Malpiede v. Townson

In this appeal, we affirm the holding of the Court of Chancery that allegations in the class action complaint challenging a merger do not support the plaintiff stockholders’ claims alleging: (1) breaches of the target board’s duty of loyalty or its disclosure duties; and (2) aiding and abetting or tortious interference by the acquiring corporation. We further affirm the granting of a motion to dismiss the plaintiffs’ due care claim on the ground that the exculpatory provision in the charter of the target corporation authorized by 8 Del. C. § 102(b)(7), bars any claim for money damages against the director defendants based solely on the board’s alleged breach of its duty of care. Accordingly, we affirm the judgment of the Court of Chancery dismissing the amended complaint.

With respect to the dismissal based on the exculpatory effect of the Section 102(b)(7) charter provision, we had an initial concern about the propriety of the trial court’s consideration of the exculpatory charter provision on a Rule 12(b)(6) motion to dismiss because it is a matter outside the complaint. Although presentation of matters outside the pleadings required the court to convert the Defendants’ motion to dismiss into a motion for summary judgment, the failure to do so was not reversible error. Because the plaintiffs do not contest the existence, terms, validity or authenticity of the Frederick’s exculpatory charter provision, we hold that the charter provision was properly before the Court of Chancery, which correctly held that the plaintiffs’ due care claim was barred. Accordingly, we affirm the judgment of the Court of Chancery.

Facts

Frederick’s of Hollywood (“Frederick’s”) is a retailer of women’s lingerie and apparel with its headquarters in Los Angeles, California. 1 This case centers on the merger of Frederick’s into Knightsbridge Capital Corporation (“Knightsbridge”) under circumstances where it became a target in a bidding contest. Before the merger, Frederick’s common stock was divided into Class A shares (each of which has one vote) and Class B shares (which have no vote). As of December 6, 1996, 2 there were outstanding 2,995,309 Class A shares and 5,903,118 Class B shares. Two trusts created by the principal founders of Frederick’s, Frederick and Harriet Mellinger (the “Trusts”), held a total of about 41% of the outstanding Class A voting shares and a total of about 51% of the outstanding Class B non-voting shares of Frederick’s. 3

On June 14, 1996, the Frederick’s board announced its decision to retain an investment bank, Janney Montgomery Scott, Inc. (“JMS”), to advise the board in its search for a suitable buyer for the company. In January 1997, JMS initiated talks *1080 with Knightsbridge. 4 Four months later, in April 1997, Knightsbridge offered to purchase all of the outstanding shares of Frederick’s for between $6.00 and $6.25 per share. At Knightsbridge’s request, the Frederick’s board granted Knights-bridge the exclusive right to conduct due diligence.

On June 18, 1997, the Frederick’s board approved an offer from Knightsbridge to purchase all of Frederick’s outstanding Class A and Class B shares for $6.14 per share in cash in a two-step merger transaction. 5 The terms of the merger agreement signed by the Frederick’s board prohibited the board from soliciting additional bids from third parties, but the agreement permitted the board to negotiate with third party bidders when the board’s fiduciary duties required it to do so. 6 The Frederick’s board then sent to stockholders a Consent Solicitation Statement recommending that they approve the transaction, which was scheduled to close on August 27, 1997.

On August 21, 1997, Frederick’s received a fully financed, unsolicited cash offer of $7.00 per share from a third party bidder, Milton Partners (“Milton”). Four days after the board received the Milton offer, Knightsbridge entered into an agreement to purchase all of the Frederick’s shares held by the Trusts for $6.90 per share. 7 Under the stock purchase agreement' the Trusts granted Knights-bridge a proxy to vote the Trusts’ shares, but the Trusts had the right to terminate the agreement if the Frederick’s board rejected the Knightsbridge offer in favor of a higher bid. 8

On August 27, 1997, the Frederick’s board received a fully financed, unsolicited $7.75 cash offer from Veritas Capital Fund (“Veritas”). In light of these developments, the board postponed the Knightsbridge merger in order to arrange a meeting with the two new bidders. On September 2, 1997, the board sent a memorandum to Milton and Veritas outlining the conditions for participation in the bidding process. The memorandum required that the bidders each deposit $2.5 million in an escrow account and submit, before September 4, 1997, a marked-up merger agreement with the same basic terms as the Knightsbridge merger agreement. Veritas submitted a merger agreement and the $2.5 million escrow payment in accordance with these conditions. Milton *1081 did not. 9

On September 3, 1997, the Frederick’s board met with representatives of Veritas to discuss the terms of the Veritas offer. According to the plaintiffs, the board asserts that, at this meeting, it orally informed Veritas that it was required to produce its “final, best offer” by September 4, 1997. The plaintiffs further allege that that board did not, in fact, inform Veritas of this requirement.

