The recent In re Puda Coal, Inc. Stockholders Litigation decision serves as a cautionary note to directors of corporations with significant activities overseas. Specifically, the decision provides guidance to directors as to what is expected from them in order to fulfill their duties.
Puda Coal concerned a Delaware corporation listed on the New York Stock Exchange following a reverse triangular merger. The operating subsidiary and assets of the parent corporation, Puda Coal, were based in China. According to the plaintiffs, the corporation’s Chairman and Chief executive officer illegally sold the shares of the subsidiary to a third party, effectively looting the corporation of its assets.
The independent directors of Puda Coal, however, took 18 months to realize that the assets had been looted, during which time they authorized the disclosure of documents referring to the corporation’s ownership of the assets. The shareholders plaintiffs sued the directors for breach of their duty of loyalty, more specifically breach of their duty to monitor the corporation’s affairs and officers.
In an interlocutory decision where he refused to dismiss claims of breach of fiduciary duty, Chancellor Strine recited the parameters of the duty to monitor and applied them to the context of corporations with overseas activities.
Specifically, Chancellor Strine remarked that where the assets of the corporation are overseas, directors “better have in place a system of controls to make sure that you know you actually own the assets”. Directors were thus required to have their “physical body in China an awful lot”. Further, directors are required in such cases to “have the language skills to navigate the environment in which the company is operating” and retain legal and accounting professionals “who are fit to the task of maintaining a system of controls over a public company”.
Ultimately, Chancellor Strine found that directors could not simply remain in the United States and discharge their duties by simply attending quarterly telephone conference calls.
Thus, the alleged facts gave rise to a Caremark claim, i.e. a breach of the duty to monitor, given the “magnitude of what happened, the length of time it went undiscovered, [and] the repetitive filing of statements saying that the company owned assets”. In so ruling, the Chancellor stressed that “[t]here’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”.
For a pdf version of this post, see Legal Trends Fall 2013.