DealLawyers.com Blog

When I blogged about the Chancery Court decision in Dodiya v. Franklin, et al. (Del. Ch., 8/26) – the first decision analyzing whether a transaction process met the new Section 144 safe harbors – I focused on the finding that Section 203 does not require that a stockholder vote be “informed,” rather than Vice Chancellor Will’s analysis of Section 144. That was because VC Will described the facts “as an extreme scenario where a board acted with reckless indifference to its own safeguards against a known leak.” But despite some unusual facts that go beyond the “ordinary imperfections of a sale process,” there are still some important Section 144-related takeaways from the decision, as this Goodwin alert details.

The case arose from a take-private acquisition led by Sababa Holdings Free LLC (Sababa), an entity owned and managed by Martin Franklin. Martin Franklin’s son, Michael Franklin, had joined the Whole Earth board in August 2022 and became interim CEO [. . .] Michael Franklin secretly sent his father’s investment firm “a 54-page goodwill impairment test” report containing material nonpublic information [. . .] a draft Form 10-K, the status of credit agreement negotiations, and a draft earnings and guidance release. Sababa subsequently purchased millions of shares of Whole Earth stock and accumulated a 19.8% stake before proposing to acquire the company.

After Sababa submitted its initial proposal, the board recognized Michael Franklin’s conflict and asked him to “sign an undertaking” prohibiting him from participating in the sale process, accessing process-related confidential information, or sharing information with his father or Sababa affiliates. He refused and was placed on paid leave [. . .] “the full [b]oard [knew he] had previously provided non-public information to his father’s company.”

Michael Franklin remained a director after resigning as CEO. On October 24, 2023, he received materials from “meetings held during his suspension,” including “nonpublic financial results,” special committee materials, “and an update on the […] investigation into his own misconduct.” A week later, he attended a board meeting for updates on that investigation, company financial results, and the special committee’s consideration of Sababa’s proposal.

No mechanism was in place “to prevent or detect further” leaks. The proxy statement nevertheless told stockholders that Michael Franklin had not participated in process-related activities, meetings, or communications and had received no process information from Whole Earth.

Vice Chancellor found these facts to be problematic for Section 144(a)(1) and (a)(2).

The court explained that a majority vote by disinterested directors is “necessary” but “not sufficient” by itself for Section 144(a)(1)’s safe harbor. The statute also requires that the board or committee authorizes the transaction “in good faith and without gross negligence.” This requirement, however, includes not just the mere act of director voting but also “the collective conduct of the board or committee that authorized the transaction.” Specifically, this requirement applies to how the board “informed itself, deliberated, negotiated, and reached its decision.” The participation of an interested director “does not [automatically] defeat the safe harbor,” but it “may bear on whether” the authorizing body acted “in good faith and without gross negligence.”

Drawing on Delaware fiduciary law, the court explained that good faith and gross negligence are distinct conditions [. . .] Because Section 144(a)(1) uses the conjunctive “and,” both conditions must be satisfied for the safe harbor to apply. Thus, a board may be grossly negligent even if it believes it is serving the corporation, while a careful process may still be undertaken in bad faith if directors “consciously advanc[e] interests other than those of the corporation.”

The Section 144(a)(1) safe harbor was unavailable at the dismissal stage because the court found it was “reasonably conceivable that the board acted with reckless indifference ‘to the risk that confidential information would reach the buyer,’ thereby compromising ‘the integrity of the sale process.’ Section 144(a)(1)’s safe harbor was therefore unavailable at the dismissal stage.”

As to Section 144(a)(2):

The court separately held that Section 144(a)(2)’s stockholder-vote safe harbor was unavailable. Although the merger received overwhelming approval, the proxy’s assurance that Michael Franklin had been “walled off from the process” was inconsistent with the pleaded facts and incorporated board materials. Because a reasonable stockholder would consider his continued access important given the father-son conflict and the prior leak, the “vote was not informed for purposes of [the] motion to dismiss.”

Notably, failure to meet the safe harbor conditions did not mean that the board was liable for breach of fiduciary duty. Although it was reasonably conceivable that the board was grossly negligent, the company’s exculpation provision shielded them from liability for breaches of the duty of care. The court dismissed claims against all but two directors. Only plaintiff’s duty of loyalty claims against two directors — the former CEO who shared confidential information and a director who negotiated a secret $1.4 million consulting arrangement with the buyer — survived the motion to dismiss.

– Meredith Ervine