Circle of Trust: When can a Corporate Director Share Confidential Documents with a Stockholder-Plaintiff?

Stockholders who suspect mismanagement or other fiduciary misconduct generally begin by investigating via a books-and-records demand in order to articulate the allegations for the complaint in a so-called “plenary” action.   But, what happens if the stockholders have allies on the board itself?  In Icahn Partners LP et al. v. Francis deSouza et al., C.A. No. 2023-1045-PAF (Del. Ch. Jan. 17, 2024), the Court holds that directors cannot pass confidential or privileged material to their stockholder allies, and those allies cannot incorporate the improperly acquired material, unless there is a special relationship between the director and stockholder such that they constructive share “one brain.”  Because the director here did not have such a relationship, the sharing was improper, and the pertinent portions of the stockholders’ Complaint were stricken.

In Icahn Partners, a parent spun off a subsidiary which raised money and then held an IPO.  Post-IPO, the two companies agreed to a transaction by which the parent would re-acquire the subsidiary.  European regulators issued a standstill order, which the companies disregarded, consummating the merger instead.  European regulators issued a final ruling barring the merger, ordering divestiture, and levying nearly a half-billion euro fine for violation of the standstill order.  Contemporaneously, entities affiliated with investor Carl Icahn owning approximately 1.4% of the company’s stock sponsored a slate of candidates for the parent’s board.  One candidate prevailed and was seated.  He was an employee of a different, non-stockholding Icahn affiliate.  The new director signed on to confidentiality agreements pertaining to the secrecy of certain corporate documents and information.  That new director used his position on the parent’s board to furnish confidential materials to the stockholding Icahn entities.  The entities incorporated the material a complaint alleging breach of fiduciary duty against  the parent’s other directors.  The defendants moved to strike parts of the (under seal) complaint  which made use of those confidential materials.

The Court walked through a decades-long history of cases which create two categories of special relationships between directors and stockholders in which the director can share confidential material with the affiliated stockholder:

(1) the director is designated to the board by the stockholder pursuant to contract or the stockholder’s voting power; or (2) if the director also serves in a controlling or fiduciary capacity with the stockholder.

Outside of those categories, the Court held such sharing was improper, and that the appropriate remedy was to strike the corresponding portions of the complaint.

Here, the director was elected at-large by the stockholders generally, and so  his means of ascend did not create a special relationship under the first arm.  Nor did his outside relationship to the stockholder-plaintiffs make him a co-fiduciary, failing the second arm.  Instead, he was an employee of an affiliate.  Thus, the Court held the director should not have shared the material and granted the corresponding motion to strike.

This might strike a reader at first glance as a somewhat counterintuitive result.  If a director who is beholden to a sponsoring stockholder can share documents with that stockholder in order to prosecute a corporate injury, why is that power denied to a director who has that ally and the support of a broader constituency?  As the Court explained, the underpinnings of the special relationship theory is that the stockholder and the director share “one brain,” such that the stockholder is in some sense constructively on the Board.  Where the constituency supporting the insurgent director is broader, and where the director’s relationship with the key stockholder-ally is remote, that one-brain alignment is absent.  A major stockholder needs to sponsor a sufficiently high-level fiduciary to bring itself fully into the circle of trust — and, as the Court observes, that closeness then operates in both directions, potentially constraining the stockholder’s ability to buy and sell shares of the company.

So, the key points are:

  • A director or board minority cannot breach the confidences of the corporation and board in order to act as a whistleblower/informant to an allied stockholders, absent a special relationship with the stockholder.
  • A special relationship exists if the stockholder gets to unilaterally select the director — such as a controller, or a special series or class of stock, or via a stockholders’ agreement.
  • A special relationship also exists if the director is a co-fiduciary  of the stockholder.

Stockholders running insurgent director slates on the belief that an incumbent board may be in breach of its duties should bear these requirements in mind.  If an insurgent slate cannot actually win control of the board, then the stockholder needs for its sponsored directors to be so close into its own confidence as to bring itself within the board’s circle of trust — with all the attendant obligations from that closeness — in order to make use of the director’s document access in investigating those suspected breaches.  Failing that, the stockholders must to rely on the more limited inspection rights available to stockholders under DGCL Section 220.

Conversely, Icahn gives guidelines to corporate boards for fending off partially-successful insurgent slates sponsored by major stockholders.  By setting up strong confidentiality rules and agreements for directors, it forces those stockholders to make a choice — in or out.

© 2009- Duane Morris LLP. Duane Morris is a registered service mark of Duane Morris LLP.

The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

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