Opinion ID: 2370284
Heading Depth: 3
Heading Rank: 2

Heading: The Court of Chancery Misapplied the Business Judgment Standard

Text: The plaintiffs next claim that the legal sufficiency of Count I should have been reviewed under the entire fairness standard. That claim is assessed within the framework of the business judgment standard, which is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. [24] Procedurally, the plaintiffs have the burden to plead facts sufficient to rebut that presumption. [25] On a motion to dismiss, the pled facts must support a reasonable inference that in making the challenged decision, the board of directors breached either its duty of loyalty or its duty of care. [26] If the plaintiff fails to satisfy that burden, a court will not substitute its judgment for that of the board if the ... decision can be `attributed to any rational business purpose.' [27] We first consider the sufficiency of Count I as against the Director Defendants. That Count alleges that those defendants (together with non-party director Zuzolo) improperly rejected a value-maximizing bid from First Place and terminated the Sales Process. Plaintiffs allege that the defendants rejected the First Place bid to preserve personal benefits, including retaining their positions and pay as directors, as well as valuable outside business opportunities. The complaint further alleges that the Board failed to deliberate before deciding to reject the First Place bid and to terminate the Sales Process. Indeed, plaintiffs emphasize, the Board retained the Financial Advisor to advise it on the Sales Process, yet repeatedly disregarded the Financial Advisor's advice. A board's decision not to pursue a merger opportunity is normally reviewed within the traditional business judgment framework. [28] In that context the board is entitled to a strong presumption in its favor, because implicit in the board's statutory-authority to propose a merger, is also the power to decline to do so. [29] Our analysis of whether the Board's termination of the Sales Process merits the business judgment presumption is two pronged. First, did the Board reach its decision in the good faith pursuit of a legitimate corporate interest? Second, did the Board do so advisedly? [30] For the Board's decision here to be entitled to the business judgment presumption, both questions must be answered affirmatively. We consider first whether Count I alleges a cognizable claim that the Board breached its duty of loyalty. In TW Services v. SWT Acquisition Corporation , the Court of Chancery recognized that a board's decision to decline a merger is often rooted in distinctively corporate concerns, such as enhancing the corporation's long term share value, or a plausible concern that the level of debt likely to be borne by [the target company] following any merger would be detrimental to the long term function of th[at] [c]ompany. A good faith pursuit of legitimate concerns of this kind will satisfy the first prong of the analysis. [31] Here, the plaintiffs allege that the Director Defendants had a disqualifying self-interest because they were financially motivated to maintain the status quo. A claim of this kind must be viewed with caution, because to argue that directors have an entrenchment motive solely because they could lose their positions following an acquisition is, to an extent, tautological. By its very nature, a board decision to reject a merger proposal could always enable a plaintiff to assert that a majority of the directors had an entrenchment motive. For that reason, the plaintiffs must plead, in addition to a motive to retain corporate control, other facts sufficient to state a cognizable claim that the Director Defendants acted disloyally. [32] The plaintiffs have done that here. At the time the Sales Process was terminated, the Board members were Stephens, Kramer, Eddy, Zuzolo and Gantler. Only Gantler voted to accept the First Place merger bid. The pled facts are sufficient to establish disloyalty of at least three ( i.e., a majority) of the remaining directors, which suffices to rebut the business judgment presumption. First, the Reclassification Proxy itself admits that the Company's directors and officers had a conflict of interest with respect to [the Reclassification] because he or she is in a position to structure it in a way that benefits his or her interests differently from the interest of the unaffiliated stockholders. Second, a director-specific analysis establishes (for Rule 12(b)(6) purposes) that a majority of the Board was conflicted. Stephens: Aside from Stephens losing his long held positions as President, Chairman and CEO of First Niles and the Bank, the plaintiffs have alleged specific conduct from which a duty of loyalty violation can reasonably be inferred. Stephens never responded to Cortland's due diligence request. The Financial Advisor noted that Stephens' failure to respond had caused Cortland to withdraw its bid. Even after Cortland had offered First Niles an extension, Stephens did not furnish the necessary due diligence materials, nor did he inform the Board of these due diligence problems until after Cortland withdrew. Cortland had also explicitly