In Gantler v. Stephens, C.A No. 2392, 2009 WL188828 (Del. Jan. 27, 2009), the Delaware Supreme Court affirmed a principle of corporate law that had been implied in prior decisions:  officers of Delaware corporations owe the same fiduciary duties of care and loyalty to the corporation and its shareholders as directors owe.  The Court also resolved contradictory prior opinions on the common law doctrine of shareholder ratification by limiting the doctrine to approval of board action that is not otherwise required to be approved by shareholders in order to be effective.  The en banc Court reversed and remanded the dismissal by the Court of Chancery of claims against the defendant directors and officers, finding that the complaint had sufficiently alleged breaches of the duty of loyalty by these defendants in connection with the rejection of a merger proposal and the approval of a going-private proposal.

Case Facts:  Board Rejected Acquisition Proposal to Which Officers Were Cool; Approved Officer-Proposed Going-Private Proposal

Multiple Bidders Were Interested in Bank.  Gantler arose from a sale process initiated by the board of directors of First Niles Financial, Inc., a single-bank holding company.  Although the board retained a financial advisor to pursue the sale process, the officers of the corporation proposed an alternative plan to take the company private.  Three potential acquirers submitted bid letters, all within the financial advisor's preliminary range of fairness.  The board directed management to proceed to due diligence with two of the three bidders.  According to the complaint, management failed to respond to the diligence requests of one bidder, which then dropped out of the process.   The remaining bidder proposed a stock-for-stock merger at an 11% premium, which the board rejected 4-1, allegedly without discussion.  The sole affirmative vote came from director Gantler, the named plaintiff in the litigation.

Board Approved Management-Supported Going-Private Transaction.  The board then turned to management's proposal to take the company private, under which holders of 300 or fewer shares of the common stock would have their shares reclassified into a special class of preferred stock with limited voting rights.  After the board voted to proceed with the reclassification, Gantler resigned.  Because the reclassification required an amendment to the certificate of incorporation that had to be approved by the shareholders, the company prepared and mailed a proxy statement that disclosed the aborted sale process and the fact that each of the directors and officers had a conflict of interest with respect to the reclassification.  The shareholders approved the reclassification.

Court of Chancery Dismissed Claims Alleging Breach of Fiduciary Duties.  Gantler and others then filed suit alleging breach of fiduciary duty relating to the board's rejection of the merger offer, approval of the reclassification, and dissemination of a false and misleading proxy statement.  The Court of Chancery dismissed all claims, finding that, among other things, the alleged facts were not sufficient to overcome the presumption of the business judgment rule with regard to the board's actions, and that the shareholders had ratified the board's decision to reclassify the shares.  The Delaware Supreme Court unanimously reversed and remanded on all counts.

Court Allows Claim for Breach of the Duty of Loyalty and Requires Review Under the Entire Fairness Standard

Normal Standard of Review Is the Business Judgment Rule.  The Court acknowledged that a board's decision not to pursue a merger is normally reviewed under the business judgment standard,[1] which entitles the board 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."  But to get the benefit of the presumption, the board had to reach its decision "in the good faith pursuit of a legitimate corporate interest" and had to act "advisedly."

Board Acting in Own Financial Interest Is Evidence of Disloyalty.  The plaintiffs alleged that the defendant directors acted disloyally in rejecting the merger proposal because they were financially motivated to maintain the status quo.  The Court observed that the fact that the directors would lose their positions in a merger was insufficient, without more, to support a breach of loyalty claim as that allegation could be made in virtually any merger.  Here, plaintiffs pled additional facts to establish that a majority of the directors acted in their own financial interests, rather than in the interests of the shareholders:  the Chairman of the Board failed to respond to due diligence requests from a potential acquirer who intended to terminate the incumbent board, causing that potential acquirer to drop out of the sales process; and two other directors provided services to the bank that were economically significant to each of them and that were likely to be terminated in the event of a merger.

Appropriate Standard Is Entire Fairness Standard, Not Business Judgment Rule.  The board's rejection of the merger proposal was therefore subject to entire fairness review, requiring the trial court, on remand, to examine whether that decision was the result of fair dealing and involved a fair price.  Acknowledging that the fair-price prong of the test would be difficult to apply to an unconsummated merger, the Court nonetheless found that the trial court could assess fair dealing.

