Corporate Governance

Interlocking Directors and the Failure of Fiduciary Duties (Part 1)

By J Robert Brown Jr.

Directors have fiduciary obligations.  If these duties have any meaning, it is that officers and directors cannot compete with the same business.  See Brown v. Fenimore, 1977 Del. Ch. LEXIS 189 (Del. Ch. 1977)("A similar rule applies to corporate officers and directors who engage in competition with the corporation at the expense of the corporation,"). 

Indeed, Section 144 specifically applies to any contract or transaction between corporations with interlocking directors.  See Del. C. § 144 (2010)(applying to contracts or transactions "between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers,"). 

Directors in these circumstances would likely find themselves in contradictory positions.  Any number of decisions made at the board level of one company could have a deterimental effect on the other.   One would think this would result in a policy to exclude from the board persons who serve as directors on competing companies.

Yet in fact this is apparently not the case.  Fiduciary obligations have not been sufficiently robust to ensure that this inherent conflict does not arise.  Shareholders objecting to the arrangement have had to result to legal requirements contained not in a board's fiduciary obligations but in the antitrust laws. 

In Robert F. Booth Trust v. Crowley, shareholders of Sears challenged the composition of the board, alleging that two of the directors also sat on the boards of competitors.  Specifically, the shareholders asserted that the directors violated Section 8 of the Clayton Act, a federal antitrust statute adopted back in 1914.  The provision prohibits interlocking directors for corporations above a certain size threshhold.  As the provision provides:

• No person shall, at the same time, serve as a director or officer in any two corporations . . . that are . . . competitors, so that the elimination of competition by agreement between them would constitute a violation of any of the antitrust laws.  . . [,] if each of the corporations has capital, surplus, and undivided profits aggregating more than $10,000,000 . . . . [unless] (A) the competitive sales of either corporation are less than [$26,161,000.00 as of January 13, 2009]; (B) the competitive sales of either corporation are less than 2 per centum of that corporation's total sales; or (C) the competitive sales of each corporation are less than 4 per centum of that corporation's total sales.

15 U.S.C. § 19(a)(1) & (2). 

According to the complaint: 

• Two of the directors of Sears – Ann N. Reese ('Reese') and William C. Crowley ('Crowley') – are 'interlocking' directors within the meaning of Section 8. Reese is Chair of the Audit Committee of the Sears board and also sits on the board of Jones Apparel Group, Inc. ('Jones Apparel'), a competitor of Sears in the area of women's clothing and accessories, men's clothing, and women's and children's shoes. Crowley is a member of the Finance Committee of the Sears board and also sits on the boards of AutoZone, Inc. ('AutoZone'), a competitor of Sears in the area of automotive replacement parts and accessories, and AutoNation, Inc. ('AutoNation'), a competitor of Sears in the area of auto service and repair.

The complaint asserted that both Jones Apparel and AutoNation competed with Sears.  

Two of the claims were for violations of the Clayton Act.  The third alleged violations of the board's fiduciary obligations.  Among other things, shareholders asserted that the board "had a fiduciary duty to, among other things, exercise good faith to ensure that Sears was operated in a diligent, honest and prudent manner and complied with all applicable federal laws."  They violated this duty by nominating the two directors "for re-election to the Sears Board and recommend[ing] that shareholders vote in favor of their re-election," causing a violation of the Clayton Act. 

We will discuss the outcome in the next post.  The primary materials are posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on June 11, 2010 (boomark / email).