Delaware law has long provided that the decisions of disinterested and independent directors who receive no special benefit from a transaction ought not be the basis of personal liability in monetary damages. To subject directors who are independent of interested parties and who themselves receive no benefit in a transaction not otherwise shared with public stockholders would discourage quality individuals from serving on boards or committees of Delaware corporations and likely also reduce appropriate risk-taking. Nonetheless, the courts since two Delaware Supreme Court decisions in Emerald Partners v. Berlin, 726 A.2d 1215 (Del. 1999), in 1999 (Emerald I) and 2001, 787 A.2d 85 (Del. 2001) (Emerald II), often denied motions to dismiss brought by disinterested and independent directors if a plaintiff could plead facts sufficient to invoke the entire fairness standard of review.
In In re Cornerstone Therapeutics Stockholder Litigation, No. 564, 2014, and In re Zhongpin Stockholders Litigation, No. 706, 2014 (collectively, Cornerstone), a consolidated appeal, the Delaware Supreme Court clarified that if an exculpatory charter provision protects directors, the trial court should grant motions to dismiss by any director against whom a plaintiff cannot plead a non-exculpated claim. As explained below, while the decision should provide comfort to independent directors, controlling stockholders or conflicted directors against whom a plaintiff can plead a duty of loyalty claim are not affected by the Cornerstone decision.
Motions to Dismiss Brought by Independent Directors Denied
The Cornerstone appeals arose from challenges to transactions in which controlling stockholders acquired the shares they did not already own in a Delaware public corporation. Although in both cases special committees of independent directors negotiated the transactions and a majority of the minority stockholders approved them, in neither case did the controlling stockholder condition the transaction on such approval. Entire fairness therefore governed the review of the transaction because neither controlling stockholder chose at the outset to follow the process authorized in the In re MFW Shareholders Litigation, 67 A.3d 496, 528 (Del. Ch. 2013),decision that might have afforded business judgment standard of review. The Cornerstone lower court read Emerald I andEmerald II as requiring denial of the independent directors' motion to dismiss. In particular, the lower court held that it was constrained to deny the motion to dismiss because of language in Emerald II 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. The Zhongpin court deferred to the lower court's Cornerstone decision and thus held that the claims against the independent directors survived a motion to dismiss because the transaction was subject to entire fairness review "regardless of whether the complaint state[d] a non-exculpated claim."
Dismissal Entitled If Non-Exculpated Claim Can't Be Pleaded
The Delaware Supreme Court rejected the contention that, merely because the entire fairness standard of review applies to a transaction, an independent director is not entitled to be dismissed from an action. Instead, where an exculpatory provision in a charter protects the directors, a plaintiff can only survive a motion to dismiss, regardless of the standard of review, if the plaintiff can 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 they could not be presumed to act independently, or acted in bad faith." The Court justified its holding in part by noting a scholarship finding that deals negotiated by independent directors have been priced on terms attractive to minority stockholders. The court recognized that the General Assembly enacted Section 102(b)(7), Delaware's statutory exculpation provision, so that independent directors would not be dissuaded by the fear of liability from negotiating and approving value-maximizing transactions. The Supreme Court thus grounded its decision as well on that policy rationale underlying Delaware's statutory exculpation.
'Emerald Partners' and 'Malpiede' Decisions
The Supreme Court recognized at the outset of its Cornerstone decision that there were two competing but colorable views of whether independent directors could be dismissed in transactions governed by the entire fairness standard of review. In Malpiede v. Townson, 780 A.2d 1075, 1094 (Del. 2001), the Supreme Court held that on a motion to dismiss, "a plaintiff must allege well-pleaded facts stating a claim on which relief may be granted. Had plaintiff alleged such well-pleaded facts supporting a breach of loyalty or bad-faith claim, the Section 102(b)(7) charter provision would have been unavailing as to such claims, and this case would have gone forward." The Cornerstone court noted that in Emerald I the Supreme Court had explained that "where the factual basis for a claim solely implicates a violation of the duty of care, this court has indicated that the protections of such a [Section 102(b)(7)] charter provision may properly be invoked and applied." What distinguishes Emerald Partners from Malpiede, therefore, is that the Emerald Partners court found that "plaintiffs had successfully shown that issues of fact remained that implicated the independent directors' duty of loyalty, and because those issues were not separable from the factual issues about whether the transaction was fair, the independent directors' motion for summary judgment was properly denied." Thus, Emerald Partners is not inconsistent with Malpiede and if a plaintiff cannot plead a non-exculpated claim against a director, that director is entitled to be dismissed.
Lessons Learned
Independent and disinterested directors are the beneficiaries of the Cornerstone decision. By clarifying that a plaintiff must state a non-exculpated claim against a director to survive a motion to dismiss, the Supreme Court has assured independent and disinterested directors that even in transactions governed by the entire fairness standard of review, the independent directors against whom no non-exculpated claim is pleaded can be dismissed as defendants at an early stage of litigation. At the same time, the interested parties will remain. Plaintiffs can therefore continue to litigate claims of unfair dealing in conflict-of-interest transactions against controlling stockholders and conflicted directors against whom they can plead a loyalty violation. The Cornerstone decision thus reinforces that Delaware will protect risk-taking by independent directors to maximize value while enabling plaintiffs to pursue claims of self-dealing against the interested parties who may have benefited improperly from an unfair transaction.
