Nevada
vs. Delaware
The Latest
Research!
This research will review the accuracy of the
claims made in the "Nevada vs. Delaware" reported on many
web sites in our industry. The issues will be discussed in the order
presented in the report. Specifically, there are five areas wherein
it is asserted that a specific act would be protected under Nevada law,
but that a corporate director or officer would be exposed to liability
in Delaware. Research reveals that the report is quite accurate.
ACTS OR OMISSIONS NOT IN GOOD
FAITH
Before it was amended effective June 15, 2001,
Nevada Revised Statutes (NRS) 78.037(1) allowed a Nevada corporation's
articles of incorporation to contain:
A provision eliminating or limiting the personal
liability of a director or officeholder to the corporation or its
stockholders for damages for breach of fiduciary duty as a director
or officer[.]
However, such protection was prohibited for "[a]cts
or omissions which involve intentional misconduct, fraud or a knowing
violation of law[.]" NRS 78.037(1)(a). [Repealed as of 6/15/01;
the current version of NRS 78.037 allows corporate articles to contain
any provision not prohibited by law.]
Prior to the change, this section was discussed
in David Mace Roberts & Rob Pivnick, "Tale of the Corporate
Tape: Delaware, Nevada and Texas," 52 Baylor L. Rev. 45 (2000).
They wrote:
Without doubt on this subject, Nevada is more
director and officer friendly than either Delaware or Texas . . .
.
The NRS seems to imply that a limitation
of liability statement may exculpate directors for a breach of
the duty of loyalty, acts not in good faith, and receiving
improper benefits. If true, directors may act contrary to the interests
of the corporation by receiving improper benefits or otherwise
act in bad faith, without vicarious liability, if the articles
of incorporation eliminate director liability for such acts.
Id. at 51 (footnotes omitted)(emphasis added).
Concurrent with the change to NRS 78.037 came
an amendment to NRS 78.138. Effective June 15, 2001, a subsection (7)
was added to the statute:
[A] director or officer is not individually
liable to the corporation or its stockholders for any damages as a
result of any act or failure to act in his capacity as a director
or officer unless it is proven that:
(a) His act or failure to act constituted a
breach of his fiduciary duties as a director or officer; and
(b) His breach of those duties involved intentional
misconduct, fraud or a knowing violation of law.
This subsection, in effect, gives all directors
and officers of Nevada corporations the protection that the former NRS
78.037(1) merely allowed corporations to include in their articles.
In other words, all Nevada corporations now have a limitation of
liability statement for directors and officers imposed by law. And,
this protection includes acts not in good faith, since NRS 78.138(7)tracks
the language of the former NRS 78.037(1).
With these amendments, there no longer exists
in Nevada corporations which have limitation of liability statements
and corporations which do not.
In Delaware, such is not the
case.
When a Delaware corporation's articles of incorporation
do not contain a limitation of liability statement, the protection provided
for directors from personal liability is the business judgment rule.
"As a substantive rule of law, the business judgment rule provides
that there is no liability for an injury or loss to the corporation
arising from corporate action when the directors, in authorizing such
action, proceeded in good faith and with appropriate care."
Rodman Ward, Jr., Edward P. Welch & Andrew J. Turezyn, Folk on
the Delaware General Corporation Law, 4th ed. (Aspen Law & Business,
2002), Vol. I, § 141.2.2.2 at GCL-TV-33 (emphasis added). See
also Roberts & Pivnick, supra, at 48 (Directors of Delaware
corporations must act in good faith to invoke the protection of the
business judgment rule, citing Smith v. Van Gorkom, 488 A.2d
858 (Del. 1985) and Aronson v. Lewis, 473 A.2d 805 (Del. 1984)).
(As discussed previously, the standard of liability under the business
judgment rule is "gross negligence." See Roberts &
Pivnick, supra, at 48; Ward, et al., supra,
§ 141.2.2.4 at GCL-IV-35.)
This being the case, an act of a Delaware corporate
director not in good faith which rises to the level of "gross negligence"
can lead to personal liability, if the corporation has no limitation
of liability statement in its articles. When such a statement does exist,
acts not in good faith are still not protected.