The same day that the board met with Veritas, Knightsbridge and the Trusts amended their stock purchase agreement to eliminate the Trusts’ termination rights and other conditions on the sale of the Trusts’ shares. On September 4, 1997, Knightsbridge exercised its rights under the agreement and purchased the Trusts’ ■shares. Knightsbridge immediately informed the board of its acquisition of the Trusts’ shares and repeated its intention to vote the shares against any competing third party bids.

One day after Knightsbridge acquired the Trusts’ shares, the Frederick’s board participated in a conference call with Veri-tas to discuss further the terms of the proposed merger. During this conference call, Veritas representatives suggested that, if the board elected to accept the Veritas offer, the board could issue an option to Veritas to purchase authorized but unissued Frederick’s shares as a means to circumvent the 41% block of voting shares that Knightsbridge had acquired from the Trusts. Frederick’s representatives also expressed some concern that Knightsbridge would sue the board if it decided to terminate the June 15, 1997 merger agreement. In response, Veritas agreed to indemnify the directors in the event of such litigation.

On September 6, 1997, Knightsbridge increased its bid to match the $7.75 Veri-tas offer, but on the condition that the board accept a variety of terms designed to restrict its ability to pursue superior offers. 10 On the same day, the Frederick’s board approved this agreement and effectively ended the bidding process. Two days later, Knightsbridge purchased additional Frederick’s Class A shares on the open market, at an average price of $8.21 per share, thereby acquiring a majority of both classes of Frederick’s shares.

On September 11, 1997, Veritas increased its cash offer to $9.00 per share. Relying on (1) the “no-talk” provision in the merger agreement, (2) Knightsbridge’s stated intention to vote its shares against third party bids, and (3) Veritas’ request for an option to dilute Knightsbridge’s interest, the board rejected the revised Veri-tas bid. On September 18, 1997, the board amended its earlier Consent Solicitation Statement to include the events that had transpired since July 1997. The deadline for responses to the consent solicitation was September 29, 1997, the scheduled closing date for the merger.

Before the merger closed, the plaintiffs filed in the Court of Chancery the purported class action complaint that is the prede *1082 cessor of the amended complaint before us. The plaintiffs also moved for a temporary restraining order enjoining the merger. The Court of Chancery denied the requested injunctive relief. 11

The plaintiffs then amended their complaint to include a class action claim for damages caused by the termination of the auction in favor of Knightsbridge and the rejection of the higher Veritas offer. The amended complaint alleged that the Frederick’s board had breached its fiduciary duties in connection with the sale of the company and had misstated and omitted material information in the Consent Solicitation Statement. The plaintiffs also sued Knightsbridge, alleging that it aided and abetted the board’s breach of fiduciary duties and it tortiously interfered with the stockholders’ prospective business relations (that is, the $9.00 Veritas bid).

The Court of Chancery granted the directors’ motion to dismiss the amended complaint under Chancery Rule 12(b)(6), concluding that: (1) the complaint did not support a claim of breach of the board’s duty of loyalty, (2) the exculpatory provision in the Frederick’s charter precluded money damages against the directors for any breach of the board’s duty of care, and (3) any misstatements or omissions in the Consent Solicitation Statement were immaterial as a matter of law. 12 The court also dismissed the claims against Knights-bridge, holding that the allegations in the amended complaint do not suggest complicity between Knightsbridge and the board and do not support the plaintiffs’ argument that the $9.00 Veritas bid was a “valid business expectancy.” 13

