By James Hamilton, J.D., LL.M.
A company board of director’s rejection of a merger offer and their termination of a process they had begun to sell the company was protected by the business judgment rule. Similarly, the Delaware Chancery court also held that a concomitant decision to reclassify company stock and deregister the company with the SEC was also protected despite the interest of some directors in the transaction. Shareholder ratification of the transaction brought it back under the protection of the business judgment rule. The actions of the directors had been attacked by six company shareholders. Gantler v. Stephens, Del. Chan. Ct., Feb. 14, 2007, Civ. Action No. 2392-VCP).
Vice Chancellor Parsons refused to submit the directors’ rejection of the merger to the enhanced scrutiny of the Unocal standard, which is applied when directors take defensive measures in response to a perceived threat that touches on control issues. Unocal starts from the premise that the transaction was defensive, reasoned the court, and here there was neither a hostile takeover attempt nor a threatening action. Rather, the sales process was initiated by the board.
The business judgment rule protected the decision to reject the merger, said the court, because the board reached the decision in good faith pursuit of legitimate corporate interests, which is a duty of loyalty prong, and it did so advisedly, which is a duty of care prong. The board’s decision to initiate a sale of the company of its own accord was taken to reduce the expenses of complying with SEC disclosure and reporting rules, including the internal control rules mandated by the Sarbanes-Oxley Act. The board’s later decision to reclassify the shares and go private did not indicate bad faith. Thus, the board did not act disloyally.
The court rejected the argument that the board’s lack of deliberation on terminating the sales process violated its duty of due care. The court found that the board had extensive discussions with, and received reports from, its financial advisor, and also involved outside counsel as part of the sales process. These actions were indicative of the exercise of due care.
Separately, the court said that Delaware law recognizes a board’s ability, in a proper exercise of their business judgment, to cause the corporation to take steps to deregister with the SEC even if, as an incidental matter, deregistration might adversely impact the market for the corporation’s securities. But the business judgment rule presumption can be rebutted when the board is either interested in the transaction or lacks the independence to consider it objectively. Directors are considered interested when they will receive a personal financial benefit from a transaction not equally shared by the stockholders or when a corporate decision will have a materially detrimental impact on the director, but not on the company or its stockholders.
For determining disinterestedness and independence, noted the court, the key issue is whether the possibility of gaining some benefit or the fear of losing a benefit is likely to be of such importance to directors that it is reasonable for the court to question whether valid business judgment or selfish considerations animated their vote on the challenged transaction. In this regard, the Delaware courts do not apply an objective reasonable director test, but rather use a subjective actual person standard to determine whether a particular director’s interest is material and debilitating or that he or she lacks independence because they are controlled by another.
Applying these principles, Vice Chancellor Parsons found an inference that three of the five board members may have been either interested or not independent, causing a presumptive loss of business judgment rule protection. For example, allegations that one director hoped to obtain future employment with the company cast doubt on his independence. But, the court also held that the ratification of the transaction by fully informed and disinterested shareholders revived the powerful presumptions of the business judgment rule. When evaluated under the business judgment rule, the board’s decision to effect the reclassification stands.