Exculpatory Provisions Provide Powerful Protection for Independent Directors
The Delaware Supreme Court recently issued an important decision clarifying the standards that govern claims for money damages against independent directors of corporations whose charters contain exculpatory provisions.
An “exculpatory provision” in a corporation’s charter provides that directors are not liable to stockholders for monetary damages for breaches of fiduciary duty, except under certain limited circumstances. Such provisions are authorized for Delaware corporations under Section 102(b)(7) of the Delaware General Corporation Law. If a stockholder plaintiff attempts to assert a claim against a director that is covered by the exculpatory provision, the claim is subject to dismissal.
The effect of such provisions in controlling stockholder transactions was before the Delaware Supreme Court in In re Cornerstone Therapeutics, Inc. Stockholder Litigation, No. 564, 2014 & No. 706, 2014 (Del. May 14, 2015). In that case, the Delaware Supreme Court considered the consolidated appeal of two cases challenging the acquisition of a company by its controlling stockholder. The first case concerned Cornerstone Therapeutics Inc., a Delaware-chartered corporation headquartered in North Carolina. The second case concerned China-based Zhongpin Inc. In both cases, a special committee made up of independent directors evaluated and negotiated the ultimate transaction, and a stockholder brought breach of fiduciary duty claims in the Delaware Court of Chancery seeking monetary damages against not only the controlling stockholder, but also against the independent directors on the special committee.
The independent directors moved to dismiss on the grounds that the claims against them were all covered by the exculpatory provision. The Court of Chancery denied the motions to dismiss, holding that when a controlling stockholder stands on both sides of a transaction, and the independent directors facilitated that transaction, a determination that the independent directors were exculpated from paying money damages could only be made after a full review of the transaction. The Court of Chancery, however, certified the issue for appeal to the Delaware Supreme Court.
Reversing the Court of Chancery, the Delaware Supreme Court concluded that exculpated claims for damages against independent directors are subject to dismissal regardless of the standard of review that governs the court’s evaluation of the transaction: “A plaintiff seeking only monetary damages must plead non-exculpated claims against a director who is protected by an exculpatory charter provision to survive a motion to dismiss, regardless of the underlying standard of review for the board’s conduct—be it Revlon, Unocal, the entire fairness standard, or the business judgment rule.” In reaching this result, the court acknowledged the value of negotiating efforts by independent directors and their ability to secure transactions with controlling stockholders that are favorable to minority stockholders, and expressed concerns that adopting a different standard would create incentives for independent directors to avoid serving as special committee members or reject transactions solely because acceptance would put them at risk of prolonged litigation. Accordingly, the court held that “[w]hen the independent directors are protected by an exculpatory charter provision and the plaintiffs are unable to plead a non-exculpated claim against them, those directors are entitled to have the claims against them dismissed.”
The In re Cornerstone decision provides an important clarification to Delaware law on the liability of independent directors. In particular, it confirms that independent directors are insulated from exculpated claims even for transactions subject to entire fairness review, which should be welcome news to such directors and to Delaware corporations.