The Delaware General Corporation Law (GCL) is
codified at Del. Code Ann. title 8. GCL § 102(b)(7) was added to
the law in 1986. Ward, et al., supra, § 102.15 at
GCL-I-27. This section, which covers only directors, allows a provision
in the articles of incorporation:
[E]liminating or limiting the personal liability
of a director to the corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director, provided that
such provision shall not eliminate or limit the liability of a director:
(i) For any breach of the director's duty of loyalty to the corporation
or its stockholders; (ii) for acts or omissions not in good faith
or which involve intentional misconduct or a knowing violation of
law; (iii) under § 174 of this title; or (iv) for any transaction
from which the director derived an improper personal benefit. No such
provision shall eliminate or limit the liability of a director for
any act or omission occurring prior to the date when such provision
becomes effective.
GCL § 102(b)(7) (emphasis added).
The legislative commentary states that §
102(b)(7) "makes clear that no such provision shall eliminate or
limit the liability of a director for . . . failing to act in good faith[.]"
S. 533, 133d Gen. Assembly 2, 65 Del. Laws ch. 289, §§ 1-2
(1986)(quoted in Ward, et al., supra, § 102.15 at GCL-1-27 n. 56).
Delaware statute quoted above
treats intentional acts of misconduct and knowing violations of law
as different from acts or omissions not in good faith.
It is noteworthy to mention that section (ii)
of the Delaware statute quoted above treats intentional acts of misconduct
and knowing violations of law as different from acts or omissions
not in good faith. This bolsters the interpretation of NRS 78.138(7)
above, as under that statute a Nevada director is only liable for breaches
of fiduciary duty which involve intentional misconduct, fraud, or knowing
violations of law. Thus, such acts are not acts "not in good faith."
Thus, in Delaware, under no circumstance is a
director protected for acts not in good faith. However, in Nevada, such
acts are protected, either by a limitation of liability statement found
in the articles of incorporation prior to June 15, 2001, or by NRS 78.138(7)
since that date. Therefore, on the issue of corporate director acts
not in good faith, Nevada law provides protection not found in Delaware
law.
ACTS BY OFFICERS EXEMPT FROM MONETARY
DAMAGES
Under the former NRS 78.037(1), a limitation of
liability statement in the articles of incorporation could include officers
as well as directors. This made Nevada one of only six states to have
such laws cover officers as well as directors. (The other five states
are Louisiana, Maryland, New Hampshire, New Jersey, and Virginia.) See
Clarence E. Hagglund, Britton D. Weimer & Joseph P. Monteleone,
D & 0: Directors & Officers Liability: Guide to Risk Exposure
and Coverage (The National Underwriter Co., 1999), at 9.
With the recent changes to Nevada's corporate
laws, a limitation of liability statement is no longer needed for officers
or directors, as NRS 78.138(7) covers both. To repeat, this section,
applicable since June 15, 2001, is a statutorily-imposed limitation
of liability statement for officers and directors. Only acts of intentional
misconduct, fraud, prior a knowing violation of law will lead to an
officer's (or director's) liability.
With the recent changes to Nevada's
corporate laws, a limitation of liability statement is no longer needed
for officers or directors
Protection for officers in Delaware corporations
is nearly non-existent. GCL § 102(b)(7), which allows limitation
of liability statements in the articles of Delaware corporations, applies
on its face to directors only. See Ward, et al.,
supra, § 102.15 at GCL-I-32.1 ("Section 102(b)(7) exempts
only directors from liability").
Protection for officers in Delaware
corporations is nearly non-existent.
When a director is not protected by a limitation
of liability statement in the articles, he can still find solace in
the business judgment rule. Not so for officers of Delaware corporations.
"Some states extend the business judgment rule to officers as well
as directors, limiting officers' liability to gross negligence."
Hagglund, et al., supra, at 8 (citing cases from
Ohio, Minnesota, Washington, and Illinois. See at 17 n. 37).
"Most jurisdictions, though, have not addressed the application
of the business judgment rule to officers. The reason for this is unclear[.]
. . . In any event, it is prudent for officers to assume that they will
have exposure for ordinary negligence." Id. at 9.
As can be seen, Nevada corporate law provides
substantial protection for corporate officers from monetary damages.
Conversely, Delaware provides little to no protection for officers.
On this issue, Nevada law is superior.
Delaware provides little to no
protection for officers. On this issue, Nevada law is superior.
