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Chancery Dismisses Part of Fiduciary Claim that Sought Removal of Director Based on Inherent Equitable Power of Court

By Francis Pileggi

Shocking Technologies, Inc. v. Michael, C. A. No. 7164-VCN (Del. Ch. April 10, 2012).

Issue Addressed: Whether the Court of Chancery has the inherent authority to remove a director for breach of fiduciary duty, other than via DGCL Section 225? 

Short answer:  The issue was not directly decided, but based on the facts of this case, the Court was not inclined to exercise such an inherent power, if such a power exists, prior to the expedited trial.

Overview

This delightfully short letter ruling discusses an issue that is of widespread interest and importance. DGCL Section 225 specifies exactly how one can seek the removal of a director for a breach of fiduciary duty and under what circumstances. The issue discussed in this decision was whether the Court of Chancery has the inherent power to remove a director, outside the confines of Section 225, based on a general or generic breach of fiduciary duty claim.  Section 225(c) provides in pertinent part that:

If 1 or more directors has been convicted of a felony in connection with the duties of such director or directors to the corporation, or if there has been a prior judgment on the merits by a court of competent jurisdiction that 1 or more directors has committed a breach of the duty of loyalty in connection with the duties of such director or directors to that corporation, then, upon application by the corporation, . . . in a subsequent action brought for such purpose, the Court of Chancery may remove from office such director or directors if the Court determines that the director or directors did not act in good faith in performing the acts resulting in the prior conviction or judgment and judicial removal is necessary to avoid irreparable harm to the corporation.

The primary claims in this case are that a director, whose last name is Michael, allegedly breached his fiduciary duties by interfering with the efforts of the company to raise additional capital, supposedly in order to enable him to gain greater authority over the company, and to increase his investment at a lower price. The funds are needed for the company to survive and based on the colorable claims, the Court scheduled an expedited trial of limited scope for next week.

 The remedy sought is removal of Michael from the board–but not via Section 225. Instead, the plaintiff, an entity named Shocking, relies on what it describes as the Court’s inherent equitable powers. In response, Michael argues that Section 225(c) is the only means by which the Court may remove a particular director, and because there has been no prior judgment on the merits concluding that Michael breached his fiduciary duties, the prerequisites of Section 225 for removal cannot be satisfied. See footnote 5 for citations to cases, commentary and legislative history on whether the Court has authority to remove a director outside the procedures provided in Section 225.

The Court determined that even if it did have an inherent equitable power of removal outside of Section 225 (which it did not decide), the circumstances of this case would not move it to exercise that power. Nonetheless, the Court ruled that if the plaintiff prevails at trial and Michael is found to have violated his fiduciary duty, it is possible that such a judgment could serve as a basis for a Section 225(c) action to remove him.

Full post as published by Delaware Corporate and Commercial Litigation Blog on April 11, 2012 (boomark / email).