Matera LUISS Course Packet Section 7 PDF

SECTION 7 THE DUTY OF CARE AND THE BUSINESS JUDGMENT RULE LUISS Guido Carli Law and Economics – Corporate and Business Law, Antitrust and Regulation Prof. Pierluigi Matera [email protected] Spring Term 2024 Course Packet – Section 7 I. INTRODUCTION TO FIDUCIARY DUTIES II. THE BUSINESS JUDGMENT RULE T...

SECTION 7 THE DUTY OF CARE AND THE BUSINESS JUDGMENT RULE LUISS Guido Carli Law and Economics – Corporate and Business Law, Antitrust and Regulation Prof. Pierluigi Matera [email protected] Spring Term 2024 Course Packet – Section 7 I. INTRODUCTION TO FIDUCIARY DUTIES II. THE BUSINESS JUDGMENT RULE Table of Contents III. WHY A BUSINESS JUDGMENT RULE? IV. THE LAW OF BUSINESS JUDGMENT V. THE DUTY OF CARE VI. STATUTORY RESPONSES TO VAN GORKOM AND THE “D&O LIABILITY CRISIS” VII.APPENDICES AND ANNEX Pierluigi Matera Corporate and Business Law I. INTRODUCTION TO FIDUCIARY DUTIES Pierluigi Matera Corporate and Business Law Fiduciary standards play a crucial role in corporate governance The duties of a fiduciary are essentially three Duty of obedience I. Introduction to Fiduciary duties This duty plays a significant role in agency law but is less prominent (definitely not significant, hence usually not even mentioned) in corporate law Duty of care In its classic formulation, requires managers to act with “the care of an ordinarily prudent person in the same or similar circumstances” and in a manner reasonably believed to be in the best interest of the corporation Duty of loyalty Requires that corporate fiduciaries exercise their authority in a good-faith attempt to advance corporate purposes / interest of corporations (shareholder value) Pierluigi Matera Corporate and Business Law To whom do directors owe these duties? I. Introduction to Fiduciary duties The short answer is that they owe their duty to the corporation as a legal entity Ø Yet the meaning of that answer is still disputed today The “corporation” has multiple constituencies with often conflicting interests: stockholders, creditors, employees, suppliers, and customers The question of whose interests ultimately count (and Ds should serve) is of practical importance when the corporation faces insolvency or when it contemplates a terminal transaction for equity investors or where contract, reputation, or corporate liability rules do not effectively induce firms to take into account their effects on other constituencies These are examples of when the question of “Duty to whom?” may be most acute Pierluigi Matera Corporate and Business Law The Shareholder Primacy Norm Loyalty to equity investors is of utmost importance in U.S. corporate law I. Introduction to Fiduciary duties Shareholders elect the boards of directors in U.S. corporations, but exactly what additional weight the norm of shareholder primacy carries in corporate law is not always clear Delaware law and a minority of other U.S. jurisdictions make the centrality of shareholder interests in defining the duties of corporate directors clear as an abstract proposition 28 states have adopted so-called constituency statutes that suggest that shareholder primacy is itself a matter of board discretion Constituency statutes are themselves a legacy of a period between 1985 and 1990, when management feared that greater board discretion was needed to defend against hostile takeovers Pierluigi Matera Corporate and Business Law For most of the history of American corporate law, the dominant role of shareholder interests in defining the duties of directors has more closely resembled a deep but implicit norm rather than a legal rule I. Introduction to Fiduciary duties In 1919, the Supreme Court of Michigan recognized this value explicitly as a rule in Dodge v. Ford Motor Co, 204 Mich. 459, 170 N.W. 668. The court affirmed the primacy of the shareholders’ interests stating: [I]t is not within the lawful powers of a board to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others, and no one will contend that, if the avowed purpose of the defendant directors was to sacrifice the interests of shareholders, it would not be the duty of the courts to interfere Pierluigi Matera Corporate and Business Law Shareholder Value Doctrine The shareholder primacy has clearly become the dominant doctrine since the 80s under the term of Shareholder Value Doctrine I. Introduction to Fiduciary duties SV doctrine postulates that the primary goal for a company is to increase the wealth of its shareholders (by paying dividends and/or causing the stock price to increase). Therefore, managers’ duty is exclusively to maximize shareholder wealth—implying that managers owe their fiduciary duties only to shareholders This view is firmly grounded in economic theories developed in 50’ and 60’. Nevertheless, it is also known as the Friedman doctrine. This is due to the fact that (in a much-cited and today much-criticized 1970 article entitled “A Friedman Doctrine: The Social Responsibility of Business is to Increase its Profits”, published on the New York Times) the renowned economist Milton Friedman harshly criticized those in the business community who maintained that private enterprises had a mission to promote desirable social ends. He argued that companies have no social responsibility to the public or society. Instead, their only responsibility is to its shareholders. This articles is commonly believed to mark the beginning of a shareholder-focused reorientation of managerial priorities in corporate America Pierluigi Matera Corporate and Business Law Further, an influential 1976 business paper, authored by finance professors Michael C. Jensen and William Meckling (“Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”) provided a quantitative economic rationale for maximizing shareholder value I. Introduction to Fiduciary duties Despite the common belief, though, Milton Friedman is not to blame (or credit) for the rise of shareholder primacy in American corporations—as prof. Cheffins argues in his paper: “Stop Blaming Milton Friedman!”. In order for Friedman’s views to be as influential as has been assumed, his essay should have constituted a fundamental break from prevailing thinking of his times, i.e., an innovation so important to change minds and imply a doctrinal shift. Nevertheless, what Friedman said on corporate purpose was largely familiar to readers in 1970, and his essay did little to change managerial priorities at that point in time Instead, the rise and early diffusion of the shareholder value doctrine are best understood in light of the changing power relations in the economic field during the first half of the 1980s. The deep economic recession at the end of the 1970s and early 1980s led to a crisis in the prevailing management beliefs, offering newcomers the opportunity to promote alternative business strategies, among which the shareholder value conception became dominant (see Heilbron, Verheul, & Quak) Pierluigi Matera Corporate and Business Law The advocates of the new business conception were initially wealthy outsiders, corporate raiders, who used the economic crisis to oppose management and acquire shares in undervalued firms with the threat of restructuring and selling parts of them in the name of shareholders’ interests I. Introduction to Fiduciary duties Although this unprecedented wave of hostile takeovers were widely contested as an effective tool to promote efficiency over the financial market, the Reagan administration blocked regulation and stimulated the takeover market. The rivalry between “raiders” and public pension funds over the profits of these takeovers led to the founding the Council of Institutional Investors (1985), which adopted the shareholder value doctrine and inaugurated the organized activism of public pension funds Competition and conflict among different groups of shareholders, primarily corporate raiders and pension funds, are likely to have triggered the shift in the balance of power between managers and shareholders. The diffusion was also sustained by a dramatic shift in favor of incentive-laden executive pay which made the new balance of power profitable for mangers—who therefore rapidly adapted. As a result, the shareholder value ideology spread rapidly through the economic field, becoming the dominant business model of North American firms in the second half of the 1980s (see Heilbron, Verheul, & Quak; Cheffins) Pierluigi Matera Corporate and Business Law Corporate Charitable Contributions I. Introduction to Fiduciary duties A common arena of conflict between different conceptions of corporate purpose and director duties prior to the 1980s involved corporate charitable giving How can directors ever justify giving away some of the corporation’s profits to worthy causes if their principal duty is owed to shareholders? Unsurprisingly, when defendant directors justified their actions by reference to long-term corporate benefits, courts have deferred to director action A.P. Smith Manufacturing Co v. Barlow, 98 A.2d 581 (N.J. 1953) Pierluigi Matera Corporate and Business Law Public Benefit Corporations What if a group of individuals wanted to form a for-profit corporation with the aim of pursuing some mission-driven business (say, a delivery service with a minimal carbon footprint)—could they do so under standard corporate law statutes? I. Introduction to Fiduciary duties Starting in 2010, state legislatures began making this easier by providing a standard form corporation, generally called a Public Benefit Corporation (PB Corp), which in default provides provisions facilitating this sort of commitment. (DGCL §§361-368) A PB Corp is formed like other corporations and its shareholders elect the directors, who have the customary broad authority. A major difference is that the statutes contemplate the inclusion in the corporation’s charter of one or more specific social purposes along with the profit-making purpose. There is in this case, then, a fiduciary obligation of the directors to the corporation and its shareholders to pursue that purpose in addition to shareholder long-term gain. This gives directors and officers of PB Corps explicit legal protection to pursue the stated social mission and to consider additional stakeholders as well as equity investors Pierluigi Matera Corporate and Business Law II. THE BUSINESS JUDGMENT RULE Pierluigi Matera Corporate and Business Law Standards of conduct differ from standards of judicial review II. The Business Judgment Rule Standards of conduct are rules outlying norms and responsibilities of an individual party. Namely, how an actor should conduct a given activity Standards of judicial review are tests that a court must apply to scrutinise (secondguess) a business decision. Namely, the amount of reviewing a court will do. Essentially duty of care and duty of loyalty The business judgment rule (BJR) is an example Pierluigi Matera Corporate and Business Law Relation between the SoC and the SoR In particular, the DoC and the BJR The Duty of Care requires corporate directors to exercise “that amount of care which ordinarily careful and prudent men would use in similar circumstances” II. The Business Judgment Rule However, directors are insulated from liability for negligence à Liability is rarely imposed on corporate D&O simply for bad judgment, and this reluctance to impose liability for unsuccessful business decisions has been doctrinally labeled the business judgment rule Pierluigi Matera Corporate and Business Law The Rule that isn’t a Rule II. The Business Judgment Rule The BJR is the rule that is not a rule—it is a standard of judicial review The BJR is essentially misnamed It has no mandatory content and involves no substantive do’s and don’ts for directors and officers—rather, it entails only slight review of business decisions BJR Many practicioners and scholars tend to collapse the duty of care into the BJR Yet, the BJR is related to but separate from the duty of care Does the BJR insulate directors from liability of negligence? Pierluigi