Fiduciary-Duties-of-the-Board-of-Directors.pdf

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Fiduciary Duties of the Board of Directors

by Practical Law Corporate & Securities

Maintained • Delaware, USA (National/Federal)

A Practice Note describing the fiduciary duties of the board of directors, including the core duties of

care and loyalty. This Note also discusses the standards of review that courts apply when judging

directors' conduct, including the business judgment rule, enhanced scrutiny, and entire fairness.

Legal Framework

Corporate Contract

Common Law

Role of Directors in Management of the Corporation

Stockholders Do Not Manage the Corporation

Delegation

Core Fiduciary Duties

Who Owes Duties to Whom

Duty of Care

Duty of Loyalty

Protections for Directors

Exculpation from Liability

Indemnification and Advancement

Abstention Defense

Standards of Review: Overview

Business Judgment Rule

Rebutting the Business Judgment Rule

Corporate Waste

Breach Committed in Bad Faith

Failure of Oversight

Conflict Transactions and Entire Fairness

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Entire Fairness Standard of Review

Liability for Failing to Satisfy Entire Fairness Review

Conflicted-Board Transactions: Director Disinterest and Independence

Controlling-Stockholder Transactions

Fraud on the Board

Avoiding Entire Fairness Review with Procedural Protections

Intermediate Standard of Review: Enhanced Scrutiny

Defensive Measures Against Takeovers

Interference with Stockholder Vote

Sale of Control

Subsidiary Duties

Duty of Good Faith

Duty to Obey the Law

Duty of Disclosure

Fiduciary Duties and Director Oversight During COVID-19

Directors bear fiduciary duties to protect the interests of the corporation and to act in the stockholders' best interests. When

stockholders invest in a corporation, they entrust their capital to the corporation's directors. But while it is the stockholders'

investment that is at risk, it is a cardinal precept of Delaware corporate law (and of many other jurisdictions) that the business

and affairs of the corporation are managed by its directors, not its stockholders (Aronson v. Lewis, 473 A.2d 805, 811 (Del.

1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244, 253-54 (Del. 2000)). Through this arrangement, the

directors act as agents for the stockholders, guided by their fiduciary duties.

This Practice Note describes the fiduciary duties of the board of directors under Delaware law. This Note focuses on

Delaware law because:

• Delaware is a leading jurisdiction of incorporation, with a majority of all US Fortune 500 companies incorporated in

Delaware.

• Delaware's law on fiduciary duties is well established and widely followed in other jurisdictions.

Fiduciary duties are codified in some states' statutes, but remain a product of common law in Delaware. For information on

how fiduciary duties are applied in other states, see Corporation Law: State Q&A Tool: Question 5.

This Note is a general overview of the fiduciary duties of directors of Delaware corporations. For overviews of fiduciary duties

in other contexts, see Practice Notes:

• Fiduciary Duties in M&A Transactions, addressing fiduciary duties of directors of solvent, public corporations in

negotiated M&A transactions under Delaware law.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• Fiduciary Duties of Directors of Financially Troubled Corporations, covering fiduciary duties of directors of

corporations that are insolvent or nearing insolvency.

• Defending Against Hostile Takeovers, discussing fiduciary duties of directors and takeover defenses in the context

of hostile bids.

• Fiduciary Duties of Officers of Corporations, explaining the fiduciary duties of officers under Delaware law.

• Fiduciary Duties in LLCs and LPs, describing the fiduciary duties owed by members and managers of limited liability

companies and by general partners of limited partnerships under Delaware law.

This Note does not address the corporate governance requirements for public companies under the rules of the Securities

and Exchange Commission (SEC) and various stock exchanges. For more information on the obligations of directors

under those regimes, see Practice Notes, Corporate Governance Standards: Board of Directors and Periodic Reporting and

Disclosure Obligations: Overview.

For a more detailed discussion of fiduciary duties of directors in M&A transactions, see Practice Note, Fiduciary Duties in

M&A Transactions. For a description of fiduciary duties of directors of insolvent corporations, see Practice Note, Fiduciary

Duties of Directors of Financially Troubled Corporations.

Legal Framework

Under Delaware law, corporate acts are reviewed for their compliance with two sets of rules:

• The technical rules of the corporate contract between the directors and stockholders that address the legality of the

act taken by the corporation.

• An overlay of equitable rules to ensure that otherwise legal acts are taken in compliance with the board's fiduciary

duties to the corporation and its stockholders.

Delaware courts call this review the twice-testing principle (Sample v. Morgan, 914 A.2d 647, 672 (Del. Ch. 2007); Carsanaro

v. Bloodhound Techs., Inc., 65 A.3d 618, 641-42 (Del. Ch. 2013), abrogated on other grounds by El Paso Pipeline GP Co.

v. Brinckerhoff, 152 A.3d 1248, 1264 (Del. 2016)).

A corporation may not eliminate or modify the fiduciary duties of directors unless authorized by Delaware statute. The

Delaware statutes only grant limited authority to corporations relating to the fiduciary duties of directors, primarily in Section

102(b)(7) of the DGCL and Section 122(17) of the DGCL (see Exculpation from Liability and Corporate Opportunity Doctrine).

