Delaware Supreme Court Holds That a Non-Exculpated Claim Against Independent Directors Must Be Pled to Survive Motion to Dismiss, Irrespective of Applicable Standard of Review for Board’s Conduct
In a May 14, 2015 decision in In re Cornerstone Therapeutics Inc. Stockholder Litig., which resolved two interlocutory appeals in unrelated litigation, the Supreme Court of the State of Delaware reversed the denial of the independent directors’ motions to dismiss in those actions and remanded for determination as to whether plaintiffs had sufficiently pled facts that the independent directors committed a non-exculpated breach of their fiduciary duty. In so doing, the Court answered in the affirmative the question whether a plaintiff bringing a damages action challenging an interested transaction that is presumptively subject to entire fairness review must plead a non-exculpated claim against disinterested, independent directors to survive a motion to dismiss by those directors. The Court held that a plaintiff seeking only monetary damages (as opposed to, for example, injunctive relief) must plead non-exculpated claims against a particular director who is protected by an exculpatory charter provision to survive a motion to dismiss, regardless of whether the underlying standard for reviewing the board conduct in question is the Revlon or Unocal standard, entire fairness or the business judgment rule.
The Court of Chancery opinions in question had essentially held that the disinterested/independent directors were required to remain defendants under existing precedent (and to have the issue of exculpation decided later in the litigation) because the transactions at issue were found to be scrutinized under Delaware’s strict entire fairness standard, and plaintiffs had been held to state non-exculpated claims against the interested parties and their affiliates. The Delaware Supreme Court acknowledged that existing precedent could arguably be read in different ways, but clarified 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 [require] 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….”
According to the Court, when a director is protected by an exculpatory charter provision authorized by Section 102(b)(7) of Delaware’s General Corporation Law (which provision is contained in most corporate charters), to survive a motion to dismiss a 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 [the director] could not be presumed to act independently, or acted in bad faith”. The Court rejected the notion of an “automatic inference that a director facilitating an interested transaction is disloyal”, noting that “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”. The Court similarly emphasized that the required individualized consideration of each director “does not start with the assumption that each director was disloyal”.
Noting the policy reasons underlying Section 102(b)(7) charter exculpation provisions, the Court declined “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.”
It has become all too common in transaction-related stockholder damages litigation for the pleading net to be cast widely, embroiling disinterested and independent directors against whom no specific allegations are directed in long and costly litigation. The Cornerstone decision confirms that absent pleading of facts creating an inference that seemingly independent directors approved a conflicted transaction for improper reasons and breached their duty of loyalty, those directors should be entitled to an early dismissal of claims against them. This decision should lead to closer scrutiny of allegations against individual directors and may provide an avenue for early exit from such litigation by disinterested and independent directors.