We previously discussed the Delaware Court of Chancery decision in In re Zale Corp. S’holders Litig., 2015 WL 65514128 (Del. Ch. Oct. 29, 2015), in which the Court of Chancery dismissed an action commenced against, among others, Merrill Lynch, Pierce, Fenner & Smith (Merrill), the financial advisor to the board of directors of Zale Corporation (Zale), arising from the merger (the Merger) between Zale and Signet Jewelers Limited (Signet). Specifically, plaintiffs alleged, among other things, that a presentation made by Merrill to Signet regarding the possible acquisition of Zale “created an unreasonable sale process” because the presentation occurred before Merrill’s engagement by Zale’s board, and was not disclosed to Zale’s board until after the Merger was approved by Zale’s board.
In dismissing the action against Merrill, the Court of Chancery stated that, based upon the Supreme Court decision in Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015), if a court is reviewing the actions of directors during a merger process after the merger has been approved by a majority of disinterested stockholders in an informed, uncoerced vote, then (a) the appropriate standard of review is the business judgment rule; and (b) under the business judgment rule, gross negligence is the appropriate standard in determining the existence of due care liability. The Court of Chancery then held that plaintiffs failed to plead that Zale’s board acted with gross negligence and, thus, plaintiffs failed to plead a breach of the duty of care under the business judgment rule. Accordingly, absent a predicate fiduciary duty breach for Merrill to have aided and abetted, the Court of Chancery concluded that Merrill’s motion to dismiss should be granted.
On May 6, 2016, the Delaware Supreme Court, sitting en banc, issued a five-page Order in which the Supreme Court affirmed the decision of the Court of Chancery to grant Merrill’s motion to dismiss (the Order).1 Although the Delaware Supreme Court affirmed the decision, Chief Justice Strine, writing for the unanimous court, cautioned that the Court of Chancery’s “decision to consider post-closing whether the plaintiffs stated a claim for breach of the duty of care after invoking the business judgment rule was erroneous.” The Delaware Supreme Court explained this cautionary language by highlighting the difference between application of the business judgment rule standard of review (a) to sale transactions (which are challenged post-closing) that were not approved by an informed, uncoerced vote of disinterested stockholders; and (b) to sale transactions (which are challenged post-closing) that were approved by an informed, uncoerced vote of disinterested stockholders:
Absent a stockholder vote and absent an exculpatory charter provision,2 the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence, even if the transaction was a change-of-control transaction. Therefore, employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review-shifting effect to the vote. When the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result. That is because the vestigial waste exception has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful. Certainly, there is no rational argument that waste occurred here.
Simply stated, if a sale transaction is not approved by an informed, uncoerced vote of the disinterested stockholders (and if there is no exculpatory charter provision), then disinterested and independent directors may be exposed to damages liability if their decision to approve the transaction is grossly negligent; if a sale transaction is approved by an informed, uncoerced vote of the disinterested stockholders, then disinterested and independent directors may be exposed to damages liability only if their decision to approve the transaction is wasteful.
In addition, the Delaware Supreme Court “distance[d] [itself] from the Court of Chancery’s original decision of October 1, 2015 in terms of its handling of the claims against the [Zale] board’s financial advisor.” Specifically, the court stated:
We are skeptical that the supposed instance of knowing wrongdoing – the late disclosure of a business pitch that was then considered by the board, determined to be immaterial, and fully disclosed in the proxy – produced a rational basis to infer scienter. Furthermore, to the extent the Court of Chancery purported to hold that an advisor can only be held liable if its aids and abets a non-exculpated breach of fiduciary duty, that was erroneous. Delaware has provided advisors with a high degree of insulation from liability by employing a defendant-friendly standard that requires plaintiffs to prove scienter and awards advisors an effective immunity from due-care liability.
