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Director Independence Under New York Law

Tuesday, January 29, 2013
By Mara Leventhal, Gregory P Joseph Law Offices LLC

While New York law outlining the contours of director independence is somewhat less robust than the precedents that inform similar analyses under Delaware law, the fact that New York statutes and case law address circumstances that a court should consider in determining a director's interest in a given issue or transaction cannot be gainsaid. The purpose of this article is to set forth a practical set of issues that a court—or any board, committee, or other person or entity—evaluating director disinterest should consider in the discharge of an independence analysis exclusively pursuant to New York authorities. A checklist of questions and an overview of New York precedents that inform such an independence analysis follow.

1. Is the director a party to the transaction?

Pursuant to N.Y. Business Corporations Law (“BCL”) § 713(a) (McKinney 2012), director self-interest is expressly implicated where there is a “contract or transaction between a corporation and one or more of its directors.” In other words, a director who is also a counter-party to the corporation in a given transaction is, by definition, interested.1

2. Is the director affiliated with party to the transaction?

BCL § 713(a) also makes clear that director self-interest is in play where there is a contract or transaction “between a corporation and any other corporation, firm, association or other entity in which one or more of its directors are directors or officers, or have a substantial financial interest.”2 Thus, for example, directors who control an entity receiving a corporate loan3 or a below market lease,4 or merging with the corporation,5 or to which other valuable corporate assets are assigned6 are unlikely to be deemed independent.

3. Will the director receive a direct benefit from the transaction different from the benefit received by shareholders generally?

A director's receipt of a financial benefit as a result of a transaction may also suggest self-interest,7 unless the same financial benefit is “received by the shareholders generally.”8 Excessive director compensation is the quintessential example of a “different” benefit,9 but self-interest may not be established if the defendant director did not participate in the challenged compensation decision.10 Of course, potentially self-interested financial benefits can take many other forms, including receipt of backdated options,11 an ownership interest in the corporation's merger counter-party12 or lessee,13 insider trading,14 loan forgiveness15 or any other expense reduction for the director,16 diversion of commissions17 or corporate funds,18 or receipt of any other allegedly usurped corporate asset.19 Significantly, receipt of normal directors' fees is not a sufficient “financial benefit” to show self-interest by a director.20

4. Is the director controlled by a self-interested director?

A director “with no direct interest in a transaction” nevertheless may be deemed interested if he or she “is controlled by a self-interested director.”21 A plaintiff alleging such control must “present specific and detailed allegations that the [controlling] defendant directors have coercive power over the other directors.”22 Allegations that may demonstrate control sufficient to overcome independence include economic dependence on an interested director;23 close business and personal relationships with an interested director;24 membership on the board of a controlled corporation;25 and continued support for an interested director notwithstanding strong evidence of his or her wrongdoing.26 Factors that have been held insufficient to demonstrate control by an interested director include a casual acquaintance;27 a regular working relationship;28 a loan that the director is obligated to repay;29 a share sale transaction;30 status as an inside director;31 a track record of casting votes consistent with another director;32 or appointment by an allegedly controlling director.33

5. Is the director potentially subject to a “substantial threat” of personal liability?

While the “mere threat of personal liability is insufficient to challenge either the independence or disinterestedness of directors,” “particularized facts showing that a majority of directors face a substantial threat of personal liability” may suffice to establish a disabling interest,34 especially in the context of an assessment of a derivative demand or a special litigation committee investigation. Such a particularized showing is not satisfied by the fact that a demand was rejected35 or that a corporation's insurance policy would exclude coverage for an indemnified director sued by the corporation,36 particularly where the director did not non-participate in the challenged conduct.37 However, a complaint that “alleges acts for which a majority of the directors may be liable” may suffice to demonstrate that “[t]he board would not be responsive to a demand.”38

6. Are there any other relevant facts or circumstances?

As the issues outlined above make clear, an independence analysis is highly fact intensive. It depends on an assessment of director-specific information, including any relationship between a director and the challenged action, transaction or other directors or transactional counter-parties. Accordingly, a thorough independence analysis must also search out any other potentially significant relationships between the director and the relevant parties or events—such as past dealings, family relationships, or charitable contributions to affiliated entities—and evaluate whether those contacts taint the director's motives in respect of the actions at issue. A thorough advance review of possible director self-interest is, of course, the best protection against subsequent independence attacks.

Mara Leventhal is a partner with the Gregory P. Joseph Law Offices in New York.

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