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Directors' liability (IVOR nr. 101) 2017/4.2.3
4.2.3 Section 102(b)(7) DGCL as a device to dismiss claims
mr. drs. N.T. Pham, datum 09-01-2017
- Datum
09-01-2017
- Auteur
mr. drs. N.T. Pham
- JCDI
JCDI:ADS393750:1
- Vakgebied(en)
Ondernemingsrecht / Rechtspersonenrecht
Voetnoten
Voetnoten
Section 102(b)(7) may also be employed in motions to dismiss derivative lawsuits for failure to make demand under Rule 21.1 of the Delaware Rules of Civil Procedure. See Wood v. Baum, 953 A.2d 136 (Del. 2008), par. 141 (holding that when courts adjudicate the sufficiency of allegations of demand futility, they should take exculpatory clauses into account. In this case, there were no particular allegations that the directors had ‘actual or constructive knowledge’ about the illegality of their conduct). See also Stone v. Ritter, 911 A.2d 362 (Del. 2006), par. 372-373. A motion to dismiss based on futility grounds was also raised in Disney, but could not waylay the doubts raised in the complaint as to whether the board’s actions were taken honestly and in good faith, as required under Rule 21.1 (In re Walt Disney Company Derivative Litigation, 825 A.2d 275 (Del. Ch. 2003), par. 286. I will leave further discussion of Rule 21.1 outside the scope of this research and would like to limit myself to note that, under Delaware law, shareholders are permitted to bring a derivative action if they satisfy several requirements. One important procedural barrier is that there has been harm to the corporation but the board of directors has not taken measures against the wrongdoers. Accordingly, eligible shareholders must first file a demand for the board to take action. See Kroeze 2004 p. 208-215 (discussing the rationale of the requirement of the demand for board action).
In a case involving a merger, the Chancery Court decided that, where a ‘shareholder failed to make any allegations in the complaint that the special committee engaged in any conduct that would not be exculpated by the company’s 102(b)(7) charter provision’, the complaint must be dismissed (Direinzo v. Lichtenstein, 2013 Del. Ch. Lexis 242 (Del. Ch. Sept. 30, 2013).
Emerald Partners v. Berlin, 726 A.2d 85 (Del. 2001), par. 92. Note that section 102(b)(7) is only at the disposal of Delaware’s directors, not officers. Courts may dismiss complaints pursuant to Rule 12(b)(7) based on the business judgement rule or section 102(b)(7), unless material facts raise doubts as to the directors’ good faith and necessitates judicial review at trial.
‘The plaintiffs are entitled to all reasonable inferences flowing from their pleadings, but if those inferences do not support a valid legal claim, the complaint should be dismissed without the need for the defendants to file an answer and without proceeding with discovery. Here we have assumed, without deciding, that the amended complaint on its face states a due care claim. Because we have determined that the complaint fails properly to invoke loyalty and bad faith claims, we are left with only a due care claim’ (Malpiede v. Townson, 780 A.2d 1075 (Del. 2001), par. 1094.
Nelson v. Emerson, 2008 Del. Ch. Lexis 56 (Del. Ch. May 6, 2008).
In re Cornerstone Therapeutics, 115 A.3d 1173 (Del. 2015), par. 1176.
In re Cornerstone Therapeutics, 115 A.3d 1173 (Del. 2015), par. 1181.
In re Cornerstone Therapeutics, 115 A.3d 1173 (Del. 2015), par. 1182. The importance of pleading a non-exculpated claim was also critical in Americas Mining Corp. v. Theriault, 51 A. 3d 1213 (Del. 2012). The derivative suit first filed in 2004 involved a merger between Southern Peru and Americas Mining Corporation and was reviewed under the entire fairness test. At a hearing held on 21 December 2010, the Court of Chancery dismissed the Special Committee defendants from the case, because the claimant had failed to present evidence supporting a non-exculpated breach of their fiduciary duty of loyalty. The remaining defendants had a self-dealing interest directly in conflict with Southern Peru. The exculpatory clause could not benefit them. Moreover, at trial, these director defendants did not make efforts to show that they acted in good faith and were entitled to exculpation despite their lack of independence. On 27 August 2012, the Supreme Court affirmed the Chancery Court’s decision awarding damages of more than $ 2 billion and $ 304 million in attorneys’ fees. It was determined and affirmed that the controlling shareholder defendants breached their fiduciary duty of loyalty in a transaction involving the controlling shareholder’s subsidiary. The transaction failed the entire fairness standard of review. Southern Peru overpaid more than $ 1 billion when it acquired the controlling shareholder’s subsidiary.