Matera Corporate and Business Law The duty of care resembles a tort law traditional concept: the reasonable care. So, is the duty of care violated each time a director acts negligently? No, this is misleading. In this, the interaction with the BJR is crucial II. The Business Judgment Rule Some scholars emphasise that it is a standard of review (some contend that it raises the bar from mere negligence to gross negligence; some argue that the rule shields directors from liability if they act in good faith) Others follow the so called abstention doctrine: it is a presumption that requires courts to abstain from reviewing the substantive merit of directors’ conduct in duty of care claims—unless the plaintiff can rebut the BJR by showing the lack of preconditions Pierluigi Matera Corporate and Business Law Actually, these are 2 ways of reconciling the duty of care and the BJR II. The Business Judgment Rule Standard of Review The BJR shields directors from liability as long as they act in good faith Or, the BJR raises the bar from mere negligence to gross negligence or recklessness Abstention Doctrine It creates a presumption against judicial review of duty of care claims The court will abstain from reviewing the substantive merits of directors’ conduct unless the plaintiff can rebut the BJR by showing that one or more preconditions are lacking Pierluigi Matera Corporate and Business Law A II. The Business Judgment Rule B C Shlensky and Abstention Doctrine Technicolor and Substantive Review Where is Delaware now? Pierluigi Matera Corporate and Business Law A II. The Business Judgment Rule B C Shlensky and Abstention Doctrine Technicolor and Substantive Review Where is Delaware now? Pierluigi Matera Corporate and Business Law The Abstention Doctrine II. The Business Judgment Rule Shlensky v. Wrigley (Ill.App. 1968) (see Appendix I) Plaintiff Shlensky challenged Wrigley’s refusal to install lights in Wrigley Field Defendants moved to dismiss, asserting a strong abstention version of the BJR à Granted 1. Courts do not undertake to control policy or business methods Courts extracted “ground rules” 2. It is not courts’ function to resolve conflicts between managers, majority and minority shareholders 3. The authority of directors in the conduct of business is absolute Pierluigi Matera Corporate and Business Law The “ground rules” expressed in Shlensky describe the BJR in action II. The Business Judgment Rule Absent a showing of fraud, illegality, or conflict of interest, the court must abstain from reviewing the directors’ decision—no scrutiny of substantive merit Kamin v. Amex (NY App.Div. 1976) (see Appendix II) confirms Shlensky à The directors’ room rather than the courtroom is the appropriate forum for thrashing out purely business questions Absent “fraud, dishonesty, or nonfeasance”, the court would not substitute its judgment for that of the directors Pierluigi Matera Corporate and Business Law A II. The Business Judgment Rule B C Shlensky and Abstention Doctrine Technicolor and Substantive Review Where is Delaware now? Pierluigi Matera Corporate and Business Law Cede & Co. v. Technicolor (Del. 1993) and the Substantive Review—a more intrusive approach II. The Business Judgment Rule The case is about the 1982 Acquisition of Technicolor by McAndrews & Forbes (with a second-step cash-out merger in a McA&F’s subsidiary, for a $23 cash consideration per share Cinerama Inc. (dissenting shareholder—actually the beneficial owner of 4.4%) and Cede (acting for the CSD) petitioned the trial court for appraisal of shares. The question was whether nonspeculative post-merger plans should be considered in computing Technicolor’s going concern, hence the fair value for the shares. They also brought a personal liability suit against defendant Technicolor and its board members (for approving the second-step merger), alleging fraud, breach of fiduciary duty, and unfair dealing and included a claim for rescissory damages. A convoluted evolution of the case, but the interesting question was the application of BJR + the burden of proof Del. Ch. focused on the process that led to the board’s decision (citing Van Gorkom’s process due care = acting in “in an informed and deliberate manner”). Chancellor Allen expressed grave doubts that Technicolor’s BoDs had complied with the process due care and discharged its Van Gorkom duties, which is a prerequisite for the BJR to apply. However, he found it unnecessary to resolve these doubts, since Cinerama could not prove damages (the consideration paid for the merger was $23 per share, and the fair value was $21.60 as determined earlier by Chancellor Allen). So Cinerama failed to meet its burden of proof Pierluigi Matera Corporate and Business Law The Supreme Court held that the Chancellor erroneously imposed on plaintiff, for purposes of rebutting business judgment rule, a burden of proof, since the plaintiff did not have to show injury to rebut the business judgment presumption of care. The Court contended that the breach of the duty of care, without any requirement of proof of injury, was sufficient to rebut the business judgment rule (ok, but isn’t this a tautological consideration?) II. The Business Judgment Rule In more detail: – On appeal, Justice Horsey revealed a willingness to second-guess the board decision and articulated Chancellor Allen’s doubts into 5 “presumed findings” of gross negligence (among which the failure by the board to be adequately informed before approving the agreement) – Then, it gets worse, and Justice Horsey broadened the review: the rule precludes a court from unreasonably interfering in corporate affairs; thus it may if it is reasonable to do so In this view, BJR is intended “to preclude a court from imposing itself unreasonably on the business and affairs of a corporation” but… Pierluigi Matera Corporate and Business Law It apparently allows to second-guess board decisions if it is “reasonable” to do so II. The Business Judgment Rule – In the words of Horsey, “to rebut the rule, a […] plaintiff assumes the burden of proving evidence that directors […] breached any one of the triad of their fiduciary duty—good faith, loyalty, or due care” – (…) “If the rule is rebutted, the burden shifts to the defendant […] to prove […] the ‘entire fairness’ of the transaction to the […] plaintiff” Justice Horsey put the cart before the horse (Bainbridge) à Directors who violate their duty of care do not get the protections of the BJR: the rule is rebutted by showing that the directors violated their fiduciary duty of due care… but that is exactly what you may not ascertain if the rule is shielding directors (that’s why the cart before the horse) Pierluigi Matera Corporate and Business Law – Under Technicolor, the BJR’s primary function is a merely procedural task of assigning burdens of proof: if plaintiffs fail to carry their burden, the BJR requires the court to dismiss the case without inquiry on the merit of the litigation II. The Business Judgment Rule – But actually, Technicolor broadened the scope of judicial review of board decision making to reach also the substance of directors’ decisions: it authorized precisely the sort of “fishing expeditions” the BJR was intended to prevent – Under Shlensky, the BJR precludes courts from scrutinizing whether the Ds violated their duty of care – Under Technicolor, it appears that the BJR function is merely to assign the plaintiff the burden of establishing a prima facie case—the same burden a plaintiff would have in any civil litigation. If so the BJR would be nothing more than a restatement of the basic principle that, should the plaintiff fail to state a prima facie case, then the defendant is entitled to summary judgment Pierluigi Matera Corporate and Business Law II. The Business Judgment Rule Technicolor can be reconciled with mainstream case law on BJR only by interpreting that duty of care as the due care or process due care in the sense of adequacy of the decision-making process (yet, there isn’t much in the case to allow such limitation of that duty of care to the decision-making process) Pierluigi Matera Corporate and Business Law A II. The Business Judgment Rule B C Shlensky and Abstention Doctrine Technicolor and Substantive Review Where is Delaware now? Pierluigi Matera Corporate and Business Law On one hand Brehm v. Eisner (Del. 2000) failed even to cite Technicolor: Justice Veasey rejected the plaintiff’s argument that the BJR could be rebutted by a showing that the Ds failed to exercise “substantive due care” II. The Business Judgment Rule Directors’ decision must be respected unless directors are interested or lack independence in the decision, or failed to act in good faith, or acted in a manner that cannot be attributed to a rational business purpose, or made the decision by grossly negligent process It is not the pure abstention formulation made in Shlensky but (it’s close enough) there is no substantive merit Pierluigi Matera Corporate and Business Law On the other hand McMullin v. Beran (Del. 2000) reaffirmed Technicolor (Justice Holland) – II. The Business Judgment Rule – The initial burden is on the plaintiff to rebut the presumption of the BJR: the plaintiff must prove evidence that the BoDs breached any one of its triad of fiduciary duties—loyalty, good faith, due care If the plaintiff fails to meet that burden, the BJR applies and protects the individual defendant from personal liability So, the BJR is treated as an abstention doctrine as a standard of review and not Unsurprisingly, McMullin survived a motion to dismiss (Shlensky did not) Bottom line: Delaware law on the matter of BJR is still ambiguous to a certain extent Pierluigi Matera Corporate and Business Law III. WHY A BUSINESS JUDGMENT RULE? Pierluigi Matera Corporate and Business Law The BJR’s traditional explanation is that courts are not business experts III. Why a Business Judgment Rule? Moreover, even though neither courts nor boards are infallible, someone must be “final” A simple question arises: who is better suited to be vested with the mantle of infallibility that comes by virtue of being final—directors or judges? Pierluigi Matera Corporate and Business Law III. Why a Business Judgment Rule? – Judges know less about a particular firm than D&O do, so they would make better decisions only “in hindsight”—and hindsight review is problematic – Moreover, D&O are subject to a Darwinian selection which erring judges don’t face – Therefore, rational shareholders might prefer the risk of managerial error to that of judicial error – The preference for managerial error only extends to those decisions motivated by a desire to maximize shareholder wealth – Where D&O’s decisions are motivated by considerations other than shareholder wealth, the question is no longer one of honest error but of intentional misconduct – Despite limitation of judicial review, rational shareholders prefer judicial intervention with respect to board decisions so tainted: the risk of legal liability may be a deterrent against such a misconduct Pierluigi Matera Corporate and Business Law Another explanation for the BJR is that it encourages directors to take risks à The BJR protects D&Os from the risks inherent in hindsight reviews of their unsuccessful decisions Why hindsight review is inconsistent with shareholder interests? III. Why a Business Judgment Rule? As the firm’s residual claimants, shareholders do not get a return on their investment until all other claims are satisfied For this reason, shareholders prefer higher return projects; but since risk and return are positively correlated, implementing such a preference entails choosing risky projects à Shareholders have high tolerance for this risk – The doctrine of limited liability insulates shareholders from the downside risks of corporate activity – Portfolio theory teaches that shareholders can eliminate firmspecific risk by holding a diversified portfolio Pierluigi Matera Corporate and Business Law III. Why a Business Judgment Rule? By