A provision in a corporation's organizational documents that attempts to otherwise eliminate or modify a director's fiduciary

duties will be ineffective. For example, the Delaware Chancery Court held that a provision in a corporation's certificate of

incorporation stating that the board's good faith decisions on certain matters are conclusive and binding does not prevent

the court from reviewing a director's actions in equity for a breach of fiduciary duty or change the court's standard of review.

(Totta v. CCSB Fin. Corp., 2022 WL 1751741, at *14-18 (Del. Ch. May 31, 2022).) This is in contrast to the broad authority

the Delaware legislature has granted to limited liability companies and limited partnerships to modify and eliminate fiduciary

duties (see Practice Note, Fiduciary Duties in LLCs and LPs).

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Corporate Contract

There are three primary components of the corporate contract:

• The corporate statute of the corporation's state of incorporation. In Delaware, this is the Delaware General

Corporation Law (DGCL). The majority of other states base their legislation on Delaware law or on the Model

Business Corporation Act (MBCA).

• The corporation's certificate of incorporation (often referred to as the charter).

• The corporation's by-laws.

These three sources form a hierarchy. A by-law that conflicts with the charter is void and a charter provision that conflicts

with the statute is void (Sinchareonkul v. Fahnemann, 2015 WL 292314, at *6 (Del. Ch. Jan. 22, 2015)).

Corporate charters and by-laws, within the framework of the DCGL, operate in some respects as a contractual arrangement

among the corporation, the stockholders, and the directors, but directors are not contractually bound to the corporation

by the charter. Although stockholders can bring breach of contract claims against a corporation for violating its charter,

a corporation cannot (either directly or derivatively) bring a breach of contract claim against its directors for allowing the

corporation to violate its charter. The directors' failure to follow the charter may, however, be a breach of fiduciary duty (see

Breach Committed in Bad Faith). (Lacey v. Mota-Velasco, 2021 WL 508982, at *7-9 (Del. Ch. February 11, 2021).)

Common Law

The rules governing directors' fiduciary duties stem from decades-old, yet continuously evolving, common law. Combining

the two bodies of law, the Delaware courts interpret the statute and language in the subject corporations' organizational

documents, evaluate the context of any alleged misconduct, and apply a standard of review based on precedent.

Role of Directors in Management of the Corporation

The board of directors holds ultimate responsibility for the business and affairs of the corporation. This power is codified in

Section 141(a) of the DGCL and by similar statutes in other states. The board discharges this responsibility by:

• Appointing officers who run the day-to-day operations of the corporation, propose strategies and objectives, and

implement corporate plans.

• Supervising those officers.

• Making major decisions for the corporation (for example, selling the company or entering into a significant joint

venture).

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For a discussion about the directors' ability to delegate duties to officers, see Delegation to Officers.

Stockholders Do Not Manage the Corporation

The stockholders of the corporation, by contrast, have two fundamental rights:

• To elect directors to the board.

• To exit the corporation by selling their shares.

The stockholders do not manage the corporation themselves. Even a majority stockholder who has the voting power to

replace the directors does not manage the corporation, even though it owes fiduciary duties to the other stockholders (see

Who Owes Duties to Whom). The Delaware Court of Chancery ruled that stockholders cannot amend the corporation's by-

laws to give them the right to remove and appoint officers, even if they have the votes to do so, since that right is a substantive

business decision reserved to the board (Gorman v. Salamone, 2015 WL 4719681, at *5 (Del. Ch. July 31, 2015)).

Stockholders have limited statutory consent rights to approve certain fundamental transactions. For a summary of some of

these consent rights, see Corporate and LLC Consents Required for Mergers and Acquisitions Checklist.

Stockholders may also have other special rights such as dividend payments, veto rights, and consent rights, if provided for

contractually in the certificate of incorporation or in a stockholders agreement (see Practice Note, Stockholders Agreement

Commentary). But these rights must be specifically negotiated, and are not automatically available as a matter of law.

Delegation

Delegation to Board Committees

Directors are often selected for their expertise in a particular area or for their industry connections, and are added to the board

to fill an advisory or supervisory role within their area of focus. To facilitate this, state law permits, and corporate charters

typically authorize, the board to delegate any of its powers to a committee of directors. However, many states restrict the

activities that a committee of less than an entire board can conduct.

Board committees have significant power under Delaware law. A duly appointed committee (such as a compensation or

nominating committee) holds all powers delegated to it by the full board (or as otherwise provided for in the certificate of

incorporation or by-laws), other than the power to:

• Approve, adopt, or recommend to the stockholders any action or matter (other than the election or removal of

directors) expressly required by Delaware law to be approved by the stockholders.

• Adopt, amend, or repeal any of the corporation's by-laws.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

(DGCL § 141(c)(2).)

Delegating powers to committees also benefits the other members of the board. Directors are explicitly protected from liability

when they reasonably rely in good faith on reports from committees, officers, and other experts when making decisions for

the corporation (DGCL § 141(e)). For a discussion of the advantages of forming a special committee, see Practice Note,

Making Good Use of Special Committees: The Advantages of Using a Special Committee.

Delegation to Officers

Directors are ultimately responsible for managing the corporation, but they are not expected to manage its day-to-day

activities. Directors are therefore permitted to delegate managerial duties to officers, except to the extent delegation is

prohibited by the corporation's charter or by-laws (DGCL §141(a)).