Standard of Review

We review de novo the dismissal by the Court of Chancery of a complaint under Rule 12(b)(6). 14 The complaint ordinarily defines the universe of facts from which the trial court may draw in ruling on a motion to dismiss. 15 Because a motion to dismiss under Chancery Rule 12(b)(6) must be decided without the benefit of a factual record, the Court of Chancery may not resolve material factual disputes; instead, the court is required to assume as true the well-pleaded allegations in the complaint. 16 The trial court may dismiss a complaint under Rule 12(b)(6) only where the court determines with “reasonable certainty” that the plaintiff could prevail on *1083 no set of facts that may be inferred from the well-pleaded allegations in the complaint. 17 This standard is based on the “notice pleading” requirement established in Ct. Ch. R. 8(e) and is “less stringent than the standard applied when evaluating whether a pre-suit demand has been excused in a stockholder derivative suit filed pursuant to Chancery Rule 23.1.” 18

Of course, the trial court is not required to accept every strained interpretation of the allegations proposed by the plaintiff, but the plaintiff is entitled to all reasonable inferences that logically flow from the face of the complaint. Moreover, a claim may be dismissed if allegations in the complaint or in the exhibits incorporated into the complaint effectively negate the claim as a matter of law. 19

The Duty of Loyalty Claim

The central claim in the amended complaint is that the sale of Frederick’s to Knightsbridge “constituted a breach of [the Frederick’s board’s] fiduciary obligation to maximize shareholder value” because the board did not “conduct an auction with a ‘level playing field’ ” as required by Revlon, Inc. v. MacAndrews & Forbes Holdings. 20 The plaintiffs contend that this sort of allegation cannot be neatly divided into duty of care claims and duty of loyalty claims.

In our view, Revlon neither creates a new type of fiduciary duty in the sale-of-control context nor alters the nature of the fiduciary duties that generally apply. Rather, Revlon emphasizes that the board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise. 21 Al *1084 though the Revlon doctrine imposes enhanced judicial scrutiny of certain transactions involving a sale of control, it does not eliminate the requirement that plaintiffs plead sufficient facts to support the underlying claims for a breach of fiduciary duties in conducting the sale. 22 Accordingly, we proceed to analyze the amended complaint to determine whether it alleges sufficient facts to support a claim that the board breached any of its fiduciary duties. 23

The Court of Chancery concluded, and the plaintiffs do not appear to contest on appeal, that the amended complaint adequately alleges a conflict of interest with respect to only one of the directors who approved the Knightsbridge merger. 24 The amended complaint does not allege that the lone conflicted director dominated the three other directors who approved the merger on September 6, 1997. 25 The Court of Chancery therefore correctly held that the Knightsbridge merger was ap *1085 proved by a majority of disinterested directors.

The plaintiffs nevertheless argue that the amended complaint supports a claim that the directors breached their duty of loyalty by approving the Knightsbridge merger. 26 The complaint alleges that “Frederick’s representatives expressed concern that if Frederick’s approved the [June 15, 1997] Merger Agreement in favor of a transaction with Veritas, Knights-bridge would sue Frederick’s and its directors.” The plaintiffs argue that this allegation supports a reasonable inference that the directors’ individual interests in avoiding personal liability to Knights-bridge influenced their decision to approve the Knightsbridge merger.

Except in egregious cases, the threat of personal liability for approving a merger transaction does not in itself provide a sufficient basis to question the disinterestedness of directors because the risk of litigation is present whenever a board decides to sell the company. 27 Moreover, even assuming arguendo that the threat of personal liability did raise some concerns about the disinterestedness of the directors, the amended complaint goes on to allege that Veritas agreed to indemnify the directors in the event that Knightsbridge sued them. This allegation undermines the plaintiffs’ inference that the directors rejected the Veritas offer “to avoid becoming embroiled in litigation with Knights-bridge.” 28 We therefore conclude that the facts alleged in the complaint do not state a cognizable claim that the directors acted in their own personal interests rather than in the best interests of the stockholders when they approved the Knightsbridge merger. 29

