The recent Chancery decision in Buttonwood Tree Value Partners, L.P. v. R.L. Polk & Co., Inc., C.A. No. 9250-VCG (Del. Ch. July 24, 2017), is noteworthy for its application of the entire fairness standard to a controlling stockholder transaction, and the observation that exculpatory provisions barring director liability for violations of the duty of care do not apply to a defendant in his capacity as a controlling stockholder. See footnotes 91 and 92.

Key Facts: The Polk family collectively owned more than 90% of the common stock of the company; the directors connected with the Polk family exercised a control block; they engineered a self-tender that allowed them to maintain their control; they set the price through the use of a financial advisor that also did work for the Polk family; within around two years of the self-tender the remaining stockholders received extraordinary dividends amounting to 1/3rd of the self-tender price, together with merger consideration of 300% of the self-tender price. Based on those facts, the court explained that the controlling defendants had the burden to demonstrate that the transaction was entirely fair at the time it was made. They were not able to satisfy that burden.

Key Takeaways 

  • When a transaction involves self-dealing by a controlling stockholder the applicable standard of judicial review is entire fairness. That standard imposes on the defendants the burden to prove that the challenged transaction with the controlling stockholder was entirely fair to the minority stockholders.
  • In this context, an exculpatory provision does not apply to the defense of such a challenged transaction by a controlling stockholder because it alleges breach of a duty of loyalty. But the exculpatory provision under Section 102(b)(7) applies to alleged violations of the duty of care.
  • Notably, common familial relationships among holders of a majority of corporate voting power are not per se sufficient to establish a controlling group of stockholders.
  • Likewise, directors and stockholders who are also family members are not necessarily presumed to vote together “as one undifferentiated mass with a single hypothetical brain.” See footnote 93.
  • Even in the context of an entire fairness review, and in the presence of an exculpatory provision, each defendant must be the subject of well-pleaded non-exculpated claims – – that is, a breach of the duty of loyalty. Specifically, the liability of directors must be determined on an individual basis because the nature of their breach of duty, if any, and whether they are exculpated from liability, can vary for each director. See footnotes 100 and 101.
  • Bad faith allegations in this matter did not survive a motion to dismiss. In order to sufficiently plead bad faith, it must be demonstrated that “disinterested directors were intentionally disregarding their duties or that the decision was so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.” See footnote 102.
  • Another noteworthy discussion in this opinion was the dismissal of a claim against a law firm for the company alleging the aiding and abetting of a breach of fiduciary duty of the board. The court explained that such a claim requires a knowing participating in the breach and damages proximately caused by that breach. The standard for such a claim is intentionally stringent and it turns on the proof of scienter of the alleged abettor.
  • In addition, a claim for aiding and abetting must include factual allegations of knowing participation in a breach which requires that the third party act with the knowledge that the conduct advocated or assisted constituted a breach. Moreover, the element of knowing participation “ requires that the secondary actor have provided substantial assistance to the primary violator.” See footnotes 108 through 112.
  • The court found that the law firm was not alleged to have knowingly participated in the alleged breaches by the board of their fiduciary duties. The court observed the obvious: “Almost all corporate boards retain law firms to advise them on significant transactions         . . . [I]f pleading a plausible breach of the duty on the part of the director or controller is also sufficient to implicate her lawyer as an aider and abettor, a significant and perverse chilling effect on the ability of fiduciaries to obtain legal counsel would result.”
  • Also noteworthy in connection with the dismissal of similar claims against the financial adviser were the following two points: (1) There is no general duty on third parties to ensure that all material facts are disclosed by fiduciaries; (2) “Passive failure on the part of third parties to ensure adequate disclosures to stockholders, without more, cannot support an inference of scienter for knowing participation in a breach.”