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Delaware Court of Chancery Clarifies Application of Business Judgment Review in Post-Closing Merger Context
November 3, 2015 download PDF
In two opinions published in the last week, the Delaware Court of Chancery had the opportunity to apply and clarify the Delaware Supreme Court's recent decision in Corwin v. KKR, which held that, in situations where entire fairness review does not apply (e.g., a merger without a controlling stockholder), the approval of the transaction by a fully informed, uncoerced vote of disinterested stockholders, even if statutorily required, will invoke the business judgment rule, to the exclusion of other heightened standards of review, such as Revlon or Unocal.Notably, the court in one case applied the heightened pleading standard required by the application of the business judgment rule to post-closing claims against both the board of directors and alleged aiders and abettors, such as financial advisors.
In In re Zale Corporation Stockholders Litigation, the Delaware Court of Chancery held that, once the stockholder vote has shifted the standard of review to business judgment, a complaint must contain well pleaded allegations of facts that a company's directors were grossly negligent in order to maintain a claim for a breach of the fiduciary duty of care. Gross negligence is a higher threshold than under Revlon (which examines whether directors' actions were in a range of reasonableness) and requires that the directors' actions be "so grossly off-the-mark as to amount to reckless indifference or a gross abuse of discretion". Plaintiffs must "articulat[e]. . . facts that suggest a wide disparity between the process the directors used. . . and [a process] which would have been rational." In this particular case, the court found that such facts were not sufficiently pleaded to support a finding that the defendant directors breached their duty of care under the gross negligence standard. Because there was no predicate breach of fiduciary duty, the court also dismissed any allegations of aiding and abetting liability on the part of the company's financial advisers. This is a fact intensive inquiry, however, and while gross negligence is a high threshold, it is not one that is wholly impossible to meet, especially at a pretrial stage such as on a motion to dismiss. For example, in the recent In re Tibco Software Inc. Stockholders Litigation decision, the Delaware Court of Chancery found that a target board's failure to make basic inquiries after discovering an error in the count of shares outstanding that resulted in an effective $100 million (or approximate 2.4%) reduction in the equity value payable for target raised litigable questions as to whether the board acted in a grossly negligent manner. Although the claims against the board were exculpated under the target's certificate of incorporation and therefore dismissed, the court found that the alleged breach of the fiduciary duty of care was sufficient as the predicate for an aiding and abetting claim against target's financial advisor, allowing such claim to move on to a trial.
Facts and formalities also play an important role in the procedures needed to invoke the business judgment rule in the post-closing merger context. In Espinoza v. Zuckerberg, the Delaware Court of Chancery confirmed that only a formal vote or written consent of the majority of disinterested stockholders that complies with the technical requirements for stockholder action under the Delaware General Corporation Law will be effective to shift the standard of review. Because of a desire to ensure precision and transparency of the stockholder action, any alternative or less formal indications of stockholder assent, such as tendering into a tender offer or deposition testimony and an affidavit in support of the particular action (as occurred in Espinoza), is insufficient.
 For more detail on the Corwin decision, see our memo here.