Delaware Supreme Court Issues Important Opinion on Interested Transactions
In an opinion on a consolidated appeal in In re Cornerstone Therapeutics Inc. Stockholder Litigation and Leal v. Meeks, the Delaware Supreme Court held that, regardless of the underlying standard of review (including in interested transactions subject to entire fairness review), a claim solely for monetary damages against a facially independent director of a corporation with an exculpatory charter provision will be dismissed unless a plaintiff has alleged facts to support a nonexculpated claim with respect to that director. The Supreme Court clarified that its prior decisions in Emerald Partners v. Berlin, which many practitioners and some members of the Court of Chancery had interpreted as requiring that claims against all directors challenging a transaction to which the entire fairness standard applied survive a motion to dismiss, did not control the specific question at issue in the appeals.
The Supreme Court’s decision involved a consolidated appeal of two actions, each of which involved allegations relating to a target board’s approval of a controlling stockholder-led going-private transaction. In each case, (i) it was undisputed that the prerequisites for application of the business judgment rule set out in the Delaware Supreme Court’s 2014 opinion in Kahn v. M&F Worldwide Corporation were not satisfied, (ii) the target corporation had a provision in its certificate of incorporation, authorized by Section 102(b)(7) of the Delaware General Corporation Law, exculpating directors from monetary liability for a breach of the duty of care, (iii) in light of that provision, the independent directors moved to dismiss claims against them because the plaintiff did not plead any non-exculpated claims against them, (iv) the Court of Chancery interpreted Emerald Partners to require denial of the motion to dismiss solely because entire fairness applied (and regardless of whether any non-exculpated claims were made against the independent directors) and (v) the Court of Chancery recommended certification of an interlocutory appeal to the Supreme Court. The opinion is the result of those interlocutory appeals.
The Supreme Court began by noting that both sides had raised “competing but colorable views of the law.” Ultimately, the Court resolved the question definitively by holding “that plaintiffs must plead a non-exculpated claim for breach of fiduciary duty against an independent director protected by an exculpatory charter provision, or that director will be entitled to be dismissed from the suit.” In doing so, the Court clarified that the plaintiffs in Emerald Partners had pled a “viable, non-exculpated loyalty claim against each putatively independent director,” and that the statements in those decisions relating to the refusal to dismiss claims against the independent directors had to be “read in their casespecific context.” As stated by the Supreme Court, the holding in Cornerstone and Leal should mitigate “incentives for independent directors to avoid serving as special committee members.” At the same time, the opinion allows for retaining the interested fiduciaries (the “proverbial deep-pocketed defendants”) in the case and the possibility for bringing claims against facially independent directors if facts adduced in discovery suggest those directors acted (or failed to act) in a way that is unprotected by the exculpation provision.
Delaware jurisprudence regarding transactions involving controlling stockholders has seen rapid development over the past year. Just a year ago, in Kahn v. M&F Worldwide Corporation, the Supreme Court set out a process by which a controlling stockholder-led going-private transaction might be subject to the business judgment rule (as opposed to review under the entire fairness standard) (See our client alert on M&F Worldwide here.) And over the course of the past year, the Court of Chancery has issued several opinions setting out the circumstances when a less-than-majority stockholder could be deemed a “controlling stockholder.” (See our client alerts on several of these cases here and here.) Morris Nichols Corporate Counseling and Corporate & Business Litigation Groups 2
Although the Supreme Court expressly noted that it was not evaluating issues of control, and that the existence of control was the premise upon which the interlocutory appeals rested, the Cornerstone and Leal decision represents an important development protecting independent directors in the litigation landscape for controlling stockholder and other interested transactions. Such litigation is sure to continue. In the event stockholder plaintiffs are unable to plead sufficient facts to require independent directors to remain as party defendants, those directors will remain subject to discovery directed to non-parties and may also remain central figures in attempts by controlling stockholders and other interested parties to demonstrate that the burden of proof on the question of entire fairness shifted to the plaintiffs based on the presence of a vigorous special committee process.
Copyright © Morris, Nichols, Arsht & Tunnell LLP. These materials have been prepared solely for informational and educational purposes, do not create an attorney-client relationship with the author(s) or Morris, Nichols, Arsht & Tunnell LLP, and should not be used as a substitute for legal counseling in specific situations. These materials reflect only the personal views of the author(s) and are not necessarily the views of Morris, Nichols, Arsht & Tunnell LLP or its clients.