Friday, March 29, 2013

Delaware Chancery Court Addresses Effect of Good Faith and Fair Dealing, the Burdens Imposed on a Directed Fiduciary

Delaware Chancery Court Addresses Effect of Good Faith 
  and Fair Dealing, the Burdens Imposed on a Directed Fiduciary

     A recent letter decision by Vice Chancellor Noble provides helpful guidance as to the implied contractual covenant of good faith and fair dealing and the burden imposed upon a fiduciary who is bound to vote in a particular way.  Ross Holding and Management Co. v. Advance Realty Group, LLC, 2013 WL 764688 (Del. Ch. Feb. 28, 2013; revised March 7, 2013).
      The plaintiffs had been officers of Advance Realty prior to their termination and its subsequent recapitalization.  Their first objection (for purposes of this decision) was that Advance Realty had not redeemed their units in accordance with a Unit Holders Agreement.  Vice Chancellor Nobel noted, however, that the Agreement provided that Advance Realty “may” redeem the units.  Differentiating that permission “may” from a mandatory “shall,” at least at that point Advance Realty “had no express duty to repurchase” the units.

      He then turned to the implied covenant of good faith and fair dealing.  Advance Realty was based in new Jersey, and its law on the implied covenant controlled.  After noting the disconnect between an expectation that the units would be repurchased against an argument that said they may be redeemed, and in the absence of indications there was an agreement that the units would be redeemed, the Court would not under the implied covenant convert a permissive “may” into a mandatory “shall.”  On that basis Advance Realty was granted summary judgment on that claim.
      The Court next considered a claim against Rayevich, a member of Advance Realty’s managing board.  Under Delaware law it is presumed that Rayevich “acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of” Advance Realty, citing Gantler v. Stephens, 965 A.2d 695, 705-06 (Del. 2009).  The plaintiffs alleged that Rayevich breached his fiduciary duties by “(1) failing ‘to evaluate the terms of the Conversion Agreement to determine whether it was in the best interests of the company and its unit holders’; (2) by failing to ‘voice opposition to the agreement in light of the conflicts of interest involved in his fellow board members’; and (3) by failing to take ‘any steps to prevent the self-dealing of the insider defendants.’”
      Rayevich was granted summary judgment on the basis that the Plaintiff’s pleadings did not assert facts sufficient to overcome the presumption of appropriate discharge of fiduciary obligations.  Before doing so, however, the Court considered the effect of structural limitations on Rayevich.  Under the controlling documents, he was required to vote as directed by Peter Cocoziello, Advance Realty’s founder, President and CEO.
      Rejecting the notion that his lack of discretion in voting is equivalent to a “get out of jail free card” (my characterization, not the Court’s), the Court wrote:

Rayevich cannot avoid liability simply by pointing out that he had no discretion—as restricted by the ARG Operating Agreement—to vote as a board member. He is correct that Cocoziello controlled his vote, but fiduciary duties extend beyond voting. They may involve, for example, studying the proposed action, determining the appropriateness of the proposed action, setting forth a dissenting view to fellow board members, and, in the proper circumstances, informing unit holders about the potential adverse affects of a proposed action.
      The decision also addressed aiding and abetting breach of fiduciary duty, conspiracy to breach fiduciary duty, and the disclosure of incorrect information.
      Clearly directed fiduciaries have obligations, and they cannot adopt the pose of a potted plant.  Rather, except as to the vote itself, they need to do what is expected of any other fiduciary.

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