Business Judgment Standard for Disinterested-Stockholder Approval
The Delaware Supreme Court in Corwin v. KKR Financial Holdings LLC, No. 629, 2014 (Del., October 2, 2015), issued an important opinion authored by Chief Justice Leo E. Strine Jr. resolving uncertainty about the effect fully informed, disinterested shareholder approval has on the judicial review of a transaction. Specifically, the court ruled that in a merger transaction with a party other than a controlling shareholder, the voluntary, informed judgment of the disinterested shareholders to approve the transaction will invoke the business judgment rule standard of review. Thus, even if the board of directors is not independent and disinterested, and in the absence of a valid disclosure or waste claim, the approving shareholder vote will permit pleading-stage dismissal of the claims against the directors.
The uncertainty and need for clarification arose from an earlier 2009 Delaware Supreme Court decision, Gantler v. Stephens, 965 A.2d 695 (Del. 2009). The court then stated the doctrine of shareholder ratification would not apply to a disinterested majority shareholder vote to amend the certificate of incorporation because the approving vote was statutorily required. The court stated the cleansing effect of shareholder ratification on allegedly wrongful director action applied only when shareholder approval was not legally required for the director action to become effective. Although clarification of the shareholder ratification doctrine was not necessary in Gantler because the court determined the vote was based on material misrepresentations and not fully informed, Gantler generated uncertainty about the effect, if any, that voluntary, fully informed shareholder approval of a transaction should have on the court's standard of review. (See In re Zale Stockholders Litigation, C.A. No. 9388-VCP (Del. Ch. October 1, 2015).)
The underlying transaction in Corwin involved a stock-for-stock merger in which KKR & Co. acquired the shares of KKR Financial Holdings. Both companies were widely held and publicly traded. The merger was approved by a majority of outstanding Financial Holdings shares entitled to vote held by shareholders other than KKR and its affiliates. The plaintiffs asserted the Financial Holdings board members breached their fiduciary duties of loyalty and care in approving the merger; that KKR breached its duty as a controlling shareholder; and that KKR, Financial Holdings and the merger affiliate aided and abetted the Financial Holdings board members' breaches. The plaintiffs argued the entire fairness standard applied because KKR was a controlling shareholder. The plaintiffs did not move to enjoin the merger or to challenge the sufficiency or accuracy of the disclosures. The lower court granted the defendants' Rule 12(b)(6) motion to dismiss under the business judgment rule standard of review, finding that KKR was not a controlling shareholder and that a majority of the members of Financial Holdings' board were independent and disinterested. The court went on to find that even if the board was interested, the fully informed, approving vote of the disinterested shareholders subjected the transaction to business judgment review. The court rejected the plaintiffs' Gantler argument that shareholder approval should not affect the standard of review because the shareholder vote was statutorily required.
On appeal, the Delaware Supreme Court affirmed the lower court's decision in all respects. With respect to the Gantler argument and the effect of shareholder approval, the Supreme Court rejected a narrow reading of Gantler that would limit its application to shareholder approval votes that are not statutorily required. Instead, the court interpreted Gantler as a narrow decision focused on defining a specific legal term, "ratification," and not on the question of what standard applies.
Finally, the Supreme Court rejected the plaintiffs' argument that application of business judgment review would impair the operation of Unocal or Revlon standards or expose shareholders to unfair action by directors without protection. Dismissing the argument, the court noted the two review doctrines are primarily tools of injunctive relief for the Court of Chancery before deal closings and are not designed as post-closing, liability-imposing standards or money damages tools.
Corwin represents a strong affirmation by the Delaware Supreme Court of the longstanding corporate policy underlying the business judgment rule and for judicial restraint with respect to the review of corporate transactions not involving a controlling shareholder. In circumstances where shareholders have a voluntary choice to accept or reject a transaction, the Supreme Court's ruling recognizes that the judiciary is poorly positioned to second-guess the determination of informed, disinterested shareholders who have an actual economic stake in the outcome. This level of review will facilitate early dismissal of Revlon-type claims for those transactions not preliminarily enjoined on disclosure or other grounds before the shareholder vote of approval.