Cornerstone decision instructive on claims against directors for fiduciary breach

Issue November/December 2016 By Alec Zadek

In in re Cornerstone Theraputics Inc., 2015 Del. LEXIS 231 (Del. Ch. May 14, 2015), the Delaware Supreme Court held that allegations that a director approved an interested transaction will not be sufficient to survive that director's motion to dismiss where the corporation has enacted an exculpatory charter provision and the plaintiff failed to specifically allege a non-exculpated claim against that director. Prior to the Delaware Supreme Court's holding, disinterested, independent directors were often required to remain parties to litigation until the end of trial even where the certificate of incorporation contained an exculpatory provision pursuant to 8 Del. C. § 102(b)(7) and the plaintiffs did not allege any non-exculpated claims against those directors. This holding provides an avenue for directors to dismiss the claims against them, and avoid the unnecessary burden and expense of protracted litigation when there are no specific allegations that they engaged in wrongdoing.

The Cornerstone decision was a consolidated opinion issued on two appeals that involved actions for damages by stockholder plaintiffs arising out of mergers in which tthe controlling stockholder, who had representatives on the board of directors, acquired the remainder of the shares that it did not own in a Delaware public corporation. Both mergers were negotiated by special committees of independent directors, were ultimately approved by a majority of the minority stockholders, and were at substantial premiums to the pre-announcement market price. The plaintiffs in both cases sued the controlling stockholder and their affiliated directors as well as the independent directors who had negotiated and approved the mergers. In both cases, independent directors moved to dismiss the claims against them because the plaintiffs failed to plead any claims that were not exculpated by their company's charter provision adopted pursuant to 8 Del. C. § 102(b)(7).

In reaching its holding on the appeals, the court rejected the plaintiffs' argument that they should be entitled to an automatic inference that the directors who facilitated the interested transaction were disloyal where the transaction involved a controlling shareholder. The court held that "to require independent directors to remain defendants solely because the plaintiffs stated a non-exculpated claim against the controller and its affiliates would be inconsistent with Delaware law and would also increase costs for disinterested directors ... without providing a corresponding benefit."

The court explained that "[a]lthough it is wise for our law to focus on whether the independent directors can say no, it does not follow that it is prudent to create an invariable rule that any independent director who says yes to an interested transaction subject to entire fairness review must remain as a defendant until the end of the litigation, regardless of the absence of any evidence suggesting that the director acted for an improper motive." Thus, the decision preserves room for the important role of independent directors in serving as members of special committees and negotiating transactions with controlling shareholders by enabling independent directors to escape from litigation where there are no claims that they breached their duty of loyalty.

Takeaways

For plaintiffs, the Cornerstone decision provides the following guidance: "[w]hen a director is protected by an exculpatory charter provision, a plaintiff can survive a motion to dismiss by that director defendant by pleading facts supporting a rational inference that the director harbored self-interest adverse to the stockholders' interests, acted to advance the self-interest of an interest party from whom they could not be presumed to act independently, or acted in bad faith." Id. at *14. In short, if a plaintiff fails to plead specific allegations implicating a director's duty of loyalty or good faith, then that director will have grounds to be dismissed from the case.

For independent directors, it highlights the protection offered by exculpatory charter provisions adopted pursuant to 8 Del. C. § 102(b)(7).

The bottom line is that the Cornerstone decision provides guidance that will be instructive to both litigants and companies when contemplating the best strategy for initiating or defending against breach of fiduciary duty claims and for organizing Delaware corporations to begin with.

This article appeared in the December 2015 edition of the ComCom Quarterly, the newsletter of the Complex Commercial Litigation Section. For more articles like these on business litigation, bankruptcy, and intellectual property topics, check out the Quarterly at http://is.gd/lFJCJw.

Other Articles in this Issue: