On May 14, 2015, the Delaware Supreme Court issued its decision in In re Cornerstone Therapeutics Inc., S’holder Litig., clarifying that damages claims against independent directors can be dismissed where: (1) an applicable exculpatory charter provision exists; and (2) a plaintiff fails to plead a non-exculpated claim against them, regardless of the applicable standard of review. That is, independent directors will not automatically be required to remain defendants in a litigation simply because, for example, the challenged transaction was with a controlling stockholder. Rather, plaintiffs must state facts sufficient to support an inference of disloyalty against independent directors themselves.

As background, under Section 102(b)(7) of the Delaware General Corporation Law, a Delaware corporation may include a provision in its certificate of incorporation providing that directors cannot be personally liable for damages resulting from breaches of the duty of care—i.e., an exculpatory or “102(b)(7)” provision. Nearly all Delaware corporations include such a charter provision. Directors cannot, however, be exculpated for breaches of the duty of loyalty or bad faith conduct.

In the two companion cases leading up to the new Supreme Court decision,[1] the Court of Chancery read the Supreme Court’s 2001 decision in Emerald Partners v. Berlin, 787 A.2d 85 (Del. 2001), to hold that, where a plaintiff challenges an interested transaction or board decision that is subject to the stringent entire fairness standard of review, an independent director could not obtain dismissal even if the only claims alleged against that particular director involved alleged breaches of the duty of care and were therefore exculpated. The defendants argued—unsuccessfully—that the disinterested, independent directors in those cases should be dismissed, so that disinterested, independent directors who had the benefit of an exculpatory provision would not be subject to protracted litigation seeking money damages. The Court of Chancery, though acknowledging that the defendants’ view of Emerald Partners was preferable as a matter of policy, ruled for the plaintiffs based on Emerald Partners.

In reversing the two Court of Chancery decisions, the Supreme Court addressed the tension created between Emerald Partners and existing precedent where disinterested, independent directors were able to obtain dismissal. Specifically, the Supreme Court held that a plaintiff seeking money damages in the context of an interested transaction must adequately plead a non-exculpated claim against an independent director protected by an exculpatory charter provision in order to avoid dismissal as to that director. That is, a plaintiff must plead “facts supporting a rational inference that the director harbored self-interest adverse to the stockholders’ interests, acted to advance the self-interest of an interested party from whom they could not be presumed to act independently, or acted in bad faith”—regardless of whether the applicable standard of review is the business judgment rule, Revlon, Unocal, or entire fairness. The court carefully distinguished Emerald Partners by noting that, in that line of cases, unlike the two cases at issue here, the plaintiffs had pled valid, non-exculpated claims against the independent directors. The court reasoned that adopting the plaintiffs’ reading of Emerald Partners would cut against existing law and would undermine the very purpose of Section 102(b)(7). In so ruling, the Supreme Court emphasized that requiring disinterested, independent directors to remain as defendants until the completion of litigation, despite the absence of any non-exculpated claims against them, would have a potentially chilling effect on disinterested, independent directors’ willingness to serve on special committees or to approve value-maximizing transactions.

For more information on the Cornerstone decision or any related matters, please contact William Chandler, Tamika Montgomery-Reeves, or any member of the litigation practice at Wilson Sonsini Goodrich & Rosati.

ENDNOTES

[1] In re Cornerstone Therapeutics Inc., S’holder Litig. 2014 WL 4418169 (Del. Ch. Sept. 10, 2014); In re Zhongpin Inc. S’holders Litig., 2014 WL 6735457 (Del. Ch. Nov. 26, 2014).

The preceding post is based on a memorandum that was prepared by Wilson Sonsini Goodrich & Rosati on May 5, 2015.  A copy of the memorandum is available here.