July 20, 2010

Delaware Applies Entire Fairness Analysis To Corporate Transactions With Controlling Shareholder

Here is news drawn from this Milbank alert, drafted by Robert Reder:

In Gentile v. Rossette, the Delaware Court of Chancery recently reaffirmed the duty of a board of directors to establish the “entire fairness” of both the process and price of a transaction likely to benefit a controlling shareholder. Vice Chancellor Noble’s opinion demonstrates that the board of directors of even a relatively small corporation in financially dire straits, when approving a transaction between the company and a controlling shareholder, will find its actions subject to strict judicial scrutiny. On the other hand, the decision also points out that a director who approves a transaction found not to be entirely fair will not be held personally liable for damages, at least so long as the director acts “loyally and in good faith” and the corporation’s charter contains appropriate exculpatory language for duty of care violations.

The decision is a reminder that a board of directors must not shy away from its inherent duty to carefully structure and analyze transactions that have the likelihood of benefiting a controlling shareholder. Even with their companies facing financial calamity, directors must diligently consider both price and process, and obtain expert and independent financial and legal advice, when approving seemingly crucial transactions with a controlling shareholder. Nevertheless, directors of Delaware corporations can take comfort from the fact that, if the appropriate exculpatory provisions are available in their corporations’ certificates of incorporation, they will not be held monetarily liable for approving transactions that fail an entire fairness analysis so long as they act “loyally and in good faith.”