The Disclosure Claims

The plaintiffs next argue that September 18, 1997 Consent Solicitation Statement for the Knightsbridge merger contained material omissions and misrepresentations. In particular, the amended complaint alleges that the board (1) falsely *1086 asserted that it orally informed Veritas of a September 4, 1997 deadline for its final offer, (2) failed to disclose the reason for the resignation of two directors just before the board approved the initial Knights-bridge offer in June 1997, and (3) failed to disclose that the board did not negotiate with Veritas concerning terms of the proposed dilutive option. The Court of Chancery concluded that the alleged misstatements and omissions were immaterial as a matter of law. 30

We begin by observing that the board’s fiduciary duty of disclosure, like the board’s duties under Revlon and its progeny, is not an independent duties but the application in a specific context of the board’s fiduciary duties of care, good faith, and loyalty. 31 Where the board issues a Consent Solicitation Statement in contemplation of stockholder action, the board is obligated “to disclose fully and fairly all material information within the board’s control.” 32 In Arnold v. Society for Savings Bancorp, Inc., this Court adopted the following definition of materiality: “[T]here must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” 33

Although materiality determinations under this standard are necessarily fact-intensive and do not generally lend themselves to dismissal on the pleadings, 34 some statements or omissions may be immaterial as a matter of law. 35 To survive a *1087 motion to dismiss, the plaintiffs “must provide some basis for a court to infer that the alleged violations were material. For example, a pleader must allege that facts are missing from the statement, identify those facts, state why they meet the materiality standard and how the omission caused injury.” 36

In the present case, the amended complaint alleges that the board falsely asserted in the Consent Solicitation Statement that Veritas had been orally informed of the September 4, 1997 deadline for its “best, final offer.” The amended complaint also alleges that Veritas’ failure to comply with this requirement was among the reasons presented in the Consent Solicitation Statement for the board’s decision to reject the Veritas offer. The plaintiffs maintain that this alleged misrepresentation is material because a stockholder’s decision to ratify or reject a board decision is based, at least in part, on the board’s stated rationale for its recommendation. The plaintiffs thus argue that a Frederick’s stockholder would be more likely to ratify the board’s decision to reject the Veritas bid if the board’s decision was based on a good reason — that is, because the bid came too late. 37

The Court of Chancery found that this alleged misstatement was immaterial as a matter of law because the Consent Solicitation disclosed Veritas’ later $9.00 offer. 38 Since the stockholders were aware of the higher bid, the Court of Chancery concluded that the timeliness of the offer was irrelevant.

We agree with the Court of Chancery that the board’s disclosure of the $9.00 bid renders immaterial as a matter of law any misstatement about the rationale of the Frederick’s board for rejecting the bid. The importance that a stockholder ascribes to the availability of a higher bid in deciding whether to vote for or against a proposed merger is independent of the timeliness of the higher bid. Whether the bid was submitted on time or late would not “significantly alter” the stockholder’s assessment of the attractiveness of the offer. 39 Accordingly, we conclude that the *1088 board’s misstatement could not have been material to the reasonable stockholder.

The amended complaint also alleges that the Consent Solicitation Statement failed to disclose the reasons for the resignation of two directors in June 1997, although that pleading does acknowledge that the fact of these resignations was disclosed. The allegation that two directors resigned from the board immediately before the board approved the Knightsbridge merger tends to support, for notice pleading purposes, a reasonable inference that the directors resigned as a result of a disagreement over corporate policy. Moreover, the resignation of board members and other key advisors based on a disagreement about corporate policy may, in some circumstances, be material information that must be disclosed to stockholders. 40

But the amended complaint does not allege — or present facts supporting an inference — that the board was aware of the reasons for the directors’ resignations. 41 Absent some indication that the directors informed the board of their reasons for leaving, the board did not have a duty to disclose its assumptions about why the directors resigned. We also note that the two directors resigned before the board approved the June 15, 1997 merger agreement with Knightsbridge — well before the Frederick’s stockholders were asked to approve the September 1997 merger agreement. It thus requires a significant logical leap to suppose that reasonable stockholders would consider this information significant in the total mix of information available to them in September 1997.

Finally, the amended complaint alleges that the Consent Solicitation Statement did not disclose the fact that Veritas was prepared to negotiate the terms of the dilutive option that it had requested to circumvent Knightsbridge’s voting “power. Since the Consent Solicitation Statement indicated that the board relied on Veritas’ request for a dilutive option in rejecting the bid, the plaintiffs argue, the board was obligated to disclose that the terms of the option were negotiable.

