary duties
as a director or officer; and
(b) His
breach of those duties involved intentional misconduct, fraud or a
knowing violation of law.
This subsection,
in effect, gives all directors and officers of Nevada corporations the
protection that the former NRS 78.037(1) merely allowed corporations
to include in their articles. In other words, all Nevada corporations
now have a limitation of liability statement for directors and officers
imposed by law. And, this protection includes acts not in good faith,
since NRS 78.138(7)tracks the language of the former NRS 78.037(1).
With
these amendments, there no longer exists in Nevada corporations which
have limitation of liability statements and corporations which do not.
In
Delaware, such is not the case.
When a
Delaware corporation's articles of incorporation do not contain a limitation
of liability statement, the protection provided for directors from personal
liability is the business judgment rule. "As a substantive rule
of law, the business judgment rule provides that there is no liability
for an injury or loss to the corporation arising from corporate action
when the directors, in authorizing such action, proceeded in good
faith and with appropriate care." Rodman Ward, Jr., Edward
P. Welch & Andrew J. Turezyn, Folk on the Delaware General Corporation
Law, 4th ed. (Aspen Law & Business, 2002), Vol. I, § 141.2.2.2
at GCL-TV-33 (emphasis added). See also Roberts & Pivnick,
supra, at 48 (Directors of Delaware corporations must act in
good faith to invoke the protection of the business judgment rule, citing
Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) and Aronson
v. Lewis, 473 A.2d 805 (Del. 1984)). (As discussed previously, the
standard of liability under the business judgment rule is "gross
negligence." See Roberts & Pivnick, supra, at
48; Ward, et al., supra, § 141.2.2.4 at GCL-IV-35.)
This being
the case, an act of a Delaware corporate director not in good faith
which rises to the level of "gross negligence" can lead to
personal liability, if the corporation has no limitation of liability
statement in its articles. When such a statement does exist, acts not
in good faith are still not protected.
The Delaware
General Corporation Law (GCL) is codified at Del. Code Ann. title 8.
GCL § 102(b)(7) was added to the law in 1986. Ward, et al.,
supra, § 102.15 at GCL-I-27. This section, which covers
only directors, allows a provision in the articles of incorporation:
[E]liminating
or limiting the personal liability of a director to the corporation
or its stockholders for monetary damages for breach of fiduciary duty
as a director, provided that such provision shall not eliminate or
limit the liability of a director: (i) For any breach of the director's
duty of loyalty to the corporation or its stockholders; (ii) for acts
or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law; (iii) under § 174 of this title;
or (iv) for any transaction from which the director derived an improper
personal benefit. No such provision shall eliminate or limit the liability
of a director for any act or omission occurring prior to the date
when such provision becomes effective.
GCL §
102(b)(7) (emphasis added).
The legislative
commentary states that § 102(b)(7) "makes clear that no such
provision shall eliminate or limit the liability of a director for .
. . failing to act in good faith[.]" S. 533, 133d Gen. Assembly
2, 65 Del. Laws ch. 289, §§ 1-2 (1986)(quoted in Ward, et
al., supra, § 102.15 at GCL-1-27 n. 56).
Delaware
statute quoted above treats intentional acts of misconduct and knowing
violations of law as different from acts or omissions not in good faith.
It is noteworthy
to mention that section (ii) of the Delaware statute quoted above treats
intentional acts of misconduct and knowing violations of law as different
from acts or omissions not in good faith. This bolsters the interpretation
of NRS 78.138(7) above, as under that statute a Nevada director is only
liable for breaches of fiduciary duty which involve intentional misconduct,
fraud, or knowing violations of law. Thus, such acts are not acts "not
in good faith."
Thus, in
Delaware, under no circumstance is a director protected for acts not
in good faith. However, in Nevada, such acts are protected, either by
a limitation of liability statement found in the articles of incorporation
prior to June 15, 2001, or by NRS 78.138(7) since that date. Therefore,
on the issue of corporate director acts not in good faith, Nevada law
provides protection not found in Delaware law.
ACTS
BY OFFICERS EXEMPT FROM MONETARY DAMAGES
Under the
former NRS 78.037(1), a limitation of liability statement in the articles
of incorporation could include officers as well as directors.
This made Nevada one of only six states to have such laws cover officers
as well as directors. (The other five states are Louisiana, Maryland,
New Hampshire, New Jersey, and Virginia.) See Clarence E. Hagglund,
Britton D. Weimer & Joseph P. Monteleone, D & 0: Directors
& Officers Liability: Guide to Risk Exposure and Coverage (The
National Underwriter Co., 1999), at 9.
With the
recent changes to Nevada's corporate laws, a limitation of liability
statement is no longer needed for officers or directors, as NRS 78.138(7)
covers both. To repeat, this section, applicable since June 15, 2001,
is a statutorily-imposed limitation of liability statement for officers
and directors. Only acts of intentional misconduct, fraud, prior a knowing
violation of law will lead to an officer's (or director's) liability.