The board has the authority to delegate powers to the officers "as in the board's good faith, informed judgment are

appropriate," but the power to delegate "is not without limit." The board may not formally or effectively abdicate its power and

fiduciary duties to manage or direct the management of the corporation. A board may delegate powers subject to possible

review, but it cannot abdicate them. (In re Pattern Energy S'holders Litig., 2021 WL 1812674, at *59 (Del. Ch. May 6, 2021)

(quoting Grimes v. Donald, 1995 WL 54441, at *8-9 (Del. Ch. Jan. 11, 1995)).) Abdication of directorial duty is evidence of

a breach of the duty of loyalty and lack of good faith (for example, see Abdication of Duty of Disclosure).

The determination of whether a director has abdicated a particular duty is a fact specific inquiry. Delaware courts consider:

• Why the delegation was made.

• What task was delegated.

• Whether the board acted independently in delegating the task.

In determining whether the delegation was made in bad faith, Delaware courts consider:

• The agent to whom the directors delegated the task (for example, whether the agent had a known conflict of interest

related to the delegated matter).

• The scope of the delegation (for example, whether the delegation was complete and whether the directors retained

the ability to review, discuss, or approve the delegated matters).

(In re Pattern Energy, 2021 WL 1812674, at *59-61.)

Delegation to Others

The board may delegate to a person or body other than a board committee or officers the authority to:

• Issue stock (DGCL § 152(b)).

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• Sell treasury shares (DGCL § 153(c)).

• Issue rights or options to acquire stock (DGCL § 157(c)).

To delegate, the board must adopt a resolution that fixes the following:

• The maximum number of shares of stock, rights, or options that the delegate may issue or sell.

• A time period during which the issuances or sales may occur.

• The minimum amount of consideration to be received for the issuances or sales

The delegated person or body is prohibited from issuing or selling to themselves the stock, rights, or options they have been

delegated authority over. (DGCL §§ 152(b), 251(c), and 157(c).).

Core Fiduciary Duties

Directors owe two core fiduciary duties:

• The duty of care, which requires that directors be fully and adequately informed and act with care when making

decisions and acting for the corporation (see Duty of Care).

• The duty of loyalty, which requires that directors act and make decisions in the best interest of the corporation, not in

their own personal interest (see Duty of Loyalty).

Courts and practitioners frequently refer to other duties, such as the duty of good faith (see Duty of Good Faith), the duty

of disclosure (see Duty of Disclosure), and the duty of oversight (see Failure of Oversight). This nomenclature implies that

these are standalone fiduciary duties, and in some states the duty of good faith is analyzed as a separate duty. Under

Delaware law, however, they are treated as obligations that stem from the core fiduciary duties of care and loyalty.

Who Owes Duties to Whom

Identifying which persons owe fiduciary duties, and to whom they are owed, is complex:

• Directors owe fiduciary duties to the corporation and its stockholders. Directors owe their fiduciary duties to

the corporation and its stockholders (Arnold v. Soc'y for Sav. Bancorp, Inc., 678 A.2d 533, 539 (Del. 1996)). Certain

states (for example, Pennsylvania) have constituency statutes that explicitly allow the board of directors to consider

the interests of constituencies other than the stockholders, including employees, customers, suppliers, and creditors

(15 Pa C.S.A. §515(a)). The DGCL contains no such provision.

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• Directors owe fiduciary duties to common stockholders in preference to preferred stockholders. Under

ordinary circumstances, the board owes fiduciary duties to preferred and common stockholders equally. However,

if the interests of preferred and common stockholders diverge, the board owes its fiduciary duties to its common

stockholders in preference to the preferred stockholders (In re Trados Inc. S'holder Litig., 2009 WL 2225958, at *7

(Del. Ch. July 24, 2009)). Directors only owe fiduciary duties to the preferred stockholders to the extent the preferred

stockholders' and common stockholders' rights are the same. Directors do not owe preferred stockholders fiduciary

duties when the preferred stockholders rely on their preferred rights and preferences which are contractual in nature

and are governed by the terms of the certificate of designation under which the preferred stock was issued

(Frederick Hsu Living Trust v. ODN Holding Corp., 2017 WL 1437308, at *21 (April 24, 2017)).

• An insolvent corporation owes fiduciary duties to its creditors. If the corporation is insolvent, directors

continue to owe fiduciary duties to the corporation, but the corporation's creditors replace the stockholders as the

primary beneficiaries of those duties. Creditors of solvent corporations are generally protected by contract and by

debtor-creditor law, not by corporate law binding the directors. For a discussion of the fiduciary duties of an insolvent

corporation, see Insolvency.

• A controlling stockholder owes fiduciary duties to the corporation and the minority stockholders. A

controlling stockholder owes fiduciary duties to the corporation and minority stockholders if it owns 50% or more

of the voting power of or exercises control over the affairs of the corporation (Kahn v. Lynch Commc'n Sys., Inc.,

638 A.2d 1110, 1114 (Del. 1994)). For a discussion of the test for control, see Defining Control for Entire Fairness.

For a discussion of when non-stockholders may owe fiduciary duties if they exercise control, see Control By Non-

Stockholders.

• Officers owe fiduciary duties to the corporation and its stockholders. Officers of Delaware corporations owe

the same fiduciary duties of care and loyalty as directors owe (Gantler v. Stephens, 965 A.2d 695, 709 (Del. 2009)).

