In Re Lear Corp. Shareholder Litigation, 2008 WL 4053221 (Del. Ch., Sept. 2, 2008), read opinion here.
This is the third Chancery Court decision in about as many (business) days that addresses the issue of whether: claims against a board of directors will be dismissed based on the exculpation clause in a corporate charter as authorized by DGCL Section 102(b)(7). The results (if we were to use an analogy from sports) are: 2 to 1. That is, 2 cases involving such claims have been dismissed under Rule 12(b)(6) and 1 decision denied a motion for summary judgment filed by the board.
Two of the 3 cases I am referring to include: (i) the instant Lear case; and (ii) the McPadden case of Aug. 29 summarized here. The other case I refer to is the Ryan II decision also of Aug. 29 and summarized here.
A prior decision in this case, partially granting a motion for preliminary injunction, is summarized here. See In Re Lear Corp S’hlder Litig., 926 A.2d 92 (Del. Ch. 2007).
In some ways, this opinion is akin to a scholarly law review article with practical application that also includes a court decision (after a full recitation of the particlular facts of this case.)
There is so much that can be written about this case, but let’s start with a few basics. The primary complaint was that the board agreed to a termination fee of $25 million (less than 1% of the transaction price) in exchange for an increase in the purchase price by the winning bidder for the sale of the company. The plaintiffs claimed that the board knew that the shareholders would most likely not approve the merger and, therefore, by agreeing to pay a termination fee simply upon a "no vote" by the shareholders, they breached their fiduciary duties.
The court summarized its reasoning thusly:
"Directors are entitled to make good faith business decisions even if the stockholders might disagree wth them. Where, as here, the complaint itself indicates that an independent board majority used an adequate process, employed reputable financial, legal and proxy solicitation experts, and had a substantial basis to conclude a merger was financially fair, the directors cannot be faulted for being disloyal simply because the stockholders ultimately did not agree with the recommendation. In particular, where, as here, the directors are protected by an exculpatory charter provision, it is critical that the complaint plead facts suggesting a fair inference that the directors breached their duty of loyalty by making a bad faith decision to approve the merger for reasons inimical to the interests of the corporation and its stockholders. Where a complaint, as here, does not even create an inference of mere negligence or gross negligence, it certainly does not satisfy the far more difficult task of stating a non-exculpated duty of loyalty claim."
Although this case started out asserting Revlon claims and proxy disclosure frailties, after the merger was voted down, those claims were dismissed as moot. (Curiously, with Lear’s stock now trading at about $13, the shareholders now wish they would have had voted for the offer at $37.25 per share.)
Aronson and Section 102(b)(7)
The plaintiffs skipped any attempt to satisfy the first prong of the Aronson test, and instead attempted to satisfy the second prong of Aronson by attempting to state particularized facts to establish a non-exculpated breach of fidcuicary duty by the Lear board.
Because the Lear charter contains an exculpatory provision under DGCL Section 102(b)(7), the plaintiffs cannot sustain their complaint even by pleading facts supporting an inference of gross negligence. (continued below)
See footnote 26 citing to the Gutman and McMillan cases for a discussion of the pleading standard that must be met to overcome the protection of Section 102(b)(7) as envisioned by the Legislature in order for Section 102(b)(7) to be of any worth.
Several facts presented the plaintiffs with an uphill battle:
- the board was comprised of a "super-majority" of independent directors
- the company was freely shopped and no better offers had been made during a period of time that has been described as a frothy M & A market.
- the board used a thorough process to determine whether to approve the merger agreement
- the board had a sound financial basis to conclude that the $37.25 price was a good one.
- the difference between the $1.25 per share increase in price and the $1.50 amount that "may" have increased the chance for shareholder approval, was described by the court as "… prosciutto-thin margins [that] are indicative of tough end-game posturing, not a huge value chasm."
In order to analyze the second prong of the Aronson pleading standard, the court recites a classic summary of the business judgment rule. See footnote 42 and related text (including a citation to a law review article by Professor Bainbridge).
In addition to discussing the important difference, especially for policy reasons, between negligence and gross negligence, the court explained the pleading hurdle that must be overcome to cross the threshold barrier of Section 102 (b)(7).
That is, to assert successfully a non-exculpated breach of fiduciary duty in this case, the plaintiff was required to plead particularized facts to support an inference that the directors committed a breach of the fiduciary duty of loyalty–namely, that the directlors consciously acted in a manner contrary to the interests of the company and its stockholders.
Footnote 48 cites to the Integrated Health case for its explanation that to survive a motion to dismiss based on a Section 102 (b)(7) provision, the plaintiff must plead facts that, if true, would imply that the Board "consciously and intentially disregarded its responsibilites". (quoting Disney).
The Hardest Question in Corporation Law (according to the court): "What is the standard of lilability to apply to independent directors with no motive to injure the corporation when they are accused of indolence in monitoring the corporation’s compliance with its legal responsibilities?"
The court’s answer to the question should be the focus of a separate article. Some highlights of the court’s answer include the acknowledgement that : "Although everyone has off days, fidelity to one’s duty is inconsistent with persistent shirking and conscious inattention to duty." (citing in footnote 57 to Teachers’ Retirement System of Louisiana v. Aidinoff, 900 A.2d 654 (Del. Ch. 2006)("Conscious torpor in the face of duty is disloyal behavior…."))
The court discussed the high threshold that must be met to hold a disinterested director liable for a breach of the non-exculpated breach of the duty of loyalty for acting in bad faith. Citing to the Disney decision in footnote 60 of this opinion ( see Disney, 906 A.2d 27, 67 (Del. 2006)), the court quoted examples of the purposeful wrongdoing required, such as:
- "intent to violate applicable positive law"
- "intentionally failing to act in the face of a known duty to act"
Caremark should not be readily applied to review a discrete transaction reviewed by the board
The reasoning of the court to support the foregoing position was extensive, but here is a good quote from part of it:
" In the transactional context, a very extreme set of facts would seem to be required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties."
The court also observed that even when Revlon applies, it does not change the plaintiff’s burden to establish the monetary culpability of directors. That is,
"if a board unintentionally fails, as a result of gross negligence and not bad faith or self interest, to follow up on a materially higher bid and an exculpatory charter provision is in place, then the plaintiff will be barred from recovery, regardless of whether the board was in Revlon-land." (citing Intercargo, 768 A.2d at 502) (bold mine)
Waste: Finally, the court quickly dispatched a claim for waste, even calling it frivolous, for not coming close to satisfying the elements of this most difficult of claims in Delaware. In addition, at footnote 69, the court cited other cases where it approved termination fees contingent on a "naked no vote" of up to 1.4% compared to the termination fee in this case that was only 0.9% of the deal value.
UPDATE: Prof. Davidoff comments on the case here, and ties it in to the Ryan case (which the professor writes is being referred to in the opinion by the author of this case, politely, even if not by name, though in an apparently contrary way.)
UPDATE II: Prof. Bainbridge provides his insightful analysis of Revlon issues here.