BREACH OF A DIRECTOR'S DUTY OF LOYALTY
Under the former NRS 78.037(1), a limitation of
liability statement in a Nevada corporation's articles of incorporation
protected directors from personal liability except in cases of intentional
misconduct, fraud, or a knowing violation of law. As previously stated,
this protection has now been codified at NRS 78.138(7), thus giving
all Nevada directors a limitation of liability statement as a matter
of law.
In reviewing the "intentional conduct, fraud,
or a knowing violation of law" language of the former NRS 78.037(1),
Roberts & Pivnick, supra, stated that this "seems to
imply that a limitation of liability statement may exculpate directors
for a breach of the duty of loyalty[.]" Id. at 51. Their conclusion
is sound, given the language of the statute. Since NRS 78.138(7) mirrors
the language of the former NRS 78.037(1), their conclusion is equally
applicable to the new statute. Thus, Nevada laws appear to protect Nevada
corporate directors from breaches of the duty of loyalty. Delaware law
does not follow suit.
Thus, Nevada laws appear to protect
Nevada corporate directors from breaches of the duty of loyalty. Delaware
law does not follow suit.
In Delaware corporations wherein the articles
include a limitation of liability statement, the limits of GCL §
102(b)(7) come into play. This section reads, in pertinent part, that
a limitation of liability
provision shall not eliminate or limit the liability
of a director: (i) for any breach of the director's duty of loyalty
to the corporation or its stockholders[.]
The courts in Delaware have construed this section
literally, holding that a limitation of liability statement in a Delaware
corporation's articles pursuant to § 102(b)(7) shields directors
from breaches of the duty of care (i.e., for acts of "gross negligence"),
but not for breaches of the duty of loyalty. See Emerald Partners
v. Berlin, 787 A.2d 85, 90 (Del. 2001); Graham v. Taylor Capital
Group, 91 F. Supp.2d 706, 732 (D. Del. 2000). "A breach of
loyalty claim requires some form of self-dealing or misuse of corporate
office for personal gain." Id. at 732.
Where a corporation's articles do not include
a limitation of liability statement, and thus §102(b)(7) is inapplicable,
the only protection available for Delaware directors is the business
judgment rule. However, this rule does not protect directors who
breach their duty of loyalty.
Under Smith v. Van Corkom, 488 A.2d 858
(Del. 1985), the fiduciary duties of directors include a duty of care
and a duty of loyalty. Id. at 872-73. This latter duty has been
described as follows:
The duty of loyalty is a broad and encompassing
duty that, in appropriate circumstances, is capable of impressing
a special obligation upon a director in any of his relationships with
the corporation. This duty of loyalty embodies both an affirmative
duty to protect the interests of the corporation and an obligation
to refrain from conduct that would injure the corporation and its
stockholders or deprive them of profit or advantage. In other words,
directors must eschew any conflict between duty and self-interest.
Ward, et al., supra, §
141.2.1.1 at GCL-IV-18.
In Delaware, a breach of the duty of loyalty is
not protected by the business judgment rule. See, e.g.,
Smith, supra; Cede & Co. v. Technicolor, Inc.,
634 A.2d 345 (Del. 1993); In re TriStar Pictures Litigation,
634 A.2d 319 (Del. 1993).
Thus, on this issue once again, Nevada law provides
more protection for directors than does the law of Delaware.
TRANSACTIONS INVOLVING UNDISCLOSED PERSONAL BENEFIT TO A DIRECTOR
This issue is closely related to the issue of
the duty of loyalty just reviewed. In Delaware, interested director
transactions are allowed and are valid if 1) there is good faith approval
by a majority of disinterested directors upon full disclosure; 2) there
is approval by shareholders after full disclosure (interested shareholder
votes do not count); or 3) the transaction is fair and either approved
or ratified by the directors or shareholders. GCL § 144(a). Nevada
law is similar. See NRS 78.140. These statutes involve disclosed
transactions. When an undisclosed transaction occurs, the two states
differ.
In Nevada, the former NRS 78.037(1) allowed limitation
of liability statements in corporate articles, except for acts or omissions
involving either intentional misconduct, fraud, or a knowing violation
of law. As interpreted by Roberts & Pivnick, supra, this
seemed "to imply that a limitation of liability statement may exculpate
directors for . . . receiving improper benefits." Id. at
51 (citing Keith Paul Bishop, "The Delaware of the West: Does Nevada
Offer Better Treatment for Directors?," 7 no. 3 Insights 20, 23
(Mar. 1993)).
