Opinion ID: 1535019
Heading Depth: 1
Heading Rank: 5

Heading: The Due Care Claim

Text: Having concluded that the complaint was properly dismissed under Chancery Rule 12(b)(6) for failure to state a claim on which relief may be granted on other fiduciary duty claims, we now turn to the due care claim. The primary due care issue is whether the board was grossly negligent, and therefore breached its duty of due care, in failing to implement a routine defensive strategy that could enable the board to negotiate for a higher bid or otherwise create a tactical advantage to enhance stockholder value. In this case, that routine strategy would have been for the directors to use a poison pill to ward off Knightsbridge's advances and thus to prevent Knightsbridge from stopping the auction process. Had they done so, plaintiffs seem to allege that the directors could have preserved the appropriate options for an auction process designed to achieve the best value for the stockholders. Construing the amended complaint most favorably to the plaintiffs, it can be read to allege that the board was grossly negligent in immediately accepting the Knightsbridge offer and agreeing to various restrictions on further negotiations without first determining whether Veritas would issue a counteroffer. Although the board had conducted a search for a buyer over one year, plaintiffs seem to contend that the board was imprudently hasty in agreeing to a restrictive merger agreement on the day it was proposed  particularly where other bidders had recently expressed interest. [43] Although the board's haste, in itself, might not constitute a breach of the board's duty of care because the board had already conducted a lengthy sale process, the plaintiffs argue that the board's decision to accept allegedly extreme contractual restrictions impacted its ability to obtain a higher sale price. Recognizing that, at the end of the day, plaintiffs would have an uphill battle in overcoming the presumption of the business judgment rule, [44] we must give plaintiffs the benefit of the doubt at this pleading stage to determine if they have stated a due care claim. Because of our ultimate decision, however, we need not finally decide this question in this case. We assume, therefore, without deciding, that a claim for relief based on gross negligence during the board's auction process is stated by the inferences most favorable to plaintiffs that flow from these allegations. The issue then becomes whether the amended complaint may be dismissed upon a Rule 12(b)(6) motion by reason of the existence and the legal effect of the exculpatory provision of Article TWELFTH of Frederick's certificate of incorporation, adopted pursuant to 8 Del. C. § 102(b)(7). That provision would exempt directors from personal liability in damages with certain exceptions ( e.g., breach of the duty of loyalty) that are not applicable here. [45]
The threshold inquiry is whether Article TWELFTH of the Frederick's certificate of incorporation was properly before the Court of Chancery. In their brief in support of their motion to dismiss in the Court of Chancery, the director defendants interposed the Section 102(b)(7) charter provision as a bar to plaintiffs' claims based on an alleged breach of the duty of care. [46] This provision, which appeared for the first time in the director defendants' brief in the Court of Chancery, was placed before the court without any authentication or supporting affidavit. The existence and authenticity of this provision was never questioned by plaintiffs, however. The trial court therefore tacitly accepted it as authentic without defendants formally asking the court to take judicial notice of its existence, which could easily be found in the public files in the Secretary of State's office and could properly be noticed judicially by the court. [47] Because the charter provision is not found within the four corners of the complaint, it is a matter outside the pleading. Accordingly, on a Rule 12(b)(6) motion to dismiss, if matters outside the pleading are presented to and not excluded by the Court the motion shall be treated as one for summary judgment and disposed of as provided in Rule 56, and all parties shall be given a reasonable opportunity to present all material made pertinent to such a motion by Rule 56. [48] Under Rule 56 in this context, there may be an opportunity for either side to submit affidavits or engage in discovery [49] to explore the matter outside the pleadings [that had been] ... presented to and not excluded by the Court. [50] Simply because a matter outside the pleading has been presented under Rule 12(b)(6) and thereby must be treated as one for summary judgment with all parties ... given a reasonable opportunity to present all material made pertinent to such a motion by Rule 