The Court of Chancery in the recent decision styled In re Zale Corporation Stockholders Litigation, C.A. No. 9388-VCP (Del. Ch. Oct. 29, 2015), in a rare grant of a motion for reargument pursuant to Rule 59, dismissed a financial advisor after the court had previously denied the same motion to dismiss the financial advisor. The current ruling is based on the application of a Delaware Supreme Court decision that was issued the day after the original opinion in this case. The crux of the motion for reargument addressed the issue of whether the director defendants breached their fiduciary duties – – and more specifically, whether the business judgment rule standard of review applied or the enhanced scrutiny standard of review under Revlon should apply. The Delaware Supreme Court decision of Corwin v. KKR Financial Holdings LLC, 2015 WL 5772262 (Del. Oct. 2, 2015), held that a fully informed vote of a majority of disinterested stockholders invokes BJR review in cases in which the Revlon standard would otherwise apply.
The basis for granting the motion for reargument and changing the result of the initial decision was an incorrect application of the Revlon standard rather than BJR to determine whether the directors breached their fiduciary duties.
The BJR more appropriately applied, based on the recent Corwin decision of the Delaware Supreme Court, because: (1) The Supreme Court held that the fully informed vote of a disinterested majority of stockholders invokes BJR review in cases in which Revlon otherwise would apply; and (2) The prior decision in this Zale matter held that the merger was approved by a majority of disinterested stockholders in a fully informed vote.
The Standard for a Breach of the Duty of Care is Gross Negligence
This reconsidered ruling also explained that gross negligence is the standard for a breach of the duty of care. In Corwin, the Supreme Court suggested that the gross negligence standard for director due care liability is the proper standard for evaluating post-closing money damages claims.
Distinguishing the Recent TIBCO Decision
This decision in Zale went to considerable lengths to distinguish the recent Chancery decision in which the court denied a motion to dismiss the financial advisor. See In Re TIBCO Software, Inc. Stockholders Litigation, 2015 WL 6155894 (Del. Ch. Oct. 20, 2015). The author of the TIBCO decision was the same Chancellor who authored the KKR decision referenced above which was affirmed by the Delaware Supreme Court in Corwin. In TIBCO, the Court of Chancery denied a motion to dismiss after it found that it was reasonably conceivable that the directors had breached their duty of care by acting in a grossly negligent manner despite the merger apparently being approved by a majority of disinterested stockholders in a fully informed vote.
Based on the language in Corwin and TIBCO, this decision in Zale concluded that when a reviewing board of directors acts during a merger process after the merger has been approved by a majority of disinterested stockholders in a fully informed vote, the standard for finding a breach of the duty of care under BJR is gross negligence. See footnote 18 in which the court observes that the threshold for finding a breach of the duty of care under Revlon is lower than in the BJR context which is predicated upon concepts of gross negligence.
Gross Negligence Defined
To support an inference of gross negligence, a decision has to be so grossly “off-the-mark” as to amount to reckless indifference or gross abuse of discretion. See footnote 19. Delaware law instructs that the “core inquiry in this regard is whether there was a real effort to be informed and exercise judgment.” This involves: “an examination of whether the directors informed themselves, before making a business decision, of all material information reasonably available to them.” Gross negligence requires facts “that suggest a wide disparity between the process the directors used and a process which would have been rational.”
In TIBCO, the court found that it was reasonably conceivable that the target’s board was grossly negligent in the context of a merger price that was possibly due to an error in several capitalization tables as to the number of outstanding target company shares. Although the target’s financial advisor notified the board of the error, “it did not notify the board that the acquirer had relied on erroneous number of shares in making its bid.” After learning of the error, the board met several times to assess and respond to the situation just as the director defendants did after learning of Merrill Lynch’s presentation to Signet, “but the board [in TIBCO] did not inquire further with their financial advisor to determine if the acquirer had relied on the erroneous share count in making its bid.” In TIBCO, the board was exculpated for a breach of a duty of care under Section 102(b)(7) but the financial advisor in that case was not so protected and the court found that it was reasonably conceivable that the financial advisor aided and abetted the board’s duty of care breach by withholding data about the reliance by the acquirer on the erroneous share count in order to increase the odds of the merger being consummated, thereby earning a significantly larger fee for its services.
Court Provides Guidance to Boards When Hiring Financial Advisors
This decision provides specific practical advice regarding the duties of a board in connection with retaining a financial advisor. The court instructs that: “Directors must act reasonably to identify and consider the implications of the investment banker’s compensation structure, relationship and potential conflicts.” (quoting In re Rural Metro Corp., 88 A.3d 54, 90 (Del. Ch. 2014)). The court found the conduct of Merrill Lynch in this case troubling and expects that boards in the future will “take additional steps to obtain information material to the evaluation of their financial advisors’ independence, such as by negotiating for representations and warranties in the engagement letters as well as asking probing questions to determine what sorts of past interactions the advisor has had with known potential buyers.” Although the court found that the performance of Merrill Lynch was less than ideal in this case, because there was no basis for a predicate fiduciary duty breach by the board, the allegations against Merrill Lynch for aiding and abetting such breach failed. Therefore, the court granted the motion to dismiss as to Merrill Lynch and the complaint was also dismissed.