Delaware Supreme Court rules that friendship and business relationships together are enough to challenge director’s independence
by: Litigation at Dinsmore, Christopher Deabler of Dinsmore & Shohl LLP  -  Legal News
Friday, October 9, 2015

The full Delaware Supreme Court recently provided commentary on considerations of director independence in connection with corporate transactions important to Delaware publicly traded companies, private equity groups and other closely held companies. In Delaware County Employees Retirement Fund v. Sanchez, No. 702, 2014, 2015 Del. LEXIS 472 (Del. Oct. 2, 2015) (en banc), the Supreme Court reversed the Chancery Court’s dismissal of a stockholder derivative suit for failing to satisfy the requirements excusing stockholder demand that the corporation pursue those claims. In this case, the Supreme Court held that the stockholders did satisfy those requirements by alleging facts permitting the court to infer that a particular transaction was not approved by a majority of disinterested and independent directors.

The transaction was between public traded Sanchez Energy Corporation and privately held Sanchez Resources, LLC. Chairman A.R. Sanchez Jr. and President & CEO A.R. Sanchez III collectively owned 21.5 percent of Sanchez Energy and served on its five member board. The three remaining board members separately constituted Sanchez Energy’s audit committee, which was expressly chartered to evaluate and approve transactions with related parties and affiliates. Sanchez Resources was owned by members of the Sanchez family and the private equity group Altpoint Capital Partners. On the advice of an independent financial advisor, the audit committee approved a transaction that resulted in Sanchez Energy’s purchase of Sanchez Resources’ interests in oil development rights and the buy-out of Altpoint’s equity interest.

Sanchez Energy stockholders commenced a derivative action without demand, alleging (1) breaches of fiduciary duty against the individual directors and the president, (2) aiding and abetting breaches of fiduciary duty against Sanchez Resources and Altpoint and (3) unjust enrichment against the chairman and the president. In response to a motion to dismiss, they asserted that Alan Jackson, an audit committee member, lacked independence from the chairman, alleging that:

The chairman and Jackson had been close friends for over five decades.

The chairman was one of nine directors and the largest stockholder of a parent company that wholly owned an insurance brokerage subsidiary employing both Jackson and his brother full time.

The subsidiary provided brokerage services to Sanchez Energy and other Sanchez-family affiliates and Jackson and his brother both serviced that work.

The Supreme Court held that Jackson’s personal and business relationships with the chairman together warranted the inference that Jackson was not independent from the chairman, which when taken in conjunction with the chairman and president’s status as interested directors, warranted the inference that a majority of the five member board was not disinterested and independent when approving the transaction. Consequently, the Supreme Court reversed the Chancery Court’s decision and remanded the case for further proceedings.

This case serves as an important reminder that the individual status of directors must be carefully monitored with respect to transactions of sufficient size to warrant a derivative suit. Sanchez Energy’s audit committee was chartered specifically to evaluate transactions apart from Sanchez family members on the board, was composed of disinterested members and engaged an independent financial advisor for the transaction. But the company neglected to consider certain relationships the committee members had with the other directors that might suggest their independence could be questioned. As this case demonstrates, that may be enough to permit a derivative suit to proceed. In light of this decision, Delaware public companies, private equity groups and closely held companies should reexamine the complexion of their boards and committees and those of their subsidiaries and affiliates in relation to one another to determine which of their directors, officers, stockholders or employees might have a financial interest in a transaction or whether their directors have relationships that might be questioned in connection with their approval of a transaction.

 

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