Loyalty in the boardroom: a court decision affirms what a bad idea it is for directors to share confidential information without authorization.

• Author: Raymond, Doug
• Position: LEGAL BRIEF

A RECENT DELAWARE CASE reminds directors of the risks involved in speaking out of school at the expense of the corporation on whose board they serve. The case, Shocking 'Technologies, Inc. v. Michael, was brought by a privately held Delaware corporation against one of its directors. The company alleged that this director had breached his duty of loyalty to the company by revealing confidential information to a third party and interfering with a critical financing transaction.

The director, who was the sole board representative of a series of preferred stock, had for some time expressed deep concern about Shocking's corporate governance, principally that while the investors in the preferred stock had provided 60% of the company's capital, they were only able to designate one of six directors. He was also concerned that a "control block" of directors was too cozy with management, particularly around issues of compensation.

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Motivated by these concerns, the director, who knew that the company was in a "precarious cash position" and that its survival depended on obtaining new funding from a single crucial investor, lobbied the investor to hold off on investing in Shocking and to instead use its negotiating leverage to expand the board seats for the holders of preferred stock. In doing so, the director told the investor that Shocking had no other source of financing other than the investor, which dramatically shifted the playing field for negotiations.

When his actions were challenged, the director asserted that he had acted in good faith to try and improve the company's governance structure and to re-align its compensation practices. The court's analysis essentially assumed that the director had acted in good faith and that this was not merely a grab for power. Nonetheless, Vice Chancellor John Noble was unpersuaded that the director's good faith could justify actions that would foreseeably cause significant harm to the company. The court therefore found that the director had breached his duty of loyalty by frustrating a crucially needed source of financing and disclosing to the third party the extremely sensitive and confidential information that the company had no other available alternative.

The fiduciary duty of loyalty, together with the duty of care, are the most fundamental obligations of corporate directors. At its core, the duty of loyalty prohibits a director from engaging in conduct that is adverse to the...