Officers Have the Same Fiduciary Duties as Directors

Under Delaware Law, Officers Owe the Same Duties of Care and Loyalty as Directors.  The Court then examined the disloyalty claim against the defendant officers, stating definitively what had been implied in prior cases:  corporate officers owe the same duties of care and loyalty as do directors.  The Court had no difficulty concluding that the allegations of officer disloyalty were supported.  The same facts that supported the Chairman's breach of the duty of loyalty as a director supported his disloyalty as an officer.  The Court found that the Treasurer depended on the Chairman for his job and benefits, could not have acted independently of the Chairman, and therefore may have assisted the Chairman in "sabotaging" the due diligence process. 

Model Act States Explicitly Provide for the Same Fiduciary Duties.  Had Gantler involved a company incorporated in a Model Act state, such as Washington, Arizona, Idaho or Oregon, the Court would not have had to find explicitly that directors and officers are subject to the same duties.  In such states, corporate statutes define virtually identical general standards of conduct for directors and officers.

Court Allows Claim Related to Material Misstatements and Omissions in the Proxy Statement

Information About the Extent of the Board’s Deliberations Is Material.  Finding that the reclassification proxy statement may have contained material misstatements and omitted material information, in violation of the directors' fiduciary duty of disclosure, the Court focused on the statement that the board had rejected the merger proposal only "[a]fter careful deliberations."  The plaintiffs alleged that the board spent no time deliberating the merger proposal.  The proxy statement also disclosed that each of the 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 such a way that benefits his or her interests differently from the interests of unaffiliated shareholders."  The Court concluded that a reasonable shareholder would have found it significant whether such a completely conflicted board had, in fact, carefully deliberated before determining the reclassification proposal to be superior to the merger proposal and that dismissal of the disclosure claim was therefore inappropriate.

Shareholder "Ratification" of the Reclassification Did Not Reinstate the Business Judgment Presumption

Court Allows Claim for Breach of Duty of Loyalty to Proceed.  The Court also reversed on the third claim:  that the defendant directors and officers breached their duty of loyalty by recommending the reclassification proposal to the shareholders for self-interested reasons.  The Court did not agree with the lower court that the board's admittedly self-interested action had been "ratified" by a disinterested majority of the shareholders who voted to approve the reclassification. 

Shareholder Ratification Is Only Effective Where Shareholder Approval Is Not Required.  The Court acknowledged the confusion in Delaware case law regarding application of the doctrine of common law shareholder ratification.  To "restore coherence and clarity" to this area, the Court limited the doctrine to its "classic" form:  "where a fully informed shareholder vote approves director action that does not legally require shareholder approval in order to become legally effective."  The Court explained that its decision on common law shareholder ratification did not affect prior case law under Section 144 of the Delaware General Corporation Law.  Section 144 provides a process for approving contracts or transactions with a corporation in which one or more of its directors or officers, or their affiliates, are interested, which contracts or transactions could be voidable without such approval.  The Court added that "void acts such as fraud, gift, waste and ultra vires acts cannot be ratified by a less than unanimous shareholder vote."

In Gantler, the directors' reclassification decision was not ratified for two reasons.  First, the statutorily required shareholder approval of the reclassification could not do double duty to also ratify the directors' decision to recommend the reclassification.  Second, because the complaint stated a claim that the reclassification proxy statement was materially misleading, the Court could not find, as a matter of law, that the shareholders' decision had been fully informed.

Additional Information

This Update is only intended to provide a general summary of the Delaware Supreme Court's decision in Gantler.  Read the full text of the Gantler decision.  You can find discussions of other recent cases, laws, regulations and rule proposals of interest on our website.

 [1] The Court discussed the enhanced judicial scrutiny that applies under Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), which applies when a board takes "defensive measures in response to a perceived threat to corporate policy and effectiveness which touches on issues of control." (Internal quotations and citations omitted.)  The Court agreed with the Court of Chancery that the Unocal standard did not apply because the complaint did not allege "any hostile takeover attempt or similar threatened external action from which it could reasonably be inferred that the defendants acted 'defensively.'"