The Delaware Chancery Court in Shocking Technologies, Inc. v. Michael held that a corporate board member breached the fiduciary duty of loyalty when the member attempted to convince the only investor interested in the company to demand a board seat while the company was in financial distress. The court rejected the board member’s defense that he acted with good faith in the interest of promoting improved board governance.
Shocking Technologies, Inc. (Shocking), a start-up company that manufactures components for electronic devices, accused one of its directors, Simon J. Michael, of breaching his fiduciary duty of loyalty. Michael, however, claimed that his actions, that gave rise to the alleged breach, were in the interest of the company, because the other directors agreed to double one director’s compensation despite Shocking’s lack of revenue. To challenge the power of the other directors, Michael sought to convince Littelfuse, Inc., a company considering investing in Shocking, to demand a spot on Shocking’s board in exchange for financing. In furtherance of this scheme, Michael told Littelfuse that it was the only potential investor in Shocking. As a result, Littelfuse obtained a strategically enhanced bargaining position when negotiating the terms of its investment.
The court analyzed whether Michael violated his fiduciary duty by addressing two issues: first, whether Michael’s conduct harmed Shocking; and, second, whether Michael acted in good faith. The court found that Michael violated his duty in each of the two instances, noting that a director’s duty of loyalty prohibited conduct that would be adverse to the interests of the corporation. First, Michael frustrated Shocking’s fundraising efforts by encouraging Littlefuse to demand a better deal from Shocking. The court found that Shocking was in dire need of finding cash to finance itself, and Michael’s actions jeopardized the relationship between Shocking and Littlefuse. This in turn caused Michael to violate his affirmative duty to protect the corporation’s interests and a duty to refrain from conduct that would harm the corporation.
The second manner in which Michael violated his fiduciary duty was by informing Littelfuse that they were the only investor that could save Shocking from its dire economic circumstances. The court held that a board director may not distribute privileged information to aid a third party with an adversarial position to that of the corporation. The court found that Littlefuse had increased leverage because of the knowledge of the confidential material; a harm that could not be counterbalanced by Michael’s good intentions.
While acknowledging that Michael’s desire to change Shocking’s board may have been in good faith and prudent for the company, the methods he used to achieve the change violated his duty of loyalty. The court held that a director may not enhance a potential investor’s bargaining position, because this interferes with a company’s financing efforts. Even though the long term gain from Michael’s efforts may have been better for the company, the short term detriment of jeopardizing Shocking’s financing can never amount to a good faith defense for breach of a duty of loyalty.
However, the court’s holding left open the question of when the long term gain will outweigh the short term detriment. The court stated, “In theory, there may be something of a continuum on which actions, such as Michael’s, should be measured.” The court went on to note that “where that line is … may not be readily pinpointed.” Unfortunately, the court did not define methodology to “pinpoint” this “line.”