The Court of Chancery recently issued a thorough opinion explaining why a complaint that pleads a Unocal claim does not, per se, satisfy the pre-suit demand excusal requirements of Rule 23.1.  In Ryan v. Armstrong, Del. Ch., C.A. No. 12717-VCG (Del. Ch., May 15, 2017), the court addressed a claim related to the failed transaction between The Williams Companies (TWC) and Energy Transfer Equity (ETE), L.P., several Delaware decisions about which have been highlighted on these pages.

Brief Background:  The prior Delaware decisions involving TWC highlighted on these pages that addressed the failed transaction between TWC and ETE included issues much different than the one involved in this decision.  In this matter, the court addressed a claim against the directors of TWC in connection with a transaction with an entity that was affiliated with TWC, it allegedly was a transaction designed to make it more difficult for ETE to consummate a deal.  Ultimately, prior to the failed merger, TWC accepted an offer from ETE that was contingent upon the deal with the affiliated company being terminated.  As a result of that termination with the affiliated company, TWC was required to pay a $410 million break-up fee.  The claim in this case was based on the theory that it was a breach of fiduciary duties of the directors of the TWC to enter into a transaction for which they ultimately paid a break-up fee because that terminated transaction was entered into as an unreasonable defensive tactic in violation of the standard described by the Delaware Supreme Court in Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

Legal Analysis:  This 46-page opinion carefully examines the applicable Delaware case law and the Vice Chancellor in this opinion ultimately decides that he would not follow several prior Chancery decisions that could be read to support a different conclusion.  The opinion was based on a motion to dismiss for failure to satisfy the pre-suit demand excusal requirements of Court of Chancery Rule 23.1.  The court provided an extensive explanation of the policy underpinnings of Rule 23.1 and the case law interpreting the procedural prerequisites for derivative cases.

Notably, the court explained that this was not a case subject to the so called Corwin doctrine because the facts did not involve a fully informed, non-coerced shareholder vote that invoked the Business Judgment Rule.  Rather, this case involved a defensive measure theoretically designed by the director defendants to prevent a transaction that they initially spurned, but eventually approved, though it nonetheless eventually failed.  This derivative action seeks to recoup on behalf of the company the break-up fee and other monetary damages that allegedly were incurred by the company by the director defendants in connection with an improper defensive measure that they employed.

The primary ground on which the plaintiff argued that Rule 23.1 was satisfied, was because that he plead a viable claim for review under Unocal, and therefore, he argued that the majority of the board could not properly evaluate a pre-suit demand.

The court noted that Unocal claims are generally presented prior to a deal closing and are presented in the context of a request for preliminary injunction.  By contrast, this claim was presented after the deal was terminated, and sought damages only.

Unocal Standard:  The court ultimately did not need to decide whether Unocal applies in a damages-only action.  The court explained that Unocal requires enhanced scrutiny and is primarily a tool for providing equitable relief were defensive measures by directors threatened the right of the stockholders to approve a value-enhancing transaction.  Where the directors cannot show that a defensive measure is reasonable, a plaintiff has satisfied the first prong of the injunctive relief analysis which permits the court to impose injunctive relief to remove an unreasonable impediment to a transaction if irreparable harm and the balance requirement are also satisfied.  In other words, the court explained that enhanced scrutiny under Unocal allows injunctive relief without a showing by the plaintiff that it is probable that a defendant has breached a fiduciary duty.

Key Highlights:  This opinion provides an exemplary explanation of the requirements under Rule 23.1, as well as the interfacing between the articulation of those requirements in the Aronson and Rales cases.

The court explained that the wide deference to director decisions provided by the Business Judgment Rule does not apply in certain situations where directors take measures to fend off a potential acquisition, which raises entrenchment concerns.  The Delaware Supreme Court has explained that enhanced judicial scrutiny under Unocal applies whenever the record reflects that a board took defensive measures “in response to a perceived threat to corporate policy and effectiveness which touches upon issues of control.”  Unocal applies to a preemptive defensive measure even where the corporation was not under immediate attack.  See footnotes 81 to 83 and accompanying text.  The court discusses the progeny of Unocal and the various nuances of a well pleaded Unocal claim.

The court explained that Unocal, like Revlon, is not a “duty” per se – – rather it is a standard of review.  Nonetheless it does not change the fact that a duty of loyalty violation is required to recover damages where a board is protected by an exculpatory charter provision.

The court cited the recent Delaware Supreme Court decision of In re Cornerstone Therapeutics, Inc., Stockholder Litigation, 115 A.3d 1173, 1175 – 76 (Del. 2015), for the proposition that whether Revlon or Unocal or the entire business standard or the Business Judgment Rule applies, a plaintiff seeking only monetary damages must still plead non-exculpated claims against the director who is protected by an exculpatory charter provision to survive a motion to dismiss.

Bottom Line:  The court in this case reasoned that the inference of an entrenchment that arises under Unocal falls short of demonstrating a disabling interest that raises a “substantial likelihood of liability” of directors such that pre-suit demand would be excused as required under Rule 23.1.

Importantly, the author of this decision explained that other decisions from the Court of Chancery that found pleadings invoking Unocal claims sufficient to excuse demand under Rule 23.1 would not be followed in this ruling.  The court explained that the Supreme Court decision in Cornerstone cannot be squared with a per se rule that defendant directors are incapable of evaluating a demand solely because a well plead Unocal claim exists.  The court explained further what is necessary in order for specific pleadings to demonstrate that a majority of directors were motivated by entrenchment, or other non-corporate considerations – – as well as what the Delaware decisions have defined as “a substantial likelihood of liability” such that the director would be disabled from considering a non-exculpated claim to the extent that pre-suit demand would be excused under Rule 23.1.  See footnote 153 and accompanying text.

In conclusion, the Unocal claims did not plead sufficient particularized facts that implied a substantial likelihood of liability for damages arising out of those actions on the part of a majority of the directors.  Therefore, Rule 23.1 pre-suit demand was not excused and the case was dismissed.