For a detailed discussion of officers' duties and the standard of review of their conduct under Delaware law, see

Practice Note, Fiduciary Duties of Officers of Corporations.

• The corporation itself does not owe fiduciary duties to its stockholders. The corporation itself does not owe

fiduciary duties to the stockholders and cannot be held to have aided or abetted any breaches by the directors

of their duties (see Arnold, 678 A.2d at 539; Buttonwood True Value P'rs, L.P. v. R.L. Polk & Co., Inc., 2014 WL

3954987, at *4 (Del. Ch. Aug. 7, 2014)).

Insolvency

Under Delaware law, the fiduciary duties of the board do not typically extend to other constituencies such as bond holders

and other creditors because they are protected by contract or other statutory schemes (such as state commercial laws).

However, as a corporation approaches insolvency, the creditors start to resemble equity holders in that they may ultimately

have the final claim on the corporation's assets. At that point, creditors arguably hold the interest in maximizing the value

of the corporation that is ordinarily held by the common stockholders. Some courts have indicated that a director's fiduciary

duties might shift at this point to the creditors.

The Delaware Supreme Court addressed this question in the Gheewalla case. The Court held that creditors of a corporation

have no right to assert direct claims against directors for breach of fiduciary duty. This remains the case whether the

corporation is merely approaching insolvency (referred to as the zone of insolvency) or is already insolvent. The court

rationalized that creditors should continue to be protected by contracts, commercial laws (such as the covenant of good faith

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

and fair dealing), and bankruptcy laws. When a corporation falls into the zone of insolvency, directors should not be hindered

by the threat of fiduciary duty lawsuits when negotiating with creditors. (N. Am. Catholic Educ. Programming Found. Inc.

v. Gheewalla, 930 A.2d 92, at *99-103 (Del. 2007).) However, creditors hold standing to bring a derivative claim for any

breaches of fiduciary duty on behalf of the corporation once a corporation becomes insolvent (Quadrant Structured Prod.

Co., Ltd. v. Vertin, 102 A.3d 155, 172-176 (Del. Ch. 2014)).

For more information on the fiduciary duties of directors of distressed or insolvent companies, see Practice Note, Fiduciary

Duties of Directors of Financially Troubled Corporations.

Duty of Care

A director must follow the duty of care when acting on behalf of the corporation. Many states have codified the duty of care,

generally following the standards of the MBCA. Both California and New York have codified the duty of care and closely

follow the MBCA with minor modifications:

• The California statute requires a director to act in good faith, in a manner the director believes to be in the best

interests of the corporation and its stockholders, and with such care, including reasonable inquiry, as an ordinarily

prudent person in a like position would use under similar circumstances (Cal. Corp. Code § 309(a)).

• The New York statute requires a director to act in good faith and with the degree of care which an ordinarily prudent

person in a like position would use under similar circumstances (NYBCL § 717(a)).

While not codified in Delaware, the duty of care has been developed in case law along similar lines. Delaware courts generally

describe the duty of care as the obligation to use the amount of care that an ordinarily careful and prudent person would

use in similar circumstances. A director breaches the duty of care by failing to take action in a situation where a careful

person would have taken action. This formulation implies that directors' decisions are always scrutinized for reasonableness.

However, Delaware courts recognize that directors sometimes must take business risks to promote the best interests of the

corporation and its stockholders, and that judges and stockholders are not in the best position to second-guess business

decisions made by the board of directors. Judges have been particularly careful not to impose liability for a decision that

seems wrong only in hindsight.

No Duty to Maximize Profits or Minimize Taxes

The duty of care does not require the board to take any particular actions. Of particular note, directors have no per se duty

to maximize the profits of the corporation. Directors can take actions that do not directly increase the corporation's profits

(for example, cause the corporation to make charitable donations) if there is a connection to a rational business purpose.

The board cannot be held liable for making a business decision simply because another decision would have been more

profitable.

For example, the Delaware judiciary has repeatedly ruled that a board has no fiduciary duty to minimize corporate taxes (see

Freedman v. Adams, 58 A.3d 414, 417 (Del. 2013) ("The decision to sacrifice some tax savings in order to retain flexibility

in compensation decisions is a classic exercise of business judgment"); Seinfeld v. Slager, 2012 WL 2501105, at *3 (Del.

Ch. June 29, 2012) ("Delaware law is clear that there is no separate duty to minimize taxes, and a failure to do so is not

automatically a waste of corporate assets")).

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Duty of Loyalty

The duty of loyalty requires directors to act in good faith for the benefit of the corporation and its stockholders, not for their

own personal interests. The duty of loyalty embodies not only an affirmative duty to protect the interests of the corporation,

which is the purpose of the duty of care, but also an obligation to refrain from conduct that would harm the corporation and

its stockholders.

A breach of the duty of loyalty is implicated if there is:

• A conflict of interest (see Conflict Transactions and Entire Fairness).

• Bad faith (see Breach Committed in Bad Faith).

Breaches of the duty of loyalty are treated more seriously than breaches of the duty of care in terms of both the initial

standard of review and the consequences of a breach.

Decisions or transactions involving a breach of the duty of loyalty, including a conflict of interest or bad faith, are not protected

by either:

• The business judgment rule (see Business Judgment Rule).

