Corporate investors often have the right to designate individuals to serve on their investees’ boards of directors. In Hyde Park Venture Partners Fund III, L.P. v. FairXchange, LLC, 2023 WL 2417273 (Del. Ch. Mar. 9, 2023), the Delaware Court of Chancery issued a valuable reminder that companies generally will not be permitted to assert privilege or immunity to withhold information generated during a director’s tenure from the directors or his or her appointing investor in litigation. Corporate boards and investors alike will benefit from an understanding of the principles articulated in this ruling.
At all relevant times, FairXchange LLC (“FairXchange”) had a three-person board of directors, which included Ira Weiss. Weiss had been designated as a director by investors Hyde Park Venture Partners Fund III L.P. and Hyde Park Venture Partners Fund III Affiliates LP (together, “the Funds”).
A company called Coinbase Global made an offer to acquire FairXchange, which prompted Weiss to want to explore potential alternatives. FairXchange’s other directors wanted to go forward with the Coinbase deal. They resented Weiss’s opposition so much that they allegedly shut Weiss out of further sale negotiations and devised a plan with preferred stockholder allies to remove him from the board. The sale to Coinbase ultimately was completed.
After the sale closed, the Funds filed an appraisal action seeking fair value for their shares. In subsequent discovery disputes, FairXchange tried to force the Funds to destroy privileged company information given to them by Weiss, which he had received in his capacity as a director. The company further asserted attorney-client privilege over materials prepared during Weiss’s tenure as a director. The Funds moved to compel as to all documents so withheld except for those relating to topics to which both parties agreed the company and Weiss were legally adverse.
The Court’s Ruling
The Court of Chancery began its analysis by recounting Delaware’s “longstanding approach” of generally recognizing directors on a corporate board as joint clients along with the corporation. A director’s right to corporate information is essentially “unfettered.” The rationale for this rule is that “all directors are responsible for the proper management of the corporation, and thus, should be treated as a ‘joint client’” along with the company.
The fact that directors function as joint clients with one another and the corporation means that the expectation of confidentiality that is essential to invoking the privilege does not exist among the joint clients. Relatedly, Delaware law has also recognized that when a director represents an investor, there is an implicit expectation that the investor comes within the company’s privilege sphere as well.
The Court then noted the three recognized exceptions to these default rules. First, the parties can alter the arrangement by contract, such as through a confidentiality agreement. Second, the board of directors can form a committee that excludes a certain director or directors, at which point the committee can retain and consult confidentially with counsel. Third, in the case where a sufficient adversity of interests has arisen and becomes known to a director, the director can no longer reasonably rely on corporate counsel as to the matters where the interests of the director and corporation are adverse, and the corporation can assert the attorney-client privilege against the director as to that matter.
Under the facts of the FairXchange case, none of the exceptions to the default joint client rule applied, and therefore Weiss was a joint client along with the company. The company, therefore, had no expectation of privacy against Weiss or, by extension, the Funds. The Court held that the company was, therefore, unable to assert privilege against the Funds for materials created during Weiss’s tenure.
Corporate boards of directors, as well as corporate counsel, must understand that directors and their investor affiliates are presumptively within a company’s privilege sphere. In order for a company to assert privilege against a director (and the director’s affiliated investors), one of the three recognized exceptions to the joint client rule must typically be present before the privileged information is generated: (1) a contractual agreement permitting the withholding of information from the director; (2) the formation of a special committee of the board that excludes the director, such that the committee can consult with counsel confidentially; or (3) the existence of sufficient adversity of interests between the company and the director, with notice of same to the director, which justifies the withholding of the company’s privileged information on that topic. Thus, corporations will benefit from advance planning with respect to the protection of privileged information.
However, to the extent privileged information must be produced in litigation under this joint client rule, Delaware Rule of Evidence 510(f) provides some comfort that the information will not be shared more broadly. That rule provides that “[n]otwithstanding anything in these rules to the contrary, a court may order that the privilege or protection is not waived by disclosure connected with the litigation pending before the court—in which event the disclosure is also not a waiver in any other proceeding.” A similar procedure is available in federal court under F.R.E. 502(d). Litigation counsel should take advantage of this protection to ensure that the production of privileged information to a joint client in litigation will not result in a broader waiver of privilege to the outside world.