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Gantler v. Stephens, C.A. No. 2392, 2008 (Del. Jan. 27, 2009)

January 27, 2009

In this en banc decision, the Supreme Court of Delaware reversed the Court of Chancery’s decision dismissing three separate claims that officers and directors of First Niles Financial, Inc. violated their fiduciary duties to stockholders, and remanded the case for proceedings consistent with the Supreme Court’s Opinion. In reversing the Court of Chancery, the Supreme Court expressly affirmed for the first time that the fiduciary duties of officers are concomitant with those of directors. The Supreme Court also clarified that the doctrine of stockholder ratification is limited to circumstances where informed stockholders approve director action that does not legally require stockholder approval, and stated that stockholder ratification is limited to director action that stockholders are affirmatively called upon to approve. 

In its suit against the directors and officers of First Niles, plaintiff stockholders charged that the directors and officers of First Niles: 1) breached their fiduciary duties of loyalty and care by rejecting a valuable offer to sell the Company; 2) violated their fiduciary duty of disclosure by distributing a proxy statement for a company-sponsored reclassification proposal containing materially misleading information; and 3) breached their fiduciary duty of loyalty by recommending a stock reclassification proposal to stockholders that was allegedly structured to benefit the incumbent board. In its review de novo of the Court of Chancery’s decision, the Supreme Court addressed each of these claims in turn.

In reversing the Court of Chancery’s finding that the First Niles directors and officers breached their fiduciary duties to stockholders by “sabotaging” the due diligence process, rejecting a merger proposal, and terminating the sales process that had been initiated by the Board in favor of the reclassification proposal, the Supreme Court first confirmed that the Unocal standard was inapplicable to the Board’s actions, because Unocal is uniquely applicable to defensive actions taken by a board of directors, and “Count I sounds in disloyalty, not improper defensive conduct.” The Supreme Court then analyzed whether the Court of Chancery properly applied the deferential business judgment rule to the Board's decision to reject the merger proposal, or whether, as plaintiffs argued, the entire fairness standard should apply. Noting that business judgment protection typically attaches to a decision by a board of directors to accept or reject a proposed merger offer, the Supreme Court nonetheless stated that for the business judgment rule to be applicable, the Board must reach its decision “in the good faith pursuit of a legitimate corporate interest,” and also make its decision  "advisedly.”

In analyzing the question of whether plaintiffs had alleged facts sufficient to rebut the business judgment rule, the Supreme Court stated that plaintiffs are required to plead “in addition to a motive to retain corporate control, other facts sufficient to state a cognizable claim that Director Defendants acted disloyally.” The Court found that the allegations  that a majority of the directors stood to lose substantial personal financial benefits from continued employment with or providing services to First Niles if a change in control of First Niles occurred were sufficient to raise an inference of a disabling conflict in rejecting the proposed merger transaction, and held that the actions of the Director Defendants under count one of plaintiff stockholders’ suit should have been subject to entire fairness review.

The Supreme Court similarly found that the actions of the officer defendants (Officer Defendants) raised a reasonable inference that they had acted disloyally. Noting past holdings by the Court of Chancery that the fiduciary duties of officers are identical to those of directors, the Supreme Court clarified a matter of first impression for the Court, stating that “the fiduciary duties of officers are the same as those of directors.” Finding that the Officer Defendants’ actions raised a reasonable inference that both Officer Defendants intended to sabotage the due diligence process, the Supreme Court held that the complaint stated a cognizable breach of fiduciary duty claim against the Officer Defendants.

Turning to count two, which alleged that the reclassification proxy violated the Board’s fiduciary duty of disclosure by distributing materially misleading information to First Niles stockholders, the Supreme Court reversed the Court of Chancery’s finding that certain alleged misleading disclosures contained in the proxy were immaterial, finding instead that a reasonable stockholder would have found information regarding the Board’s decision-making process material enough “to alter the total mix of information provided” to stockholders. Noting that the reclassification proxy claimed that the Board “carefully deliberated” the merits of the First Place offer before rejecting the takeover bid when no such discussion or deliberations allegedly occurred, and citing the reassurance such a statement could potentially provide to stockholders in light of the Board’s representation that the reclassification proposal was superior to other available options, the Supreme Court held that the Court of Chancery erred in granting defendants’ motion to dismiss count two.

Finally, with respect to count three, the Supreme Court reversed the Court of Chancery’s holding that, even if First Niles’ directors breached their fiduciary duty of loyalty by recommending the reclassification proposal to stockholders, the breach of fiduciary duty claim was moot because “a disinterested majority of the shareholders had ‘ratified’ the Reclassification by voting to approve it.” Finding that the Court of Chancery erred in dismissing the breach of fiduciary claim, the Supreme Court reasoned that since a stockholder vote was required to amend the First Niles certificate of incorporation, the vote of stockholders approving the amendment could not simultaneously “operate to ‘ratify’ the challenged conduct of the interested directors.” In addition, the Supreme Court stated that material misrepresentations contained in the reclassification proxy likewise negated the argument that the stockholder vote approving the reclassification was fully informed. Having reversed the Court of Chancery’s dismissal of all three counts in the complaint, the Supreme Court  remanded the case for further proceedings consistent with its Opinion.

The full opinion is available here