Controlling-stockholder transactions: evolving standards of review.

Delaware's treatment of controlling-stockholder transactions is in the midst of an important evolutionary stage. One aspect involves required protective measures and the other involves application of the same standard to both negotiated mergers and tender offers.

WHY THE STANDARD OF REVIEW IS SO IMPORTANT

The standard of review applicable to a transaction has enormous implications for any litigation--which inevitably follows from the announcement of a large public-company deal, Regardless of the merits of such suits, the standard of review affects the timing within which unmeritorious actions can be dismissed, and this affects litigation costs, people costs due to time devoted to discovery, etc., and it creates business uncertainty as well as uncertainty about personal liability for the directors involved,

In carrying out the business of the corporation, management is protected by the Business Judgment Rule, which is the standard by which courts review most, but not all, board decisions. The Business Judgment Rule reflects the legal premise that decisions made by directors who are fully informed, free from conflicts of interest, and acting in the corporation's best interests should not, and will not, be second-guessed by a court, even if the business decision under review turns out to have been "poor." To receive a favorable presumption of the Business Judgment Rule, a director must be disinterested and independent (i.e., satisfy the fiduciary duty of loyalty), review and consider all pertinent information reasonably available (i.e., satisfy the fiduciary duty of care), and not act in a manner or with a motive prohibited by statute or otherwise improper, and at all times act in good faith when discharging his or her fiduciary duties. This is a process inquiry,

If the directors are not conflicted and are fully informed, the action will be dismissed and the substance of the transaction will not be reviewed.

If the Business Judgment Rule cannot be asserted, the transaction is not void but voidable; however, the heightened "entire fairness" standard will be applied and, under such circumstances, the burden is on the directors to prove that the decision or transaction at issue is "entirely fair" to both the company and its stockholders. Even if the transaction is approved by an independent special committee or a vote of a majority of the minority stockholders, such procedural safeguards only shift the burden back to a stockholder-plaintiff to prove that the transaction was unfair, which means the substance of the transaction will be evaluated by a court. This is very different from transactions that are eligible for Business Judgment Rule protection where the court merely evaluates whether a board was fully informed (duty of care) and whether a majority of the board was disinterested and independent (duty of loyalty). Satisfying the entire fairness standard is extremely difficult because the board must demonstrate both fair process and fair price. Failure to establish the entire fairness of the decision or transaction can render it void and lead to personal liability for directors. Endeavoring to satisfy the entire fairness standard means extensive discovery, a trial on the merits, a time-table that can now be more than a year instead of a few months, and a legal budget in the...