By: Marc Casarino and Ryan Udell
Most directors and officers are aware of Section 144 of the Delaware General Corporation Law, which provides that a corporate transaction involving an interested director or officer is not void solely because of that reason, or because the director or officer votes upon or otherwise participates in the meeting wherein the transaction is considered, so long as proper disclosure of the interest is provided and the majority of disinterested board members or shareholders, if by ratification, vote in good faith to approve the transaction. And, directors and officers are also keenly aware of their common law fiduciary duties (and that by properly discharging such duties Delaware law defers to the business decision made). What is less than clear, however, is whether compliance with the safe harbor provisions of Section 144 is deemed to also satisfy their fiduciary duties in approving a transaction where a director or officer has an interest. This issue was recently tackled by the Court of Chancery in Cumming v. Eden, C.A. No. 13007-VCS, decided February 20, 2018, acknowledging that the Delaware courts’ historical interpretation of this interplay has been “murky at best.”
The Cumming decision clarifies that compliance with the Section 144 safe harbor does not automatically mean that the directors have satisfied their fiduciary obligations and, hence, any challenge to such approval would be evaluated under the deferential business judgment standard of review. Rather, Section 144 compliance does nothing more than protect an interested transaction from being void ab initio; it does not in and of itself validate the transaction. “The Court must still adhere to settled common law principles when fixing the appropriate standard of review by which fiduciary conduct should be measured,” according to the Cumming decision. In other words, Cumming distinguishes that Section 144 turns on the approval of a majority of disinterested directors, whereas the common law analysis generally requires that a majority of the entire board be disinterested to maintain the business judgment standard of review. Further delineating this point, Cumming references an example of the informed, good faith vote by a lone disinterested director on a nine-member board bringing a covered transaction within the Section 144 safe harbor, whereas that same transaction is subject to the heightened entire fairness standard of review because a majority of the board is not disinterested.
As such, practitioners advising boards with respect to potentially conflicted transactions are on notice that Delaware courts will not automatically impose a deferential business judgment standard of review simply because the Section 144 safe harbor provisions are satisfied. Instead, a two-step analysis is required. First, have appropriate steps been taken to satisfy the Section 144 safe harbor? Second, is the transaction structured to maximize opportunity to remain subject to the more lenient business judgment standard of review? Although less than a majority of disinterested directors can subject the transaction to an entire fairness review, appropriate steps can be taken in such circumstances to retain business judgment deference. For example, business judgment deference may be applied despite a majority conflicted board where there is a well-informed process, free of coercion, with a special committee properly exercising its duty of care upon counsel of independent advisors.
If you have questions or need assistance with a particular transaction, please contact Marc Casarino (firstname.lastname@example.org; 302-467-4520) or Ryan Udell (email@example.com; 215-864-7152).