Publications

(Article from Securities Law Alert, May 2015)

For more information, please visit the Securities Law Alert Resource Center.

On May 14, 2015, the Delaware Supreme Court addressed the following question: “in an action for damages against corporate fiduciaries, where the plaintiff challenges an interested transaction that is presumptively subject to entire fairness review, must the plaintiff plead a non-exculpated claim against the disinterested, independent directors to survive a motion to dismiss by those directors?” In re Cornerstone Therapeutics Inc., S’holder Litig., 2015 WL 2394045 (Del. 2015) (Strine, C.J.) (Cornerstone II). The court “answer[ed] that question in the affirmative,” and held that “[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.”

Background

The Delaware Supreme Court considered appeals in two cases in which the Delaware Chancery Court had denied defendants’ motions to dismiss claims against independent directors in transactions subject to the entire fairness standard of review even though plaintiffs had failed to plead non-exculpated claims against those directors. In re Cornerstone Therapeutics Inc. Stockholder Litig., 2014 WL 4418169 (Del. Ch. Sept. 10, 2014) (Cornerstone I);[1] In re Zhongpin Inc. Stockholders Litig., 2014 WL 6735457 (Del. Ch. Nov. 26, 2014).

Both cases “involve[d] damages actions by stockholder plaintiffs arising out of mergers in which the controlling stockholder, who had representatives on the board of directors, acquired the remainder of the shares that it did not own in a Delaware public corporation.” Cornerstone II, 2015 WL 2394045. In both instances, the “mergers were negotiated by special committees of independent directors, were ultimately approved by a majority of the minority stockholders, and were at substantial premiums to the pre-announcement market price.” However, because the companies “did not follow the process established in” Kahn v. M&F Worldwide Corporation, 88 A.3d 635 (Del. 2014)[2] “as a safe harbor to invoke the business judgment rule in the context of a self-interested transaction,” the Chancery Court found in both cases that “the entire fairness standard presumptively applied.”

In both cases, an exculpatory provision adopted in accordance with 8 Del. C. § 102(b)(7) protected the independent directors from monetary damages for breach of the duty of care. The Chancery Court interpreted Delaware precedent to find that “even if the plaintiffs could not plead a non-exculpated claim against any particular director, as long as the underlying transaction was subject to the entire fairness standard of review, and the plaintiffs were therefore able to state non-exculpated claims against the interested parties and their affiliates, all of the directors were required to remain defendants until the end of litigation.” Defendants appealed.  

Delaware Supreme Court Holds Plaintiffs Must Plead Non-Exculpated Claims Against Independent Directors to Survive Dismissal Regardless of the Applicable Standard of Review

On appeal, the Delaware Supreme Court held 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.” The court underscored that this “rule applies regardless of the underlying standard of review for the transaction.” The Delaware Supreme Court explained that “the mere fact that a plaintiff is able to plead facts supporting the application of the entire fairness standard to the transaction, and can thus state a duty of loyalty claim against the interested fiduciaries, does not relieve the plaintiff of the responsibility to plead a non-exculpated claim against each director who moves for dismissal.”

In so holding, the Delaware Supreme Court relied on its earlier decision in Malpiede v. Townson, 780 A.2d 1075 (Del. 2001). There, the court “analyzed the effect of a Section 102(b)(7) provision on a due care claim against directors who [had] approved a transaction which the plaintiffs argued should be subject to review under the Revlon standard.” The court found that “[b]ecause a director will only be liable for monetary damages if she has breached a non-exculpated duty, a plaintiff who pleads only a due care claim against that director has not set forth any grounds for relief” since the Section 102(b)(7) exculpatory provision bars such a claim as a matter of law.

Delaware Supreme Court Rejects an Automatic Inference of Director Disloyalty in Controller Transactions as Inconsistent with “Basic Tenets of Delaware Law” and Not in the Best Interests of Minority Stockholders

The Delaware Supreme Court in Cornerstone II determined that there were “several problems” with plaintiffs’ contention that “they should be entitled to an automatic inference that a director facilitating an interested transaction is disloyal because the possibility of conflicted loyalties is heightened in controller transactions.” First, the court explained that “each director has a right to be considered individually when the directors face claims for damages in a suit challenging board action.” This “individualized consideration does not start with the assumption that each director was disloyal; rather, ‘independent directors are presumed to be motivated to do their duty with fidelity.’”

Second, the Delaware Supreme Court found that such an inference “would likely create more harm than benefit for minority stockholders in practice.” The court explained that Delaware law has long “recognized that the negotiating efforts of independent directors can help to secure transactions with controlling stockholders that are favorable to the minority.” The court stated that it “decline[d] 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.” The Cornerstone II court observed that “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.”

Delaware Supreme Court Finds That Emerald Partners Does Not Support Plaintiffs’ Position

The Chancery Court had relied on the Delaware Supreme Court’s prior decision in Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001), in denying defendants’ motion to dismiss claims against the independent directors. On appeal, the Cornerstone II court found Emerald Partners distinguishable because the case involved “a viable, non-exculpated loyalty claim against each putatively independent director.” Given the circumstances, the Emerald Partners court “held that the determination of whether any failure of the putatively independent directors was the result of disloyalty or a lapse in care was best determined after a trial, because the substantive fairness inquiry would shed light on why the directors acted as they did.” The Cornerstone II court explained that Emerald Partners “did not answer the specific question” of “whether the application of the entire fairness standard requires the Court of Chancery to deny a motion to dismiss by independent directors even when the plaintiffs may not have sufficiently pled a non-exculpated claim against those directors.”

The Delaware Supreme Court in Cornerstone II held that “when the plaintiffs have pled no facts to support an inference that any of the independent directors breached their duty of loyalty, fidelity to the purpose of Section 102(b)(7) requires dismissal of the complaint against those directors.” The court reversed the Chancery Court’s judgments in both Cornerstone I and Zhongpin and “remand[ed] each case for the Court of Chancery to determine if the plaintiffs have sufficiently pled facts suggesting that the independent directors committed a non-exculpated breach of their fiduciary duty.”