August 25, 2017

Duty of Loyalty: Chancery Sets a High Bar for “Bad Faith” Claims

This Fried Frank memo reviews the Delaware Chancery Court’s recent decision in In re MeadWestvaco S’holders Litig. (Del. Ch.; 8/17), in which Chancellor Bouchard dismissed allegations of bad faith in connection with a target board’s approval of a stock-for-stock merger entered into in the wake of an activist campaign.  Here’s an excerpt summarizing the key aspects of the case:

– The decision — in which the court suggests that the standards of “waste” and “bad faith” are equivalent — highlights the extremely high bar to potential liability of disinterested target company directors. We note that if, under Corwin, business judgment review applies in a post-closing action for damages, the only basis on which a transaction can be successfully challenged is that it constituted “waste”; and that if Corwin does not apply, then, given the effect of the exculpation statute, the only route to a successful post-closing action for damages is that the directors’ conduct in approving the transaction was so egregious that it constituted “bad faith.” In MeadWestvaco, the court indicated that the two standards are essentially equivalent — and virtually impossible to meet.

– Non-controller, non-Revlon transactions (like the stock-for-stock merger in MeadWestvaco) continue to be subject to business judgment review both pre-closing and post-closing. We note that Corwin — which when applicable transforms the standard of review post-closing to business judgment (regardless of what the standard was pre-closing) — should have no practical impact on non-Revlon transactions.

– Although the court did not address the issue, MeadWestvaco may signal that there remains some uncertainty whether Corwin “cleanses” bad faith by directors. As discussed below, although one early post-Corwin decision stated that Corwin does cleanse bad faith, and a number of decisions since then have stated that Corwin cleanses breaches of the duty of loyalty (of which, we note, the duty of good faith is a part), MeadWestvaco may signal that some uncertainty remains as to whether Corwin would cleanse director action that is “so ‘egregious,’ so ‘irrational,’ or ‘so far beyond the bounds of reasonable judgment’ as to be ‘inexplicable on any ground other than bad faith.’”

John Jenkins