contrast, managers are risk-averse: if a risky course of action fails to pay off, managers may suffer greater losses than diversified shareholders do (they may lose their jobs) On top of that, if managers face the risk of legal liability if a risky decision turns out badly, such risk aversion will be even more exaggerated Pierluigi Matera Corporate and Business Law The hindsight bias III. Why a Business Judgment Rule? Decision makers tend to assign an erroneously high probability of occurrence to a probabilistic event simply because it ended up occurring à Knowing with the benefit of hindsight that a business decision turned out badly could bias judges towards finding a breach of the duty of care See Gagliardi v. TriFoods Int. (Del.Ch. 1996); In Re Citigroup Shareholder Derivative Litig. (Del.Ch. 2009) – Both shareholders and judges will find it difficult to distinguish between competent and negligent management – Due to the hindsight bias, bad outcomes are often regarded ex post as foreseeable ex ante – If bad outcomes result in liability, managers will be even more discouraged from taking risks (defensive management) Pierluigi Matera Corporate and Business Law “It is in the shareholders’ economic interest to offer sufficient protection to directors from liability for negligence to allow directors to conclude that (…) there is no risk that, if they act in good faith and meet minimal (…) standards of attention, they can face liability as a result of a business loss” (Gagliardi v. TriFoods (Del.Ch. 1996)) III. Why a Business Judgment Rule? Rational shareholders should prefer a regime that encourages managerial risk-taking à The BJR can be seen as providing a default rule that both shareholders and managers would prefer = it reconciles their interest “Since shareholders (…) select among investments partly on the basis of management, the BJR (…) recognizes a certain voluntariness in undertaking the risks of a bad business decision” “Potential profits often corresponds to the potential risks” and “shareholders can reduce the volatility of risk by diversifying their holdings” (Joy v. North (2d Cir. 1982)) Pierluigi Matera Corporate and Business Law All the previous considerations argue for treating the BJR as an abstention doctrine rather than as a standard of review If the BJR is treated as a standard of review, judicial intervention would become the norm rather than the exception III. Why a Business Judgment Rule? This is why Technicolor is so problematic: under the cart-before-the-horse decision, the BJR does not preclude judicial review of cases in which the board failed to exercise reasonable care, but it is exactly in those cases in which it is important for courts to abstain, as trying to measure the “quantity” of negligence is a task best left untried – If the BJR is framed as an abstention doctrine, judicial review is likely to be an exception and not a rule – Starting from an abstention perspective, courts will begin with a presumption against review – Unless the process was tainted by self-dealing, nonfeasance, etc., the merits of the board’s decisions are irrelevant, and the prerequisite questions are objective: Did the board commit fraud? Did the board commit an illegal act? Did the board self-deal? Were they informed? (Investigation on facts more than on the quality of the decision) Pierluigi Matera Corporate and Business Law IV. THE LAW OF BUSINESS JUDGMENT Pierluigi Matera Corporate and Business Law A IV. The Law of Business Judgment B C D The Nature of the Rule Preconditions The Contextual BJR Application to Officers Pierluigi Matera Corporate and Business Law A IV. The Law of Business Judgment B C D The Nature of the Rule Preconditions The Contextual BJR Application to Officers Pierluigi Matera Corporate and Business Law The Nature of the Rule IV. The Law of Business Judgment Abs. doctrine or Subst. Rev. doctrine—either way, as a matter of fact. the BJR provides that courts shall not review board decisions unless those decisions are tainted by fraud, illegality, or self-dealing à Courts should only reach duty of care questions when the BJR does not apply Courts often refer to the BJR as a presumption—a presumption that directors or officers acted on an informed basis, in good faith, and in the honest belief that the action was legal and taken in the best interest of the corporation In the strict evidentiary sense of the term, it is actually more an assumption: courts assume they should not review a business decision absent fraud, illegality, self-dealing, and present process due care That said, let’s operationalize the BJR (see following points) Pierluigi Matera Corporate and Business Law A IV. The Law of Business Judgment B C D The Nature of the Rule Preconditions The Contextual BJR Application to Officers Pierluigi Matera Corporate and Business Law The BJR reflects the balance between: – Substantial discretion to be given to directors – Prohibition to put their own interests ahead of shareholders’ IV. The Law of Business Judgment Preconditions are the way to strike this balance, and they must be satisfied for the BJR to apply An Exercise of Judgment 1 6 2 5 Disinterested and Independent Decision Makers Rationality 3 Absence of Fraud or Illegality An Informed Decision (Process Due Care) 4 Absence of Waste Pierluigi Matera Corporate and Business Law 1. An Exercise of Judgment IV. The Law of Business Judgment The BJR is relevant only where directors have actually exercised business judgment, while there is no protection where directors have made no decision A decision to refrain from action is a decision; inaction is not and will be scrutinised under the duty of care Pierluigi Matera Corporate and Business Law 2. Disinterested and Independent Decision Makers IV. The Law of Business Judgment Directors must have no conflicts of interest – “A director is interested if he will be materially affected (…) by a decision of the board, in a manner not shared by the corporation and the shareholders”—Seminaris v. Landa (Del.Ch. 1995) – A director can be interested by virtue of direct and indirect connections—Bayer v. Beran (N.Y. Sup. Ct. 1944): hiring president’s wife; Globe Woolen v. Utica Gas & Electric (N.Y. 1918): defendant director was also president and chief stockholder of the plaintiff Pierluigi Matera Corporate and Business Law 2. Disinterested and Independent Decision Makers Directors must be independent IV. The Law of Business Judgment – “A director is independent if he can base his decisions on the corporate merits of the subject before the board rather than extraneous considerations or influences”—Seminaris – Plaintiffs must establish personal or business relationships by which directors are either beholden to or controlled by the interested party Where the board acts collectively, the BJR will insulate the decision unless plaintiffs can show that a majority of directors was interested and/or lacked independence Pierluigi Matera Corporate and Business Law 3. Absence of Fraud or Illegality IV. The Law of Business Judgment Decisions must not be tainted by fraud or illegality – The BJR will not protect defendants for illegal acts even if they benefitted the corporation—Miller v. AT&T (3d Cir. 1974) (See Appendix III): case is about the failure to collect a debt owed by the Democratic National Committee, violating federal telecommunication and campaign finance laws Pierluigi Matera Corporate and Business Law 3. Absence of Fraud or Illegality – – – IV. The Law of Business Judgment – – – Should there be a de minimis exception (double-park, speeding)? Should the BJR be set aside only for criminal statutes? Should the BJR be set aside only for crimes that are malum in se and not malum prohibitum? Infractions, misdemeanors, felonies? If neither the corporation nor the board was convicted or indicted, should the plaintiff prove criminal elements in a civil suit? Is a knowing violation of criminal law a per se violation of the DoC unprotected by the BJR? What if the benefit is for the corporation and it is a derivative action where the real plaintiff/interested party is the attorney? Illegality of a board decision—standing alone—should not result in automatic liability Courts should carefully consider whether the decisions to cause an illegal act was so grossly negligent as to violate the directors’ duty of care Pierluigi Matera Corporate and Business Law 4. Absence of Waste IV. The Law of Business Judgment The BJR doesn’t protect actions amounting to waste – A showing of waste requires proof that the consideration received is so clearly inadequate to amount to a gift – Courts will dismiss a waste claim so long as any reasonable person might conclude that the deal made sense à Successful waste claims are quite rare Pierluigi Matera Corporate and Business Law 5. Rationality IV. The Law of Business Judgment BJR will preclude the review of decisions if they can be attributed to a rational business purpose – The BJR doesn’t apply if the board “acted in a manner that cannot be attributed to any rational business purpose”—Brehm v. Eisner (Del. 2000) – The BJR is “rebutted in those rare cases where the decision under attack is so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith”; if “it is inexplicable that independent directors, acting in good faith, could approve the deal”—Parnes v. Bally (Del. 1999) Pierluigi Matera Corporate and Business Law 5. Rationality IV. The Law of Business Judgment – “Irrational” or “beyond reason”: the word is to be equated with “conceivable” or “imaginable”—requires a very limited substantive review that is really a way of inferring bad faith – Litwin v. Allen (25 N.Y.S. 2d 667) created an “incredible stupidity” exception: the board decision is so irrational as to not deserve the protection of the BJR – It may be that there are some board decisions that are so dumb that the BJR will not insulate them from judicial review, but they represent minor exceptions Pierluigi Matera Corporate and Business Law 6. An Informed Decision (Process Due Care and Van Gorkom Duties in the Sale of the Company) IV. The Law of Business Judgment – “Exercise of reasonable care and diligence” is an unfortunate phraseology, as it would inquire into the care exercise (Technicolor flaw). As anticipated, we reconcile this wording with mainstream case law by interpreting it as referred to the process to make the decision, rather than the substantive merit of the decision – Therefore, the requisite precondition is better stated as an adequate decision-making process – Smith v. Van Gorkom (Del. 1985) is the seminal case In 1980, Trans Union’s CEO and Chairman Van Gorkom negotiated a merger between TU and an entity controlled by financer Pritzker for $55 per share, and TU’s board and shareholders approved the deal. Shareholder-plaintiff Smith sued alleging TU directors violated their duty of care. None of the traditional triad of exceptions fraud/illegality/self-dealing was present. The court focused on process adopted by the board to make the decision, since directors clearly failed to inform themselves (see Appendix IV) Pierluigi Matera Corporate and Business Law Process Due Care and Van Gorkom Duties in a Sale of the company Van Gorkom serves to identify some crucial procedural steps A. Consultations Deal-makers should, early in the process, consult with senior management and “get them on board”; defendant Van Gorkom didn’t do so IV. The Law of Business Judgment B. Setting the price – When selling an entire business—whether or not it is nominally structured as a merger—the board must secure the best value/price reasonably available for all stockholders (as later clarified in Revlon) – Van Gorkom focused on feasibility more than on Trans Union’s real value – Price for control (control premium)—Trans Union’s board made no effort to determine what control was worth to Pritzker – Feasibility studies should not be prepared internally but by those who do it for a living—hire financial experts and/or investment bankers. Van Gorkom is sometimes referred to