Throwing Grenades and Casting Plagues Upon Your Fellow Directors: A Lesson in Fiduciary (Ir)responsibility
March 04, 2019
This week’s post is by Matthew D. Donovan, a commercial litigation partner and member of Farrell Fritz’s business divorce practice group.
There is a bit of folk wisdom that’s been passed down through my family over the generations that speaks to the rite of passage when one is confronted with the reality that there is more to life than oneself. The familial adage, as usually (and colorfully) pronounced by a superior elder, went something like: “The sun doesn’t rise and set over your own Irish arse!”
I must confess that I’ve often considered this as a kind of vernacular anchor to understanding the concept of fiduciary responsibility in the closely-held business context where officers, directors, and controlling shareholders are obligated under the law to put the interests of their company and business partners before their own. A recent post-trial decision out of Delaware’s Court of Chancery, Personal Touch Holding Corp. v Glaubach, brings home this lesson with similar colloquial color.
Not infrequent is the occasion on which we here at New York Business Divorce report on developments in Delaware law. As we have noted, Delaware has long been the preferred state of incorporation for both public and private companies, and its Court of Chancery is considered by many to be the preeminent business court in the land. Small wonder, then, that the Personal Touch decision serves as a kind of archetypal example of how not to behave in the corporate fiduciary context.
By Way of a Little Background
The Personal Touch saga involved a “wide-ranging mishmash of issues” among the founding shareholders and directors of a Long Island-based provider of home healthcare services organized as a Delaware corporation. The company was co-founded in 1974 by defendant Felix Glaubach and non-party Robert Marx. Glaubach and Marx were equal partners in the business until 2010 when they expanded the company’s ownership and board of directors through the establishment of an ESOP and the preparation of formal shareholder and employment agreements.
Management tensions between Glaubach on the one hand, and Marx and the rest of the board members on the other, began to mount in or around 2013-14 when the company entered into negotiations to purchase an office building next door to its Queens location. After the seller temporarily pulled out, Glaubach picked up the negotiations on his own with an eye toward purchasing the building for himself. He did so secretly, going so far as to hire a full time “Assistant to the President” on the company’s dime to meet off-site and communicate through a personal Gmail account so as to avoid what Glaubach dubbed “a lot of blabbermouths” in the office. After closing on the purchase of the building, Glaubach announced the acquisition at a board meeting and offered to lease office space to the company.
The tensions reached a flashpoint, both figuratively and literally, when Glaubach sent a “bombshell” of a letter to the board à la Émile Zola, accusing Marx and his fellow board members of an “historic pattern of misappropriation of funds and sexual misconduct.” A month later, Glaubach instructed an employee to hang a painting of a “red, jewel-encrusted hand grenade” outside Marx’s office in the lobby of the company’s corporate headquarters. Glaubach told the employee that “‘there is an explosive situation’ within the Company and that ‘he d[id] not know when it [wa]s going to blow up.’”
Glaubach threw the first litigation grenade in March 2015 when he brought a derivative action against Marx and the other directors in a New York court, alleging that they engaged in a “continuing education expense scandal” by which they mischaracterized hundreds of thousands of dollars in bonus compensation as reimbursements for professional continuing education classes they never took.
Three months later, Marx and the other directors reciprocated in the Court of Chancery, alleging that Glaubach breached his fiduciary duty to the company primarily by usurping a corporate opportunity vis-à-vis his purchase of the Queens office building. But the company later amended its complaint to include allegations concerning, among other things, a “campaign” of letter-writing harassment against Marx, the other directors, and their spouses. The letters threatened criminal prosecution, imprisonment, and even condemnation – of biblical proportion, no less.
Two letters in particular indicted their recipients as “sinners” and forewarned of eternal damnation:
To all sinners BLOOD was the first plague, nine to follow, repent before it’s too late.
Who in your family is going to be stricken next as a result of your sins? REPENT BEFORE IT’S TOO LATE!
