On May 14, 2015, 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 in order to survive a motion to dismiss by that director, regardless of the underlying standard of review for the challenged transaction. In re Cornerstone Therapeutics Inc. Stockholder Litigation, Nos. 564, 2014 & 706, 2014 (Del. May 14, 2015). The Court’s decision resolved two interlocutory appeals, reversing the Chancery Court’s decisions last year in In re Cornerstone Therapeutics Inc. Stockholder Litigation, C.A. No. 8922-VCG (Del. Ch. Sep. 9, 2014) and In re Zhongpin Inc. Stockholders Litigation, C.A. No. 7393-VCN (Del. Ch. Nov. 26, 2014), and providing some comfort to independent directors facing shareholder suits following conflict-of-interest transactions.
Cornerstone and Zhongpin both involved damages actions challenging controlling shareholder mergers. In both cases, the defendant directors were protected from liability for breaches of the fiduciary duty of care by exculpatory charter provisions adopted under 8 Del. C. § 102(b)(7). The boards in both cases formed special committees and negotiated to secure substantial premiums over market price, but did not follow the process outlined in Kahn v. M&F Worldwide to secure the protection of the business judgment rule in interested transactions, and the transactions were thus subject to entire fairness review. The independent directors in each case brought motions to dismiss the claims against them, arguing that the plaintiffs failed to plead any claims against them that would not have been exculpated. Interpreting ambiguous precedent from the Delaware Supreme Court, the Chancery Court denied the motions to dismiss in each of Cornerstone and Zhongpin, but recommended certification of an interlocutory appeal to the Delaware Supreme Court.
In reversing the Chancery Court and clarifying its stance, the Supreme Court held that in order to survive a motion to dismiss by a director defendant protected by an exculpatory charter provision, the plaintiff must plead facts that support a claim that cannot be exculpated under Delaware law. That is, the plaintiff must plead “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.” While entire fairness review permits (at the pleading stage) an inference of disloyalty on the part of interested directors, it does not permit the same inference as to independent directors.
The Court emphasized that holding otherwise would not only contradict a basic principle of Delaware law– that each director is entitled to be considered individually and with the assumption that he or she acted in good faith – but would also harm shareholders. Such a rule would likely create a fear of liability that would incentivize independent directors to avoid negotiating on behalf of shareholders in controlling stockholder transactions and serving on special committees altogether. The decision thus reaffirms the importance of independent directors in the negotiation and sale process, and should provide additional comfort to directors covered by exculpatory charter provisions.