Going Private Outside Delaware: Holes in the Director Raincoat and Other Concerns

Meade v. Christie et al., an interlocutory appeal in a shareholder class action challenging a going private merger, is currently pending before the Iowa Supreme Court.[1] The appeal will test the strength of a director-liability shield law patterned on the Model Business Corporation Act template. It also presents questions of corporate law that pertain to going private transactions and are largely unsettled outside of Delaware.

A key question in Meade (and one of first impression in Iowa and other MBCA states) is whether the MBCA director shield exception for “intentional infliction of harm on the corporation or the shareholders” encompasses claims against directors for “conscious disregard” or “intentional dereliction” of duty. Read this broadly, the exception might permit damage claims against directors who engaged in a flawed sale process when approving a going private merger, as alleged by the class plaintiff in Meade. In a forthcoming article, I argue against such a broad reading. Delaware experience and precedent, as well as drafting choices reflected in the MBCA, support a more rigorous “intent to do harm” standard for the “intentional infliction of harm” director raincoat exception.

Delaware decisions have evolved in recent years and now impose high standards for establishing “conscious disregard” and “intentional dereliction of duty” by directors. The state permits such claims under DGCL Section 102(b)(7)’s shield exception for “acts not in good faith” by directors. But in cases involving sales of corporate control, allegations of a flawed sale process do not suffice; plaintiff must instead show that directors “utterly failed to attempt to obtain the best price” for shareholders. As one Delaware court recently put it, to show the level of conscious disregard or intentional dereliction of duty required for an exculpation exclusion to apply, plaintiff must plead that a director decision approving the sale “lacked any rational conceivable basis associated with maximizing stockholder value.” [2]

A narrow interpretation of the “intentional infliction of harm” exception also comports with drafting choices reflected in the MBCA director raincoat provision, which omits broad shield exceptions that Delaware chose to include, like exclusions for “conduct not in good faith” and for violations of a director’s “duty of loyalty.” The apparent concern of the MBCA drafters was that creative litigants could easily recast claims based on honest errors in director oversight or decision-making (appropriately exculpable duty of care claims) as breaches of open-ended duties like good faith or loyalty.

And there is good reason to draw exculpation lines more precisely in MBCA jurisdictions. To the extent Delaware shield exceptions are vague or ambiguous, a constant stream of corporate litigation in chancery and appellate courts will inevitably clarify the contours of director exculpation. Outside of Delaware, however, relatively few director liability claims are litigated, and even fewer reach appellate courts. If director exculpation is to achieve its intended purpose in these jurisdictions – to provide flexibility for director decisions without unreasonable liability risks – clear lines are needed.

Critically, director exculpation does not remove director decisions from judicial scrutiny in going private merger litigation. Such cases also typically include claims against controlling shareholders for failure to pay “fair value” for the public share stake. Under Delaware’s MFW decision, courts review the merger terms with business judgment deference, but only if disinterested and independent directors properly approved the transaction and provided appropriate disclosure when obtaining disinterested shareholder approval.[3] In MBCA jurisdictions, Section 13.40(b)(3) requires similar approval by independent directors and by informed, disinterested shareholders before appraisal remedies become exclusive, or nearly so, for “interested shareholder” transactions. Shielding directors from liability will encourage their participation in the authorized disinterested approval processes. The controlling shareholder, who potentially benefits from any failure by directors to carry out appropriate measures, can remedy those process defects by proving the terms of the merger transaction were fair.

This post leaves for another day consideration of two very interesting procedural questions presented by the Meade appeal, also covered in my article. (1) Do non-shareholder constituency statutes eliminate duties to shareholders in going private mergers and thus require that suits challenging such transactions be brought derivatively? I argue they don’t. (2) In MBCA states, plaintiffs must disprove the applicability of a director shield defense “interposed” by a director. So should plaintiffs suffer dismissal if they don’t initially plead one or more shield exceptions when suing directors?  I argue that dismissal isn’t appropriate before defendant directors raise a shield defense.

ENDNOTES

[1] Iowa Sup. Ct. No. 21-0098 (submitted for decision after oral argument on March 23, 2022).

[2] In re Essendant, Inc. Stockholders Litig., 2019 WL 7290944, at *13 (Del. Ch. 2019).

[3] Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).

This post comes to us from Matthew G. Doré, the Richard and Anita Calkins Distinguished Professor of Law at Drake University Law School. The post is based on his recent article, “Going Private Ex Delaware: Holes in the Director Raincoat and Other Concerns,” available here and forthcoming in Drake Law Review Discourse, an online publication of the Drake Law Review.

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