‘When a corporate director is protected by an exculpatory charter provision, a plaintiff can survive a motion to dismiss by that director defendant, by pleading 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; but the mere fact that a plaintiff is able to plead facts supporting the application of the entire fairness standard to the transaction, and can thus state a duty of loyalty claim against the interested fiduciaries, does not relieve the plaintiff of the responsibility to plead a non-exculpated claim against each director who moves for dismissal’ (In re Cornerstone Therapeutics, 115 A.3d 1173 (Del. 2015), par. 1180). See In re Alloy, A.3d 2011 Del. Ch. Lexis 159 (Del. Ch. Oct. 13, 2011) in which the Chancery Court also required facts to support an inference that the alleged disclosure violations were ‘the product of anything other than good faith omissions’ by the directors who authorised them. And In Re Novell, A.3d, 2013. Del. Ch. Lexis (Del.Ch. Jan. 3, 2013).
The requirements posed on the claimants’ complaint was rationalised as follows: ‘As is well understood, the fear that directors who faced personal liability for potentially valuemaximizing business decisions might be dissuaded from making such decisions is why Section 102(b)(7) was adopted in the first place (...) The purpose of Section 102(b)(7) was to “free[ ] up directors to take business risks without worrying about negligence lawsuits.” Establishing a rule that all directors must remain as parties in litigation involving a transaction with a controlling stockholder would thus reduce the benefits that the General Assembly anticipated in adopting Section 102(b)(7) (In re Cornerstone Therapeutics, 115 A.3d 1173 (Del. 2015), par. 1185).
As has been discussed in the previous paragraph, the important objective of the exculpatory provision is to reduce the exposure of directors to liability. One strategy in this regard involves pre-trial dismissal of ill-founded complaints on the basis of Rule 12(b)(6) of the Federal Rules of Civil Procedure (FRCP).1 A claim against a director risks dismissal if the complainant fails to sufficiently argue that the director’s conduct falls into at least one of the exceptions under which a director is not afforded the protection of the exculpatory provision (see paragraph 4.2.1).2 For instance, the Delaware Supreme court ruled in Emerald v. Partners that section 102(b)(7) DGCL must be seen as an affirmative defence and explicitly noted that pre-trial dismissal is still proper when only due care claims are pleaded or claimants failed to rebut the presumptions of the business judgment rule.3 It was made clear in Malpiede v. Townson, however, that dismissal is still justified when a claimant pleads a duty of loyalty claim if the complaint fails to include any adequate allegation of a breach of a duty of loyalty.4 Material details seem to be important. For instance, an allegation that the defendant-directors instructed an insolvent company to pay excessive compensation to themselves did not duly support a duty of loyalty claim if the complaint omits to state the amount of the allegedly excessive compensation or indicate which directors approved the compensation.5 The fact remains however that claimants strategically find ways to ‘plead around’ the statute by raising issues of facts with respect to the various elements of the statute in the attempt to survive motions to dismiss and to press for credible settlement leverage.
The recent Delaware Supreme Court decision in In re Cornerstone Therapeutics is promising insofar as it underlines the legislative purpose of exculpatory clauses to mitigate claims. The Court formulated a general rule: ‘A plaintiff seeking only monetary damages must plead non-exculpated claims against a director who is protected by an exculpatory charter provision to survive a motion to dismiss, regardless of the underlying standard of review for the board’s conduct – be it Revlon, Unocal, the entire fairness standard, or the business judgment rule.’6 In Cornerstone, the company’s minority shareholders brought actions against the directors arising out of transactions in which the controlling shareholder acquired the remaining shares. The independent directors of the company filed motions to dismiss the action by invoking the company’s exculpatory charter provision. The court ruled that the claimants were ‘not entitled to an automatic inference that a director facilitating an interested transaction is disloyal.’ A mere allegation that a disinterested director facilitated a transaction with a controlling shareholder that was not entirely fair was insufficient to survive dismissal.7 Accordingly, Cornerstone indicates that, in spite of the judicial review at issue, claimants remain compelled to plead nonexculpated claims against each of the defendant directors in order to survive dismissal of the claim.8 In Cornerstone, the court required at the very least, that the facts create an inference that a director acted out of self-interest, adverse to the stockholders’ interests or acted in bad faith.9
It is clear now that, under Delaware law, where a corporate transaction was made by a controlling shareholder standing on both sides of the transaction, the controlling shareholder bears the burden of proving the entire fairness of the transaction. Disinterested directors with no financial stake in the transaction may be liable for breach of fiduciary duty only when they have breached a non-exculpated duty in connection with the negotiation or approval of the transaction. Moreover, as Cornerstone has shown, the fact that the liability of disinterested directors depends on a non-exculpated breach of duty makes it necessary for claimants to allege sufficient facts at the motion to dismiss stage to support an inference of a non-exculpated breach.10 The ruling in Cornerstone could not be more clear and precise in demonstrating that the purpose of section 102(b)(7) DGCL is to reduce directors’ liability risks by formulating a rule for dismissing ‘ill-founded’ monetary claims.