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By Michael Greene
May 14 — The Delaware Supreme Court May 14 held that when a transaction is subject to entire fairness review, independent directors protected by exculpatory charter provisions do not need to wait for a fully developed record to have claims against them dismissed.
In late 2014, relying on the Supreme Court's Emerald Partners decisions, the Delaware Chancery Court in separate decisions denied independent directors' motions to dismiss solely because the underlying transactions were governed by entire fairness.
However, in a consolidated opinion, the state's high court reversed and remanded, finding that the plaintiffs must plead non-exculpated claims against the directors.
“A plaintiff seeking only monetary damages must plead non-exculpated claims against a director who is protected by an exculpatory charter provision to survive a motion to dismiss, regardless of the underlying standard of review for the board's conduct—be it Revlon, Unocal, the entire fairness standard, or the business judgment rule,” Chief Justice Leo E. Strine Jr. wrote for the court.
The appeals—In re Cornerstone Therapeutics Inc., Stockholder Litigation and In re Zhongpin Inc., Stockholder Litigation—arose from minority stockholders alleging breaches of fiduciary duties in connection with mergers that were presumptively subject to entire fairness review.
In both cases, the stockholders brought claims not only against the controlling stockholders and their affiliated directors, but also independent directors that had negotiated and approved the mergers.
The chancery court declined to analyze whether the plaintiffs had pled non-exculpated claims against the independent directors because the court believed it was required to deny the independent directors' motions to dismiss regardless of whether such claims had been sufficiently pled.
Subsequently, interlocutory appeals were granted and consolidated.
“These cases thus exemplify a benefit of careful employment of the interlocutory appeal process: to enable this Court to clarify precedent that could arguably be read in two different ways before litigants incur avoidable costs,” Strine wrote, opining on why the interlocutory appeals were granted under Delaware Supreme Court Rule 42, which was amended last month.
In keeping with its earlier decision in Malpiede v. Townson, the Supreme Court found that a plaintiff must plead a non-exculpated claim against each independent director who moves for dismissal regardless of the standard of review.
Accordingly, the court rejected an automatic inference that a director approving an interested transaction is disloyal, “because the possibility of conflicted loyalties is heightened in controller transactions, and the facts that give rise to a duty of loyalty breach may be unknowable at the pleading stage.”
Chief Justice Strine found such an inference problematic because it “would be inconsistent with Delaware law and would also increase costs for disinterested directors, corporations, and stockholders, without providing a corresponding benefit.”
Chief Justice Strine noted that under the Delaware corporate law, independent directors are presumed to be motivated to complete their duties with fidelity.
He found that adopting the plaintiffs' approach went against this presumption and “would likely create more harm than benefit for minority stockholders in practice.”
“We decline to adopt an approach that would create incentives for independent directors to avoid serving as special committee members, or to reject transactions solely because their role in negotiating on behalf of the stockholders would cause them to remain as defendants until the end of any litigation challenging the transaction.” he opined. “As is well understood, the fear that directors who faced personal liability for potentially value-maximizing business decisions might be dissuaded from making such decisions is why Section 102(b)(7) was adopted in the first place.”
The court also clarified that its decisions in Emerald Partners did not directly address the issue in these appeals.
Instead, it found that in Emerald Partners, there was sufficient evidence that the independent directors were precluded from an exculpation provision by virtue of their conduct, not because the transaction was subject to entire fairness review.
“Thus, to the extent that other isolated statements in Emerald Partners could be interpreted as inconsistent with the result we reach today, we clarify that the Emerald Partners decisions should be read in their case-specific context and not for the broad proposition that the plaintiffs advocate,” Stine wrote.
Accordingly the high court reversed and remanded both cases so that the lower court could determine whether the plaintiffs had sufficiently pled facts suggesting that the independent directors breached a non-exculpated fiduciary duty.
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The Supreme Court's opinion is available at http://courts.delaware.gov/opinions/download.aspx?ID=223540.
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