This argument is based on a misreading of the Consent Solicitation Statement. The Statement indicates that the board declined to pursue the $9.00 bid in part because of “the Board’s continuing concern regarding the legality and practicality of issuing a dilutive option to [Veritas].” Thus, the board rejected the Veritas offer because the board was concerned about the legal validity of a dilutive option— regardless of the option’s terms — and not because the terms of the option were nonnegotiable. 42 We therefore agree with *1089 conclusion of the Court of Chancery that the negotiability of the option terms was not relevant to the board’s asserted concerns with the Veritas bid and would not be material to assessing the board’s rationale for rejecting the bid.

The Due Care Claim

Having concluded that the complaint was properly dismissed under Chancery Rule 12(b)(6) for failure to state a claim on which relief may be granted on other fiduciary duty claims, we now turn to the due care claim. The primary due care issue is whether the board was grossly negligent, and therefore breached its duty of due care, in failing to implement a routine defensive strategy that could enable the board to negotiate for a higher bid or otherwise create a tactical advantage to enhance stockholder value.

In this case, that routine strategy would have been for the directors to use a poison pill to ward off Knightsbridge’s advances and thus to prevent Knightsbridge from stopping the auction process. Had they done so, plaintiffs seem to allege that the directors could have preserved the appropriate options for an auction process designed to achieve the best value for the stockholders.

Construing the amended complaint most favorably to the plaintiffs, it can be read to allege that the board was grossly negligent in immediately accepting the Knights-bridge offer and agreeing to various restrictions on further negotiations without first determining whether Veritas would issue a counteroffer. Although the board had conducted a search for a buyer over one year, plaintiffs seem to contend that the board was imprudently hasty in agreeing to a restrictive merger agreement on the day it was proposed — particularly where other bidders had recently expressed interest. 43 Although the board’s haste, in itself, might not constitute a breach of the board’s duty of care because the board had already conducted a lengthy sale process, the plaintiffs argue that the board’s decision to accept allegedly extreme contractual restrictions impacted its ability to obtain a higher sale price. Recognizing that, at the end of the day, plaintiffs would have an uphill battle in overcoming the presumption of the business judgment rule, 44 we must give plaintiffs the benefit of the doubt at this pleading stage to determine if they have stated a due care claim. Because of our ultimate decision, however, we need not finally decide this question in this case.

We assume, therefore, without deciding, that a claim for relief based on gross negligence during the board’s auction process is stated by the inferences most favorable to plaintiffs that flow from these allegations. The issue then becomes whether the amended complaint may be dismissed upon a Rule 12(b)(6) motion by reason of the existence and the legal effect of the exculpatory provision of Article TWELFTH of Frederick’s certificate of incorporation, adopted pursuant to 8 Del. C. § 102(b)(7). That provision would exempt directors from personal liability in damages with *1090 certain exceptions (e.g., breach of the duty of loyalty) that are not applicable here. 45

A. The Exculpatory Charter Provision Was Properly Before the Court of Chancery

The threshold inquiry is whether Article TWELFTH of the Frederick’s certifícate of incorporation was properly before the Court of Chancery. In their brief in support of their motion to dismiss in the Court of Chancery, the director defendants interposed the Section 102(b)(7) charter provision as a bar to plaintiffs’ claims based on an alleged breach of the duty of care. 46

This provision, which appeared for the first time in the director defendants’ brief in the Court of Chancery, was placed before the court without any authentication or supporting affidavit. The existence and authenticity of this provision was never questioned by plaintiffs, however. The trial court therefore tacitly accepted it as authentic without defendants formally asking the court to take judicial notice of its existence, which could easily be found in the public files in the Secretary of State’s office and could properly be noticed judicially by the court. 47

Because the charter provision is not found within the four corners of the complaint, it is a “matter outside the pleading.” Accordingly, on a Rule 12(b)(6) motion to dismiss, if

matters outside the pleading are presented to and not excluded by the Court the motion shall be treated as one for summary judgment and disposed of as provided in Rule 56, and all parties shall be given a reasonable opportunity to present all material made pertinent to such a motion by Rule 56. 48

