In a bench ruling issued on February 6, 2013, the Delaware Court of Chancery in In re Puda Coal, Inc. Stockholders Litigation refused to dismiss claims of breach of fiduciary duty brought against the independent directors of a Delaware corporation that operated solely in China. The lawsuit claimed that the independent directors of Puda Coal had failed in their oversight of the company, which allowed the board's chairman to misappropriate the company's funds for his own use. The Court, implicating the Caremark standard for personal liability, held that the directors' conduct in this case was extreme enough to make it "perfectly conceivable" that they had failed to make a good-faith effort to monitor the company's management. The opinion serves as a warning for independent directors against assuming that they can ignore a foreign-based corporation's governance and management just because of the challenge of properly overseeing the corporation's activity. The opinion describes several of the baseline actions that these directors must take to fulfill their fiduciary duties.

The subject company, Puda Coal, Inc., is a Delaware corporation operating entirely in China. The stockholders of Puda Coal brought a claim for breach of fiduciary duty against the company's US independent directors for their failure to properly oversee the management of the corporation. According to the complaint, for 18 months, the independent directors had failed to notice and stop the chairman of the company from appropriating and selling off a majority of the company's assets. When the directors finally realized the extent of the fraud, they resigned rather than sue to retrieve the company's assets, leaving the company in the hands of the chairman.

The independent directors moved to dismiss the suit, arguing that the stockholder-plaintiffs had:

In his bench ruling, Chancellor Strine refused to grant the motion to dismiss. Addressing the failure to make requisite demand on the board, Chancellor Strine emphasized that granting the motion on those grounds would leave control of the lawsuit with the sole remaining director of the company, the chairman who had misappropriated the company's funds. Chancellor Strine called this outcome "ridiculous" and "Kafkaesque."

Chancellor Strine placed his decision in the context of the criticism that the Delaware judges sometimes receive for not sufficiently holding managers accountable for breaches of fiduciary duties. Chancellor Strine voiced his view of this claim as "astonishingly outdated and simple-minded" in light of both Delaware's "much more pro-stockholder and more balanced" statutory law and recent decisions where the Court has "held people accountable in big ways for things" (see Legal Update, Chancellor Strine Declines to Enjoin Kinder Morgan Acquisition of El Paso: Further Discussion and Legal Update, In re Southern Peru Copper: Court of Chancery Grants $1.263 Billion Award in Fiduciary Duty Case with Controlling Stockholder for two examples mentioned by Chancellor Strine).

As for finding a breach by the independent directors, Chancellor Strine stated that the facts supported a finding for a breach even under the Caremark standard for personal liability owing to lack of good faith. In making this finding, Chancellor Strine stressed that directors of foreign-based corporations that incorporate in Delaware cannot be "dummy directors." He advised outside directors who oversee corporations situated in China that to meet the good-faith standard, they must:

By contrast, the directors cannot simply "sit in [their] home in the U.S. and do a conference call four times a year and discharge [their] duty."

The Puda Coal ruling is critical for its recitation of the actions and efforts that outside directors of foreign-based corporations must take to fulfill their fiduciary duties. Of note, Chancellor Strine's description is not of the ideal for these directors, but rather of the bare minimum for avoiding personal liability under Caremark.

Directors should also be mindful that resigning in the face of corporate wrongdoing will not necessarily be upheld as an aggressive, or even appropriate, response. The ruling suggests that the directors of Puda Coal may have breached their fiduciary duty by resigning and leaving the company in the hands of the chairman who stole the company's assets. The situation at hand demanded that the directors stay on and exert efforts to recover the company's assets.