Once again, since the new NRS 78.138(7) codifies
the limitation of liability statement as a matter of law for Nevada
corporate directors, the same conclusion still pertains. That is, Nevada
corporate directors are apparently protected in situations involving
transactions wherein they receive undisclosed personal benefits. This
is not the case in Delaware.
Nevada corporate directors are
apparently protected in situations involving transactions wherein they
receive undisclosed personal benefits.
This is not the case in Delaware
Undisclosed personal benefits to a Delaware director
is an issue of the duty of loyalty. (See the previous section,
especially the quotes from Graham v. Taylor Capital and Ward,
et al.) As such, Delaware law does not protect them, either
in situations involving GCL § 102(b)(7) or under the business judgment
rule.
Even beyond this, in cases involving director
interest in a corporate transaction, the business judgment rule is inapplicable,
and the director has the burden of proving the transaction is "fair."
If he cannot do so, he is liable. See Ward, et al.,
supra, § 141.2.3. at GCL-IV-48 to 51; AC Acquisitions
Corp. v. Anderson, Clayton & Co., 519 A.2d 103 (Del. 1986).
The director's only hope is to disclose the transaction, and come within
the terms of GCL § 144(a), supra. If he does so, the business judgment
rule applies, unless the transaction rises to the level of disloyalty
to the corporation. See Cede & Co. v. Technicolor, Inc.,
634 A.2d 345 (Del. 1993).
On the issue of undisclosed personal
benefits to corporate directors, Nevada law appears to provide protection,
whereas Delaware law clearly provides none.
ACTS OR OMMISSIONS OCCURRING PRIOR
TO STATUTORY INDEMNIFICATION
Both Nevada and Delaware allow for the indemnification
of corporate directors for acts performed in good faith and with a reasonable
belief that the act was in the best interest of the corporation. See
NRS 78.7502; GCL § 145. However, as stated by Roberts & Pivnick,
supra, at 52, "[t]he battle of director friendly indemnification
laws goes to Nevada, with . . .Delaware struggling to get out of the
starting gate . . . . Nevada allows corporations to provide broad indemnification
to their directors and officers . . . . Delaware's indemnification provisions
are comparatively narrow." The reason for this conclusion is NRS
78.752, which allows a corporation to make "other financial arrangements"
on behalf of its directors, beyond the maintenance of insurance. "As
such, greater protection for directors is possible." Roberts &
Pivnick, supra, at 52.
The battle of director friendly
indemnification laws goes to Nevada, with Delaware struggling to get
out of the starting gate!
However, there is nothing in the indemnification
statute in Delaware which states that indemnification is not available
for an act or omission which occurred prior to the date the statute
was created. Perhaps there is some confusion on this issue because of
GCL § 102(b)(7), which allows Delaware corporations to have an
article provision limiting or eliminating director liability in certain
situations. This section states, in part:
No such provision shall eliminate or limit the
liability of a director for any act or omission occurring prior to
the date when such provision becomes effective.
In other words, in Delaware, a § 102(b)(7)
provision which is created after an act or omission occurs provides
no help to a director, whose only defense would then be the business
judgment rule. In such a situation, liability follows if "gross
negligence" is found. (When such a provision pre-dates the act
or omission, the director is exempt from breaches of the duty of care,
i.e., from acts of "gross negligence.") However, this has
nothing to do with "indemnification," which is a completely
separate issue.
CONCLUSION
On the above issues, as argued in the report entitled
"Nevada vs. Delaware," Nevada law provides much more protection
for directors and officers than does Delaware law. As stated by Roberts
& Pivnick, supra:
[B]ecause Delaware's laws are designed to protect
the rights of minority shareholders in large corporations, it has
found itself in a difficult position regarding closely held companies.
This may have come at the expense of protecting the directors and
officers of Delaware corporations . ...
Nevada is striving on an ongoing basis to challenge Delaware as the
state of choice for incorporation. In this vein, Nevada has adopted
statutes that are more director friendly and anti-takeover favorable
than Delaware's.
Id. at 46-47 (quotation marks and citation omitted).
- This research
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can apply its own law regarding piercing an entity to so-called "pseudo-foreign" corporations.
Which State to Incorporate In?