Leal v. Meeks

I. INTRODUCTION

These appeals were scheduled for argument on the same day because 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? 1 We answer that question in the affirmative. A plaintiff 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,2 *1176Unocal,3 the entire fairness standard, or the business judgment rule.

The Court of Chancery in both of these cases denied the defendants’ motions to dismiss because it read the precedent of this Court to require doing so, regardless of the exculpatory provision in each company’s certifícate of incorporation. Under the Court of Chancery’s analysis, even if the plaintiffs could not plead a non-exculpated claim against any particular director, as long as the underlying transaction was subject to the entire fairness standard of review, and the plaintiffs were therefore able to state non-exculpated claims against the interested parties and their affiliates, all of the directors were required to remain defendants until the end of litigation. The Court of Chancery was reluctant to embrace that result but felt that it was the reading most faithful to our precedent.

In this decision, 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 their 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, in keeping with this Court’s opinion in Malpiede v. Townson4 and cases following that decision.5 Accordingly, we remand both of these cases to allow the Court of Chancery to determine if the plaintiffs have sufficiently pled non-exculpated claims against the independent directors.

II. BACKGROUND

These appeals both involve damages actions by stockholder plaintiffs arising out of mergers in which the controlling stockholder, who had representatives on the board of directors, acquired the remainder of the shares that it did not own in a Delaware public corporation.6 . Both merg*1177ers were negotiated by special committees of independent directors, were ultimately approved by a majority of the minority stockholders, and were at substantial premiums to the pre-announcement market price.7 Nonetheless, the plaintiffs filed suit in the Court of Chancery in each case, contending that the directors had breached their fiduciary duty by approving transactions that were unfair to the minority stockholders.

In both appeals, it is undisputed that the companies did not follow the process established in Kahn v. M & F Worldwide Corporation as a safe harbor to invoke the business judgment rule in the context of a self-interested transaction.8 Thus, the entire fairness standard presumptively applied, although the burden of persuasion on that issue might ultimately rest with the plaintiffs.9 In both cases, the defendant directors were insulated from liability for monetary damages for breaches of the fiduciary duty of care by an exculpatory charter provision adopted in accordance with 8 Del. C. § 102(b)(7). Despite that provision, the plaintiffs in each case not only sued the controlling stockholders and their affiliated directors, but also sued the independent directors who had negotiated and approved the mergers.

In the first of these cases to be decided, In re Cornerstone Therapeutics Inc. Stockholder Litigation, the independent director defendants moved to dismiss on the grounds that the plaintiffs had failed to plead any non-exculpated claim against them.10 The independent directors argued that although the entire fairness standard applied to the Court of Chancery’s review of the underlying transaction, and thus the controlling stockholder and its affiliated directors were at risk of being found liable for breaches of the duty of loyalty, the plaintiffs still bore the burden to plead non-exculpated claims against the indépen-dent directors.11 The independent directors noted that this Court held in Malpiede v. Townson that, in the analogous context of review under the Revlon standard, plaintiffs seeking damages must plead non-exculpated claims against each individual director or risk dismissal.12 The *1178independent directors also pointed out that in a number of cases, including several affirmed by this Court, the Court of Chancery dismissed claims against independent directors when the plaintiffs failed to plead non-exculpated claims for breaches of fiduciary duty, notwithstanding the applicability of entire fairness review to the transaction.13

In response, the plaintiffs argued that the Court of Chancery could not grant the independent directors’ motion to dismiss, regardless of whether they had sufficiently pled non-exculpated claims.14 Under their reading of language in two of the four decisions issued by this Court in the extensive Emerald Partners litigation,15 the plaintiffs contended that they could defeat the independent directors’ motions to dismiss solely by establishing that the underlying transaction was subject to the entire fairness standard.16 In the first of the two relevant Emerald Partners decisions (“Emerald I ”), this Court determined that the plaintiffs had sufficiently pled duty of loyalty claims against the disinterested directors that were “intertwined” with their duty of care claims.17 In the second of the two decisions (“Emerald II”), this Court stated that “when entire fairness is the applicable standard of judicial review, a determination that the director defendants are exculpated from paying monetary damages can be made only after the basis for their liability has been decided,” on a fully-developed factual record.18 The Cornerstone plaintiffs argued that this language in Emerald II should be read broadly to require the court to deny independent directors’ motions to dismiss whenever the applicable standard of re*1179view is entire fairness.19 Although the Court of Chancery suggested that it believed that the defendants’ view of the law was the preferable one,20 it nonetheless concluded that it was bound to deny the motion because its reading of the Emerald II decision was the one advocated by the plaintiffs.21

