The Delaware Supreme Court on May 14th held that independent directors, who approved a going private transaction by which a controlling shareholder freezes out the minority, must be dismissed from shareholder litigation claiming inadequate price unless the complaint alleges specific wrong-doing on the part of those independent directors.
Followers of Delaware corporate law know that in any liquidity event wherein a controlling insider is a principal, directors are not protected by the broad business judgment rule but, rather, the transaction must pass the more rigorous “entire fairness” test. In other words, it must be demonstrated that the transaction, substantively, is entirely fair to the minority shareholders. (There is an exception for merger transactions which are conditioned from the very beginning upon approval by a special board committee and the affirmative vote of the majority of the minority shareholders.)
In these two cases before the Supreme Court, shareholders sued all the directors for breach of fiduciary duty in a freeze-out merger, claiming inadequate price, even though the transaction was a negotiated by a special committee of independent directors, was approved by a majority of the minority shareholders, and was effected at a substantial premium above the pre-announcement market price of the company stock.
The question before the Court was not whether the interested directors could be sued; the law is clearly affirmative in that regard.
The question here was whether the independent directors, constituting the special committee, were entitled to be dismissed from the litigation pursuant to an exculpatory charter provision, where no specific improper act was alleged against them. The only thing pleaded was that the independent directors voted in favor of the transaction, and that the price was inadequate.
The Court cleaned up some prior and cryptic decisions by making it clear that, if you do not allege that the independent directors acted in bad faith, or had their own self-interest, or had an interest in advancing the self-interest of an insider, then those independent directors were entitled to be dismissed from the case even though the standard of review to be applied to the transaction by the Court, “entire fairness,” would be applied to the insiders.
A principal driver of the decision was to encourage independent directors to serve on fiduciary committees for the benefit of minority shareholders. The Court observed, not surprisingly, that if an independent director exercised best judgment and had done nothing wrong, and still was subject to suit, no independent director would be willing to serve and thus there would be no one to protect the minority.