In a move consistent with the Delaware courts’ recent general inclination for early dismissal of M&A related litigation, the Delaware Supreme Court today reversed the Chancery Court’s 2014 holding in Cornerstone.
As a result of the Supreme Court decision, where a plaintiff seeks monetary damages for alleged breaches of fiduciary duty by disinterested, independent directors who are protected by an exculpatory charter provision, the plaintiff must sufficiently plead non-exculpated claims (i.e., claims for duty of loyalty violations) in order to survive a motion to dismiss—regardless of the judicial standard of review that applies to the board’s conduct.
Under the Chancery Court’s decision, in a challenge to directors’ conduct in an interested transaction in which the entire fairness standard of review presumptively applied (i.e., a transaction that had not been structured to satisfy the MFW requirements for review under the business judgment rule), the plaintiffs’ claims would survive a motion to dismiss even if the only claims made would be exculpated (i.e., claims for duty of care violations). Thus, for purposes of a motion to dismiss, independent, disinterested directors were subject to the same standard as the controller and its affiliated directors. There was, in effect, an “automatic inference” of disloyalty in the context of an interested transaction subject to entire fairness review.
The Chancery Court had noted that its holding was required by Delaware Supreme Court precedent that, when entire fairness presumptively applies, a determination whether directors will be exculpated can be made only after a fully-developed factual record and a determination as to whether the transaction was entirely fair. The Chancery Court had suggested in dicta that the issue be reviewed by the Delaware Supreme Court or the legislature, reasoning that “doctrinally it seems insufficient to simply plead that … a director has participated in a transaction with a controller to automatically obtain a sufficient inference of disloyalty to survive a motion to dismiss by a disinterested director.”
The Supreme Court distinguished Emerald v. Berlin (2001)—the precedent by which the Chancery Court had felt bound—as having been decided in a different context. The issue in Emerald, Chief Justice Strine explained, was whether an exculpation provision could be invoked before trial when the duty of care and duty of loyalty claims were “intertwined” and issues of fact remained that implicated the directors’ duty of loyalty. The court determined in Emerald that “a determination of whether any failure of the putatively independent directors was the result of disloyalty or a lapse in care was best determined after a trial, because the substantive fairness inquiry would shed light on why the directors acted as they did.” The Supreme Court noted also that its reversal of the Chancery Court’s Cornerstone holding was (i) consistent with a director’s right to have claims against him or her considered individually and without an assumption of disloyalty and (ii) removed the disincentive to directors from “saying yes” to interested transactions subject to entire fairness review or from serving as special committee members.
Based on the Supreme Court reversal, claims against disinterested directors for fiduciary duty violations may be dismissed at the pleading stage of litigation if no particularized pleadings have been made that, if true, would give rise to an inference of a breach of the duty of loyalty. This pleading standard will apply whether the standard of review of the underlying transaction is Revlon, Unocal, entire fairness, or the business judgment rule. Thus, in controlling stockholder freeze-out mergers, companies will no longer have to bear the cost of prolonged litigation relating not only to claims against the controller but also to claims against the disinterested directors who are entitled to exculpation.
The Delaware Supreme Court result was not unexpected, given the Delaware courts’ recent apparent general inclination for early dismissal of litigation challenging M&A transactions and the Chancery Court’s own reluctance about its Cornerstone ruling.