The Delaware Supreme Court explained its skepticism by distinguishing the action in Zale from the action in RBC Capital Markets, LLC v. Jervis,3 where a financial advisor to a board of directors was “liable for aiding and abetting” because the advisor’s “bad-faith actions cause[d] its board clients to breach their situational fiduciary duties (e.g., the duties Revlon4 imposes in a change-of-control transaction).” The court emphasized the rationale that supports this distinction:
The advisor is not absolved from liability simply because its clients’ actions were taken in good-faith reliance on misleading and incomplete advice tainted by the advisor’s own knowing disloyalty. To grant immunity to an advisor because its own clients were duped by it would be unprincipled and would allow corporate advisors a level of unaccountability afforded to no other professionals in our society. In fact, most professionals face liability under a standard involving mere negligence, not the second highest state of scienter – knowledge – in the model penal code. Nothing in this record comes close to approaching the sort of behavior at issue in RBC Capital Markets . . . .
In affirming the decision of the Court of Chancery in Zale, the Delaware Supreme Court (like the Court of Chancery) emphasized the importance of full disclosure to stockholders under Delaware law, and further identified and clarified the benefits that will be realized by directors and their advisors if defects in the underlying sale process are disclosed fully to the stockholders before the stockholders approve the transaction. Specifically, the Delaware Supreme Court identified the “standard-of-review-shifting effect” caused by an informed, uncoerced vote of the disinterested stockholders, holding that gross negligence is the damage liability standard for alleged breaches of the duty of care by disinterested and independent directors if a vote is absent, and waste is the damage liability standard for alleged breaches of the duty of care by disinterested and independent directors if a vote is present.
Moreover, the Delaware Supreme Court clarified that an advisor to a board of directors is not immune from liability simply because the advisor is alleged to have aided and abetted an exculpated breach of fiduciary duty of the directors. In fact, the court confirmed that a corporate advisor may be found liable for aiding and abetting if the advisor acted in bad faith and the bad faith conduct caused the directors to breach their fiduciary duty. For purposes of aiding and abetting liability of corporate advisors, therefore, it appears to be irrelevant whether the damage liability of directors resulting from the breach of fiduciary duty is eliminated. Rather, the relevant issue appears to be whether the bad faith conduct of the corporate advisor caused the directors’ breach.
Although the Delaware Supreme Court offers significant guidance, certain questions still require judicial development. For example, it remains unclear whether directors who are not disinterested, who lacked independence, or who otherwise acted in bad faith will benefit from the post-closing “standard-of-review-shifting effect” if the sale transaction is approved by an informed, uncoerced vote of the disinterested stockholders.5 Similarly, it remains unclear whether a corporate advisor that acts in bad faith, and discloses the bad faith conduct to the directors who do not act other than to disclose the bad faith conduct to the stockholders, will benefit from the post-closing “standard-of-review-shifting effect” if the sale transaction is approved by an informed, uncoerced vote of the disinterested stockholders.
Accordingly, the simple issue that forms the basis for these questions is whether breaches of the duty of loyalty or other bad faith conduct of directors and/or their advisors may be cleansed (and, thus, whether directors and/or their advisors may be made immune from damages liability) if the sale transaction is approved by an informed, uncoerced vote of the disinterested stockholders. Notwithstanding this remaining issue, the decision of the Delaware Supreme Court in Zale highlights the need for (and the benefits that result from) full disclosure to stockholders under Delaware law.
1See Singh v. Attenborough, 2016 WL 2765312 (Del. May 6, 2016).
2See 8 Del. C. § 102(b)(7).
3129 A.3d 816 (Del. 2015).
4Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1986).
5The Court of Chancery in In re KKR Fin. Hldgs. S’holder Litig., 101 A.3d 980, 1001 (Del. Ch. 2014), aff’d sub nom. Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015), suggested that the post-closing “shift” will occur if a transaction is approved by an informed, uncoerced vote of the disinterested stockholders regardless of the disinterestedness, independence, and good faith of the directors who approved the transaction. The Supreme Court, however, did not address this issue in its decision in Corwin or its decision in Zale.