Corporate Governance

Delaware Courts and the [Non-] Duties of Directors: Pfeffer v. Redstone

By J. Robert Brown

We have today a student post on Pfeffer v. Redstone, 2008 Del. Ch. LEXIS 12, a case involving Viacom's divestiture of its ownership of Blockbuster.  The central issue in the case was the decision by the board of Blockbuster (including approval by a special committee of independent directors) and the board of Viacom to authorize a cash dividend by Blockbuster of $5 a share, costing the company $905 million, most of which ($738 million) would go to Viacom.  The dividend would be paid with borrowed funds. 

The suit alleged that the company failed to disclose internal analysis indicating that the payment of the dividend would impair Blockbuster's ability to achieve planned initiative.  According to the opinion: 

• this analysis concluded that the proposed special dividend would prevent Blockbuster from funding its planned initiatives. Allegedly, this report also concluded that some of Blockbuster's strategic plans, such as its online subscription program and the elimination of late fees, would be unprofitable. The plaintiff alleges that when the cash flow analysis was distributed to senior management at Blockbuster, the Senior Vice President of Investor Relations and Treasurer of Blockbuster told employees to disregard it.

Ultimately the court dismissed the case because, on a motion to dismiss, plaintiff could not demonstrate that the information had been transmitted to the board of Viacom or Blockbuster.  Moreover, there was little or no likelihood that the boards would otherwise be aware of this information.  As the court noted:  "By contrast, directors are not as a matter of general experience presumed to know business operational information that is not of a kind routinely disclosed to boards of directors. For example, it would be at odds with what is known of how large public corporations run their affairs to expect directors to have knowledge of studies prepared by staff that are not presented to them for some purpose."

In other words, the court treats internal evidence that the dividend might impair future operations as ordinary "operations information not of a kind routinely disclosed to boards of directors."  But that entirely ignores the board's duty with respect to a non-ordinary transaction like the dividend.  In those circumstances, it would be very reasonable to expect a board to request information on any harmful consequences that might result from the transaction.  This was particularly given speculation by the press about the difficulties likely to befall the video industry. 

Had the court allowed the case to go forward, it might have turned out that the board fulfilled its duties to be informed and still did not learn of the internal reports.  But by cutting the case off at a motion to dismiss, the court is essentially concluding that boards do not have an obligation to ask about adverse information when approving a significant transaction. 

Is it any wonder that Congress had to step in and adopt SOX, imposing on companies an obligation to create internal controls (with deficiencies reported to the board) and to have audit committees with predetermined duties?  A decision like Pfeffer shows that there is plenty of additional room for federal involvement in defining the duties of directors. 

Full post as published by The Race to the Bottom on March 01, 2008 (boomark / email).