as “Investment Bankers’ Full Employment Act” or “Investment Bankers’ Relief Act” because of the business it has generated for investment bankers from boards seeking to avoid liability since then Pierluigi Matera Corporate and Business Law C. Negotiations IV. The Law of Business Judgment Van Gorkom’s negotiations with Pritzker were not demanding at all: Pritzker’s quick acceptance of the price suggests that he was getting a bargain D. Time Pressure – Van Gorkom’s decision-making process went quickly and decisions were taken under serious time constraints; however, the court found no reasons to justify such speed – Speed of decisions is unobjectionable if the process is adequate, but in Van Gorkom it was not – “History has demonstrated that boards that have failed to exercise due care are frequently boards that have been rushed”—McMullin v. Beran (Del. 2000) Pierluigi Matera Corporate and Business Law E. Information and Process – IV. The Law of Business Judgment – – – – – Van Gorkom was essentially a board’s failure to make an informed decision The standard which emerged is that directors must inform themselves of all material information reasonably available; it requires an in-depth study of the problem Information is costly, and requiring directors to have all information “reasonably available” requires them to over-invest Trans Union’s directors had the duty of inquiry: they should have pressed Van Gorkom with regard to the details of the deal The board should also keep a sufficient record of the process Van Gorkom rests on the failure to keep such record: the court will not impose liability if the board provides credible evidence that they knew what they were doing Pierluigi Matera Corporate and Business Law Criticism Incentives and costs IV. The Law of Business Judgment Smith v. Van Gorkom caused many board decisions to be overprocessed Who pays the bill if the director is held liable for breaching their duty of care? Who pays the bill for hiring investment bankers and lawyers? Pierluigi Matera Corporate and Business Law A IV. The Law of Business Judgment B C D The Nature of the Rule Preconditions The Contextual BJR Application to Officers Pierluigi Matera Corporate and Business Law The Contextual BJR Note that standards of judicial review have an inherent flexibility, as courts may fine tune the application of the (appropriate) standard to the case—upon the specific context, whether operational issues or structural choices IV. The Law of Business Judgment In this light, 3 distinct versions of the BJR may be identified: Traditional A more intrusive variant, during the sale of a business: see Van Gorkom ES Conditional (e.g., during takeover defenses—Unocal) Pierluigi Matera Corporate and Business Law A Particular Application: Dismissal of Derivative Suit and SLC The board of directors has the power to terminate derivative litigation brought by a shareholder as not in the corporation’s best interests It is a business decision IV. The Law of Business Judgment During derivative suits, a conflict of interest might arise—directors and officers (who would ordinarily manage the corporation’s business) become defendants (and demand on directors can be excused under Zuckerberg or Marx v. Akers) In demand excused derivative suits, the board may delegate a Special Litigation Committee (SLC) to avoid the conflict. The committee conducts a factual investigation The SLC can file for dismissal if it finds that the case is not in the corporation’s best interests. The court will apply the Zapata (or Auerbach in NY) standard—See also In re Oracle Corporation Derivative Litigation (Del. Ch. Dec. 4, 2019) (see Course Packet - Section 9) Pierluigi Matera Corporate and Business Law Particular Application in takeover defences: Unocal, Revlon and the Enhanced Scrutiny The BJR can also be used as a yardstick for reviewing board’s decisions to adopt takeover defences IV. The Law of Business Judgment Poison Pills: directors must demonstrate that they had reasonable grounds for believing that a threat existed, and that the measure taken was proportional to the threat (Unocal) During the auction phase of a takeover, the directors have the duty to negotiate the highest price for the stockholders (Revlon) Both Unocal and Revlon represent the Enhanced Scrutiny. This standard can also be seen as a conditional BJR because if directors meet it, then BJR will apply Pierluigi Matera Corporate and Business Law The ES as a Conditional BJR EFS no IV. The Law of Business Judgment Revlon-like or Unocal-like case Did the plaintiff meet the Enhanced Scrutiny? yes BJR Pierluigi Matera Corporate and Business Law In DoC cases, directors enjoy the the presumption/assumption to have acted in accordance with the mentioned preconditions. Nevertheless, if the complaint pleads facts demonstrating otherwise, the BJR gets overcome IV. The Law of Business Judgment If the BJR is rebutted, then: the burden shifts from the plaintiffs to defendant directors defendants are to demonstrate that the challenged act or transaction was entirely fair (=fair dealing+fair price) to the corporation and its stockholders à Entire Fairness Standard applies (EFS is the standard applicable to duty of loyalty cases, where there is no protection from the BJR) Pierluigi Matera Corporate and Business Law Once the BJR is rebutted, then the presumption falls and the Entire Fairness Standard will apply IV. The Law of Business Judgment EFS consists in the burden of directors to prove both fair dealing and fair price re the relevant transaction à EFS = fair dealing + fair price In detail, the standard places on directors the burden to prove, subject to careful scrutiny by the courts, “their utmost good faith and most scrupulous inherent fairness of the bargain”—Weinberger v. UOP Inc. (Del. 1983) The EFS is an exacting and strict standard but makes sense, since knowledge of facts to prove nature and extent of self-dealing is typically within the possession of defendant directors. Therefore, the allocation of the burden of proof on them is also efficient Pierluigi Matera Corporate and Business Law The Rebuttal of the BJR EFS yes IV. The Law of Business Judgment DoC case Did the plaintiff rebut the BJR (6 preconditions to apply the BJR)? no BJR Pierluigi Matera Corporate and Business Law However, the application of EFS to DoC cases when the BJR has been rebutted is problematic IV. The Law of Business Judgment Because the EFS has little relevance to duty of care cases like Van Gorkom or Technicolor In these cases, the relevant factual issues do not go to fairness but rather to negligence and errors of judgment Invocation of EF entails important remedial implications: under Weinberger, a court may grant “any form of equitable or monetary relief as may be appropriate, including rescissory damages”. But, unlike duty of loyalty cases, in Technicolor-like cases rescissory damages would cause the defendant directors to return a benefit that they have never received (directors risk to pay money out of their pocket even if they pursued no personal interest and never got a non-ratable benefit from the transaction) Pierluigi Matera Corporate and Business Law However, once the BJR is rebutted, the court will scrutinise the substantive merit and the alleged breach of duty of care IV. The Law of Business Judgment The trial can proceed (discovery and trial) and the court might determine damages Pierluigi Matera Corporate and Business Law The Spectrum judicial review standards IV. The Law of Business Judgment BJR - Enhanced Scrutiny (Unocal/Revol) Entire Fairness Standard - Blasius/Schnell Pierluigi Matera Corporate and Business Law To sum up, the spectrum of judicial review standards goes - from the deferential BJR, - to the intermediate standard of the Enhanced Scrutiny IV. The Law of Business Judgment the ES applies in Revlon-like cases and when a defensive tactic is challenged in a court of law (Unocal) (ES is also called Conditional BJR) - to the demanding Entire Fairness Standard the EFS applies to duty of loyalty cases and when plaintiffs succeed in rebutting the BJR - to the very strict standard set out in Blasius/Schnell Blasius and Schnell apply to board entrenchment/stockholder disenfranchisement cases (the survival of this standard has been recently questioned, after Coster v. UIP Companies (Del. June 28, 2023). However, some contend that a “Blasius minus” is still a viable standard, in light of In re AMC Entertainment Stockholder Litigation, (Del. Ch. Aug. 11, 2023)) Pierluigi Matera Corporate and Business Law BJR IV. The Law of Business Judgment More deferential ES EFS SoR Spectrum Schnell or Blasius ** Less deferential Pierluigi Matera Corporate and Business Law **After Coster v. UIP Companies (Del. June 28, 2023); but see In re AMC Entertainment Stockholder Litigation, (Del. Ch. Aug. 11, 2023) = “Blasius minus” BJR IV. The Law of Business Judgment More deferential ES EFS SoR Spectrum Schnell or Blasius ** Less deferential Pierluigi Matera Corporate and Business Law A IV. The Law of Business Judgment B C D The Nature of the Rule Preconditions The Contextual BJR Application to Officers Pierluigi Matera Corporate and Business Law Do officers get the benefits of the Business Judgment Rule? They do owe a duty of care to the corporation, but are they shielded by the BJR? ALI Principles IV. The Law of Business Judgment Under ALI Principles, the BJR applies to both directors and officers Judicial Precedents Judicial precedents are divided The theoretical justifications for the BJR extend from the boardroom to corporate officers Officers are even more risk-averse than directors, so insulation from liability may be necessary to encourage optimal levels of risk-taking by officers Delaware law is conveniently silent on the matter Pierluigi Matera Corporate and Business Law V. THE DUTY OF CARE Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law As the BJR is so strict, the underlying cases of Duty of Care remain poorly developed – Delaware requires “that amount of care which ordinarily careful and prudent men would use in similar circumstances” V. The Duty of Care – ALI Principles require “the care that an ordinarily prudent person would reasonably be expected to exercise in a like position and under similar circumstances” – MBCA requires “the care an ordinarily prudent person would exercise under similar circumstances” Is negligence the appropriate standard of review? In most jurisdictions, ordinary negligence is the relevant standard for DoC cases In Delaware, gross negligence is the standard: “reckless indifference to or a deliberate disregard of the stockholders”—McMullin v. Beran (Del. 2000); conduct outside the “bounds of reason”—Rabkin v. Philip A. Hunt Chemical Corp. (Del.Ch. 1986) Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law The negligence-like phrasing of the DoC leads one to assume that liability should be imposed where all the elements of the negligence cause of action are made out In tort law, liability for negligence requires not just a breach of the DoC, but also a showing of causation and damages V. The Duty of Care In Barnes v. Andrews (S.D.N.Y. 1924), Andrews escaped liability because plaintiff Barnes could not prove causation “The undoubted negligence of directors may not result in liability if the plaintiff cannot show that the negligence proximately caused damages to the corporation” The traditional tort notions of cause in fact and proximate cause apply to corporate DoC cases Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law Both the DGCL and the MBCA provide statutory safe harbors for directors who rely in good faith upon information/reports from their subordinates – DGCL §141(e): directors are “fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports, or statements presented to the corporation by any of the corporation’s officers or employees” V. The Duty of Care – MBCA §8.30(e) is similar In Smith v. Van Gorkom (Del. 1985), the oral presentation to the board did not qualify as a report under DGCL §141(e) That the board receives a report is not enough: the board’s reliance on such report must be in good faith, which on these facts imposed a duty of inquiry, which Van Gorkom’s board did not comply with Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law Monitoring management is the board’s primary function, and the BJR supposes an exercise of business judgment Mainstream of oversight cases will be explored in connection with the duty of loyalty. But Francis is a precursor in gradually approaching Caremark V. The Duty of Care Francis v. United Jersey Banks (N.J. 1981): the duty of care requires directors to pay on-going attention to the business and affairs of a corporation—“Directors are under a continuing obligation to keep informed about the activities of a corporation” – Directors are not expected to know in minute detail everything that happens on a day-by-day basis: they should have a general understanding of the firm’s activities and affairs and raise inquiries into doubtful or apparently illegal matters – It is unclear whether the board has a duty to ensure that the corporation complies with the law – Oversight Liability will then develop under the DoL and Caremark Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law Stockholder Ratification – In Smith v. Van Gorkom, director defendants argued that shareholder approval of the challenged merger cured their alleged duty of care violations V. The Duty of Care – On the facts of Van Gorkom, shareholder approval was unavailing: only a fully informed vote of the shareholders could protect directors from liability – Yet, the question requires a clarification The question is: what is the effect of stockholder ratification? Does stockholder ratification cleanse the transaction and secure it with the protection of the BJR? The evolution of this doctrine (which will be covered in Section 12) marked two important milestones in recent years: Corwin (Corwin v. KKR Financial Holdings LLC (Del. 2015)) and MFW (Kahn v. M&F Worldwide (Del. 2014)), whose effects are still being explored in subsequent cases (their progenies) Pierluigi Matera Corporate and Business Law – Corwin established the so-called Corwin test: in the absence of a controlling stockholder, when Revlon would be the appropriate standard of review, the business judgment rule applies whenever the transaction is approved by a “fully informed, uncoerced vote of disinterested stockholders” V. The Duty of Care Corwin – In other words, if the defendant had planned the transactions as to meet the Corwin test, the standard of review will shift from Revlon to BJR. This effect is termed “cleansing effect” and, in particular, a Corwin effect in this case – The best way for the plaintiff to overcome the cleansing effect is to show that the shareholders’ vote was not fully informed. Most of the cases where the Corwin doctrine failed were cases in which full information was lacking: “if there are material misrepresentations or omissions in the disclosures provided in connection with the shareholder vote, the vote will not extinguish care claims” Pierluigi Matera Corporate and Business Law Corwin effect BJR IV. The Law of Business Judgment More deferential ES EFS SoR Spectrum Schnell or Blasius Less deferential Pierluigi Matera Corporate and Business Law – MFW postulates a different scenario: transactions involving conflicted controllers or conflicted boards (i.e., where a controlling stockholder or a majority of the board have a personal interest in or will receive a non-ratable/unique benefit from the transaction) V. The Duty of Care MFW – In these cases, the appropriate standard of review should be the EFS. But, the transaction will be insulated from judicial scrutiny (and the standard will be BJR), if from the outset conditioned on approval by both an ab initio empowered committee of independent directors that fulfilled its DoC, and a fully informed, uncoerced vote of disinterested (unaffiliated) stockholders—MFW test – In other words, if the transaction is planned ahead as to meet the MFW test, then when the transaction is challenged and provided that the MFW test is met, a cleansing effect will occur and the standard will be the BJR Pierluigi Matera Corporate and Business Law V. The Duty of Care MFW – The doctrine was affirmed by Del. Sup. Court in 2014 for freezeout (a.k.a. squeezeout or going private) mergers of the minority. Yet, since then, Delaware courts have expanded the reach of this doctrine as to apply to a broad variety of conflicted transactions (such as a reverse spin-off initiated by a controller, a de-SPAC merger, a charter amendment that prolonged a company’s dual class structure, a redemption of tracking stock, consulting arrangements with a controller, and a compensation package for a controller). Recently, this expansion was criticized by some commentators, and a debate has emerged as to whether the MFW prerequisites should have to be met to cleanse fiduciary breaches in all conflicted transactions (as has been the case), or whether the MFW prerequisites should be required only in going private mergers, which was the context where MFW itself was decided—and all other types of conflicted transactions should be subject to business judgment review without compliance with MFW so long as the merger was approved either by the independent directors or the minority stockholders. The Sup. Court might be addressing this question in a pending case (In re Match Group) Pierluigi Matera Corporate and Business Law MFW effect BJR IV. The Law of Business Judgment More deferential ES EFS SoR Spectrum Schnell or Blasius Less deferential Pierluigi Matera Corporate and Business Law Corwin test breakdown V. The Duty of Care 1. fully informed 2. uncoerced vote of 3. disinterested stockholders MFW test breakdown 1. the transaction is conditioned from the beginning on approval both by 2. an ab initio empowered committee of independent directors that fulfill its duty of care and 3. a fully informed 4. uncoerced vote of 5. disinterested stockholders Pierluigi Matera Corporate and Business Law – Corwin and MFW’s rationale is as follows: the transaction so planned and approved does replicate an arm’s-length bargain transaction. Therefore, it makes sense that the standard is the BJR V. The Duty of Care – Policy reasons underlying these doctrines: incentivizing directors to plan transaction with a procedure that neutralize the potential conflict and allows minority/unaffiliated stockholders to be decisive and protect themselves in the ballot box (rather than resorting to a judicial scrutiny) (see also Course Packet – Sections 8 and 12) Pierluigi Matera Corporate and Business Law V. The Duty of Care A Is the DoC a Negligence Standard? B Causation C Reliance on Officers D Oversight Cases E Shareholder Ratification F The MBCA Pierluigi Matera Corporate and Business Law As anticipated, scholars have sought to reconcile the duty of care and the BJR by drawing a distinction between standards of conduct and standards of review V. The Duty of Care DoC is a standard of conduct, specifying how directors should act BJR is a standard of review, setting forth the tests that courts will use in determining whether the directors’ conduct can be scrutinized and gives rise to liability – In corporate law, standards of conduct and standards of review diverge – The function of the BJR is to create a less demanding standard of review than the standard of conduct created by the DoC Pierluigi Matera Corporate and Business Law MBCA §8.30 sets forth the standards of conduct for directors – §8.30(a): the director must act in good faith and in a manner the director reasonably believes to be in the corporation’s best interest – §8.30(b): the director has a duty to make informed decisions—reasonable care V. The Duty of Care Conduct that satisfies the requirements of §8.30 cannot result in liability Conversely, MBCA §8.31 sets forth the standards for director liability – §8.31(a)(2): liability can be imposed where the directors acted in bad faith, did not reasonably believe the action to be in the corporation’s best interest, were not properly informed, were not independent, engaged in self-dealing, or failed to exercise oversight Pierluigi Matera Corporate and Business Law VI. STATUTORY RESPONSES TO VAN GORKOM AND THE “D&O LIABILITY CRISIS” Pierluigi Matera Corporate and Business Law The Post Van Gorkom – It is often said that, absent the protections of the BJR, nobody would serve as a director VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” – May commentators heavily criticized the decision. Prof. Fischel defined Smith v. Van Gorkom opinion as “one of the worst decisions in the history of corporate law.” He wondered how can independent directors be potentially liable for millions of dollars in damages when they sell a company for approximately a 60% premium to its market value (i.e., the absurdity of the idea that directors may be held liable and pay money out of their pocket when they did not benefitted from the transaction in a way which was not shared with shareholders) = disincentive to serve as director, hence worse corporate governance – Both Justices McNeilly and Christie penned dissenting opinions. McNeilly called the majority’s opinion a “comedy of errors” Pierluigi Matera Corporate and Business Law However, after Smith v. Van Gorkom, D&O liability insurance became hard to get, and many demanded a reaction VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” Delaware law and many other states responded to this crisis by adopting limitations on director liability and/or by amending their indemnification statutes Pierluigi Matera Corporate and Business Law To be accurate, 2 main approaches/reactions to Van Gorkom were: VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” – Virginia changed the standard for the fiduciary duty of care itself. With regard of the DoC, in Virginia, a fiduciary is required only to act in good faith—no mention of the duty to act with reasonable information. Therefore, as long as the director believes the decision is in the company’s interest, the decisions need not be informed (and they need not be rational!?) – Post Van Gorkom Delaware’s approach to exculpation has been to retain the traditional duty of care, but adopt - §102(b)(7), under which directors can be exempted from monetary liability for breaches of care, so long as they are in good faith - Indemnification statutes Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” A B Liability Limitation Statutes Indemnification Statutes Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” A B Liability Limitation Statutes Indemnification Statutes Pierluigi Matera Corporate and Business Law Exculpation (or Raincoat) Provisions DGCL §102(b)(7) provides that VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” a corporation’s articles of incorporation may (but need not) contain a provision eliminating or limiting personal liability of a director to the corporation or its stockholders for monetary damages (equitable remedies are still available) deriving from a breach of fiduciary duties Nevertheless, such provision shall not eliminate: 1. Liability for breaches of duty of loyalty 2. Liability for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law 3. Liability under DGCL §174 = liability for unlawful dividends 4. Liability for any transaction from which the director derived an improper personal benefits Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” – MBCA §2.02(b)(4) is similar – Most states now have similar statutes – Most public corporations have amended their charters to include these raincoat provisions Pierluigi Matera Corporate and Business Law Note that 1) Although officers are also subject to a fiduciary duty of care, they were denied exculpation by charter provision—now, charter provisions can exculpate officers to a certain extent VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” Arnold v. Society for Savings Bancorp (Del. 1994): for a defendant who