Interested director transactions (transactions where one or more members of a board of directors will “receive a personal financial benefit … that is not equally shared by the stockholders.” Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993)) are common sources of derivative suits. To protect the interests of the stockholders and to preserve the application of the business judgment presumption, a board of directors may appoint independent directors to a special committee authorized to approve, reject, or consider strategic alternatives to a potential transaction. By isolating interested directors from the decision making process, use of a special committee increases the likelihood that a board’s decision will be entitled to the business judgment presumption, thereby reducing the duration and cost of litigation.

Parties structuring the special committee formation process for Maryland corporations should take note of a recent decision from the Delaware Supreme Court. Although Delaware County Employees Retirement Fund, et al. v. Sanchez, et al., C.A. No. 9132-VCG (Del. 2015), analyzes director independence in the context of demand futility, Maryland courts have historically viewed decisions from Delaware courts in this area as persuasive in reviewing direct challenges to the independence of directors and special committees. (See, Frederick v. Corcoran, No.370685-V (Md. Cir. Ct. 2013)). (See, Demand Futility under Maryland Law for a review of Maryland’s approach to demand futility).

Frederick, is perhaps the most thorough expression of Maryland law in this area. The decision in Frederick, however, should now be reconsidered in light of the holding in Sanchez because Sanchez qualified the following holdings from Delaware courts that were relied on in Frederick.

1. The law is clear that, without more, allegations that directors are friendly with one another,  travel in similar social circles, or have had prior business dealings with the proponent of the transaction are insufficient to show lack of independence. Beam v. Stewart, 845 A.2d 1040, 1051-52 (Del. 2004).
2. Allegations of pecuniary self-interest must allow the court to infer that the interest was of a sufficiently material importance, in the context of the director's economic circumstances, as to have made it improbable that the director could perform her fiduciary duties without being influenced by her overriding personal interest. In re General Motors (Hughes) Shareholders Litigation, C.A. No. 20269 (Del. Ch. 2005).

In Sanchez, the plaintiffs challenged the independence of a director due to his relationship with an interested party. The plaintiffs pled that the director and interested party had been close friends for over 50 years and that the director’s personal wealth was largely attributable to business interests over which the interested party had substantial influence. In reversing the Court of Chancery’s decision to dismiss the case, the Supreme Court observed that the Court of Chancery’s analysis considered the close personal friendship and business relationships of the parties as entirely separate issues. Under that analysis, neither category of facts on its own was enough to compromise the director’s independence.

Reversing the Court of Chancery, the Supreme Court held that all facts regarding a director’s relationship with an interested party should be considered in full context.  Under this review, the Supreme Court noted that the “plaintiffs did not plead the kind of thin social circle friendship… which was at issue in Beam.” Rather, a “deeper human friendship” such as a 50 year friendship raises a “pleading inference that it is important to the parties.” Furthermore, “[t]he plaintiffs did not simply rely on that proposition,” they pled facts regarding the economic relations of the parties to further support their contention that the director could not act impartially on a matter of economic importance to the interested party. The Supreme Court concluded that, taken together, the plaintiffs pled particularized facts sufficient to create a reasonable doubt about the director’s independence and thus survive the motion to dismiss.

The decision of the Court of Chancery on remand is pending, but the Supreme Court’s decision on the motion to dismiss raises issues for counsel of Maryland corporations to consider in structuring special committees. The holdings in Beam and Hughes should not be read separately. The depth and duration of director relationships should be considered in context and those relationships should, in turn, inform the degree to which allegations of pecuniary self-interest are evaluated for material importance to the director.