On May 6, 2016, the Delaware Supreme Court affirmed the Delaware Chancery Court’s ruling that Zale Corporation’s sale to Signet Jewelers withstood scrutiny under the business judgment rule because the transaction was approved by a fully-informed, uncoerced vote of the disinterested stockholders, and that an aiding and abetting breach of fiduciary duty claim against Zale’s financial advisor failed as a matter of law where the plaintiff failed to establish that the Zale board had acted with gross negligence.  In so holding, the Court reaffirmed its holding in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), that in cases in which Revlon would otherwise apply, approval of the transaction by a fully-informed, uncoerced majority of disinterested stockholders invokes the deferential business judgment rule standard of review.  While the Court also affirmed the Chancery Court’s dismissal of the aiding and abetting claim against Zale’s financial advisor, it called the Chancery Court’s reasoning for the dismissal into doubt and sounded a cautionary note to gatekeepers that they are not insulated from liability merely because they are alleged to have aided and abetted a non-exculpated breach of fiduciary duty by their director clients.

Background

We previously covered the Delaware Chancery Court’s decision in In re Zale Corporation S’holders Litigation, C.A. No. 9388-VCP, 2015 WL 5853693 (Del. Ch. Oct. 1, 2015) here.  By way of brief background, several of Zale’s largest shareholders challenged the board’s decision to sell the company to Signet on the ground that the Zale directors, aided and abetted by a conflicted financial advisor, breached their fiduciary duties.  Among other alleged conflicts, the plaintiffs alleged that the financial advisor had recently made a business pitch to Signet, but failed to disclose this fact to the Zale board until after the Signet-Zale merger agreement was signed.  On October 1, 2015, the Chancery Court, applying Revlon enhanced security to the all-cash merger, dismissed all of the plaintiffs’ claims except those against the financial advisor because the court found that the merger had been approved by a fully-informed, disinterested majority of Zale’s stockholders and, although the Zale board arguably could have done more to discover its financial advisor’s conflicts earlier in the process, its failure to do so did not amount to bad faith.  One day later, however, the Delaware Supreme Court ruled in KKR that the more deferential business judgment rule is the appropriate standard of review when a merger that is not subject to “entire fairness” review has been approved by a fully informed, uncoerced majority of disinterested stockholders.

In light of KKR, the Chancery Court agreed, on the financial advisor’s motion for reconsideration, that the business judgment rule was the appropriate standard of review for the merger.  While that standard of review is more deferential than Revlon review and therefore did not affect the Chancery Court’s decision to dismiss the claims against the Zale directors, the application of the business judgment rule did cause the Chancery Court to reverse course on the aiding and abetting claim against the financial advisor.  That is because (according to the Chancery Court), gross negligence was the proper standard for finding, in the context of post-closing money damages claims, that the directors breached their duty of care—the predicate finding needed to support an aiding and abetting claim against the financial advisor.  On October 29, 2015, the Chancery Court dismissed the aiding and abetting claim against the financial advisor because, even though the Zale board could have done more to discover that the financial advisor was conflicted, its actions did not arise to the level of “‘reckless indifference or a gross abuse of discretion,’” i.e., non-exculpated breaches of fiduciary duty.

On May 6, 2016, the Delaware Supreme Court affirmed the Chancery Court’s October 29, 2015 ruling that the merger was to be reviewed under the business judgment rule and that the aiding and abetting claim against the financial advisor failed as a matter of law.  The Court cautioned, however, that certain aspects of the Chancery Court’s ruling were erroneous.

Analysis

• The Court reaffirmed its holding in KKR that the business judgment rule is the standard of review even in transactions that would otherwise be subject to Revlon review, as long as the transaction has been approved by a fully-informed, uncoerced majority of disinterested stockholders.
• The Court cautioned, however, that the Chancery Court’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 Court explained that, “[a]bsent a stockholder vote and absent an exculpatory charter provision, 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.  Employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review-shifting effect to the vote.”  Thus, Chief Justice Strine wrote, “[w]hen the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result.”
• The Court also “distance[d] [itself]” from the Chancery Court’s October 1, 2015 ruling that the financial advisor’s late disclosure of the business pitch it had recently made to Signet was sufficient to infer scienter on the part of the financial advisor at the pleading stage, particularly where that fact had been “considered by the board, determined to be immaterial, and fully disclosed in the proxy.”

Finally, the Court held that, “to the extent the Court of Chancery purported to hold that an advisor can only be held liable if it aids and abets a non-exculpated breach of fiduciary duty, that was erroneous.”  The Court explained that, while the scienter standard for aiding and abetting is defendant-friendly for advisors, “an advisor whose bad-faith actions cause its board clients to breach their situational fiduciary duties . . . is liable for aiding and abetting,” and an “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,” the Court explained, “would be unprincipled and would allow corporate advisors a level of unaccountability afforded to no other professionals.”

The full memorandum was originally published by Orrick on May 12, 2016, and is available here.