Private Equity

Members of the Board of a Delaware corporation owe fiduciary duties to the corporation and all of the corporation’s shareholders. This is true even for a board member that was appointed to the Board on behalf of only one particular shareholder pursuant to some contractual right. Sometimes, in the exercise of those fiduciary duties, a member of the Board disagrees with the direction that a majority of the Board is taking the corporation. But as Vice Chancellor Laster notes in Hyde Park Venture Partners Fund III, L.P. v. FairXchange, LLC, 2023 WL 2417273 (Del. Ch. March 9, 2023), the majority of directors and the corporation’s counsel cannot, in the absence of a lawfully recognized process, simply exclude the dissenting board member from the flow of information to which all the board members are entitled.

In Hyde Park Ventures, a third party, Coinbase Global, Inc., made an unsolicited offer to acquire a private company, FairXchange, Inc. One of the FairXchange’s three directors, Weiss, was a partner in a venture capital firm whose Hyde Park Venture Partners Fund III, LP, and its affiliate, had invested in (and collectively owned approximately 15% of) the company. Weiss believed that the best course of action in response to the unsolicited offer was to hire an investment banker in order to make a more informed decision as to whether this was the right time to sell and what was the fair value of the company. The other two directors believed that the best course of action was to pursue the unsolicited offer exclusively.

Weiss made clear at a board meeting held to consider the unsolicited offer that he would not vote in favor of that offer and would instruct the Hyde Park funds to do the same, unless a process was followed that included the retention of an investment banker. The other two directors determined to continue to pursue the negotiation of the Coinbase offer and allegedly began excluding Weiss from the process. Because Coinbase apparently desired a unanimous recommendation from the Board as part of its offer, the other two directors worked with other preferred shareholders of the company to have Weiss removed as a board member, which they did. The deal was then consummated shortly thereafter through a merger with an LLC subsidiary of Coinbase.

Following the consummation of the deal, the Hyde Park funds filed an appraisal action. As part of the discovery process, the company asserted attorney-client privilege over certain information that was created while Weiss was a director. As Vice Chancellor Laster notes, “Delaware law has treated the corporation and the members of its board of directors as joint clients for the purposes of privileged material created during a director’s tenure.” As a result, Weiss was part of the “circle of confidentiality” during his tenure as a board member, and “a Delaware corporation cannot invoke privilege against the director to withhold information generated during the director’s tenure.” But there were still two issues here, (1) while the information may have been created during Weiss’s tenure as a director, he was in fact no longer serving as a current director at the time the information was requested; and (2) it was the shareholder funds that had appointed Weiss as a director, not Weiss himself, that was requesting the information as part of the appraisal action.

While the majority rule appears to be that a former director is not entitled to privileged information created at the time the director was in office, Delaware follows the minority rule that provides former directors access to any privileged material created during their tenure on the Board. The majority rule appears to treat the corporation itself as the only client for privilege purposes. But Delaware treats directors as joint clients with the corporation, and according to Vice Chancellor Laster: “When a director’s tenure ends, the director leaves the circle of confidentiality for purposes of any subsequent communications, but that does not retroactively alter the fact that the director was within the circle of confidentiality for the purposes of communications during his tenure.” Okay, but how does this apply to a shareholder seeking the information to which a director appointed by it was otherwise entitled?

The answer according to Vice Chancellor Laster is simple and long recognized by Delaware law. The funds that Weiss managed as a partner in the Hyde Park venture capital firm, who were the affected shareholders here, were also joint clients with the board and the company. Why? Because Weiss only had one brain, and “he necessarily shared information in light of his dual roles as director and fund manager; …[indeed,] Weiss could not avoid sharing information[,] [and] [t]he funds were therefore inside the circle of confidentiality as well.” Effectively, then, counsel representing a company, represents the company, the members of the board, and any stockholders who appointed specific board members, at least for purposes of any assertion of privilege in subsequent litigation involving any of those joint clients. According to Vice Chancellor Laster, this “joint client approach[,] … guarantees that a current director cannot secretly be excluded from discussions or denied access to materials, and it ensures a former director is not treated like a banished outsider, but rather as someone who previously held an important role and was inside the circle of confidentiality.” And under Delaware law:

A former director should not have to fight through a thicket of privilege to obtain materials created during the director’s tenure. The stockholder who appointed the director and who had [or should have had] access to that information should not have to fight through a thicket of privilege either. If a corporation wants to limit sharing of information, there are recognized means available.

And what are those recognized means to alter the default Delaware rule of joint client representation that includes the company, all of the directors and any shareholder who appointed a particular director? Well, according to Vice Chancellor Laster:

Three recognized methods exist by which a corporation can alter these default rules. First, as frequently happens, the parties can address the matter by contract, such as through a confidentiality agreement. Second, the board of directors can form a committee that excludes the director, at which point the committee can retain and consult confidentially with counsel. Third, once a sufficient adversity of interests has arisen and becomes known to the director, the director cannot reasonably rely on corporate counsel as to the matters where the interests of the director and corporation are adverse. At that point, the corporation can assert the attorney-client privilege as to the director. If a corporation believes that a sufficient adversity of interests exists, the corporation can put the director on notice of that fact, enabling the director to retain his own counsel and, if he wishes, call the question of information access through litigation.

Hmm. It appears that last of the three options was the most obvious course to take for the majority of the board; and had that course been followed, company counsel presumably could have maintained privilege for advice given to the board majority thereafter. Regardless, this joint client rule in Delaware for representation of a portfolio company with multiple shareholders with appointed directors may well call for some careful thinking when conflicts between directors arise.