The Delaware Supreme Court will address the standard for pleading that an independent director has breached fiduciary duties in connection with a controlling shareholder buyout. The issue was certified for interlocutory appeal in a pair of recent Delaware Chancery Court cases. In re Cornerstone Therapeutics Stockholder Litigation, No. CIV.A. 8922-VCG (Del. Ch. Sept. 10, 2014) (Glasscock, V.C.); In re Zhongpin Stockholders Litigation, No. CV 7393-VCN (Del. Ch. Nov. 26, 2014) (Noble, V.C.).
In Cornerstone and Zhongpin, minority shareholders sued after the controlling shareholder of a publicly-traded company attempted a going-private transaction. In both cases, the board of directors formed a special committee of independent directors to negotiate with the controller; however, neither deal was conditioned, at the outset, on approval of a majority of the minority shareholders. In both cases, the corporate charter contained a provision enacted pursuant to Delaware General Corporation Law 102(b)(7), which exculpated directors from liability for breach of the duty of care.
In Cornerstone, the independent director defendants filed a motion to dismiss, arguing that the plaintiffs were required to plead that the directors breached a non-exculpated duty (e.g., a breach of the duty of loyalty or bad faith). Initially, the court determined that an entire fairness review was required because the deal was not conditioned, at the outset, on approval of a majority of the minority shareholders. Although the court noted that the directors’ argument was not without merit, it determined that it was bound by the Delaware Supreme Court’s decision in Emerald Partners v. Berlin, holding 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,’ that is, upon a fully-developed factual record and a determination of whether the transaction was entirely fair.” Thus, to survive a motion to dismiss, a shareholder need only plead “that a stockholder controlled the corporate machinery; that it used that machinery to facilitate a transaction of which it thus stood on both sides; that the transaction was not entirely fair to the minority; and that the Director Defendants negotiated or facilitated the unfair transaction.” The Delaware Court of Chancery cited Cornerstone for this proposition when the issue presented itself again in Zhongpin.
The Supreme Court’s decision in these two cases will have both practical and legal implications. If the Court agrees with the Court of Chancery’s reading of Emerald Partners, there will be an additional incentive for dealmakers to structure their transactions, ab initio, upon approval by an independent special committee and an informed vote of a majority of the minority stockholders—the procedural safeguards required to avoid entire fairness review. It may also require the Court to resolve a related procedural issue. That is, whether disinterested director liability may be determined upon motion or whether it must await post-trial proceedings.
A more detailed discussion of the Cornerstone and Zhongpin appeals appears in an article written by Proskauer’s Sarah Gold and Richard Spinogatti that was published in the February 11, 2015 edition of the New York Law Journal.