is both a director and an officer, an exculpatory §102(b)(7) provision applies only to actions taken solely in his capacity as a director An amendment to DGCL, effective August 1, 2022, allows Delaware corporations to adopt charter provisions on officer exculpations from breaches of the fiduciary duty of care. Like for directors, the exculpation shall not be possible for breaches of duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, and for any transaction from which the director derived an improper personal benefits. Caveat: officers can be exculpated only for direct claims by stockholders. The 2022 amendment to DGCL §102(b)(7) will not permit an exculpation in the context of derivative claims, brought by or in the right of the corporation Pierluigi Matera Corporate and Business Law 2) The statute only limits the monetary liability of directors: equitable remedies are still available VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” Implications: – Equitable remedies are still available – Because the real party in interest in many shareholder suits is the plaintiff’s attorney rather than the shareholders, and because attorneys’ fees can be recovered in connection with equitable remedies, §102(b)(7) does not eliminate the incentive to bring shareholder litigation Pierluigi Matera Corporate and Business Law 3) A §102(b)(7) provision is an affirmative defence VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” Emerald Partners v. Berlin (Del. 1999): defendant directors have the burden of proving that they are entitled to exculpation under the statute Theoretically, this might imply that, if Emerald were to be aggressively applied, a §102(b)(7) provision usually would not allow a defendant director to succeed by moving for dismissal only on grounds that plaintiff failed to state a cause of action which is not covered by the raincoat provision. A discovery would occur first, with all the consequences in terms of costs and settlement. Yet, Chancery Court still grants §102(b)(7) motions to dismiss before a discovery when a plaintiff merely alleges the breach of the DoC and the defendant objects on grounds of a raincoat provision Pierluigi Matera Corporate and Business Law 4) The statute distinguishes self-dealing from the duty of care: plaintiffs can end-run §102(b)(7) provisions by characterizing/coloring their claim as a duty of loyalty violation, but directors who are not conflicted will be covered VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” In re Cornerstone Therapeutics Inc, Stockholder Litig. (Del. 2015): even where a claim is subject to review under the entire fairness standard, “plaintiffs must plead a non-exculpated claim for breach of fiduciary duty against an independent director protected by an exculpatory charter provision, or that director will be entitled to be dismissed from the suit” Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” A B Liability Limitation Statutes Indemnification Statutes Pierluigi Matera Corporate and Business Law All states have statutory provisions authorizing director indemnification to some extent (for present or former D/O) Indemnification Statutes in Delaware VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” DGCL §145 (a), (b), (c), (e), and (f): mandatory/permitted – direct or derivative suits – present good faith/even without – advance payment + further agreements DGCL §145(a) authorizes Indemnification – for direct suit against D/O brought by a shareholder or a third party—provided that *** – covers for expenses plus judgments, fines, and amounts paid in settlement in both civil and criminal proceedings DGCL §145(b) authorizes Indemnification – for derivative suits—provided that *** – only for expenses, yet including attorney’s expenses—if the D/O were held liable to the corp., they may only be indemnified with court approval Pierluigi Matera Corporate and Business Law DGCL §145(c) provides Mandatory Indemnification – in favor of D/O who are successful on the merits or otherwise For D/O who are unsuccessful, indemnification is permitted as long as it is not precluded by statute VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” DGCL §145(e) authorizes the corporation to advance expenses – provided that the D/O undertakes to repay any such amount if it turns out that they are not entitled to indemnification – the rationale is the long delays in litigations may frustrate the scope of the indemnification, otherwise DGCL §145(f) – the corporation may enter into specific indemnification written agreements that go beyond the statute – most public companies have done so Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” (***) Pay attention to the following requirement: there must be a finding that the person seeking indemnification acted in good faith and in a manner reasonably believed to be in the corporation’s best interests (or, in a criminal matter, without reason to believe the person’s conduct was criminal) “[…] if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that the person’s conduct was unlawful.” (§145(a), + similar wording under (b)) Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” DGCL §145(d) regards the procedure to grant the indemnification under (a) and (b), unless ordered by a court “[…] only as authorized in the specific case upon a determination that indemnification of the present or former director, officer, employee or agent is proper in the circumstances because the person has met the applicable standard of conduct set forth in subsections (a) and (b) of this section. Such determination shall be made, with respect to a person who is a director or officer of the corporation at the time of such determination: (1) By a majority vote of the directors who are not parties to such action, suit or proceeding, even though less than a quorum; or (2) By a committee of such directors designated by majority vote of such directors, even though less than a quorum; or (3) If there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion; or (4) By the stockholders.” Pierluigi Matera Corporate and Business Law Important clarifications: VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” – SEC takes the position that indemnification against liability under the federal securities laws is against public policy – Under §145(a), a Delaware corporation has the power to elect indemnification of its officers, directors, and employees/agents for liabilities that arise “by reason of the fact” of that person’s position (direct suits). But §145(a) does not cover fiduciary claims or other actions “by or in right of the corporation” (derivative suits). They are subject to different rules under §145(b) – Under §145(b) a corporation is legally prohibited from indemnifying a person sued “by or in right of” the corporation, for any costs, if that person is “adjudged to be liable,” with an exception only for cases in which the Chancery Court can be convinced it would be equitable Pierluigi Matera Corporate and Business Law Does §145(f) allow the corporation to indemnify D/O where statutory indemnification is not permitted? VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” Rule: Under Waltuch v. Conticommodity Services (2d Cir. 1996), it does not Waltuch was the silver trader for Conticommodity. After the 1979 silver market crash, Waltuch and Contic. were sued for fraud and market manipulation by clients + a separate proceeding by CFTC. Contic. paid $35M to settle the private litigation, and therefore Waltuch was dismissed by the litigation without any monetary payment. Yet, Waltuch incurred $1.2M in legal expenses. Plus, Waltuch settled the CFTC’s litigation by agreeing to pay a fine + a 6-month ban on trading Pierluigi Matera Corporate and Business Law VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” Contic. AoI provided indemnification for incumbent or former D/O, employees and agents regarding the legal expenses in any possible action, suit or proceeding Waltuch requested the indemnification. Contic. refused to pay, arguing that the specific bylaw was invalid since it mandated indemnification even in cases with no good faith. And that is against §145(a) Pierluigi Matera Corporate and Business Law 2d Cir. ruled that à “Indemnification rights may be broader than those set out in the statute, but they cannot be inconsistent with the ‘scope’ of the corporation’s power to indemnify” VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” à “Where the statute requires good faith (…), an agreement that purports even by implication to authorize indemnification for non-good faith conduct is inconsistent with the scope of the statute and therefore invalid” But, under §145(c), if the defendant was successful or otherwise, the indemnification is mandatory Waltuch was successful as to the private litigation, and unlike subsections (a) and (b), there is no good faith limitation under §145(c). Waltuch satisfied the standard of being successful and thus was entitled to mandatory indemnification for his expenses in the private party litigation (a court shall only see what is the result of the underlying litigation) Pierluigi Matera Corporate and Business Law Q1: Why doesn’t §145(c) have a good faith requirement? VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” 1. To avoid collateral litigation: omitting a requirement of good faith forecloses the risk of having collateral litigation and fees for fees (suppose a defendant succeeds on the merits or escapes liability but in a way which does not resolve the issue of good faith, such as avoiding conviction in a criminal case. Here, the issue of GF is not subject to collateral estoppel and would be litigated… there will be suits regarding “fees for fees”) 2. To permit the indemnification of D/O who act in bad faith but nonetheless prevail: this may be done (i) to induce directors to take risks, (ii) encourage people to serve as directors in Delaware, and (iii) encourage incorporators to incorporate in Delaware, by providing them with the utmost protection Pierluigi Matera Corporate and Business Law Q2: If a D/O is obliged to sue the corporation seeking indemnification, is a prevailing D/O entitled not only to indemnification of attorney’s fees incurred in the underlying litigation but also of those incurred in the indemnification suit? VI. Statutory Responses to Van Gorkom and the “D&O Liability Crisis” – Mayer v. Executive Telecard (Del.Ch. 1997): no, they are not à The statute authorizes only “the indemnification of fees incurred in the underlying action, not fees for fees” – Baker v. Health Management Systems (N.Y. 2002): no, they are not à Nothing in legislative history indicated an intent to authorize fees for fees – Stifel Financial Corp. v. Cochran (Del. 2002): yes, they are à Noting that DGCL §145 is a remedial statute, the court stated that “the indemnification statute should be broadly interpreted to further the goals it was enacted to achieve” Pierluigi Matera Corporate and Business Law VII. APPENDIX AND ANNEX Pierluigi Matera Corporate and Business Law APPENDIX I Shlensky v Wrigley, 237 NE 2d 776 (Ill. App. 1968) Pierluigi Matera Corporate and Business Law Shlensky v Wrigley, 237 NE 2d 776 (Ill. App. 1968) – Facts – The case considered the claim that the directors of the corporation owning the Chicago Cubs (including 80% shareholder Mr. Wrigley) had violated their fiduciary duties by refusing to install lights in the field Appendix I – The complaint alleged that Mr. Wrigley “has admitted that he is not interested in whether the Cubs would benefit financially” from installing lights, but rather was motivated by “his personal opinions that baseball is a ‘daytime’ sport and that the installation of lights and night baseball games will have a deteriorating effect upon the surrounding neighborhood” Pierluigi Matera Corporate and Business Law Shlensky v Wrigley, 237 NE 2d 776 (Ill. App. 1968) – Facts – The complaint further alleged a plethora of facts supporting a conclusion that installing lights would in fact