The parties eventually proceeded to a four-day trial in June 2018, which resulted in the findings of fact and conclusions of law set forth in an 85-page opinion by Chancellor Bouchard. There is much in the Personal Touch decision to appreciate and digest, but the Chancery Court’s findings and conclusions concerning the fiduciary implications of Glaubach’s “campaign of harassment” are worth a closer look.
The Novelty of Glaubach’s Fiduciary Breaches
The Chancery Court addressed what it called a “novel argument” concerning fiduciary breach – namely, whether Glaubach’s so-called “campaign of harassment” against his fellow board members and their spouses actually constituted a fiduciary breach of loyalty to the company. The Court found the argument novel “because in most cases this type of behavior is often dealt with in the criminal courts as harassment or witness tampering.”
So what type of behavior was the Court dealing with in Personal Touch? Here’s a taste:
Glaubach orchestrated sending over fifty letters anonymously to at least sixteen different individuals associated with the Company, including all of the other Board members, numerous Company officers and employees, outside counsel, and even some of their spouses. The letters were addressed to the recipients’ homes; contained biblical references and disturbing images; suggested that the recipients were guilty of crimes, infidelity, and other offenses; and plainly were intended to provoke anxiety when they were opened.
Two of Glaubach’s letters are referenced above. Another was sent to Marx’s wife, notifying her of his “sexual indiscretions.” Still others were addressed to the company’s lawyers and auditors containing additional biblical admonishments complete with a “picture of a noose.” The Court made certain to note that Glaubach achieved his provocative goals in sending the letters, recounting from the evidence that the recipients were left “crying,” “frightened,” and “distress[ed]” after receiving the threatening missives at their own homes.
Reprehensible stuff to be sure. But one might be compelled nonetheless to ask how this behavior amounts to a breach of fiduciary duty to the company? It’s one thing to snatch a real estate transaction out from under the nose of the company of which you’re the acting President – which, by the way, wasn’t lost on the Chancery Court:
Glaubach was acutely aware of the value the opportunity to acquire the Building presented to the Company because of the building’s unique location and, instead of looking out for the interests of Personal Touch, he secretly thwarted its ability to take advantage of that opportunity so that he could profit personally by acquiring the building of for himself.
But what’s the link between Glaubach’s campaign of personal animus towards his fellow board members and the business of the company?
As one might imagine, the case law in Delaware concerning fiduciary breach is legion. Given the novelty of the issue, however, and having been given no cases directly on point to rely upon, Chancellor Bouchard drew on several precedents to compile what he called “first principles” of fiduciary duty:
Directors of a Delaware corporation owe two fiduciary duties — care and loyalty. Broadly speaking, the duty of loyalty mandates that the best interest of the corporation and its shareholders takes precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the stockholders generally. The duty of loyalty includes a requirement to act in good faith. To act in good faith, a director must act at all times with an honesty of purpose and in the best interests and welfare of the corporation. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation.
Applying these principles, the Court connected the dots between Glaubach’s hostilities and the company, reasoning that Glaubach’s conduct was “inexplicable as anything but an act of bad faith”; that such acts were meant to “harass and annoy the entire management structure of the Company”; and that such harassment resulted in “hurt morale” and “an enormous distraction of time and resources to the detriment of the Company.” In sum, the Court concluded that by engaging in a campaign of anonymous letter-writing harassment, “Glaubach exalted his own personal interests while serving as a fiduciary of the Company above the best interests of Personal Touch and thus acted in bad faith in breach of his duty of loyalty.”
One other curious point of interest here. Marx’s and the other directors’ claims regarding Glaubach’s harassment-related breaches, which they presumably prosecuted and tried with unceasing vigor and at significant company expense, were for declaratory relief only. I guess it’s fair to say that when internal disputes over the management of a closely-held business rise to the level of throwing grenades and casting biblical plagues, it becomes a matter of principle.