· To obtain business judgment review of a transaction with a controlling stockholder, it is critically important that procedural safeguards be established before substantive negotiations begin.
o The controlling stockholder must agree at the outset to condition any transaction on approval by an independent special committee and the affirmative vote of a majority-of-the-minority of stockholders (these cannot be “deal points” to be negotiated).
o Unless both of these procedural safeguards are implemented at the outset (even if both are implemented ultimately), the most the parties can obtain is entire fairness review with a shift in the burden of persuasion to the plaintiffs (business judgment review will not be available).
· Where entire fairness review applies, if there is “evidence of procedural and substantive unfairness,” the exculpatory provision in a company’s charter does not automatically protect even facially independent and disinterested special committee directors from potential liability for breach of the duty of loyalty; rather, each director must establish at trial that he or she is entitled to exculpation.
· Evidence that the special committee chairman was not independent and acted in self-interest may require other facially independent and disinterested special committee members to defend their own conduct.
o Special committee membership must be vetted carefully for potential conflicts of interest and lack of independence; if warranted, the special committee should be re-constituted.
o Directors considering special committee service should pay careful attention to the conflicts and independence of other possible committee members when considering whether to accept the committee appointment.
· Under entire fairness review, post-closing damages may be awarded if disclosures to stockholders in the solicitation of majority-of-the-minority approval contain material inaccuracies.
o Further, even in arms-length third-party merger cases, post-closing damages may be available for materially misleading disclosures, subject to plaintiff’s proof of reliance, causation and quantifiable damages.
o This may lead to a reduction in pre-closing settlement of merger cases based on disclosures, or an increase in the cost of those settlements.
· The decision may be appealed eventually, and it is possible that certain of the holdings, particularly those concerning the availability of exculpation for facially conflict-free and independent directors and of money damages for disclosure claims post-closing, may be considered further.
Delaware Court of Chancery precedent has established that the business judgment rule can apply to squeeze-out mergers by controlling stockholders where certain procedural safeguards are adopted. In re CNX Gas Corporation Shareholders Litigation, 4 A.3d 397 (Del. Ch. 2010), established that a transaction with a controlling stockholder may be subject to deferential business judgment review if the transaction is conditioned on approval by an independent special committee and by a majority of the minority stockholder vote. In re MFW Shareholders Litigation, 67 A.3d 496, 502 (Del. Ch. 2013), clarified that, to obtain business judgment review, the special committee must have authorization to negotiate and the controlling stockholder must agree to the dual independent approval process up front, before beginning negotiations.
In re Orchard reiterates this timing requirement when attempting to secure business judgment protection for a transaction with a controlling stockholder. Although the transaction ultimately was approved by a special committee vested with the authority to negotiate, and by a majority–of-the-minority stockholder vote, the Court of Chancery declined to apply the business judgment rule because the controller did not agree up-front to both of those protections (and, indeed, used the majority–of-the-minority approval as a deal point to reduce the purchase price). In re Orchard confirms (resolving a question left open by CNX Gas and In re MFW), however, that the burden of persuasion may be shifted from the defendants to the plaintiff under the entire fairness standard if a controller agrees to one but not both protections. While a shift in the burden of persuasion is commonly viewed as an inferior procedural benefit because it does not obviate a potentially costly and time-consuming post-closing trial on the merits, a shift in the burden still may be valuable to defendants by incentivizing plaintiffs to settle before trial.
The decision also concludes that, in a controlling stockholder transaction subject to entire fairness review, an exculpatory clause in the company’s charter under DGCL § 102(b)(7) does not automatically shield even facially independent and disinterested directors from potential liability where there is evidence of procedural and substantive unfairness indicating a breach of the duty of loyalty. A trial is required to determine whether the transaction was entirely fair, and, if it was not, then an analysis on a director-by-director basis at trial is required to determine whether they committed any breach of loyalty. In re Orchard thus diminishes the opportunity for dismissal of facially independent and disinterested directors at an early stage in merger litigation (and increases the potential cost and hassle of service on a special committee). While DGCL § 102(b)(7) remains a strong substantive protection for directors who can reap the benefits of its protection at trial—even when the transaction was not entirely fair — In re Orchard meaningfully increases the risk that otherwise “clean” Special Committee members may need to bear the burden of preparation for and participation in a trial, as well as the associated reputational risks.
Finally, the Court held that monetary damages for alleged disclosure deficiencies in soliciting stockholder approval may continue to be available even after a merger closes. Although injunctive relief to correct disclosure deficiencies may be granted before a merger vote in order to prevent “irreparable harm” the Court rejected defendants’ inference that there can be no post-closing “remedy” in the form of monetary damages. However, plaintiffs who assert post-closing disclosure-based claims must still prove reliance, causation and quantifiable damages.