In re Cornerstone Therapeutics Inc. S’holder Litig., C.A. No. 564, 2014 (Del. May 14, 2015) & Leal v. Meeks, C.A. No. 706, 2014 (Del. May 14, 2015)
In these interlocutory appeals, the Delaware Supreme Court resolved a long-standing split in Delaware authorities by ruling that independent directors (including members of a special committee negotiating a transaction with a controlling stockholder) who are protected by a Section 102(b)(7) exculpatory charter provision will be entitled to dismissal from a case challenging a controlling stockholder transaction unless the stockholder-plaintiff asserts well-pled, non-exculpated claims for breach of fiduciary duty against the independent directors.
Both cases involved a post-closing damages action by stockholder-plaintiffs arising from a going-private merger effected by a controlling stockholder. Each merger was negotiated by a special committee of independent directors and was ultimately approved by the holders of a majority of the stock held by minority holders. Each merger also involved a transaction price that represented a substantial premium to the pre-announced market price. Neither transaction, however, qualified for business judgment review under Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014), because the controllers’ merger proposals were not conditioned from the outset on “majority of the minority” stockholder approval. Thus, the entire fairness standard presumptively applied to each challenged transaction. In each case, the relevant company charters included an exculpatory provision from liability for breaches of the fiduciary duty of care pursuant to 8 Del. C. § 102(b)(7).
The independent director defendants moved to dismiss on the ground that the claims against them asserted no more than a breach of the fiduciary duty of care, for which they could not be personally liable by operation of the Section 102(b)(7) exculpatory provision. The independent directors argued that in several cases the Court of Chancery had dismissed claims against independent directors when the plaintiffs failed to plead non-exculpated claims even though the entire fairness standard applied. The Court of Chancery relied on Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001), and denied the independent directors’ motions. The Court held that where entire fairness applies, independent directors must remain in the case through trial, regardless of whether the plaintiffs had sufficiently pled any non-exculpated claims against them.
The Delaware Supreme Court reversed, 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 . . . regardless of the underlying standard of review for the transaction.” Thus, “even if a plaintiff has pled facts that, if true, would require the transaction to be subject to the entire fairness standard of review, and the interested parties to face a claim for breach of their duty of loyalty, the independent directors do not automatically have to remain defendants.” Rather, “[w]hen the independent directors are protected by an exculpatory charter provision and the plaintiffs are unable to plead a non-exculpated claim against them, those directors are entitled to have the claims against them dismissed[.]” The Court noted that a plaintiff can plead non-exculpated claims against an independent director by “pleading facts supporting a rational inference that the director harbored self-interest adverse to the stockholders’ interests, acted to advance the self-interest of an interested party from whom they could not be presumed to act independently, or acted in bad faith.”
The Supreme Court also discussed the underlying policy factors that support its holding, noting that requiring independent directors to remain defendants solely because plaintiffs stated a claim against the controlling shareholder and its affiliates would increase costs for disinterested directors, corporations, and stockholders, without providing a corresponding benefit. Requiring independent directors to remain defendants would also ultimately harm minority stockholders in practice because such a policy would discourage independent directors from serving on special committees or cause them to reject transactions solely because their role in negotiating on behalf of the stockholders would cause them to remain defendants until the end of any litigation challenging the transaction. The Court noted that the reason Section 102(b)(7) was adopted was to eliminate the fear of personal liability for making potentially value-maximizing business decisions.
Lastly, the Supreme Court clarified its prior ruling in Emerald Partners v. Berlin. Emerald Partners focused on a distinct situation: “whether courts can consider the effect of a Section 102(b)(7) provision before trial when the plaintiffs have pled facts supporting the inference not only that each director breached not just his duty of care, but also his duty of loyalty, when the applicable standard of review of the underlying transaction is entire fairness.” In a circumstance such as Emerald Partners, the determination of whether any failure of the independent directors was the result of either disloyalty or a lapse in care or both is best determined after a trial “because the substantive fairness inquiry would shed light on why the directors acted as they did.”
The Supreme Court remanded the cases to the Court of Chancery to determine whether the plaintiffs have sufficiently pled non-exculpated claims against the independent directors.