With
the recent changes to Nevada's corporate laws, a limitation of liability
statement is no longer needed for officers or directors
Protection
for officers in Delaware corporations is nearly non-existent. GCL §
102(b)(7), which allows limitation of liability statements in the articles
of Delaware corporations, applies on its face to directors only. See
Ward, et al., supra, § 102.15 at GCL-I-32.1
("Section 102(b)(7) exempts only directors from liability").
Protection
for officers in Delaware corporations is nearly non-existent.
When a
director is not protected by a limitation of liability statement in
the articles, he can still find solace in the business judgment rule.
Not so for officers of Delaware corporations. "Some states extend
the business judgment rule to officers as well as directors, limiting
officers' liability to gross negligence." Hagglund, et al.,
supra, at 8 (citing cases from Ohio, Minnesota, Washington, and
Illinois. See at 17 n. 37). "Most jurisdictions, though,
have not addressed the application of the business judgment rule to
officers. The reason for this is unclear[.] . . . In any event, it is
prudent for officers to assume that they will have exposure for ordinary
negligence." Id. at 9.
As can
be seen, Nevada corporate law provides substantial protection for corporate
officers from monetary damages. Conversely, Delaware provides little
to no protection for officers. On this issue, Nevada law is superior.
Delaware
provides little to no protection for officers. On this issue, Nevada
law is superior.
BREACH OF A DIRECTOR'S DUTY OF LOYALTY
Under the
former NRS 78.037(1), a limitation of liability statement in a Nevada
corporation's articles of incorporation protected directors from personal
liability except in cases of intentional misconduct, fraud, or a knowing
violation of law. As previously stated, this protection has now been
codified at NRS 78.138(7), thus giving all Nevada directors a limitation
of liability statement as a matter of law.
In reviewing
the "intentional conduct, fraud, or a knowing violation of law"
language of the former NRS 78.037(1), Roberts & Pivnick, supra,
stated that this "seems to imply that a limitation of liability
statement may exculpate directors for a breach of the duty of loyalty[.]"
Id. at 51. Their conclusion is sound, given the language of the statute.
Since NRS 78.138(7) mirrors the language of the former NRS 78.037(1),
their conclusion is equally applicable to the new statute. Thus, Nevada
laws appear to protect Nevada corporate directors from breaches of the
duty of loyalty. Delaware law does not follow suit.
Thus,
Nevada laws appear to protect Nevada corporate directors from breaches
of the duty of loyalty. Delaware law does not follow suit.
In Delaware
corporations wherein the articles include a limitation of liability
statement, the limits of GCL § 102(b)(7) come into play. This section
reads, in pertinent part, that a limitation of liability
provision
shall not eliminate or limit the liability of a director: (i) for
any breach of the director's duty of loyalty to the corporation or
its stockholders[.]
The courts
in Delaware have construed this section literally, holding that a limitation
of liability statement in a Delaware corporation's articles pursuant
to § 102(b)(7) shields directors from breaches of the duty of care
(i.e., for acts of "gross negligence"), but not for
breaches of the duty of loyalty. See Emerald Partners v. Berlin,
787 A.2d 85, 90 (Del. 2001); Graham v. Taylor Capital Group,
91 F. Supp.2d 706, 732 (D. Del. 2000). "A breach of loyalty claim
requires some form of self-dealing or misuse of corporate office for
personal gain." Id. at 732.
Where a
corporation's articles do not include a limitation of liability statement,
and thus §102(b)(7) is inapplicable, the only protection available
for Delaware directors is the business judgment rule. However, this
rule does not protect directors who breach their duty of loyalty.
Under Smith
v. Van Corkom, 488 A.2d 858 (Del. 1985), the fiduciary duties of
directors include a duty of care and a duty of loyalty. Id. at
872-73. This latter duty has been described as follows:
The duty
of loyalty is a broad and encompassing duty that, in appropriate circumstances,
is capable of impressing a special obligation upon a director in any
of his relationships with the corporation. This duty of loyalty embodies
both an affirmative duty to protect the interests of the corporation
and an obligation to refrain from conduct that would injure the corporation
and its stockholders or deprive them of profit or advantage. In other
words, directors must eschew any conflict between duty and selfinterest.
Ward, et
al., supra, § 141.2.1.1 at GCL-IV-18.
In Delaware,
a breach of the duty of loyalty is not protected by the business judgment
rule. See, e.g., Smith, supra; Cede &
Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993); In re TriStar
Pictures Litigation, 634 A.2d 319 (Del. 1993).
Thus, on
this issue once again, Nevada law provides more protection for directors
than does the law of Delaware.
TRANSACTIONS INVOLVING UNDISCLOSED PERSONAL BENEFIT
TO A DIRECTOR
This issue
is closely related to the issue of the duty of loyalty just reviewed.
In Delaware, interested director transactions are allowed and are valid
if 1) there is good faith approval by a majority of disinterested directors
upon full disclosure; 2) there is approval by shareholders after full
disclosure (interested shareholder votes do not count); or 3) the transaction
is fair and either approved or ratified by the directors or shareholders.