56, [51] it does not follow that the floodgates of discovery have to be opened. The Rule 56 opportunity to present affidavits or engage in discovery is not absolute. It is necessarily circumscribed by the discretion of the trial court in determining the scope of the matters outside the pleading that had been presented in connection with the Rule 12(b)(6) motion. Indeed, plaintiffs here do not contend that simply because defendants invoked the Section 102(b)(7) charter provision they are thereby invited to go on a fishing expedition. Accordingly, when matters outside the pleading  such as a Section 102(b)(7) charter provision  are presented, the trial court should carefully limit the discovery sought to a scope that is coextensive with the issue necessary to resolve the motion. [52] Here, there was apparently no discovery issue. [53] When the issue is confined to the legal effect of a Section 102(b)(7) charter provision, it is difficult to envision what discovery would be implicated. To be sure, in a due care case where a Section 102(b)(7) charter provision is invoked, a plaintiff could theoretically contest the validity of the charter provision. In such a case, the plaintiff must have a proper basis [54] to claim that the Section 102(b)(7) charter provision presented by the defendants on the Rule 12(b)(6) motion is not authentic, was improperly adopted by the stockholders, or the like. Plaintiffs make no such claim here. Although plaintiffs contend that under Emerald Partners [55] the burden is on the defendants to produce evidence to support a Section 102(b)(7) defense, they do not contest the existence or authenticity of Frederick's 102(b)(7) charter provision. There being no Rule 56 avenue of discovery or affidavits that would be relevant to the narrow issue before the trial court in this case, we conclude that the plaintiffs were not deprived of any important procedural right arising from the fact that the trial court considered Frederick's 102(b)(7) charter exculpation provision in connection with the Rule 12(b)(6) motion to dismiss. Although it would have been preferable for the trial court to have observed the precise provisions of the rules and to have expressly treated the motion as one for summary judgment once the Section 102(b)(7) charter provision was interposed by the director defendants, we find no reversible error in failing to do so. The provision was properly before the Court of Chancery in deciding on the director defendants' motion to dismiss. As guidance for future cases, we observe that there are several methods available to the defense to raise and argue the applicability of the bar of a Section 102(b)(7) charter provision to a due care claim. The Section 102(b)(7) bar may be raised on a Rule 12(b)(6) motion to dismiss (with or without the filing of an answer), a motion for judgment on the pleadings (after filing an answer), [56] or a motion for summary judgment (or partial summary judgment) under Rule 56 after an answer, with or without supporting affidavits. In the case of a Rule 12(b)(6) motion, as here, if the Section 102(b)(7) charter provision is raised for the first time in the motion or brief in support of the motion, it is a matter outside the pleading. If not excluded by the court, the existence of such matter means that the motion will be converted, by clear force of the pleading rules, into a motion for summary judgment under Rule 56 and should be handled as we have noted above.
We now address plaintiffs' argument that the trial court committed error, based on certain language in Emerald Partners, [57] by barring their due care claims. Plaintiffs' arguments on this point are based on an erroneous premise, and our decision here is not inconsistent with Emerald Partners. In Emerald Partners, we made two important points about the raising of Section 102(b)(7) charter provisions. First we said: [T]he shield from liability provided by a certificate of incorporation provision adopted pursuant to 8 Del. C. § 102(b)(7) is in the nature of an affirmative defense. [58] Second, we said: [W]here the factual basis for a claim solely implicates a violation of the duty of care, this court has indicated that the protections of such a charter provision may properly be invoked and applied. Arnold v. Society for Savings Bancorp., Del.Supr., 650 A.2d 1270, 1288 (1994); Zirn v. VLI Corp., Del.Supr., 681 A.2d 1050, 1061 (1996). [59] Based on this language in Emerald Partners, plaintiffs make two arguments. First, they argue that the Court of Chancery in this case should not have dismissed their due care claims because these claims are intertwined with, and thus indistinguishable from, the duty of loyalty and bad faith claims. [60] Second, plaintiffs contend that the Court of Chancery incorrectly assigned to them the burden of going forward with proof.
