Issues of board independence,
and particularly the position and role of independent directors, have
resurfaced to the fore in India in recent months. Given this scenario, it may
be useful to consider developments relating to board independence occurring
elsewhere. Here, a ruling last month from the Delaware Supreme Court on the
determination of board independence would be of interest.
and particularly the position and role of independent directors, have
resurfaced to the fore in India in recent months. Given this scenario, it may
be useful to consider developments relating to board independence occurring
elsewhere. Here, a ruling last month from the Delaware Supreme Court on the
determination of board independence would be of interest.
In Thomas
Sandys v. Mark J. Pincus, the Delaware Supreme Court was concerned with
a shareholder derivative action brought by a shareholder of Zynga Inc. on
behalf of the company against some of the directors for their role in secondary
stock offering by the company. In considering whether the plaintiff shareholder
may be excused from making a demand on the board before allowing a derivative
litigation, the Court had to determine whether a majority of the board was
indeed independent or not. In doing so, the Court was essentially concerned
with the independence (or otherwise) of three directors whose status would
impinge upon the outcome of whether a majority of the board consisted of
independent directors.
Sandys v. Mark J. Pincus, the Delaware Supreme Court was concerned with
a shareholder derivative action brought by a shareholder of Zynga Inc. on
behalf of the company against some of the directors for their role in secondary
stock offering by the company. In considering whether the plaintiff shareholder
may be excused from making a demand on the board before allowing a derivative
litigation, the Court had to determine whether a majority of the board was
indeed independent or not. In doing so, the Court was essentially concerned
with the independence (or otherwise) of three directors whose status would
impinge upon the outcome of whether a majority of the board consisted of
independent directors.
In considering the position of
these the directors, the Court looked at their relationships with the company
as well as with the controlling shareholder. Zynga Inc. was controlled by Mr Pincus,
who held 61% voting shares in the company. Hence, the Court had to examine the
relationships of the directors not only with the company, but also with the
controlling shareholder.
these the directors, the Court looked at their relationships with the company
as well as with the controlling shareholder. Zynga Inc. was controlled by Mr Pincus,
who held 61% voting shares in the company. Hence, the Court had to examine the
relationships of the directors not only with the company, but also with the
controlling shareholder.
Beginning with the position of
Ms. Siminoff, one of the directors of the company, the Court noted that she and
her husband co-owned an airplane with the controlling shareholder, “which is
suggestive of an extremely intimate personal friendship between their families”.
The Court further observed:
Ms. Siminoff, one of the directors of the company, the Court noted that she and
her husband co-owned an airplane with the controlling shareholder, “which is
suggestive of an extremely intimate personal friendship between their families”.
The Court further observed:
Co-ownership
of a private plane involves a partnership in a personal asset that is not only
very expensive, but that also requires close cooperation in use, which is
suggestive of detailed planning indicative of a continuing, close personal
friendship. In fact, it is suggestive of the type of very close personal
relationship that, like family ties, one would expect to heavily influence a
human‘s ability to exercise impartial judgment. … Here, the facts support an
inference that Siminoff would not be able to act impartially when deciding
whether to move forward with a suit implicating a very close friend with whom
she and her husband co-own a private plane.
of a private plane involves a partnership in a personal asset that is not only
very expensive, but that also requires close cooperation in use, which is
suggestive of detailed planning indicative of a continuing, close personal
friendship. In fact, it is suggestive of the type of very close personal
relationship that, like family ties, one would expect to heavily influence a
human‘s ability to exercise impartial judgment. … Here, the facts support an
inference that Siminoff would not be able to act impartially when deciding
whether to move forward with a suit implicating a very close friend with whom
she and her husband co-own a private plane.
Second,
the Court was concerned with two other directors, who are partners with the
prominent venture capital firm, Kleiner Perkins Caufield & Byers, which
held not only 9.2% of Zynga’s equity as a result of being an early-stage
investor, but they also had other interlocking relationships with the
controlling shareholder as well as another shareholder of Zynga. Here, the Court
observed:
the Court was concerned with two other directors, who are partners with the
prominent venture capital firm, Kleiner Perkins Caufield & Byers, which
held not only 9.2% of Zynga’s equity as a result of being an early-stage
investor, but they also had other interlocking relationships with the
controlling shareholder as well as another shareholder of Zynga. Here, the Court
observed:
Although
it is true that entrepreneurs like the controller need access to venture
capital, it is also true that venture capitalists compete to fund the best
entrepreneurs and that these relationships can generate ongoing economic
opportunities. There is nothing wrong with that, as that is how commerce often
proceeds, but these relationships can give rise to human motivations
compromising the participants’ ability to act impartially toward each other on
a matter of material importance.
it is true that entrepreneurs like the controller need access to venture
capital, it is also true that venture capitalists compete to fund the best
entrepreneurs and that these relationships can generate ongoing economic
opportunities. There is nothing wrong with that, as that is how commerce often
proceeds, but these relationships can give rise to human motivations
compromising the participants’ ability to act impartially toward each other on
a matter of material importance.
Moreover,
the fact that the two venture capital directors were not shown as being
independent for the purposes of the listing requirements with NASDAQ also played
a role in the Court’s determination regarding their non-independence.
the fact that the two venture capital directors were not shown as being
independent for the purposes of the listing requirements with NASDAQ also played
a role in the Court’s determination regarding their non-independence.
