In the case of In Re Primedia, Inc. Derivative Litigation, 2006 WL 3365544 (Del. Ch. Nov. 15, 2006), read opinion here, the Chancery Court presents a "guidebook", based on settled bedrock principles of Delaware law, for the duties of controlling shareholders in an interested transaction. Although the duties of a controlling shareholder are not new at all, this opinion summarizes them neatly and applies them in the context of an intricate web of interlocking entities that the court drilled through with laser-like precision to find the controlling amalgamation of interest. Of course, the result of such a finding is that the defendants will not be entitled to the protection of the Business Judgment Rule. To the contrary, they will need to carry the burden of proving the entire fairness of the transaction in which they stood on both sides of the table. The transaction at issue was the redemption by the corporation of preferred shares owned by the controlling shareholder, at a handsome profit. The corporation, however, was not required to redeem the preferred shares for several more years. The common shareholders did not share in the lucre of the transaction. The court found this case to be squarely within the teaching of the hoary case (and its progeny) of Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971).
Also notable is the extensive discussion in footnote 45 of why the directors were considered by the court to be lacking in independence. Procedurally, the court observed that the motion to dismiss filed was under Rule 12(b)(6) and not based on Rule 23.1, thereby virtually conceding that the director defendants were not independent. In addition, the procedural hurdle of a 12(b)(6) motion is much easier for a plaintiff to overcome compared to a motion under Rule 23.1.
In my view, a most memorable quote from the end of the court’s opinion addresses the point that the breach of the duty of loyalty in this context is considered so important as a matter of public policy, that even if the measure of damages caused by the breach is not entirely clear, the court will be flexible on that element, which ordinarily is an essential component to any case, after a breach is established. Here is the quote that I think is destined to be referred to often as a summary of this key concept:
If the plaintiffs ultimately prove such a breach of the duty of loyalty, this court should not unduly narrow the scope of their recovery.FN46 Even in a case where transactional damages are not present, a disloyal fiduciary may still be held liable for incidental damages.FN47 Concerns of equity and deterrence justify “loosen [ing] normally stringent requirements of causation and damages” when a breach of the duty of loyalty is shown.FN48 As the Delaware Supreme Court long ago noted, the duty of loyalty “does not rest upon the narrow ground of injury or damage to the corporation resulting from a betrayal of confidence, but upon a broader foundation of a wise public policy that, for purposes of removing all temptation, extinguishes all possibility of profit flowing from the breach of confidence imposed by the fiduciary relation.” FN49
[For the convenience of the reader, I am including below the footnote contents for the footnotes in the above quote.]
FN46. Thorpe v. CERBCO, Inc., 676 A.2d 436, 445 (Del.1996). FN47. Id. FN48. Id. (quoting Milbank, Tweed, Hadley & McCloy v. Boon, 13 F.3d 537, 543 (2d Cir.1994)).FN49. Guth v. Loft, Inc., 5 A.2d 503, 510 (Del.1939).