Under Rule 56 in this context, there may be an opportunity for either side to submit affidavits or engage in discovery 49 to explore the “matter outside the pleadings [that had been] ... presented to and not excluded by the Court.” 50

*1091 Simply because a matter outside the pleading has been presented under Rule 12(b)(6) and thereby must be “treated as one for summary judgment” with “all parties ... given a reasonable opportunity to present all material made pertinent to such a motion by Rule 56,” 51 it does not follow that the “floodgates of discovery” have to be opened. The Rule 56 opportunity to present affidavits or engage in discovery is not absolute. It is necessarily circumscribed by the discretion of the trial court in determining the scope of the “matters outside the pleading” that had been presented in connection with the Rule 12(b)(6) motion. Indeed, plaintiffs here do not contend that simply because defendants invoked the Section 102(b)(7) charter provision they are thereby invited to go on a fishing expedition. Accordingly, when matters outside the pleading — such as a “Section 102(b)(7) charter provision-— are presented, the trial court should carefully limit the discovery sought to a scope that is coextensive with the issue necessary to resolve the motion. 52 Here, there was apparently no discovery issue. 53

When the issue is confined to the legal effect of a Section 102(b)(7) charter provision, it is difficult to envision what discovery would be implicated. To be sure, in a due care case where a Section 102(b)(7) charter provision is invoked, a plaintiff could theoretically contest the validity of the charter provision. In such a case, the plaintiff must have a proper basis 54 to claim that the Section 102(b)(7) charter *1092 provision presented by the defendants on the Rule 12(b)(6) motion is not authentic, was improperly adopted by the stockholders, or the like.

Plaintiffs make no such claim here. Although plaintiffs contend that under Emerald Partners 55 the burden is on the defendants to produce evidence to support a Section 102(b)(7) defense, they do not contest the existence or authenticity of Frederick’s 102(b)(7) charter provision. There being no Rule 56 avenue of discovery or affidavits that would be relevant to the narrow issue before the trial court in this case, we conclude that the plaintiffs were not deprived of any important procedural right arising from the fact that the trial court considered Frederick’s 102(b)(7) charter exculpation provision in connection with the Rule 12(b)(6) motion to dismiss. Although it would have been preferable for the trial court to have observed the precise provisions of the rules and to have expressly treated the motion as one for summary judgment once the Section 102(b)(7) charter provision was interposed by the director defendants, we find no reversible error in failing to do so. The provision was properly before the Court of Chancery in deciding on the director defendants’ motion to dismiss.

As guidance for future cases, we observe that there are several methods available to the defense to raise and argue the applicability of the bar of a Section 102(b)(7) charter provision to a due care claim. The Section 102(b)(7) bar may be raised on a Rule 12(b)(6) motion to dismiss (with or without the filing of an answer), a motion for judgment on the pleadings (after filing an answer), 56 or a motion for summary judgment (or partial summary judgment) under Rule 56 after an answer, with or without supporting affidavits.

In the case of a Rule 12(b)(6) motion, as here, if the Section 102(b)(7) charter provision is raised for the first time in the motion or brief in support of the motion, it is a matter outside the pleading. If not excluded by the court, the existence of such matter means that the motion will be converted, by clear force of the pleading rules, into a motion for summary judgment under Rule 56 and should be handled as we have noted above.

B. Application of Emerald Partners

We now address plaintiffs’ argument that the trial court committed error, based on certain language in Emerald Part ner's, 57 by barring their due care claims. Plaintiffs’ arguments on this point are based on an erroneous premise, and our decision here is not inconsistent with Emerald Partners.

