July 11, 2018

Buy-Side Fiduciary Duties: Business Judgment? Not Necessarily. . .

Cases like In re Dow Chemical stand for the proposition that Delaware courts generally apply the business judgment rule to a board’s decision to acquire another entity. But this Hunton Andrews Kurth memo says that the Chancery Court’s recent decisions in the Oracle & Tesla cases are a reminder to dealmakers that this isn’t always the case. This excerpt points out that controlling shareholder conflicts of interest may muddy the waters:

In most cases, like Dow Chemical, the acquiror’s board of directors will be protected by the business judgment rule, which is a presumption that the directors acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Dow Chemical also makes clear that the business judgment rule should protect “buy-side” decisions regardless of whether they relate to a relatively small acquisition or a “ ‘bet the company’ transformational transaction”—“Delaware law simply does not support [a] distinction” based on the size of an acquisition.

In contrast, Oracle and Tesla reveal vulnerabilities in the business judgment rule armor. In particular, where a court finds that the board lacks sufficient independence from a conflict of interest, demand may be excused. This is especially true where a dominant executive personality exercises control over the board’s decision-making process, and that process leads the company to engage in a transaction that directly benefits that dominant personality. Delaware courts have also increased their scrutiny in recent years of overlapping business relationships in the technology industry and in venture capital circles (see, e.g., Sandys v. Pincus).

The memo goes on to provide practical suggestions that a buyer’s directors should take to satisfy their fiduciary obligations, including identifying & addressing potential conflicts involving the buyer’s directors & officers and the target.

John Jenkins