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(Article from Securities Law Alert, May 2016) 

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On May 6, 2016, the Delaware Supreme Court held that when transactions are approved by a fully informed majority of disinterested stockholders, the business judgment rule applies and plaintiffs’ breach of the duty of care claims against the disinterested directors must be dismissed absent a showing of waste. Singh v. Attenborough, 2016 WL 2765312 (Del. 2016) (Strine, C.J.). The court made it clear that as a practical matter, the waste exception has “little real-world relevance” because stockholders would be unlikely to approve a wasteful transaction.

Background

On October 29, 2015, the Delaware Chancery Court held the business judgment rule standard of review applied to duty of care claims brought against Zale Corporation’s directors in connection with its merger with Signet Jewelers Limited because a majority of Zale’s disinterested stockholders approved the merger in a fully informed vote. In re Zale Corp. Stockholders Litig., 2015 WL 6551418 (Del. Ch. 2015) (Parsons, V.C.) (Zale).

However, the court held plaintiffs could “rebut the [business judgment rule] presumption . . . by showing that it [was] reasonably conceivable” that Zale’s directors were “grossly negligent.” The court stated that “when reviewing a board of directors’ actions during a merger process after the merger has been approved by a majority of disinterested stockholders in a fully informed vote, the standard for finding a breach of the duty of care under [the business judgment rule] is gross negligence.”

The court held plaintiffs had “not alleged sufficient facts to make it reasonably conceivable that” Zale’s directors breached their duty of care under the gross negligence standard. Finding no predicate breach of the duty of care, the court dismissed with prejudice plaintiffs’ aiding and abetting claims against Zale’s financial advisor, Merrill Lynch.

Plaintiffs appealed.

Delaware Supreme Court Affirms But Holds the Chancery Court Erred in Applying a Gross Negligence Standard to Plaintiffs’ Duty of Care Claims

The Delaware Supreme Court affirmed the Chancery Court’s October 29, 2015 decision insofar as the court held that that “a fully informed, uncoerced vote of the disinterested stockholders invoked the business judgment rule standard of review.” However, the Delaware Supreme Court found the Chancery Court erred in applying a gross negligence standard to plaintiffs’ breach of the duty of care claims. The Delaware Supreme Court explained that “[a]bsent a stockholder vote and absent an exculpatory charter provision, the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence.” The court reasoned that “employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review shifting effect to the vote.”

The Delaware Supreme Court held that once “the business judgment rule standard of review is invoked because of a vote,” plaintiffs’ breach of the duty of care claims can only survive dismissal if plaintiffs allege waste. The court stated that as a practical matter, this “waste exception has long had little real-world relevance because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.” The court explained that if the business judgment rule applies, “dismissal [of plaintiffs’ breach of the duty of care claims] is typically the result.”

The court found that dismissal was warranted in the case before it because there was “no rational argument that waste occurred.”

Delaware Supreme Court Also Affirms Dismissal of Plaintiffs’ Aiding and Abetting Claim Against the Board’s Financial Advisor

The Delaware Supreme Court also considered plaintiffs’ aiding and abetting breach of fiduciary duty claims against the Zale board’s financial advisor, Merrill Lynch. The court first emphasized that “Delaware has provided advisors with a high degree of insulation from liability by employing a defendant-friendly standard that requires plaintiffs to prove scienter and awards advisors an effective immunity from due-care [aiding and abetting] liability.”

However, the Delaware Supreme Court recognized that an exception to this “immunity from due care liability” applies in rare cases in which an advisor’s own “bad-faith actions cause its board clients to breach their situational fiduciary duties (e.g., the duties Revlon imposes in a change-of-control transaction).” Citing its earlier decision in RBC Capital Markets v. Jervis, 129 A.3d 816 (Del. 2015),[1] the Delaware Supreme Court explained an advisor may be held liable for aiding and abetting if “its clients’ actions were taken in good-faith reliance on misleading and incomplete advice tainted by the advisor’s own knowing disloyalty.”

In the case before it, the Delaware Supreme Court found no “rational basis to infer scienter” as to Merrill Lynch. The court emphasized that nothing in the record even came “close to approaching the sort of behavior at issue in RBC.” The Delaware Supreme Court concluded the Chancery Court “properly dismissed” plaintiffs’ aiding and abetting claims against Merrill Lynch.