GCL § 144(a). Nevada law is similar. See NRS 78.140. These
statutes involve disclosed transactions. When an undisclosed
transaction occurs, the two states differ.
In Nevada,
the former NRS 78.037(1) allowed limitation of liability statements
in corporate articles, except for acts or omissions involving either
intentional misconduct, fraud, or a knowing violation of law. As interpreted
by Roberts & Pivnick, supra, this seemed "to imply that
a limitation of liability statement may exculpate directors for . .
. receiving improper benefits." Id. at 51 (citing Keith
Paul Bishop, "The Delaware of the West: Does Nevada Offer Better
Treatment for Directors?," 7 no. 3 Insights 20, 23 (Mar. 1993)).
Once again,
since the new NRS 78.138(7) codifies the limitation of liability statement
as a matter of law for Nevada corporate directors, the same conclusion
still pertains. That is, Nevada corporate directors are apparently protected
in situations involving transactions wherein they receive undisclosed
personal benefits. This is not the case in Delaware.
Nevada
corporate directors are apparently protected in situations involving
transactions wherein they receive undisclosed personal benefits.
This
is not the case in Delaware
Undisclosed
personal benefits to a Delaware director is an issue of the duty of
loyalty. (See the previous section, especially the quotes from
Graham v. Taylor Capital and Ward, et al.) As such,
Delaware law does not protect them, either in situations involving GCL
§ 102(b)(7) or under the business judgment rule.
Even beyond
this, in cases involving director interest in a corporate transaction,
the business judgment rule is inapplicable, and the director has the
burden of proving the transaction is "fair." If he cannot
do so, he is liable. See Ward, et al., supra,
§ 141.2.3. at GCL-IV-48 to 51; AC Acquisitions Corp. v. Anderson,
Clayton & Co., 519 A.2d 103 (Del. 1986). The director's only
hope is to disclose the transaction, and come within the terms of GCL
§ 144(a), supra. If he does so, the business judgment rule applies,
unless the transaction rises to the level of disloyalty to the corporation.
See Cede & Co. v. Technicolor, Inc., 634 A.2d 345
(Del. 1993).
On
the issue of undisclosed personal benefits to corporate directors, Nevada
law appears to provide protection, whereas Delaware law clearly provides
none.
ACTS
OR OMMISSIONS OCCURRING PRIOR TO STATUTORY INDEMNIFICATION
Both Nevada
and Delaware allow for the indemnification of corporate directors for
acts performed in good faith and with a reasonable belief that the act
was in the best interest of the corporation. See NRS 78.7502;
GCL § 145. However, as stated by Roberts & Pivnick, supra,
at 52, "[t]he battle of director friendly indemnification laws
goes to Nevada, with . . .Delaware struggling to get out of the starting
gate . . . . Nevada allows corporations to provide broad indemnification
to their directors and officers . . . . Delaware's indemnification provisions
are comparatively narrow." The reason for this conclusion is NRS
78.752, which allows a corporation to make "other financial arrangements"
on behalf of its directors, beyond the maintenance of insurance. "As
such, greater protection for directors is possible." Roberts &
Pivnick, supra, at 52.
The
battle of director friendly indemnification laws goes to Nevada, with
Delaware struggling to get out of the starting gate!
However,
there is nothing in the indemnification statute in Delaware which states
that indemnification is not available for an act or omission which occurred
prior to the date the statute was created. Perhaps there is some confusion
on this issue because of GCL § 102(b)(7), which allows Delaware
corporations to have an article provision limiting or eliminating director
liability in certain situations. This section states, in part:
No such
provision shall eliminate or limit the liability of a director for
any act or omission occurring prior to the date when such provision
becomes effective.
In other
words, in Delaware, a § 102(b)(7) provision which is created after
an act or omission occurs provides no help to a director, whose only
defense would then be the business judgment rule. In such a situation,
liability follows if "gross negligence" is found. (When such
a provision pre-dates the act or omission, the director is exempt from
breaches of the duty of care, i.e., from acts of "gross negligence.")
However, this has nothing to do with "indemnification," which
is a completely separate issue.
CONCLUSION
On the
above issues, as argued in the report entitled "Nevada vs. Delaware,"
Nevada law provides much more protection for directors and officers
than does Delaware law. As stated by Roberts & Pivnick, supra:
[B]ecause
Delaware's laws are designed to protect the rights of minority shareholders
in large corporations, it has found itself in a difficult position
regarding closely held companies. This may have come at the expense
of protecting the directors and officers of Delaware corporations
. ...
Nevada is striving on an ongoing basis to challenge Delaware as the
state of choice for incorporation. In this vein, Nevada has adopted
statutes that are more director friendly and antitakeover favorable
than Delaware's.
Id. at
46-47 (quotation marks and citation omitted).
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1
The Business Voice, June 2001, "Nevada Scores "A" for
its business-friendly tax environment," by Trish Williamson