In In re Zhongpin Stockholders Litigation, the independent director defendants also argued that the claims against them should be dismissed because the plaintiffs had failed to plead any non-exculpated claims.22 The Court of Chancery in Zhongpin deferred to Cornerstone’s interpretation of precedent23 and held that the claims against the independent directors survived their motion to dismiss “regardless of whether the Complaint state[d] a non-exculpated claim” because the transaction was subject to entire fairness review.24

In each case, the Court of Chancery did not analyze the plaintiffs’ duty of loyalty claims against the independent directors because it determined that it was required to deny their motions to dismiss regardless of whether such claims had been sufficiently pled.25 But, recognizing the important and uncertain issue of corporate law at stake, the Court of Chancery in each case recommended certification of an interlocutory appeal to this Court to determine whether its reading of precedent was correct.

III. ANALYSIS

In answering the legal question raised by these appeals, we acknowledge that the body of law relevant to these disputes presents a debate between two competing but colorable views of the law. These cases thus exemplify a benefit of careful employment of the interlocutory appeal process: to enable this Court to clarify precedent that could arguably be read in two different ways before litigants incur avoidable costs.

We now resolve the question presented by these cases by determining that plaintiffs must plead a non-exculpated claim for breach of fiduciary duty against an independent director protected by an exculpatory charter provision, or that director will be entitled to be dismissed from the suit. That rule applies regardless of the underlying standard of review for the transaction. When a director is protected by an exculpatory charter provision, a plaintiff can survive a motion to dismiss by that director defendant by pleading facts supporting a rational inference that the *1180director 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.26 But the mere fact that a plaintiff is able to plead facts supporting the application of the entire fairness standard to the transaction, and can thus state a duty of loyalty claim against the interested fiduciaries, does not relieve the plaintiff of the responsibility to plead a non-exculpated claim against each director who moves for dismissal.27

No doubt, the invocation of the entire fairness standard has a powerful pro-plaintiff effect against interested parties.28 When that standard is invoked at the pleading stage, the plaintiffs will be able to survive a motion to dismiss by interested parties regardless of the presence of an exculpatory charter provision because their conflicts of interest support a plead*1181ing-stage inference of disloyalty.29 Indeed, as to the interested party itself, a finding of unfairness after trial will subject it to liability for breach of the duty of loyalty regardless of its subjective bad faith.30

The stringency of after-the-fact entire fairness review by the court intentionally puts strong pressure on the interested party and its affiliates to deal fairly before-the-fact when negotiating an interested transaction. To accomplish this, the burden of proving entire fairness in an interested merger falls on the “the controlling or dominating shareholder proponent of the transaction.”31 But applying the entire fairness standard against interested parties does not relieve plaintiffs seeking damages of the obligation to plead non-exculpated claims against each of the defendant directors.32

In Malpiede, this Court analyzed the effect of a Section 102(b)(7) provision on a due care claim against directors who approved a transaction which the plaintiffs argued should be subject to review under the Revlon standard. This Court noted that although “plaintiffs are entitled to all reasonable inferences flowing from their pleadings, ... if those inferences do not support a valid legal claim, the complaint should be dismissed.”33 Because a director will only be liable for monetary damages if she has breached a non-exculpated duty, a plaintiff who pleads only a due care claim against that director has not set forth any grounds for relief. In such a case, “as a matter of law [ ] then Section 102(b)(7) would bar the claim.”34

*1182Nevertheless, the plaintiffs in each of these cases contend that their exculpated claims against the independent directors cannot be dismissed solely because the transaction at issue is subject to entire fairness review. 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.35 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.

First, this Court and the Court of Chancery have emphasized that each director has a right, to be considered individually when the directors face claims for damages in a suit challenging board action.36 And under Delaware corporate law, that individualized consideration does not start with the assumption that each director was disloyal; rather, “indepen*1183dent directors are presumed to be motivated to do their duty with fidelity.”37 Thus, in Aronson v. Lewis, this Court emphasized that the mere fact that a director serves on the board of a corporation with a controlling stockholder does not automatically make that director not independent.38 This Court has similarly refused to presume that an independent director is not entitled to the protection of the business judgment rule solely because the controlling stockholder may itself be subject to liability for breach of the duty of loyalty if the transaction was not entirely fair to the minority stockholders.39

Adopting the plaintiffs’ approach would not only be inconsistent with these basic tenets of Delaware law, it would likely create more harm than benefit for minority stockholders in practice.40 Our common law of corporations has rightly emphasized *1184the need for independent directors to be willing to say no to interested transactions proposed by controlling stockholders.41 For that reason, our law has long inquired into the practical negotiating power given to independent directors in conflicted transactions.42 Although it is wise for our law to focus on whether the independent directors can say no, it does not follow that it is prudent to create an invariable rule that any independent director who says yes to an interested transaction subject to entire fairness review must remain as a defendant until the end of the litigation, regardless of the absence of any evidence suggesting that the director acted for an improper motive.