Plaintiffs here, while not conceding that the Section 102(b)(7) charter provision may be considered on this Rule 12(b)(6) motion nevertheless, in effect, conceded in oral argument in the Court of Chancery and similarly in oral argument in this Court that if a complaint unambiguously and solely asserted only a due care claim, the complaint is dismissible once the corporation's Section 102(b)(7) provision is invoked. [61] This concession is in line with our holding in Emerald Partners quoted above. Plaintiffs contended vigorously, however, that the Section 102(b)(7) charter provision does not apply to bar their claims in this case because the amended complaint alleges breaches of the duty of loyalty and other claims that are not barred by the charter provision. As a result, plaintiffs maintain, this case cannot be boiled down solely to a due care case. They argue, in effect, that their complaint is sufficiently well-pleaded that  as a matter of law  the due care claims are so inextricably intertwined with loyalty and bad faith claims that Section 102(b)(7) is not a bar to recovery of damages against the directors. [62] We disagree. It is the plaintiffs who have a burden to set forth a short and plain statement of the claim showing that the pleader is entitled to relief. [63] The plaintiffs are entitled to all reasonable inferences flowing from their pleadings, but if those inferences do not support a valid legal claim, the complaint should be dismissed without the need for the defendants to file an answer and without proceeding with discovery. Here we have assumed, without deciding, that the amended complaint on its face states a due care claim. Because we have determined that the complaint fails properly to invoke loyalty and bad faith claims, we are left with only a due care claim. Defendants had the obligation to raise the bar of Section 102(b)(7) as a defense, and they did. As plaintiffs conceded in oral argument before this Court, if there is only an unambiguous, residual due care claim and nothing else  as a matter of law  then Section 102(b)(7) would bar the claim. Accordingly, the Court of Chancery did not err in dismissing the plaintiffs due care claim in this case.
Plaintiffs also assert that the trial court in the case before us incorrectly placed on plaintiffs a pleading burden to negate the elements of the 102(b)(7) charter provision. Plaintiffs argue that this ruling is inconsistent with the statement in Emerald Partners that the shield from liability provided by a certificate of incorporation provision adopted pursuant to 8 Del. C. § 102(b)(7) is in the nature of an affirmative defense.... Defendants seeking exculpation under such a provision will normally bear the burden of establishing each of its elements. [64] The procedural posture here is quite different from that in Emerald Partners. There the Court stated that it was incorrect for the trial court to grant summary judgment on the record in that case because the defendants had the burden at trial of demonstrating good faith if they were invoking the statutory exculpation provision. In this case, we focus not on trial burdens, but only on pleading issues. A plaintiff must allege well-pleaded facts stating a claim on which relief may be granted. Had plaintiff alleged such well-pleaded facts supporting a breach of loyalty or bad faith claim, the Section 102(b)(7) charter provision would have been unavailing as to such claims, and this case would have gone forward. [65] But we have held that the amended complaint here does not allege a loyalty violation or other violation falling within the exceptions to the Section 102(b)(7) exculpation provision. Likewise, we have held that, even if the plaintiffs had stated a claim for gross negligence, such a well-pleaded claim is unavailing because defendants have brought forth the Section 102(b)(7) charter provision that bars such claims. This is the end of the case. And rightly so, as a matter of the public policy of this State. Section 102(b)(7) was adopted [66] by the Delaware General Assembly in 1986 following a directors and officers insurance liability crisis and the 1985 Delaware Supreme Court decision in Smith v. Van Gorkom . [67] The purpose of this statute was to permit stockholders to adopt a provision in the certificate of incorporation to free directors of personal liability in damages for due care violations, but not duty of loyalty violations, bad faith claims and certain other conduct. Such a charter provision, when adopted, would not affect injunctive proceedings based on gross negligence. [68] Once the statute was adopted, stockholders usually approved charter amendments containing these provisions because it freed up directors to take business risks without worrying about negligence lawsuits. [69] Our jurisprudence since the adoption of the statute has consistently stood for the proposition that a Section 102(b)(7) charter provision bars a claim that is found to state only a due care violation. [70] Because we have assumed that the amended complaint here does state a due care claim, the exculpation afforded by the statute must affirmatively be raised by the defendant directors. [71] The directors have done so in this case, and the Court of Chancery properly applied the Frederick's charter provision to dismiss the plaintiffs' due care claim. [72]