In Emerald Partners, we made two important points about the raising of Section 102(b)(7) charter provisions. First we said: “[T]he shield from liability provided by a certificate of incorporation provision adopted pursuant to 8 Del. C. § 102(b)(7) is in the nature of an affirmative defense.” 58 Second, we said:

*1093 [Wjhere the factual basis for a claim solely implicates a violation of the duty of care, this court has indicated that the protections of such a charter provision may properly be invoked and applied. Arnold v. Society for Savings Bancorp., Del.Supr., 650 A.2d 1270, 1288 (1994); Zim v. VLI Corp., Del.Supr., 681 A.2d 1050, 1061 (1996). 59

Based on this language in Emerald Partners, plaintiffs make two arguments. First, they argue that the Court of Chancery in this case should not have dismissed their due care claims because these claims are intertwined with, and thus indistinguishable from, the duty of loyalty and bad faith claims. 60 Second, plaintiffs contend that the Court of Chancery incorrectly assigned to them the burden of going forward with proof.

1. The Court of Chancery Properly Dismissed Claims Based Solely on the Duty of Care

Plaintiffs here, while not conceding that the Section 102(b)(7) charter provision may be considered on this Rule 12(b)(6) motion nevertheless, in effect, conceded in oral argument in the Court of Chancery and similarly in oral argument in this Court that if a complaint unambiguously and solely asserted only a due care claim, the complaint is dismissible once the corporation’s Section 102(b)(7) provision is invoked. 61 This concession is in line with our holding in Emerald Partners quoted above.

Plaintiffs contended vigorously, however, that the Section 102(b)(7) charter provision does not apply to bar their claims in this case because the amended complaint alleges breaches of the duty of loyalty and other claims that are not barred by the charter provision. As a result, plaintiffs maintain, this case cannot be boiled down solely to a due care case. They argue, in effect, that their complaint is sufficiently well-pleaded that — as a matter of law — the due care claims are so inextricably intertwined with loyalty and bad faith claims that Section 102(b)(7) is not a bar to recovery of damages against the directors. 62

*1094 We disagree. It is the plaintiffs who have a burden to set forth “a short and plain statement of the claim showing that the pleader is entitled to relief.” 63 The plaintiffs are entitled to all reasonable inferences flowing from their pleadings, but if those inferences do not support a valid legal claim, the complaint should be dismissed without the need for the defendants to file an answer and without proceeding with discovery. Here we have assumed, without deciding, that the amended complaint on its face states a due care claim. Because we have determined that the complaint fails properly to invoke loyalty and bad faith claims, we are left with only a due care claim. Defendants had the obligation to raise the bar of Section 102(b)(7) as a defense, and they did. As plaintiffs conceded in oral argument before this Court, if there is only an unambiguous, residual due care claim and nothing else — as a matter of law — then Section 102(b)(7) would bar the claim. Accordingly, the Court of Chancery did not err in dismissing the plaintiffs due care claim in this case.

2. The Court of Chancery Correctly Applied the Parties’ Respective Burdens of Proof

Plaintiffs also assert that the trial court in the case before us incorrectly placed on plaintiffs a pleading burden to negate the elements of the 102(b)(7) charter provision. Plaintiffs argue that this ruling is inconsistent with the statement in Emerald Partners that “the shield from liability provided by a certificate of incorporation provision adopted pursuant to 8 Del. C. § 102(b)(7) is in the nature of an affirmative defense_ Defendants seeking exculpation under such a provision will normally bear the burden of establishing each of its elements.” 64

The procedural posture here is quite different from that in Emerald Partners. There the Court stated that it was incorrect for the trial court to grant summary judgment on the record in that case because the defendants had the burden at trial of demonstrating good faith if they were invoking the statutory exculpation provision. In this case, we focus not on trial burdens, but only on pleading issues. A plaintiff must allege well-pleaded facts stating a claim on which relief may be granted. Had plaintiff alleged such well-pleaded facts supporting a breach of loyalty or bad faith claim, the Section 102(b)(7) charter provision would have been unavailing as to such claims, and this case would have gone forward. 65

But we have held that the amended complaint here does not allege a loyalty violation or other violation falling within the exceptions to the Section 102(b)(7) exculpation provision. Likewise, we have held that, even if the plaintiffs had stated a claim for gross negligence, such a well-pleaded claim is unavailing because defendants have brought forth the Section *1095 102(b)(7) charter provision that bars such claims. This is the end of the case.

