Independent directors of companies with substantial assets outside the U.S. should carefully consider whether they have the genuine ability to discharge their duties, given a recent ruling from the Delaware Chancery Court.

On February 6, Chancellor Leo Strine, Jr., of the Delaware Court of Chancery refused to dismiss a claim for breach of fiduciary duty against independent directors of Puda Coal Inc., a Delaware corporation whose primary assets and operations are in China. Plaintiffs alleged that the independent directors had failed to detect the unauthorized sale of the company’s assets by its chairman.

In In Re Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS (Del. Ch. Feb. 6, 2013) (Bench Ruling), Chancellor Strine bluntly reminded independent directors that they must be capable of fulfilling their fiduciary duty of oversight, no matter where the company’s assets or operations are located. Among his many forthright comments:

  • “[I]f you’re going to have a company domiciled for purposes of its relations with its investors in Delaware and the assets and operations of that company are situated in China … in order for you to meet your obligation of good faith, you better have your physical body in China an awful lot. You better have in place a system of controls to make sure that you know that you actually own the assets. You better have the language skills to navigate the environment in which the company is operating. You better have retained accountants and lawyers who are fit to the task of maintaining a system of controls over a public company.”
  • “Independent directors who step into these situations involving essentially the fiduciary oversight of assets in other parts of the world have a duty not to be dummy directors … [I]f the assets are in Russia, if they’re in Nigeria, if they’re in the Middle East, if they’re in China, that you’re not going to be able to sit in your home in the U.S. and do a conference call four times a year and discharge your duty of loyalty. That won’t cut it.” 
  • “There’s no such thing as being a dummy director in Delaware, a shill, someone who just puts themselves up and represents to the investing public that they’re a monitor.”

Strine stressed that the only reason to have independent directors is because of their independence and their ability to monitor the company’s management. He commented that if the flow of information was in a language that the director doesn’t understand, in a culture where the legal and ethical standards may be different from in the U.S., this could be “very difficult... You better be careful there. You have a duty to think. You can’t just go on this [board] and act like this was an S&L regulated by the federal government in Iowa and you live in Iowa”.

Strine also had a message for independent directors who, like the independent directors of Puda Coal, thought they could avoid responsibility by resigning. He suggested that the act of resignation itself could be a breach of fiduciary duty. “And that’s another reason for sustaining the complaint.”