Corporate Litigation Alert
www.BlankRome.com
January 2009 No. 1
Delaware Supreme Court Narrows Officer And Director
Defenses In The Context Of Mergers And Acquisitions
Ushering in the Obama era, the Supreme Court for the
State of Delaware issued a major decision this week in
which it appears to have signaled a tightening of the deferential standards many assumed applicable to officer and
director decisions. In Gantler v. Stephens, 2009 WL 188828,
the Supreme Court for the State of Delaware clarified and
narrowed the circumstances under which a Board of
Directors can insulate itself from liability for breach of
fiduciary duty under the shareholder ratification doctrine—limiting it to situations in which a shareholder vote
is not already legally required to approve directors’
actions. The Court also explicitly held (1) that corporate
officers owe the same fiduciary duties as corporate directors
and (2) that the heightened scrutiny, “entire fairness” standard (rather than the more deferential “business judgment
rule”) may apply in some circumstances beyond the transactional context.
Background
In Gantler, the plaintiffs alleged that self-interested
directors of a publicly-traded local bank breached their
fiduciary duties when, faced with a depressed economy,
little to no growth in the bank’s business and several reasonable bids from potential buyers, they failed to sell the
bank. According to the plaintiffs, the officers and directors
thwarted the efforts of several potential buyers and rejected one firm, reasonably advantageous offer in the face of
a contrary recommendation from their financial advisor.
Instead, the Board voted to take the bank private
through a reclassification of the shares, potentially to
their own benefit. In its reclassification proxy, the Board
noted its conflicts of interest and acknowledged the
merger offer, but stated that “[a]fter careful deliberations,” the merger offer was not in the best interest of the
Company. The shareholders approved the reclassification. Notwithstanding the assertion in the proxy, the
Complaint alleged the merger offer was rejected with
no deliberation.
Several shareholders filed suit alleging the members
of the Board breached their fiduciary duties by (i) rejecting the merger offer; (ii) disseminating a materially false
and misleading proxy; and, (iii) implementing the reclassification. Defendants moved to dismiss the complaint,
and the Court of Chancery granted the motion. Plaintiffs
appealed. The Supreme Court reversed.
The Doctrine of Shareholder Ratification
Clarified and Narrowed
The Supreme Court considered whether the shareholder vote in favor of the reclassification and against the
merger had “ratified” the admittedly interested decision
to enter into the transaction, cleansing it of any liability
regardless of self interest. It rejected ratification as a blanket defense, holding that shareholder ratification only
applies when shareholder votes are not required.
Noting that it was time to “restore coherence and
clarity” to an unclear doctrine, the Court held that the
shareholder ratification doctrine is limited to the “classic
form.” In other words, it is limited:
to circumstances where a fully informed shareholder vote approves director action that does
not legally require shareholder approval in order
© 2009, BLANK ROME LLP. Notice: The purpose of this newsletter is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy
and completeness of which cannot be assured. The Advisory should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.
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CORPORATE LITIGATION
to become legally effective. Moreover, the only
director action or conduct that can be ratified is
that which the shareholders are specifically asked
to approve.
The Court also noted that the Defendant Board
members misperceived the extent to which ratification
would ever provide a defense. Contrary to their position,
the “cleansing effect” of a ratifying shareholder vote is to
“subject the challenged director action to business judgment review, as opposed to extinguishing the claim altogether.” The Court narrowed the ratification defense
even further, adding that “[t]he only species of claim that
shareholder ratification can validly extinguish is a claim
that the directors lacked the authority to take action that
was later ratified.” Thus, the Court explained that the ratification doctrine is unavailable to insulate acts such as
fraud or waste without a unanimous shareholder vote.
The Court’s careful clarification to the ratification doctrine included footnote 54, dealing a shocking blow to a
long-standing Delaware decision: “That to the extent that
Smith v. Van Gorkham holds otherwise, it is overruled.”
The effect of this holding is that it eliminates shareholder ratification as an additional defense in all cases
where the shareholder vote is required. Courts will be left
to interpret whether this applies to a whole transaction or
single decisions. Interestingly, shareholder ratification
was neither briefed nor argued at any time, and the
Court, sitting en banc, first presented the issue, sua sponte,
at the second argument on this appeal. As the Court had
already found that the proxy was materially misleading,
it was seemingly unnecessary for it to delve into shareholder ratification.
Duties of Officers
Equally significant, the Court’s explicit holding that
“officers owe fiduciary duties identical to those of directors,” brought clarity to a muddy area of Delaware
corporate law. Although often assumed in theory and
practice, the Supreme Court has never unambiguously
held officers to the same standard of fiduciary duties as
directors. This, of course, invites the Delaware Legislature
to amend 8 Del. C. 102(b)(7), which currently provides
that a certificate of incorporation can limit the personal
liability of directors for certain breaches of their fiduciary
duties, to include officers as well.
Perhaps another signal of a new dawn in corporate
exposure, the Court noted that in the context of the
potential advantageous sale of the business, the officers’
delay of “a matter of days, or at most a couple of weeks”
might form sufficient basis of a breach of loyalty claim.
ALERT
The Business Judgment Rule and Entire Fairness
After what seems like decades of confidence by the
bar that a court would ordinarily protect officers and
directors’ decision-making through reliable application
of the business judgment rule, the Supreme Court in
Gantler found that the Vice Chancellor had chosen too
lax a standard by applying the business judgment rule.
The Court did not disturb the principle that the business
judgment rule’s presumption of good faith and an
informed basis applies to the decision whether to accept
or decline a merger opportunity. Rather, the Court identified conflicting interests held by at least three directors
which prevented automatic protection by the business
judgment rule. Careful to caution that disloyalty may
not be presumed solely by the natural desire to maintain
employment or continue as a director, the Court stated
that a plaintiff must support a claim of disloyalty or selfinterest beyond the desire for job retention.
Finally, the Court also recognized that a claim of disloyalty is subject to entire fairness review, even in a nontransactional context.
Conclusion
In the current climate of economic turmoil and
roiled markets, shareholders have seen the evaporation of
value, the assumption of limitless and feckless risk by
corporations, and financial ruin of previously unimaginable scope befall former corporate titans. In this context,
perhaps it is not surprising that one senses less deference
to the process of corporate decision-making reflected in
Gantler v. Stephens. Corporate directors and officers
should take heed, recognizing that their stewardship in
hard times will attract scrutiny. They must ensure that
they continue to make appropriate and hard decisions,
but their process must employ and reflect fairness, careful deliberation and good faith. BLANK ROME LLP
For Additional Information
For questions on this or related topics, contact:
Ann Blair Laupheimer
Editor and Practice Group Leader
215.569.5758 • Laupheimer@BlankRome.com
Christine S. Azar
302.425.6438 • Azar@BlankRome.com
Thomas P. Preston
302.425.6478 • Preston-T@BlankRome.com
Elizabeth A. Sloan
302.425.6472 • Sloan@BlankRome.com
Elizabeth A. Wilburn
302.425.6487 • Wilburn@BlankRome.com
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