And rightly so, as a matter of the public policy of this State. Section 102(b)(7) was adopted 66 by the Delaware General Assembly in 1986 following a directors and officers insurance liability crisis and the 1985 Delaware Supreme Court decision in Smith v. Van Gorkom. 67 The purpose of this statute was to permit stockholders to adopt a provision in the certificate of incorporation to free directors of personal liability in damages for due care violations, but not duty of loyalty violations, bad faith claims and certain other conduct. Such a charter provision, when adopted, would not affect injunctive proceedings based on gross negligence. 68 Once the statute was adopted, stockholders usually approved charter amendments containing these provisions because it freed up directors to take business risks without worrying about negligence lawsuits. 69

Our jurisprudence since the adoption of the statute has consistently stood for the proposition that a Section 102(b)(7) charter provision bars a claim that is found to state only a due care violation. 70 Because we have assumed that the amended complaint here does state a due care claim, the exculpation afforded by the statute must affirmatively be raised by the defendant directors. 71 The directors have done so in *1096 this case, and the Court of Chancery properly applied the Frederick’s charter provision to dismiss the plaintiffs’ due care claim. 72

The Aiding and Abetting Claim Against Knightsbridge

We next turn to the plaintiffs’ claims relating to Knightsbridge’s conduct during the auction process. They first argue that the trial court erred in dismissing their claim that Knightsbridge aided and abetted the board’s alleged breach of its fiduciary duty — namely, the board’s failure to obtain the highest price reasonably available during the auction. Specifically, the amended complaint alleges that Knightsbridge (1) initially misrepresented the nature of its interest in the Trusts’ shares, (2) threatened to sue the board if it breached the June 1997 merger agreement, (3) demanded a hasty consummation of the September 1997 merger, and (4) conditioned the September 1997 offer on the board’s acceptance of extremely restrictive contract terms. 73 The Court of Chancery rejected these arguments because the negotiations between Knights-bridge and Frederick’s were at arm’s-length and because the facts alleged in the complaint do not indicate that Knights-bridge knowingly participated in any fiduciary breach by the board. 74

A third party may be liable for aiding and abetting a breach of a corporate fiduciary’s duty to the stockholders if the third party “knowingly participates” in the breach. 75 To survive a motion to dismiss, the complaint must allege facts that satisfy the four elements of an aiding and abetting claim: “(1) the existence of a fiduciary relationship, (2) a breach of the fiduciary’s duty, ... (3) knowing participation in that breach by the defendants,” and (4) damages proximately caused by the breach. 76

In this case, we have concluded that the amended complaint does not adequately allege a duty of loyalty claim. But we have assumed, without deciding, that the amended complaint, construed most favorably to plaintiffs, alleges that the board’s conduct was grossly negligent and constituted a breach of its duty of care. 77 *1097 We must therefore determine whether the plaintiffs alleged facts supporting a reasonable inference that Knightsbridge “knowingly participated” in the board’s due care breach. 78

Knowing participation in a board’s fiduciary breach requires that the third party act with the knowledge that the conduct advocated or assisted constitutes such a breach. 79 Under this standard, a bidder’s attempts to reduce the sale price through arm’s-length negotiations cannot give rise to liability for aiding and abetting, 80 whereas a bidder may be liable to the target’s stockholders if the bidder attempts to create or exploit conflicts of interest in the board. 81 Similarly, a bidder may be liable to a target’s stockholders for aiding and abetting a fiduciary breach by the target’s board where the *1098 bidder and the board conspire in or agree to the fiduciary breach. 82

In the present case, the Court of Chancery concluded that the September 1997 merger agreement was the product of arm’s-length negotiations and that arm’s-length negotiations are inconsistent with participation in a fiduciary breach. 83 The plaintiffs argue that this conclusion reflected impermissible fact-finding on a motion to dismiss, but there is no indication in the amended complaint that Knightsbridge participated in the board’s decisions, conspired with board, or otherwise caused the board to make the decisions at issue. 84 Moreover, there is no dispute that only one of the Frederick’s directors who approved the merger had a conflict of interest, and that director did not dominate or control the others.

Although Knightsbridge’s tactics here, as alleged, may have been somewhat suspect, 85 we agree with the trial court’s conclusion that the plaintiffs’ aiding and abetting claim fails as a matter of law because the allegations in the complaint do not support an inference