The
fact that matters relating to definition of independence are tricky is evident
from the fact that the five-judge bench of the Delaware Supreme Court could not
arrive at a unanimous conclusion. One of the judges dissented and, in her
ruling, found that the above relationships were not so significant as to
impinge upon the independence of these directors. Calling this a “close case”,
she agreed with the Chancery judge in finding that matters such as co-ownership
of an asset “do not reveal a sufficiently deep personal connection to [the
controlling shareholder] so as to raise a reasonable doubt about [the
director’s] independence from [the controlling shareholder]”.
fact that matters relating to definition of independence are tricky is evident
from the fact that the five-judge bench of the Delaware Supreme Court could not
arrive at a unanimous conclusion. One of the judges dissented and, in her
ruling, found that the above relationships were not so significant as to
impinge upon the independence of these directors. Calling this a “close case”,
she agreed with the Chancery judge in finding that matters such as co-ownership
of an asset “do not reveal a sufficiently deep personal connection to [the
controlling shareholder] so as to raise a reasonable doubt about [the
director’s] independence from [the controlling shareholder]”.
This
decision is important
for a number of reasons. First, close personal relationships may be taken
into account by the Delaware courts while considering the independence of
directors. This they do on the basis of principles and guidance laid down in
judicial decisions. Of course, in a principles-based approach, the outcomes can
differ depending on the facts and circumstances of each case, thereby possibly
leading to some level of uncertainty. Second, the decision also bears
importance regarding directors who represent venture capital firms (or even
private equity firms) that may have invested a significant stake in the
company. Although in this case those directors had other relationships with the
controlling shareholder, the fact that a venture capital firm or private equity
firm may have a significant stake in the company could potentially itself
invoke the attention of the court as their interests may not always be concomitant
with the interests of the other minority shareholders.
decision is important
for a number of reasons. First, close personal relationships may be taken
into account by the Delaware courts while considering the independence of
directors. This they do on the basis of principles and guidance laid down in
judicial decisions. Of course, in a principles-based approach, the outcomes can
differ depending on the facts and circumstances of each case, thereby possibly
leading to some level of uncertainty. Second, the decision also bears
importance regarding directors who represent venture capital firms (or even
private equity firms) that may have invested a significant stake in the
company. Although in this case those directors had other relationships with the
controlling shareholder, the fact that a venture capital firm or private equity
firm may have a significant stake in the company could potentially itself
invoke the attention of the court as their interests may not always be concomitant
with the interests of the other minority shareholders.
While
this decision is significant from a Delaware perspective, its approach may not
be directly applicable in the Indian context. While Delaware jurisprudence on
board independence is based on a principles-based approach developed through
judicial rulings, the Indian approach is rules-based, as enshrined in the Companies
Act, 2013 and the regulations issued by the Securities and Exchange Board of
India. Nevertheless, developments in jurisdictions such as Delaware may provide
some guidance regarding the types of issues that could arise in board
independence. For example, personal relationships (that are not pecuniary in
nature) do not receive any attention under Indian law for determining board
independence. This is despite such relationships being a common feature in the
Indian business realm. Moreover, questions regarding the position and role of
directors nominated by financial investors such as private equity funds and
venture capital firms are quite common in India as well.
this decision is significant from a Delaware perspective, its approach may not
be directly applicable in the Indian context. While Delaware jurisprudence on
board independence is based on a principles-based approach developed through
judicial rulings, the Indian approach is rules-based, as enshrined in the Companies
Act, 2013 and the regulations issued by the Securities and Exchange Board of
India. Nevertheless, developments in jurisdictions such as Delaware may provide
some guidance regarding the types of issues that could arise in board
independence. For example, personal relationships (that are not pecuniary in
nature) do not receive any attention under Indian law for determining board
independence. This is despite such relationships being a common feature in the
Indian business realm. Moreover, questions regarding the position and role of
directors nominated by financial investors such as private equity funds and
venture capital firms are quite common in India as well.
Finally,
the Delaware Supreme Court’s decision in the present case may have a greater
bearing in the Indian context than other cases from that jurisdiction, since
the case involved a controlled company that is altogether common in the Indian
context. Here, as the court emphasizes, the independence of directors must be
judged both from the relationship with the company and with that of the
controlling shareholder. It would be useful to end with a quote from the
Delaware Supreme Court as to the influence of controlling shareholders in
companies with concentrated shareholding:
the Delaware Supreme Court’s decision in the present case may have a greater
bearing in the Indian context than other cases from that jurisdiction, since
the case involved a controlled company that is altogether common in the Indian
context. Here, as the court emphasizes, the independence of directors must be
judged both from the relationship with the company and with that of the
controlling shareholder. It would be useful to end with a quote from the
Delaware Supreme Court as to the influence of controlling shareholders in
companies with concentrated shareholding:
In
the case of a company like Zynga, which has a controlling stockholder, Pincus,
who wields 61% of the voting power, if a director cannot be presumed capable of
acting independently because the director derives material benefits from her
relationship with the company that could weigh on her mind in considering an
issue before the board, she necessarily cannot be presumed capable of acting
independently of the company‘s controlling stockholder. That a director sits on
a controlled company pleading stage, as that would make the question of
independence tautological. But, our courts cannot blind themselves to that
reality when considering whether a director on a controlled company board has
other ties to the controller beyond her relationship at the controlled company.
the case of a company like Zynga, which has a controlling stockholder, Pincus,
who wields 61% of the voting power, if a director cannot be presumed capable of
acting independently because the director derives material benefits from her
relationship with the company that could weigh on her mind in considering an
issue before the board, she necessarily cannot be presumed capable of acting
independently of the company‘s controlling stockholder. That a director sits on
a controlled company pleading stage, as that would make the question of
independence tautological. But, our courts cannot blind themselves to that
reality when considering whether a director on a controlled company board has
other ties to the controller beyond her relationship at the controlled company.
Such a
statement cannot be truer in the Indian context where the influence of
controlling shareholders in Indian companies continues to be quite strong, as
we have witnessed
more recently.
statement cannot be truer in the Indian context where the influence of
controlling shareholders in Indian companies continues to be quite strong, as
we have witnessed
more recently.
