August 10, 2020

Volume X, Number 223

August 10, 2020

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Delaware Supreme Court Holds That Plaintiffs Must Specifically Plead Non-Exculpated Claims Against Disinterested Directors in Transaction Under Entire Fairness Review to Survive Motion to Dismiss

In In re Cornerstone Therapeutics Inc. Stockholder Litigation/Leal v. Meeks, the Delaware Supreme Court reversed decisions of the Delaware Chancery Court denying director-defendants’ motions to dismiss breach of fiduciary duty claims brought in connection with two transactions involving controlling stockholders. In reversing the Delaware Chancery Court’s decisions, the Delaware Supreme Court 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. The cases were remanded for the Delaware Chancery Court to determine whether the plaintiffs sufficiently pled facts suggesting that the independent directors committed a non-exculpated breach of their fiduciary duties.

In each case, the plaintiffs challenged an acquisition of a public company by its controlling stockholder. Each transaction was negotiated by a special committee of disinterested directors and subsequently approved by a majority of the minority stockholders. However, neither corporation’s board complied with the procedural safe harbor set forth in Kahn v. M&F Worldwide Corporation, which would have invoked the business judgment rule and shifted the burden of proof to the plaintiff, and so the transactions were evaluated under the heightened scrutiny of the entire fairness standard. The charter documents of each target company contained exculpatory provisions that eliminated directors’ personal liability for monetary damages absent bad faith or a breach of the duty of loyalty. The plaintiffs generally alleged breaches of fiduciary duties by the disinterested directors for approving a transaction that was not entirely fair, but failed to specifically allege that any of the disinterested directors breached any non-exculpated duty. In both instances, the Delaware Chancery Court declined to determine whether an exculpation provision could exculpate directors at the pleading stage, reasoning that the court would need to review a fully developed factual record before making such a determination.

The Delaware Supreme Court explained that the presumption that each director is independent, acting in good faith and furthering the corporation’s best interests is a core principle of Delaware corporate law. By automatically inferring that disinterested directors who approve interested transactions are disloyal, the Delaware Chancery Court decision would have violated this principle. In addition, in reaching its holding, the Delaware Supreme Court was careful to avoid disincentivizing independent directors from serving as special committee members or otherwise dissuading them from making any other decisions that could benefit interested stockholders out of fear that their role in negotiating on behalf of minority stockholders would subject them to remain as defendants until the end of any resulting litigation. The Delaware Supreme Court noted that, in fact, it was exactly this concern that directors might be discouraged from making value-maximizing business decisions out of fear of facing personal liability that led to the adoption of Section 102(b)(7) of the Delaware General Corporation Law that permits corporations to adopt exculpatory provisions.

©2020 Katten Muchin Rosenman LLPNational Law Review, Volume V, Number 149

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About this Author

Martin Q. Ruhaak, Katten Muchin Law Firm, private equity transactions lawyer
Partner

Martin Ruhaak concentrates his practice on corporate matters, with an emphasis on private equity transactions, mergers and acquisitions, distressed investments and securities matters. He has represented financial sponsors and corporate clients in transactions across a variety of industries, including automotive, financial services, distribution and logistics, technology and government contracting.

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