February 10, 2009
Gantler v. Stephens
On January 27, 2009, the Supreme Court of the State of Delaware (the “Court”) issued its opinion in Gantler v. Stephens.
The plaintiffs, stockholders of First Niles Financial, Inc. (“First Niles”), brought an action against the directors and
officers of First Niles alleging that (i) they violated their fiduciary duties by rejecting an opportunity to sell First Niles in
favor of reclassifying its shares in such a way as to benefit themselves, and that (ii) the directors and officers disseminated
a materially misleading proxy. The Court, reversing the Delaware Chancery Court, determined that the complaint
contained sufficient facts to overcome the business judgment presumption, and stated substantive claims for a breach of
the duty of loyalty, as more fully discussed below.
First Niles is a federally chartered stock savings association in Niles, Ohio. In late 2003, operating in a depressed
economy, the board of directors of First Niles (the “Board”) sought advice from an investment bank regarding strategic
opportunities. In August 2004, the Board decided that First Niles should put itself up for sale. However, management
advocated a share reclassification, pursuant to which First Niles would delist from NASDAQ and reclassify the shares of
holders of 300 or fewer shares of common stock into preferred stock that would pay higher dividends and have the same
liquidation rights as common stock, but have no voting rights except in the event of a proposed sale of First Niles. In
December 2004, First Niles received three bids from potential purchasers, all of which were determined to be within the
fairness range by First Niles’ financial advisor. The Board directed management to pursue discussions with two bidders.
After one of the bidders failed to receive the diligence materials it requested, it withdrew its offer. Without discussion or
deliberation, the Board rejected the other bidder’s proposal despite the financial advisor’s positive assessment of the
offer. In December, 2005, the Board voted to proceed with the reclassification, which was approved by the First Niles
shareholders in December 2006.
The following are a few highlights of the Court’s opinion:
Business Judgment Rule
„
With respect to the fiduciary duties claim, the Court held that “rejecting an acquisition offer, without more, is not
‘defensive action’ under Unocal.1 As such, the Court affirmed the holding of the Court of Chancery that “Unocal
did not apply because the complaint did not involve any defensive action by the Board”. Therefore, the business
judgment rule applied as the default standard of review.
„
The Court, however, found that the plaintiffs pled facts sufficient to establish disloyalty of at least three directors
(on the basis of personal conflicts), thereby rebutting the business judgment rule. As such, the claim of disloyalty
1
Enhanced judicial scrutiny applies under Unocal when a board of directors takes “defensive measures in response to a perceived threat
to corporate policy and effectiveness which touches on issues of control”.
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the State of Delaware
was subject to entire fairness review. With respect to the plaintiffs’ argument that the defendants were motivated
to act disloyally to retain their positions as directors, the Court noted that “a claim of this kind must be viewed
with caution, because to argue that directors have an entrenchment motive solely because they could lose their
positions following an acquisition is, to an extent, tautological…For that reason, the plaintiffs must plead…other
facts sufficient to state a cognizable claim that they acted disloyally”.
Fiduciary Duties of Officers
„
The Court for the first time explicitly held what had been implicitly stated previously and acknowledged by the
Delaware Chancery Court: that “officers of Delaware corporations, like directors, owe fiduciary duties of care and
loyalty, and that the fiduciary duties of officers are the same as those of directors”. In a footnote the Court notes,
however, that that does not mean the consequences of a fiduciary breach by directors or officers, respectively,
would necessarily be the same.2
Shareholder Ratification under Common Law
„
The Court of Chancery had dismissed the claim that the defendants breached their duty of loyalty by pursuing the
reclassification on the ground that the shareholders had ratified the reclassification in voting to approve it. The
Court disagreed for the following reasons. Firstly, the Court had found that the proxy circulated in connection
with the reclassification was materially misleading because the Board misrepresented that it had terminated the
sale process after “careful deliberations”. Therefore, no “fully informed shareholder vote took place” and as such,
ratification was not possible. Secondly, the Court explicitly limited the doctrine of shareholder ratification to
“circumstances where a fully informed shareholder vote approves director action that does not legally require
shareholder approval in order to become legally effective”. Because a shareholder vote was required to amend the
certificate of incorporation to implement the reclassification, that vote could not also “operate to ratify the
challenged conduct of the interested directors”. The Court goes on to add that “[m]oreover, the only director
action or conduct that can be ratified is that which the shareholders are specifically asked to approve. With one
exception, the ‘cleansing’ effect of such a ratifying shareholder vote is to subject the challenged director action to
business judgment review, as opposed to ‘extinguishing’ the claim altogether (i.e., obviating all judicial review of
the challenged action)”.
2
The Court further notes that under Section 102(b)(7) of the Delaware General Corporation Law, “a corporation may adopt a provision
in its certificate of incorporation exculpating its directors from monetary liability for an adjudicated breach of their duty of care.
Although legislatively possible, there currently is no statutory provision authorizing comparable exculpation of corporate officers”.
This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to
provide additional details or advice about specific situations if desired.
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©2009 Shearman & Sterling LLP. As used herein, “Shearman & Sterling” refers to Shearman & Sterling LLP, a limited liability partnership organized under the laws of the State of Delaware.