For more than a generation, our law has recognized that the negotiating efforts of independent directors can help to secure transactions with controlling stockholders that are favorable to the minority.43 Indeed, respected scholars have found evidence that interested transactions subject to special committee approval are often priced on terms that are attractive to minority stockholders.44 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.45

*1185As is well understood, the fear that directors who faced personal liability for potentially value-maximizing business decisions might be dissuaded from making such decisions is why Section 102(b)(7) was adopted in the first place. As this Court' explained in Mahpiede, “Section 102(b)(7) was adopted 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.”46 Because of that “crisis,” the General Assembly feared that directors would not be willing to make decisions that would benefit stockholders if they faced personal liability for making them. The purpose of Section 102(b)(7) was to “free[] up directors to take business risks without worrying about negligence lawsuits.”47 Establishing a rule that all directors must remain as parties in litigation involving a transaction with a controlling stockholder would thus reduce the benefits that the General Assembly anticipated in adopting Section 102(b)(7).

We understand that the plaintiffs, and certain members of the Court of Chancery, have read the decisions this Court issued in the complex circumstances of the Emerald Partners litigation to support a different conclusion than we reach here. But 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.48 In that circumstance, the Court held that the *1186determination 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.49 The sentence in Emerald II that the plaintiffs claim is dispositive here must be understood in that context, as referring to a case where there was a viable, non-exculpated loyalty claim against each putatively independent director. The Emerald Partners litigation thus did not answer the specific question at issue in these appeals, whether the application of the entire fairness standard requires the Court of Chancery to deny a motion to dismiss by independent directors even when the plaintiffs may not have sufficiently pled a non-exculpated claim against those directors. Indeed, much of the language in the Emerald Partners decisions issued by this Court is consistent with the answer we reach here. For example, this Court observed in Emerald II that:

The rationale of Malpiede constitutes judicial cognizance of a practical reality: unless there is a violation of the duty of loyalty or the duty of good faith, a trial on the issue of entire fairness is unnecessary because a Section 102(b)(7) provision will exculpate director defendants from paying monetary damages that are exclusively attributable to a violation of the duty of care. The effect of our holding in Malpiede is that, in actions against the directors of Delaware corporations with a Section 102(b)(7) charter provision, a shareholder’s complaint must allege well-pled facts that, if true, implicate breaches of loyalty or good faith.50

Thus, to the extent that other isolated statements in Emerald Partners could be interpreted as inconsistent with the result we reach today, we clarify that the Emerald Partners decisions should be read in their ease-specific context and not for the broad proposition that the plaintiffs advocate. The reading of the Emerald Partners decisions we embrace is also the one adopted by the Court of Chancery itself in DiRienzo v. Lichtenstein.51 In that case, the Court of Chancery recognized that the Emerald Partners decisions had to be read in the context of their facts, where there was sufficient record evidence to attribute any lack of effectiveness in the putatively independent directors’ handling of the transaction to either a breach of the duty of loyalty (e.g., as the result of bad faith) or a lack of care. The Court of Chancery thus observed that “the directors in Emerald Partners were precluded from relying on a 102(b)(7) charter provision by virtue of their conduct, not because the transaction was subject to entire fairness review for other reasons.”52 In other words, DiRienzo interpreted the Emerald Partners decisions as standing for the mundane proposition that a defendant cannot obtain dismissal on the basis of an exculpatory provision when there is evidence that he committed a non-exculpated breach of fiduciary duty.53

Thus, when a complaint pleads facts creating an inference that seemingly *1187independent directors approved a conflicted transaction for improper reasons, and thus, those directors may have breached their duty of loyalty, the pro-plaintiff inferences that must be drawn on a motion to dismiss counsels for resolution of that question of fact only after discovery.54 By contrast, when the plaintiffs have pled no facts to support an inference that any of the independent directors breached then-duty of loyalty, fidelity to the purpose of Section 102(b)(7) requires dismissal of the complaint against those directors. Accordingly, we reverse the judgments of the Court of Chancery denying the independent directors’ motions to dismiss, and remand each case for the Court of Chancery to determine if the plaintiffs have sufficiently pled facts suggesting that the independent directors committed a non-exculpated breach of their fiduciary duty.