• The statutory limitation of liability under Section 102(b)(7) (see Exculpation from Liability).

For a discussion on how the board's failure to oversee a corporation's operations may be a breach of the duty of loyalty,

see Failure of Oversight.

Corporate Opportunity Doctrine

One way the duty of loyalty may be breached is if a director or officer usurps a corporate opportunity. Courts analyze several

factors to determine whether a corporate opportunity rightfully belongs to the corporation. In Delaware, these factors include:

• If the opportunity is in the same line of business as the corporation's. Delaware courts have broadly interpreted

the nature of a corporation's line of business and recognized that it should have a "flexible meaning, which is to be

applied reasonably and sensibly" (see Personal Touch Hldg. Corp. v. Glaubach, 2019 WL 937180, at *16-17 (Del.

Ch. February 25, 2019)).

• Whether the corporation has an interest or expectancy in the opportunity.

• Whether the corporation would be financially able to take the opportunity if presented. This factor is met if the

usurper had a parallel contractual obligation to present corporate opportunities to the corporation.

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• Whether taking the opportunity would create a conflict of interest or be a breach of fiduciary duties for the director or

officer.

(Yiannatsis v. Stephanis by Sterianou, 653 A.2d 275, 278-79 (Del. 1995), quoting Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939).)

Section 122(17) of the DGCL allows corporations to renounce expectations to any specified business opportunities or

specified classes or categories of business opportunities. The waivers must be specific and narrow because broad non-

specific waivers would impermissibly limit the duty of loyalty (Totta, 2022 WL 1751741, at *16).

Insider Trading

Another way the duty of loyalty may be breached is if a director engages in insider trading under Brophy v. Cities Services

Co. (70 A.2d 5 (Del. Ch. 1949)). A director breaches their duty of loyalty under a Brophy claim if the director both:

• Possessed material, nonpublic company information. For the nonpublic information to be material, the court must

determine that it would been of significance to a rational investor, in light of the total mix of public information. This

analysis is similar to, but distinct from, a director's obligation to disclose information to stockholders (see Duty of

Disclosure).

• Used that information improperly by making trades because the director was motivated, in whole or part, by that

information.

(Goldstein v. Denner, 2022 WL 1797224, at *5 (Del. Ch. June 2, 2022) (Goldstein II).)

Protections for Directors

To allow boards to take necessary business risks and to attract qualified people to serve as directors, Delaware has adopted

the following protections for directors:

• The business judgment rule. The business judgment rule presumes that directors comply with the duty of care

and imposes liability only for breaches committed with gross negligence (see Business Judgment Rule).

• A statutory limitation of liability. Most states allow the corporation's certificate of incorporation to eliminate or

limit directors' personal liability for money damages to the corporation or its stockholders for breach of their duty of

care. Delaware provides for this exculpation in Section 102(b)(7) of the DGCL. The statute allows corporations to

exculpate its directors for breaches of their fiduciary duties, barring breaches committed in bad faith or breaches of

the duty of loyalty. For a more detailed discussion, see Exculpation from Liability.

• Indemnification and advancement of expenses. Indemnification statutes protect directors from liability

stemming from their service to the corporation. Section 145 of the DGCL requires a corporation to indemnify current

or former directors who were made a party to a proceeding by reason of their service to the corporation and who

have achieved success, on the merits or otherwise, in that proceeding. It also permits a corporation to indemnify

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and advance expenses to directors in certain circumstances (DGCL §145; see Indemnification and Advancement).

For more information, see Practice Note, Director and Officer Indemnification for Delaware Corporations.

• Insurance. Delaware law permits corporations to purchase director and officer insurance (D&O Insurance) to

insure directors by covering losses (such as settlement costs, fines, and legal fees) resulting from a breach of

fiduciary duty (DGCL § 145(g)). For more information, see Practice Notes, Directors and Officers Insurance Policies

and Director and Officer Indemnification for Delaware Corporations: Directors and Officers Insurance.

Exculpation from Liability

If a board of disinterested and independent directors is found to have acted with gross negligence, it may be held to have

breached its duty of care. Section 102(b)(7) of the DGCL allows corporations to include an exculpatory provision in their

certificate of incorporation eliminating or limiting the personal liability of a director to the corporation or its stockholders for

monetary damages for a breach of fiduciary duty. This exculpatory provision has limits, however, because it:

• Only applies to breaches of duty of care. The limitation of liability is only applicable to breaches of the duty of

care. It is unavailable for breaches of the duty of loyalty (including breaches resulting from a conflict of interest), acts

or omissions committed in bad faith, acts or omissions involving intentional misconduct or a knowing violation of law,

for any transactions in which the director received an improper personal benefit, or for liabilities for the payment of

unlawful dividends or unlawful stock purchase or redemption. A conflict of interest can arise when a director acts to

advance:

• their self-interest adverse to the stockholders' interest; or

• the self-interest of an interested party from whom the director is not independent.

• Only eliminates monetary liability of directors. A Section 102(b)(7) provision only eliminates the directors'

monetary liability, and does not eliminate the underlying breach. Therefore, it does not preclude the court from

issuing an injunction to provide relief for the breach (Malpiede v. Townson, 780 A.2d 1075, 1095 (Del. 2001)).

