U.S. District Court for the District of Delaware Articulates Standards for Business Judgment Rule and Corporate Waste

In Palmer v. Reali,[1] the Plaintiff, the liquidation trustee for Baxano Liquidation Trust, filed a complaint alleging breach of fiduciary duties of loyalty and care against Reali and Slattery, two former officers of the Company (“Defendants”).  The crux of the Plaintiff’s claim is that the Defendants breached their fiduciary duty of loyalty and care “by repeatedly providing the Board with unreasonable, inflated and unachievable future revenue and revenue growth projections when Defendants knew that the projections would be critical to strategic Board decisions about the future of the company when company when the revenues were falling, expenses were rising, and capitalization dominated corporate planning.”  Further, the plaintiff alleges Defendants’ actions constituted waste when they moved the company’s facility from Wilmington, NC to Raleigh, NC.

In short, the facts are that the Defendants provided the Board of Directors in 2012 and 2013 with projections that had no reasonable basis behind them, besides the incentive of the Defendants to keep their jobs.  Based on these projections the Board approved actions that it otherwise would not have approved if it knew the financial reality.  Further, the Defendants inflated the numbers in order to meet bonuses and other financial incentives.  The Defendants are moving to dismiss under 12(b)(6) for failure to state a claim upon which relief may be granted.  Defendants also are claiming that they are protected by the business judgment rule (the “BJR”).

In regards to the BJR, and whether it applies to corporate officers, the court stated that Defendants cite no cases where a Delaware court has held the BJR applies to corporate officers.  However, the court cites to In re Tower Air,[2] which does discuss this topic.  In Tower Air, the Third Circuit stated that the BJR can be overcome by showing irrationality or inattention on the part of corporate officers or directors.  Irrationality is defined as no reasonably business judgment that its only explanation is bad faith.  Thus, the Court’s reference to the case suggests that the BJR can be applied to corporate officers.

Under the duty of care, directors are required to use the amount of care an ordinarily careful and prudent people would use in this situation and consider all material information reasonably available.  Here, the Court stated that the Defendants projections, stemming from no reasonable basis, indicated that the Defendants breached their duty of care.  Further, the knowledge by the Defendants that they were not presenting all the facts to the board and knew that the Company was not growing further breached the duty of care.  In addition, the court stated that there was enough to not dismiss the claim for breach of loyalty.

Lastly, the court discussed the issue of corporate waste.  “To prevail on a waste claim … the plaintiff must overcome the general presumption of good faith by showing that the board’s decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests.”[3]   Here, the Company’s move from Wilmington, NC to Raleigh constituted a waste since there was no real business purpose for the move besides convenience for the Defendants.  This move led to unnecessary costs.  The court stated the facts plausibly supported this claim.
This case summary was prepared by Matthew Arnold.

[1] Palmer v. Reali, et al., Civ. No. 15-994-SLR (D.Del. Sept. 29, 2016)
[2] In re Tower Air, 416 F.3d 229 (3d Cir. 2005)
[3] White v. Panic, 783 A.2d 543, 554 (Del. 2001)