Independent Directors May Be Dismissed Under Exculpatory Provisions Regardless of Standard of Review
In In re Cornerstone Therapeutics Inc. Stockholder Litigation, Nos. 564, 2014 & 706, 2014 (Del. May 14, 2015), the Delaware Supreme Court resolved two consolidated interlocutory appeal in favor of defendant directors. Try not to be too surprised. The cases were consolidated because, as noted by Chancellor Strine
- they turn on a single legal question: in an action for damages against corporate fiduciaries , where the plaintiff challenges an interested transaction that is presumptively subject to entire fairness review, must the plaintiff plead a non-exculpated claim against the disinterested, independent directors to survive a motion to dismiss by those directors?
In the prior cases, the Delaware Court of Chancery had refused to dismiss claims against independent directors who were arguably protected by an exculpatory clause at the pleading stage. For example, in one of the underlying cases, In re Cornerstone Therapeutics Stockholder Litigation, C.A. No. 8922-VCG (Del. Ch. Sept. 9, 2014) plaintiffs challenged the acquisition of the minority interest in Cornerstone Therapeutics by its controlling stockholder. Defendant directors acknowledged that the transaction was subject to the entire fairness because it was between the corporation and its controlling shareholder, but claimed that because of the exculpatory provision, all claims against them must be dismissed in the absence of a pleaded non-exculpatory claim (which there was none).
Plaintiffs claimed that because the challenged transaction was subject to entire fairness review, directors must remain parties to the action until the end of the litigation because there was a distinct possibility that discovery would produce evidence to support more serious bad-faith charges.
The Chancery Court agreed with the plaintiffs and refused to dismiss the claims, noting that Emerald Partners "made clear" that a controlling stockholder transaction was subject to entire fairness review ab initio, and therefore, any exculpatory clauses in the charter can only be applied after the basis for liability has been decided.
In the Supreme Court opinion, Chancellor Strine reversed and remanded the earlier cases holding that a
- plaintiffs 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—be it Revlon, Unocal, the entire fairness standard, or the business judgment rule.
- We hold that 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 the duty of loyalty, the independent directors do not automatically have to remain defendants. When 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 acknowledged that the law on the issue “presents a debate between two competing but colorable views of the law” and then ruled firmly in favor of directors finding multiple reasons not require independent directors to remain subject to the litigation if no non-exculpatory claim was brought against them.
The Court noted
- The plaintiffs argue that they should be entitled to an automatic inference that a director facilitating an interested transaction is disloyal because the possibility of conflicted loyalties is heightened in controller transactions, and the facts that give rise to a duty of loyalty breach may be unknowable at the pleading stage. But there are several problems with such an inference : to require independent directors to remain defendants solely because the plaintiffs stated a non-exculpated claim against the controller and its affiliates would be inconsistent with Delaware law and would also increase costs for disinterested directors, corporations, and stockholders, without providing a corresponding benefit.
According to the Court, each director is entitled to be judged separately and is presumed to be acting loyally. Further, simply because the controlling shareholder may be found to have acted disloyally, that does not entitle plaintiffs to argue that an independent director is not entitled to the business judgement rule. In addition, the Court argued that allowing dismissal of claims against independent directors at the pleading stage is beneficial to minority shareholders:
- We decline to adopt an approach that would create incentives for independent directors to avoid serving as special committee members, or to reject transactions solely because their role in negotiating on behalf of the stockholders would cause them to remain as defendants until the end of any litigation challenging the transaction.
The decision ends the uncertainty about the reach of Emerald Partners which some had believed applied in the context of these cases. Chancellor Strine addressed this issue specifically and stated
- the Court in Emerald Partners was focused on a separate question; namely, 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. [Therefore, the holding that director must remain parties to the litigation applies only when] referring to a case where there was a viable, non-exculpated loyalty claim against each putatively independent director.
Directors should be very happy with this decision (and anyone familiar with the Delaware Supreme Court cannot be surprised). The decision makes it clear that plaintiffs who seek to hold seemingly independent directors to account in a controlling party transaction must plead facts creating an inference that such directors approved the transaction through a breach of their duty of loyalty. This may be quite difficult at the initial stages of litigation and will in all likelihood end providing an avenue for early exit for allegedly disinterested and independent directors.