DealLawyers.com Blog

Last month, the Delaware Supreme Court issued its decision in CCSB Financial v. Trotta, (Del.; 7/23), in which it affirmed the Chancery Court’s prior ruling that an anti-takeover charter provision that included language to the effect that the board’s informed, good faith decisions concerning application of its terms would be “conclusive and binding” could not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.

As I noted in my blog about the Chancery Court’s decision, the case arose out of a proxy contest in which an insurgent stockholder sought to obtain two out of seven seats on the company’s board. In response to that contest, the board invoked a provision in the company’s certificate of incorporation prohibiting a stockholder from exercising more than 10% of its voting power and adopted an interpretation that language aggregating the ownership of stockholders it determined were acting in concert. The board then instructed the inspector of elections not to count any votes above the limit submitted by the insurgent stockholder, his nominees, and an entity affiliated with one of the nominees.

In response to the insurgent’s lawsuit challenging the board’s action, the company contended that the incumbent directors argued, however, that the “conclusive and binding” language shielded the board’s action from all but business judgment review. Chancellor McCormick disagreed and held that Delaware law did not permit a charter provision to alter the standard of review applicable to breach of fiduciary duty claims.

The Supreme Court agreed. Although it held in Salzberg v. Sciabacucchi that the DGCL provides “immense freedom for businesses to adopt the most appropriate terms for the organization, finance, and governance of their enterprise,” it also noted that charter provisions are only valid if they complied with Delaware law.  The Court concluded that unlike the federal forum provision at issue in Salzburg, the proposed construction of the “conclusive and binding” language at issue in this case did not comport with Delaware law:

In Salzberg, this Court held that the federal forum provisions did not violate Section 102(b)(1) because they did not transgress any laws or the public policy of this State. The Conclusive and Binding Provision, however, is fundamentally different than a federal forum provision. A federal forum provision directs federal securities claims to another forum for resolution – the federal courts, which apply their federal law expertise to the claims.

By contrast, the Conclusive and Binding Provision strips the Court of Chancery of its authority to apply established standards of review to breach of fiduciary duty claims. As explained below, the Conclusive and Binding Provision cannot exculpate fiduciaries from breach of duty of loyalty claims because it is contrary to the laws of this State and its public policy.

The Court went on to say that improper interference with an election of directors implicates the directors’ duty of loyalty, and an alleged breach of that duty is evaluated under a two-step process. The first part of that review tests the legality of the board’s action under the charter. It then applies enhanced judicial review under established standards (i.e., the Unocal+ review required under the UIP Companies decision).

The Court said that the incumbent board’s argument was that the “conclusive and binding” language eliminated the first step and required the Court to apply business judgment review for the second. Because that would have the effect of exculpating directors from liability for alleged breaches of their duty of loyalty, it was not permitted under Delaware law.

– John Jenkins