Old friends on the board: a recent case offers guidance on whether a close friendship may be seen as impairing a director's independence.

• Author: Raymond, Doug
• Position: LEGAL BRIEF

A recent Delaware Supreme Court opinion provides an important new touchstone in assessing the independence of directors. Director independence is crucial not only in derivative litigation, which was the issue in that case, but also in determining whether the directors are protected by the business judgment rule or have complied with their fiduciary duty to act solely in the best interests of the corporation and its stockholders.

Boards frequently review transactions involving a counterparty in which a director, officer or significant stockholder has a meaningful stake. These related party transactions often benefit the company, but they create potential conflicts of interest that need to be addressed. Where there is no conflict, courts give very broad deference to board action under the business judgment rule. However, when a conflict is asserted, this deference can vanish. If the board can show that its actions were not affected by the conflict, it can recover the protection of the business judgment rule.

In almost every case, the best way to do this is to show that the review and approval of a conflicted transaction were given only to disinterested directors who were not infected by the conflicts. This makes the disinterested director extremely important to effective governance.

In many companies, especially in more regional companies, there are many inter-relationships among the directors, officers and stockholders. Typical examples include: directors who served together on other boards, business associates or former co-workers, or country club friends. However, courts have usually rejected challenges to these sorts of relationships. Without a direct financial interest, courts have been understandably reluctant to parse which social or business relationships call into question a director's ability to satisfy the duty of loyalty.

In the recent case, Delaware County Retirement Fund v. Sanchez, the Delaware Supreme Court considered whether one of the directors was disinterested. This director of Sanchez Energy Corp. came under scrutiny for his several connections with the chairman of the corporation who was alleged to have engaged in several conflicted transactions with the company. The plaintiffs alleged that the director and his brother were executives of a company where the chairman was a director and the largest stockholder, he had been close friends with the chairman for over 50 years, he had donated $12,500 to the chairman's...