stated in its bid letter that the incumbent Board would be terminated if Cortland acquired First Niles. From these alleged facts it may reasonably be inferred that what motivated Stephens' unexplained failure to respond promptly to Cortland's due diligence request was his personal financial interest, as opposed to the interests of the shareholders. That same inference can be drawn from Stephens' response to the First Place bid: Count I alleges that Stephens attempted to sabotage the First Place due diligence request in a manner similar to what occurred with Cortland. Thus, the pled facts provide a sufficient basis to conclude, for purposes of a Rule 12(b)(6) motion to dismiss, that Stephens acted disloyally. Kramer: Director Kramer's alleged circumstances establish a similar disqualifying conflict. Kramer was the President of William Kramer & Son, a heating and air conditioning company in Niles that provided heating and air conditioning services to the Bank. It is reasonable to infer that Kramer feared that if the Company were sold his firm would lose the Bank as a client. The loss of such a major client would be economically significant, because the complaint alleges that Kramer was a man of comparatively modest means, and that his company had few major assets and was completely leveraged. Because Kramer would suffer significant injury to his personal business interest if the Sales Process went forward, those pled facts are sufficient to support a reasonable inference that Kramer disloyally voted to terminate the Sales Process and support the Privatization Proposal. Zuzolo: As earlier noted, Director Zuzolo was a principal in a small law firm in Niles that frequently provided legal services to First Niles and the Bank. Zuzolo was also the sole owner of a real estate title company that provided title services in nearly all of Home Federal's real estate transactions. Because Zuzolo, like Kramer, had a strong personal interest in having the Sales Process not go forward, the same reasonable inferences that flow from Kramer's personal business interest can be drawn in Zuzolo's case. In summary, the plaintiffs have alleged facts sufficient to establish, for purposes of a motion to dismiss, that a majority of the First Niles Board acted disloyally. Because a cognizable claim of disloyalty rebuts the business judgment presumption, we need not reach the separate question of whether, in deciding to terminate the Sales Process, the Director Defendants acted advisedly ( i.e., with due care). Because the claim of disloyalty was subject to entire fairness review, the Court of Chancery erred in dismissing Count I as to the Director Defendants on the basis of the business judgment presumption. [33] In dismissing Count I as to the Officer Defendants, the Court of Chancery similarly erred. The Court of Chancery has held, and the parties do not dispute, that corporate officers owe fiduciary duties that are identical to those owed by corporate directors. [34] That issuewhether or not officers owe fiduciary duties identical to those of directorshas been characterized as a matter of first impression for this Court. [35] In the past, we have implied that officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors. [36] We now explicitly so hold. [37] The only question presented here is whether the complaint alleges sufficiently detailed acts of wrongdoing by Stephens and Safarek to state a claim that they breached their fiduciary duties as officers. We conclude that it does. Stephens and Safarek were responsible for preparing the due diligence materials for the three firms that expressed an interest in acquiring First Niles. The alleged facts that make it reasonable to infer that Stephens violated his duty of loyalty as a director, also establish his violation of that same duty as an officer. It also is reasonably inferable that Safarek aided and abetted Stephens' separate loyalty breach. Safarek, as First Niles' Vice President and Treasurer, depended upon Stephen's continued good will to retain his job and the benefits that it generated. Because Safarek was in no position to act independently of Stephens, it may be inferred that by assisting Stephens to sabotage the due diligence process, Safarek also breached his duty of loyalty. The Court of Chancery found otherwise. Having characterized Safarek's actions as causing a delay of a matter of days, or at most a couple of weeks, the Vice Chancellor observed that he could not see how that conceivably could be a breach of Safarek's fiduciary duties. [38] This analysis is inappropriate on a motion to dismiss. The complaint alleges that Safarek never responded to Cortland's due diligence requests and that as a result, Cortland withdrew a competitive bid for First Niles. Those facts support a reasonable inference that Safarek and Stephens attempted to sabotage the Cortland and First Place due diligence process. On a motion to dismiss, the Court of Chancery was not free to disregard that reasonable inference, or to discount it by weighing it against other, perhaps contrary, inferences that might also be drawn. By dismissing Count I as applied to Stephens and Safarek as officers of First Niles, the trial court erred.