Additionally, because the underlying breach is not eliminated, a third party (such as a financial advisor) can be

held liable for aiding and abetting a director's breach, even if the director who committed the breach is personally

exculpated (In re Rural Metro Corp., 88 A.3d 54, 86 (Del. Ch. 2014)), aff'd sub nom, RBC Cap. Mkts., LLC v. Jervis,

129 A.3d 816, 873 (Del. 2015)). For more information on the elements for establishing a claim of aiding and abetting

a breach of fiduciary duty, see Practice Note, Fiduciary Duties in M&A Transactions: Exculpated Breach Forms

Basis for Aiding and Abetting Liability.

• Is not retroactive. A Section 102(b)(7) provision is not retroactive. It cannot exculpate the directors for any act or

omission occurring before the effective date of the provision.

• Is unavailable to officers prior to August 1, 2022. Exculpation under Section 102(b)(7) was only available for

directors, not officers, prior to August 1, 2022 (Gantler, 965 A.2d at 709 n.37). However, from and after August 1,

2022, a corporation's certificate of incorporation may include a provision exculpating certain officers for the same

types of claims that directors are permitted exculpation for, except that these officers may not be exculpated for

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claims brought by or in the right of the corporation. For further discussion, see Practice Note, Fiduciary Duties of

Officers of Corporations: Statutory Exculpation.

If the director is protected by a exculpatory provision and a plaintiff only seeks monetary damages, a director cannot be

found liable and the court must dismiss the claim, unless the plaintiff pleads non-exculpated claims against the director,

regardless of the standard of review (In re Cornerstone Therapeutics Inc., 115 A.3d 1173, 1175 (Del. 2015)). For example,

for a discussion of how an exculpatory provision affects a finding of liability under the entire fairness review, see Liability for

Failing to Satisfy Entire Fairness Review. For an example of an exculpation provision, see Standard Document, Certificate

of Incorporation (Short-Form DE): Paragraph 7.

Indemnification and Advancement

In addition to allowing exculpation, the DGCL requires a corporation to indemnify a current or former director who was

made a party to a proceeding by reason of their service to the corporation and who has achieved success, on the merits or

otherwise, in that proceeding (DGCL §145(c)(1)). The corporation is also permitted to indemnify a director who was made

a party to a proceeding by reason of their service to the corporation if the director acts in good faith and in a manner the

director reasonably believes is in the best interests of the corporation and for criminal proceedings has no reasonable cause

to believe that their behavior was unlawful. For actions brought by or in right of the corporation (such as derivative claims) a

corporation cannot indemnify a director if the director is adjudged to be liable to the corporation, unless the court determines

the director is entitled to indemnity. (DGCL §145(a), (b).) The statute prohibits a corporation from indemnifying a corporate

official who was unsuccessful in the underlying proceeding and who acted in bad faith (Hermelin v. K-V Pharm. Co., 54 A.3d

1093, 1094 (Del. Ch. 2012)).

A corporation may also advance a director's expenses as they are incurred, subject to the director's agreement to repay the

advanced expenses if it is determined the director is not entitled to indemnification (DGCL § 145(e)).

Directors usually expect to receive full indemnification and advancement of expenses to the maximum extent allowed by law.

For a more detailed discussion of Section 145 of the DGCL and the indemnification of and advancement of expenses to

directors and officers, see Practice Note, Director and Officer Indemnification for Delaware Corporations. For an example

of an indemnification provision for a certificate of incorporation, see Standard Document, Certificate of Incorporation (Short-

Form DE): Paragraph 8.

Abstention Defense

Under Delaware law, a director who "plays no role in the process of deciding whether to approve a challenged transaction

cannot be held liable on a claim that the board's decision to approve that transaction was wrongful" (In re Tri-Star Pictures,

Inc., 1995 WL 106520, at *2 (Del. Ch. Mar. 9, 1995)). But there are exceptions, such as if:

• Certain directors conspire with others to formulate a wrongful transaction, then deliberately absent themselves from

the directors' meeting at which the proposal is to be voted onto shield themselves from any exposure to liability (Tri-

Star, 1995 WL 106520, at *3).

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• The director played a role in the negotiation, structuring, or approval of the proposal (In re Carvana Co. S'holder

Litig., 2022 WL 2352457, at *17 (Del. Ch. June 30, 2022)).

• An absent director knowingly accepts a personal benefit flowing from a self-interested transaction and refuses

to return it on demand. That absent director can be thought to have ratified the action taken by the board and,

therefore, share in the full liability of the directors (Valeant Pharm. Int'l v. Jerney, 921 A.2d 732, 753-54 (Del. Ch.

2007)).

• The director abstained from the formal vote to approve the transaction, yet was closely involved with the challenged

transaction from the beginning and the transaction was rendered unfair based, in large part, on the director's

involvement (Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1166 n.202 (Del. Ch. 2006)).

• The directors abstained from the formal vote to approve the transaction, but "participated in the key board meeting

before the vote" where they explained the rationale for the transaction and expressed their opinions about the

transaction (In re Coty Inc. S'holder Litig., 2020 WL 4743515, at *10 (Del. Ch. Aug. 17, 2020)).

• The directors abstained from the transaction vote but approved a compensation package that was integral

to the challenged transaction being successful (an arrangement which the court termed as a "quid pro quo

arrangement" (In re CBS Corp. Stockholder Class Action and Derivative Lit., 2021 WL 268779, at *53 (Del. Ch. Jan.

