Court of Chancery Rejects Balancing Test Under Rule 23.1
Bakerman v. Frank Importing Co. Inc., C.A. No. 1844-N (Del. Ch. October 16, 2006).
When directors own shares in both the parent and its subsidiary, the question arises whether they are disinterested in considering a demand under Rule 23.1 in a case challenging a transaction between the two entities. This decision holds that the Court will test their interest in the transaction by focusing on their interest in the dominant party and will not also take into account their interest in the entity on the other side of the transaction. This makes sense because otherwise the Court would need to do a complex balancing to see if the interest in the subsidiary was as important as the interest in the parent. That involves tax and other issues that are difficult to determine. Note, however, that after discovery, those interests may be balanced in deciding on the merits if the directors should be given the benefit of the Business Judgment Rule.
This decision also permitted a former company counsel to act as the derivative plaintiff under circumstances where he could show that his work as counsel was not "substantially related" to the issue in suit.