In recent decisions, both the Delaware Supreme Court and the New York Court of Appeals affirmed defendant-friendly lower court rulings, holding that, if appropriate procedural safeguards are employed in M&A transactions, defendants will be insulated from liability under the business judgment rule.
Delaware: Informed, Uncoerced Shareholder Vote on Merger Leads to Application of Business Judgment Rule On May 6, 2016, in Singh v. Attenborough, No. 645, 2015, the Delaware Supreme Court held that “a fully informed, uncoerced vote of the disinterested stockholders invoked the business judgment rule standard of review.” Id. at 1-2.
As we reported December 11, 2015, in its initial opinion in In re Zale Corp. Stockholders Litigation, C.A. No. 9388-VCP, the Delaware Court of Chancery held that although the fully informed and disinterested majority of Zale’s shareholders voted in favor of the merger, the heightened Revlon standard applied in considering whether Zale’s board had breached its fiduciary duties and, consequently, whether Zale’s financial advisor had aided and abetted those breaches. In light of the Delaware Supreme Court’s subsequent opinion in Corwin v. KKR Financial Holdings LLC, No. 629, 2014 (Oct. 2, 2015), the Zale court granted reargument, applied the business judgment rule instead of Revlon, and accordingly granted dismissal.
The Delaware Supreme Court affirmed that narrow decision, finding that it correctly applied Corwin. Singh at 1-2. However, the Delaware Supreme Court was critical of other aspects of the Chancery Court’s consideration of the case. In its reconsideration opinion, after concluding that the business judgment rule applied, the Chancery Court nevertheless went on to consider whether a breach of the duty of care had occurred. The Delaware Supreme Court held that inquiry to be “erroneous” because, “[w]hen the business judgment rule . . . is invoked because of a vote, dismissal is typically the result.” Id. at 2. Additionally, in its initial opinion, the Chancery Court had held that the board’s failure to discover its financial advisor’s conflict of interests until after the merger was a breach of its fiduciary duty. The Supreme Court “distance[d]” itself from this conclusion. Id. at 3. However, the Delaware Supreme Court noted 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 . . . . [H]owever, an advisor whose bad-faith actions cause its board clients to breach their situational fiduciary duties . . . is liable for aiding and abetting. The advisor is not absolved from liability simply because its clients’ actions were taken in good-faith reliance on [its] misleading and incomplete advice.
Id. at 4. Interestingly, this language appears to open the door to Delaware courts concluding that financial advisors to transactions had acted in bad faith and therefore had aided and abetted breaches of fiduciary duty, even where the board itself had acted entirely in good faith.
New York: Approval of Going-Private Transaction by Both the Independent Directors and the Independent Shareholders Leads to Application of Business Judgment Rule On May 4, 2016, in In re Kenneth Cole Productions, Inc., Shareholder Litigation, No. 54, 2016, the New York Court of Appeals adopted Delaware’s standard of review for shareholder suits challenging controlling-party buyout deals, holding that “New York courts should apply the business judgment rule as long as certain shareholder-protective conditions are present; if those measures are not present, the entire fairness standard should be applied.” Id. at 1-2. Those “shareholder-protective conditions” include approval “from the outset . . . by both a special committee of independent directors and a majority of the minority shareholders.” Id. at 6.
The Court of Appeals recognized its own precedent that in freeze-out mergers by management or controlling shareholders, “the burden shifts to the interested directors or shareholders to prove good faith and the entire fairness of the merger.” Id. at 8 (citation omitted). But the court’s decision most closely followed the decision of the Delaware Supreme Court in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), which loosened the standard from the more stringent “entire fairness” test to the business judgment rule in cases where both of the necessary procedural safeguards were present. The New York Court’s reasoning mirrored that of the Delaware Court, and centered around the premise that “when both protections are in place, the situation replicates an arm’s length transaction and supports the integrity of the process.” Kenneth Cole at 11 (emphasis in original).
The decision upheld the dismissal of a shareholder suit over Kenneth Cole Production Inc.’s $279 million going-private transaction. Pursuant to the MFW standard and absent any fraud or bad faith, the court held that plaintiffs had not pleaded that any of the necessary protections were lacking, so the business judgment rule applied.
Conclusion Both decisions provide important guidance to boards of directors that hope to forestall shareholder suits challenging transactions they have approved. If the directors are careful to follow appropriate procedural guidelines, permitting the necessary informed and uncoerced votes, they will be rewarded with the application of the business judgment rule – a highly favorable result.