27, 2021), as corrected (Feb. 4, 2021)).

Although the abstention defense typically involves playing no role in the transaction, including its approval, in In re Dell Tech.

Inc. Class V Stockholder Class Action and Deriv. Lit., the Delaware Chancery Court dismissed a fiduciary duty claim based

on abstention even though the director approved the transaction where director did not participate in the negotiations and

the director's other involvement was limited to "attending the meetings of the Board [and] approving the issuance of the

proxy materials" (2020 WL 3096748 (Del. Ch. June 11, 2020)).

Standards of Review: Overview

The decisions and actions taken by the board of directors, together with the possibility that the directors might have breached

a fiduciary duty, are evaluated under one of three standards of review:

• Business judgment rule. The business judgment rule is the default standard of review. It applies to decisions

made by directors who are disinterested and independent. See Business Judgment Rule.

• Entire fairness. The entire fairness standard, which applies in situations of an actual conflict of interest, is the most

onerous standard of review under Delaware law. See Conflict Transactions and Entire Fairness.

• Enhanced scrutiny. Enhanced scrutiny is an intermediate standard of review, which applies in recognized

situations of potential conflict of interest (Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457-59 (Del. Ch. 2011)).

See Intermediate Standard of Review: Enhanced Scrutiny.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

The standard of review is different than the standard of conduct. The standard of conduct defines what directors are supposed

to do to comply with their duties of care and loyalty. The standard of review is the test that courts apply to determine if the

directors meet the standard of conduct. (Chen v. Howard-Anderson, 87 A.3d 648, 666 (Del. Ch. 2014).)

A court's decision on breach and liability often resolves itself based on the initial decision of which standard of review to

apply. If the directors demonstrate that they are entitled to the presumptions of the business judgment rule, it is a virtual

certainty that the court will rule in the directors' favor on any question of breach. By contrast, transactions that must be

reviewed for their entire fairness are the most common source for findings of breach of fiduciary duties.

Business Judgment Rule

Courts hesitate to substitute their business judgment for the directors' or to question business decisions with the benefit

of hindsight, unless the decision of the board cannot be attributed to any rational business purpose (Sinclair Oil Corp. v.

Levien, 280 A.2d 717, 720 (Del. 1971); see also, Corporate Waste). For this reason, directors' actions are protected by the

presumptions of the business judgment rule. The rule presumes that the board of directors acted on an informed basis and

in the honest belief that the action was in the best interest of the corporation. In a lawsuit alleging a breach of the duty of

care, the court makes this presumption unless the plaintiff shows that a majority of the directors did not meet the following

three elements:

• Stay informed. Directors have a duty to inform themselves before making a business decision of all material

information reasonably available to them (Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985), overruled on

other grounds by Gantler, 965 A.2d at 713 ). For directors to establish that they kept themselves informed of the

corporation's business and the issues brought to the board, they should attend meetings (in person, by phone, or

virtually), carefully read reports or other materials prepared for the board, and ask questions at meetings. Directors

can rely on information and opinions from consultants, management, and employees, but they must make a good-

faith determination that those persons can competently produce the reports and make the analyses on which the

board relies (DGCL § 141(e)).

• Act in good faith. The directors must act in good faith. The decision-making process must be substantive and

cannot just rubber-stamp management's actions. Delaware courts frequently define good faith as the absence of

bad faith. For a discussion of bad faith, see Breach Committed in Bad Faith.

• Take action in the best interest of the corporation. The directors must reasonably believe the action or

transaction was made in the best interest of the corporation. If the directors hold a personal interest in an action,

because the directors either appear on both sides of the transaction, or expect to receive a personal financial

benefit due to self-dealing, as opposed to a benefit for the corporation or all stockholders generally, the court will not

presume they acted in the best interest of the corporation. If a majority of the board has a conflict of interest in the

underlying action, the conflicted directors are not entitled to the presumptions of the business judgment rule.

(Aronson, 473 A.2d at 812.)

If a majority of the board qualifies for the presumptions of the business judgment rule, the standard for a finding of a breach of

the duty of care is gross negligence (In re Citigroup Inc., 964 A.2d 106, 124 (Del. Ch. 2009), citing Aronson, 473 A.2d at 812).

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Rebutting the Business Judgment Rule

If the business judgment rule is rebutted by showing that the directors did not satisfy any of the three presumptions of the

business judgment rule, Delaware courts examine directors' actions under one of the other standards of review (see Conflict

Transactions and Entire Fairness and Intermediate Standard of Review: Enhanced Scrutiny).

Corporate Waste

If the plaintiff fails to rebut the presumption of the business judgment rule (because a majority of the directors were

disinterested and independent) and cannot demonstrate a breach of a duty (because the directors did not act with gross

negligence or bad faith), the plaintiff will not be entitled to any remedy unless the challenged transaction constitutes waste.