have increased corporate profits: Appendix I ØEvery other baseball team had installed lights for the purpose of increasing attendance and revenue ØCubs road attendance, where night baseball was played, was better than Cubs home attendance ØCubs weekday attendance was worse than that of the Chicago White Sox, who played at night in the same city, even though their weekend attendance, when both teams played day ball, was the same ØThe cost of installing lights, which could be financed, would be more than offset by the extra revenue that would result from increasing attendance by playing night baseball Pierluigi Matera Corporate and Business Law Shlensky v Wrigley, 237 NE 2d 776 (Ill. App. 1968) – Facts Appendix I – The court affirmed dismissal of the complaint stating that it was “not satisfied that the motives assigned to [Mr. Wrigley] are contrary to the best interests of the corporation and the stockholders” because in the long run a decline in the quality of the neighborhood might reduce attendance or property value – The court did not allow inquiry into whether such long-run profitability was Mr. Wrigley’s actual motivation. Rather, it held irrelevant any motives other than fraud, illegality or conflict of interest, thus rendering moot the allegations that Mr. Wrigley was motivated not by corporate profits, but by public interest concerns Pierluigi Matera Corporate and Business Law APPENDIX II Kamin v. American Express Company, 383 N.Y.S.2d 807 (Sup. Ct. 1976) Pierluigi Matera Corporate and Business Law Kamin v. American Express Company, 383 N.Y.S.2d 807 (Sup. Ct. 1976) Initial Investment Appendix II 1972: Amex AMEX buys shares for over $29M in Donaldson, Lufkin and Jenrette (DLJ ) but shares DLJ Lose $25M in value after 2 years Investment drops in value – options to consider AMEX Option 1: Record loss now – it reduces profits, but less tax DLJ AMEX shareholders Option 2: Spin off DLJ by giving its shares to AMEX shareholders as an in kind dividend of stock It doesn’t reduce profits this year much…over years AMEX DLJ – Option 1 – report $26M less profits this year but less taxes ($~8M) – Option 2 – stretch out losses over 10 years but lose tax advantage this year – Board has meeting, gets informed and goes for Option 2. Less stock price impact, though lose $8M in tax savings. Why? Does it make sense? Pierluigi Matera Corporate and Business Law Kamin v. American Express Company, 383 N.Y.S.2d 807 (Sup. Ct. 1976) – In 1975, Amex declares a special (in kind) dividend to all shareholders distributing the DLJ shares Appendix II – Two shareholders (including Howard and Robert Kamin) first demand BoDs to rescind the dividends. Then, since the BoDs rejected the demand, they file a derivative suit against directors for monetary damages, claiming waste of corporate assets—because Amex could have sold the DLJ shares and use the capital loss to offset capital gains on other investments—an offset which would have resulted in a net tax savings of $8M – Defending directors say they thought about it but rejected the claim due to the negative impact on share prices. Therefore, they move for a dismissal for failing to state a cause of action or in the alternative a summary judgment – Since ‘there is no claim of fraud or self-dealing, and no contention that there was any bad faith or oppressive conduct’, the court confirms BJR and abstains from reviewing the decision Pierluigi Matera Corporate and Business Law APPENDIX III Miller v. A. T. & T. Co., 507 F.2d 759 (3d Cir. 1974) Pierluigi Matera Corporate and Business Law Miller v. A.T.&T. Co., 507 F.2d 759 (3d Cir. 1974) DNC - 1972 Appendix III 1) AT&T provides telecom. services to Dem. Nat. Comm. during 1968 Dem. Nat. Conv. in Chicago 2) Sends invoice and deliberately does not collect $1.5M worth of services AT&T Shareholders 3) Miller brought a derivative suit claiming violation of fiduciary duty by wasting corp. asset + 4) Claimed AT&T afforded illegal preference in violation of 1934 Comm. Act + violation Campaign funding laws (Tillman Act) since it’s like a loan – District Court dismisses Miller’s complaint for failing to state a claim upon which a relief can be granted. The Circuit Court reversed and remanded (holding that no BJR when Ds knowingly violate the law – BJR to protect business judgments not knowing violations of the law. Why? Public policy) – What is “knowing” – do a safety study and decide risk worth providing product (e.g., pharma, transportation, etc…)…Is this “knowing”? Pierluigi Matera Corporate and Business Law Miller v. A.T.&T. Co., 507 F.2d 759 (3d Cir. 1974) The 3rd Cir. concluded that Since plaintiffs have alleged actual damage to the corporation from the transaction in the form of the loss of a $1.5 million increment to AT&T’s treasury, we conclude that the complaint does state a claim upon which relief can be granted sufficient to withstand a motion to dismiss Appendix III We have accepted plaintiffs’ allegation of a violation of 18 U.S.C. §610 as a shorthand designation of the elements necessary to establish a breach of that statute.... That such a designation is sufficient for pleading purposes does not, however, relieve plaintiffs of their ultimate obligation to prove the elements of the statutory violation as part of their proof of breach of fiduciary duty. At the appropriate time, plaintiffs will be required to produce evidence p. 306sufficient to establish three distinct elements comprising a violation of 18 U.S.C. §610: that AT&T (1) made a contribution of money or anything of value to the DNC (2) in connection with a federal election (3) for the purpose of influencing the outcome of that election.... The order of the district court will be reversed, and the case remanded for further proceedings consistent with this opinion Pierluigi Matera Corporate and Business Law Miller v. A.T.&T.Co., Co.,507 507F.2d F.2d 759 759 (3d (3d Cir. Miller v. A.T.&T. Cir.1974) 1974) AK&K question: Appendix III – Knowing violations of law are conceptually distinct from the dutyof-care topics. A board that deliberates with the utmost care to authorize an action that they know to be illegal should be theoretically considered a board that discharges its duty of care. Yet, as the Miller court tells us, the business judgment rule will not insulate their decision from judicial scrutiny – For this reason, the duty to obey the law can be seen as a judgecreated positive overlay on the overall fiduciary duty structure – This imposition seems unproblematic in the case of definite violations of the law, but what about the far more common situation where the legal advice is “some likelihood” or “substantial risk” of violating the law? Could it be the case that corporate law prevents directors from taking any risk of violating the law? Pierluigi Matera Corporate and Business Law APPENDIX IV Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) Pierluigi Matera Corporate and Business Law Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) 3) Van Gorkom, CEO near retirement. Approaches Pritzker with chance to buy TU (key asset, NOL) for $55 per share 1) Jay Pritzker, controller Transunion (TU) Marmon Appendix IV 4) Board has very short meeting (with no agenda provided beforehand) and approves, with conditions Pritzker wants 2) Accepts price of $55 and has some conditions for deal Sept Oct Dec Jan Feb Pierluigi Matera Corporate and Business Law Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) Ch.C. ruled in favor of defendants, but Sup.Court finds TU board uninformed at board meeting approving deal – lose BJR. Did not seek indep. fin. Opinion, but CFO + unjustifiable speed of decision Reliance on officers: the report did not qualify as a financial report from an officer on which to rely Appendix IV Courts says “auction” does not cure this (i.e., board did not proved entire fairness), because auction looks “rigged” against other bids (TU may accept bids from other buyers for the next 90 days but not actively solicit bids or help bidders) After the Supreme Court’s decision to remand the case back to the Chancery Court, the defendants agreed to a settlement—under which the directors agreed to pay $23.5M in damages, of which $10M was covered by D&O insurance, and the remainder paid by Pritzker to cover directors (some were unable to pay) even though he was not a party to the lawsuit Pierluigi Matera Corporate and Business Law APPENDIX V Francis v. United Jersey Banks, 432 A.2d 814 (N.J. 1981) Pierluigi Matera Corporate and Business Law Francis v. United Jersey Banks, 432 A.2d 814 (N.J. 1981) Legend $ to insur. $ to client Board – Jnr Ps and Snr P (then Mrs. P) REI1 Appendix IV Client Insurance Pritchard & Baird, Reinsurance Broker REI2 REIn – – – – Snr P would take $ out and replace before missed After Snr P dies, Jnr Ps not so good at this and firm bankrupt Sue Mrs. P (why her?) for not monitoring – she did nothing Court holds her liable for duty of care (or so it seems) – Why no BJR (no board decision) – Director duty to monitor (ok) and also respond (?) – could Mrs. P have stopped her sons – how? Pierluigi Matera Corporate and Business Law Francis v. United Jersey Banks, 432 A.2d 814 (N.J. 1981) Intro and history of the case Appendix IV Pritchard & Baird, Inc. was a reinsurance broker. As is well known, a reins. broker arranges contracts between insurance companies and reinsuring companies for large policies in order to share the risks of those policies. The company that sells insurance to the client pays a portion of the premium to the reinsurance broker, who deducts its commission and forwards the balance to the reinsuring company. Therefore, the broker handles large amounts of money as a fiduciary for its clients By 1975, the corporation was bankrupt. This action was brought by the trustees in bankruptcy against Mrs. Pritchard and the bank as administrator of her husband’s estate. As to Mrs. Pritchard, the principal claim was that she had been negligent in the conduct of her duties as a director of the corporation. She died during the pendency of the proceedings, and her executrix was substituted as defendant. Claims were initially filed against all three directors of the company, but the Pritchard brothers were dismissed from the case after being adjudicated bankrupt, leaving their mother, Lillian Pritchard, the only solvent defendant Pierluigi Matera Corporate and Business Law Francis v. United Jersey Banks, 432 A.2d 814 (N.J. 1981) Holdings Appendix IV Mrs. Pritchard should have realized that her sons were misappropriating substantial trust funds under the guise of shareholders’ loans The financial statements for each fiscal year from Jan 1970 showed working capital deficits and the escalation of these loans. So, detecting a misappropriation of funds would not have required special expertise or extraordinary diligence The negligence of (total lack of oversight by) Mrs. Pritchard results in liability if it was a proximate cause of the loss. Cases involving nonfeasance present a much more difficult causation question than those in which the director has committed an affirmative act of negligence leading to the loss. Ds can inform other Ds of the (potential) mismanagement detected, object and absolve themselves. On the contrary, if they vote + if they are present, they are presumed to concur unless their objection/dissent is not entered in the minutes (noted dissent) of the meeting or filed promptly after adjournment Pierluigi Matera Corporate and Business Law Francis v. United Jersey Banks, 432 A.2d 814 (N.J. 1981) In this case, the scope of Mrs. Pritchard’s duties was determined by the precarious financial condition of Pritchard & Baird, its fiduciary relationship to its clients and the implied trust in which it held their funds. Thus viewed, the scope of her duties encompassed all reasonable action to stop the continuing conversion. Her duties extended beyond mere objection and resignation to reasonable attempts to prevent the misappropriation of the trust funds A leading case discussing causation where the