Legal “Raincoat” Keeps Directors Dry in Going-Private Deals Outside Delaware

Though Elon Musk’s controversy with Twitter has grabbed the headlines, another going-private legal development also merits attention: Meade v. Christie et al., an Iowa Supreme Court decision dismissing shareholder class action claims against directors who approved a going-private merger. The Meade dismissal was based on a director liability shield patterned on Model Business Corporation Act (“MBCA”) Section 2.02(b)(4).  As interpreted and applied in Meade, the MBCA shield is more protective than the comparable Delaware provision, DGCL Section 102(b)(7). Equally important, Meade answers procedural questions that aren’t fully resolved by the MBCA shield text, illustrating key pleading requirements for corporate litigants in cases where director shield defenses apply.

As I explained in an April 12, 2022 post when the Meade decision was still pending, the Iowa director liability shield, like the MBCA counterpart in effect in at least 20 states, forbids exculpation for claims based on “intentional infliction of harm on the corporation or the shareholders.”[1] A key holding in Meade is that this exception does not encompass claims against directors for “conscious disregard” or “intentional dereliction” of duty. In contrast, DGCL Section 102(b)(7) permits those same claims against directors under an exception for “acts not in good faith,” an exclusion the MBCA shield omits.[2]

The Iowa Supreme Court based its narrow reading of “intentional infliction of harm” on several considerations discussed in my previous post, including drafting choices reflected in the MBCA shield text and Delaware precedent applying the “not in good faith” shield exception. The holding is also justified from a policy perspective. As I explained in the earlier post, defining director exculpation exceptions with bright lines is particularly appropriate outside of Delaware, where corporate fiduciary litigation is less common and thus affords fewer opportunities for courts to refine shield exceptions. Moreover, shielding directors does not exempt their conduct from scrutiny in litigation over going private transactions, because any director missteps in approving such deals will typically determine whether claims against controlling shareholders succeed.

Meade is also noteworthy for novel procedural issues the Iowa Supreme Court addressed concerning the MBCA raincoat provision. In Delaware, directors must plead and prove the applicability of a liability shield as an affirmative defense,[3] while in MBCA states like Iowa a shareholder or corporate plaintiff that seeks damages from directors must establish that no shield defense “precludes liability.”[4] Meade helpfully clarified that, despite this proof burden, plaintiffs aren’t required to initially plead one or more shield exceptions when suing corporate directors because the MBCA expressly requires directors to “interpose” a shield defense. But as a few Delaware courts have done when applying DGCL Section 102(b)(7), the Iowa Supreme Court also confirmed that directors can interpose the MBCA shield defense in a motion to dismiss prior to filing an answer. That ruling is significant because, as Meade also held, once corporate directors invoke MBCA shield protection, a shareholder or corporate plaintiff faces “heightened” pleading requirements. What does that mean?

In federal court, where heightened pleading rules have traditionally applied in certain civil cases, judges require pleading with “particularity” or “specificity” – a detailed “who, what, when, where, and how” description establishing all necessary elements of a claim.[5] But as applied by the Iowa Supreme Court in Meade, heightened pleading in director litigation apparently entails something less demanding: The court must evaluate whether the plaintiff pled facts showing claims against directors that fall within one of the MBCA’s exceptions to exculpation. If, as the Iowa Supreme Court concluded in Meade, all the petition’s allegations show there is no such claim, the court can dismiss the case even before discovery begins. Conversely, if the petition includes facts that suggest an exculpation exclusion may apply, litigation should continue at least through summary judgment.

The heightened pleading standard endorsed in Meade is, without question, more onerous than traditional state court “notice” pleading requirements that permit most cases to reach the discovery phase. But the MBCA shield exceptions are narrowly drawn, and corporate litigants have access to information about potential director misconduct from corporate and securities law sources outside of litigation discovery. And as the Meade court acknowledged, by protecting directors not only from paying damages, but also from the burdens of pretrial litigation over shielded claims, the new pleading standard advances the purpose of raincoat provisions: to reduce fiduciary litigation risks for directors and thereby encourage board service. If other MBCA jurisdictions embrace Meade’s procedural template, the “director raincoat” moniker might need to change – director “slicker suits” perhaps?

ENDNOTES

[1] Iowa Code § 490.202(2)(d), patterned on Model Bus. Corp. Act § 2.02(b)(4).

[2] See In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 62–68 (Del. 2006).

[3] See, e.g., Emerald Partners v. Berlin, 726 A.2d 1215, 1224 (Del. 1999) (burden of proving good faith is on the party seeking protection from the director liability shield).

[4] Model Bus. Corp. Act § 8.31(a)(1) (2016); Iowa Code § 490.831(1)(a)(1).

[5] Summerhill v. Terminix, Inc., 637 F.3d 877, 880 (8th Cir. 2011).

This post comes to us from Matthew G. Doré, the Richard and Anita Calkins Distinguished Professor of Law at Drake University Law School. It is based on his recent article, “Going Private Outside of Delaware? An MBCA Director Raincoat Keeps Board Members Dry,” available here .

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