director’s liability is predicated upon a negligent failure to act is Barnes v. Andrews, 298 F. 614 (S.D.N.Y. 1924). In that case, the court exonerated a figurehead director who served for eight months on a board that held one meeting after his election, a meeting he was forced to miss because of the death of his mother Appendix IV Pierluigi Matera Corporate and Business Law Francis v. United Jersey Banks, 432 A.2d 814 (N.J. 1981) Appendix IV Mrs. Pritchard had the power to prevent the losses sustained by the clients of Pritchard & Baird. With power comes responsibility. She had a duty to deter the depredation of the other insiders, her sons. She breached that duty and caused plaintiffs to sustain damages. Trial court ruled for Francis, and so did the Appellate Division. The NJ Supreme Court affirmed the judgment of the Appellate Division Francis: o Board’s Duty to Monitor? o Prologue to Caremark Pierluigi Matera Corporate and Business Law ANNEX Pierluigi Matera Corporate and Business Law Robert B. Little et al., Determining the Likely Standard of Review in Delaware M&A Transactions (2017), Harvard Law School Forum on Corporate Governance, available at https://corpgov.law.harvard.e du/2017/04/28/determiningthe-likely-standard-ofreview-in-delaware-matransactions-2/ No. Facts Likely Standard of Review 1 Fully independent and disinterested board of directors; no controlling stockholder Business judgment 2 Majority of board is independent and disinterested; no controlling stockholder Business judgment 3 Board is evenly split between directors who are independent and disinterested and directors who are not independent and disinterested; no controlling stockholder Entire fairness Majority of board is not independent and disinterested; no controlling stockholder Entire fairness 4 Business judgment if transaction is approved by a properly functioning special committee or a fully-informed, uncoerced stockholder vote Business judgment if transaction is approved by a properly functioning special committee or a fully-informed, uncoerced stockholder vote 5 None of the board members is independent and disinterested; no controlling stockholder Entire fairness Business judgment if transaction is approved by a fully-informed, uncoerced stockholder vote 6 Transaction with a controlling stockholder where majority of the board is independent and disinterested Entire fairness, but either (a) a properly functioning special committee or (b) approval of a majority of the minority will shift the burden of proof to the plaintiff Business judgment if both (a) a properly functioning special committee and (b) approval of a majority of the minority Pierluigi Matera Corporate and Business Law 7 Robert B. Little et al., Determining the Likely Standard of Review in Delaware M&A Transactions (2017), Harvard Law School Forum on Corporate Governance, available at https://corpgov.law.harvard.e du/2017/04/28/determiningthe-likely-standard-ofreview-in-delaware-matransactions-2/ Transaction with a controlling stockholder where a majority of the board is not independent and disinterested Entire fairness, but either (a) a properly functioning special committee or (b) approval of a majority of the minority will shift the burden of proof to the plaintiff Business judgment if both (a) a properly functioning special committee and (b) approval of a majority of the minority 8 Controlling stockholder; majority of the board is independent and disinterested with respect to the controlling stockholder; controlling stockholder is not the counterparty in the transaction; and controlling stockholder is treated the same as other stockholders Business judgment 9 Controlling stockholder; majority of the board is not independent and disinterested with respect to the controlling stockholder; controlling stockholder is not the counterparty in the transaction; and controlling stockholder is treated the same as other stockholders Business judgment Pierluigi Matera Corporate and Business Law 10 Robert B. Little et al., Determining the Likely Standard of Review in Delaware M&A Transactions (2017), Harvard Law School Forum on Corporate Governance, available at https://corpgov.law.harvard.e du/2017/04/28/determiningthe-likely-standard-ofreview-in-delaware-matransactions-2/ 11 Controlling stockholder; majority of the board is independent and disinterested with respect to the controlling stockholder; controlling stockholder is not the counterparty in the transaction; and controlling stockholder receives different treatment in the transaction than other stockholders Entire fairness, but either (a) a properly functioning special committee or (b) approval of a majority of the minority will shift the burden of proof to the plaintiff Controlling stockholder; majority of the board is not independent and disinterested with respect to the controlling stockholder; controlling stockholder is not the counterparty in the transaction; and controlling stockholder receives different treatment in the transaction than other stockholders Entire fairness, but either (a) a properly functioning special committee or (b) approval of a majority of the minority will shift the burden of proof to the plaintiff Business judgment if both (a) a properly functioning special committee and (b) approval a of majority of the minority Business judgment if both (a) a properly functioning special committee and (b) approval of a majority of the minority Pierluigi Matera Corporate and Business Law TAKEAWAYS + LEARNING OBJECTIVES Pierluigi Matera Corporate and Business Law Takeaways 1. Directors’ fiduciary duties are the duty of care and the duty of loyalty. Managers are required to act with “the care of an ordinarily prudent person in the same or similar circumstances” and in a manner reasonably believed to be in the best interest of the corporation Takeaways 2. Directors’ duties are owed exclusively to shareholders: the interest that corporate fiduciaries are required to advance is only the interest of the shareholders. This doctrine is termed Shareholder Value Doctrine and implies that the purpose of any corporate actions must be shareholder wealth maximization. Although this conception is rooted in economic studies dated back to the 50’ and 60’, and although it was emphasized by Milton Friedman in a famous 1970 article, the SV doctrine took hold only in the 80s’ as a consequence of shift in the balance of power between managers and shareholders triggered by a wave of hostile takeovers and a conflict between corporate raiders and pension funds 3. Standards of conduct differ from standards of judicial review. Standards of Conduct are rules outlying norms and responsibilities of an individual party (essentially duty of care and duty of loyalty). Standards of judicial review are tests that a court must apply to scrutinise a business decision (e.g., BJR or EFS) Pierluigi Matera Corporate and Business Law Takeaways 4. Although the notion of care in corporate law is similar to the one we apply in other fields of law (and corporate directors are required to exercise “that amount of care which ordinarily careful and prudent men would use in similar circumstances”), the combination of DoC and BJR results in the insulation of directors from liability for negligence Takeaways 5. In some cases, the BJR is interpreted as a presumption that requires courts to abstain from reviewing the substantive merit of directors’ conduct in duty of care claims (abstention doctrine/Shlensky). In other cases, courts emphasize that BJR is a mere standard of review which places the initial burden of proof on plaintiffs and shields directors from liability as long as they act with care and in good faith (Technicolor) Pierluigi Matera Corporate and Business Law Takeaways Takeaways 6. There are several rationales for the BJR: (1) someone must be final— courts are not business experts, so rational shareholders might prefer the risk of managerial error to that of judicial error, as long as directors acted to advance shareholder interest. (2) The BJR aligns directors’ inclination (directors would be less inclined to take risks without the BJR) to shareholders’ inclination (shareholders look for profit and are inclined to risk-taking corporate strategies because they are protected by the limited liability anyway). (3) Hindsight bias—courts’ second guesses could be biased by hindsight, since bad outcomes are often regarded ex post as foreseeable ex ante 7. In operationalizing the BJR, we may say that, if the preconditions for its applications are met, the BJR will shield the business decision, and courts shall not scrutinize the decision. These preconditions are as follows: (1) Exercise of judgement; (2) Disinterested and independent decision makers; (3) Absence of fraud or illegality; (4) Absence of waste; (5) Rationality; (6) Process due care Pierluigi Matera Corporate and Business Law Takeaways Takeaways 8. The seminal case for the process due care is Smith v. Van Gorkom. The case also serves to identify crucial procedural steps to discharge Van Gorkom duties: (1) Consultations—deal-makers should, early in the process, consult with senior management; (2) Setting the price— investment bankers should be retained to assess price and condition of the transaction; (3) Time pressure—even if the BoDs is operating under time constraints, the decision-making process must be adequate; (4) Information—directors must inform themselves of all material information reasonably available, as to make an informed decision 9. In DoC cases, if plaintiffs rebut the BJR, the Entire Fairness Standard applies (EFS is the standard applicable to duty of loyalty cases, where there is no protection from the BJR) and the burden shifts from plaintiffs to defendant directors who are to demonstrate that the challenged act or transaction was entirely fair (=fair dealing+fair price) to the corporation and its stockholders. The problem is that the EFS has little relevance to duty of care cases, because (1) the relevant factual issues do not go to fairness but rather to negligence and errors of judgment, and (2) the invocation of EF entails important remedial implications (such as rescissory damages) which might be unfair in these cases Pierluigi Matera Corporate and Business Law Takeaways Takeaways 10. The spectrum of the standards of judicial review goes from the deferential BJR, to the intermediate standard of the Enhanced Scrutiny, to the demanding Entire Fairness Standard, to the very strict standard set out in Blasius/Schnell. The ES applies in Revlon-like cases + in cases on defensive tactics (Unocal). The Enhanced Scrutiny can also be seen as a conditional BJR because if directors meet it, then BJR will apply. The EFS applies to duty of loyalty cases and in DoC cases if plaintiffs succeed in rebutting the BJR. Blasius and Schnell apply to board entrenchment/stockholder disenfranchisement cases 11. Since the BJR is so strict, the underlying cases of Duty of Care remain poorly developed. However, we may say that under Delaware law, gross negligence is the standard. Furthermore, DoC cases require showing of causation and damages. In this respect, tort notions of cause in fact and proximate cause apply to corporate DoC cases 12. Reliance on officers: in lawsuits, directors will be fully protected if they relied in good faith upon information/reports provided from officers Pierluigi Matera Corporate and Business Law Takeaways 13. Under Francis v. United Jersey Banks (N.J. 1981), the duty of care requires directors to pay on-going attention to the business and affairs of a corporation. Francis is a precursor of Oversight Liability, which will then develop under the DoL and Caremark Takeaways 14. What is the effect of stockholder ratification? Does stockholder ratification cleanse the transaction and secure it with the protection of the BJR? Under Corwin, in the absence of a controlling stockholder, when Revlon would be the appropriate standard of review, the business judgment rule applies whenever the transaction is ap