To recover on a claim of waste, a plaintiff must prove that the relevant exchange was "so one sided that no business person

of ordinary, sound judgment could conclude that the corporation has received adequate consideration." This is considered

a stringent standard that is only met in the "rare, unconscionable case where directors irrationally squander or give away

corporate assets." (In re the Walt Disney Co. Deriv. Litig., 906 A.2d 27, 74 (Del. 2006).) To constitute waste, there must be no

business purpose for the action. For example, the Delaware Chancery Court has found that awards of allegedly excessive

compensation do not constitute waste because even excessive compensation has a business purpose. (Knight v. Miller,

2022 WL 1233370, at *6 (Del. Ch. Apr. 27, 2022).) Similarly, spending on items such as employee vehicles, outings, social

club dues, and holiday gifts is usually attributable to a rational business purpose and typically does not support a finding of

waste (see Zutrau v. Jansing, 2014 WL 3772859, at *20 (Del. Ch. July 31, 2014)).

Breach Committed in Bad Faith

In Delaware common law, the duty of good faith is analyzed as a component of the duty of loyalty, not as a standalone fiduciary

duty (Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 370 (Del. 2006)). Exculpation under Section 102(b)(7)

is unavailable for breaches of the duty of loyalty and acts made in bad faith (see Exculpation from Liability). Hence, if the

board's wrongful conduct is committed in bad faith, the directors at fault cannot rely on the charter's exculpation provision.

To act in good faith, a director must act with honesty of purpose and in the best interest of the corporation. No single definition

or set of factors exists that defines good faith or bad faith, but the courts have identified several situations that usually involve

bad faith. These include:

• An intentional failure to act in the face of a known duty to act, demonstrating a conscious disregard for one's duties.

For example, a director knows management is violating corporate policy, but makes no attempt to change the

situation. (See also Failure of Oversight.)

• A knowing violation of law. For example, a director approves a waste-removal plan knowing it violates environmental

laws.

• If a director acts for any purpose other than advancing the best interests of the corporation or its stockholders. For

example, a director approves a sale transaction because the director wants to sell its stock.

(Disney, 906 A.2d at 67.)

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• A knowing violation of the corporation's charter. For example, a director approves related-party transactions that

have not been reviewed by an independent committee, even though the director knows that the corporation's

charter requires related-party transactions be reviewed by an independent committee before approval (Lacey, 2021

WL 508982, at *9).

• A complete abdication of a directorial duty, especially if the duty is delegated to someone with a known conflict of

interest. For example, see Abdication of Duty of Disclosure.

Because a finding of gross negligence is necessary to establish a breach of the duty of care (which can be exculpated

by a Section 102(b)(7) provision), a bad-faith act (not exculpated) must be "qualitatively more culpable than gross

negligence" (Disney, 906 A.2d at 66). An element of scienter, or actual or constructive knowledge of the improper action,

is necessary. The Delaware Supreme Court recently reaffirmed this high threshold for bad faith, explaining that bad faith

means either:

• The conduct was "motivated 'by an actual intent to do harm.'"

• There was an "intentional dereliction of duty, a conscious disregard for one's responsibilities."

(McElrath v. Kalanick, 224 A.3d 982, 991-92 (Del. 2020).)

For example, the board is not entitled to the presumptions of the business judgment rule if the plaintiff demonstrates with

particularized allegations that the board knowingly or deliberately failed to adhere to the terms of a stock incentive plan

(Pfeiffer v. Leedle, 2013 WL 5988416, at *5 (Del. Ch. Nov. 8, 2013)). A knowing or intentional violation is inferred if the board

violates an unambiguous term in such a plan (Sanders v. Wang, 1999 WL 1044880, at *7-9 (Del. Ch. Nov. 10, 1999)).

The Chancery Court has also accepted at the pleading stage, a novel theory of liability that directors (even those that were

not on the committee that approved the award) may have breached their fiduciary duties by not fixing an award that was

made to the CEO in violation of a plain and unambiguous limitation in an equity compensation plan, after the board received

a litigation demand letter from the plaintiff describing the problem. The court inferred bad faith from the board's inaction of

not fixing an award it knew to be erroneous. The court cautioned that courts should apply this theory of liability cautiously,

but that it may fit these limited facts because the CEO to whom the incorrect awards were issued also owed fiduciary duties

to the company to fix award. (Garfield v. Allen, 277 A.3d 296, at 336-48 (Del. Ch. 2022); Legal Update, Delaware Chancery

Court Refuses to Dismiss Claims Alleging Breach of Contract, Breach of Fiduciary Duty, and Unjust Enrichment Related

to Equity Grants.)

By contrast, a board's failure to have a CEO succession plan in place is not considered a conscious disregard of a known

duty to act, unless there is a recognized duty to implement such a plan (see Zucker v. Andreessen, 2012 WL 2366448, at

*11 (Del. Ch. June 21, 2012)).

Notably, a board's knowing breach of a corporation's contractual obligations may not implicate bad faith by the board if

the board determines the benefits of the breach outweigh the costs of the breach. Due to the doctrine of efficient breach,

directors have some fiduciary discretion in determining whether to breach a corporation's contractual obligations. Under that

doctrine, a contract party may decide it is better off breaching the contract and paying damages than completing performance.

(Frederick Hsu Living Trust, 2017 WL 1437308, at *24.)

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Failure of Oversight

When the business judgment rule applies (no conflict of interest and no other set of facts that calls for a heightened standard

of review), and assuming the directors are exculpated by a Section 102(b)(7) provision (see Exculpation from Liability), a

claim of breach of fiduciary duty usually must establish bad faith on the part of the board. This claim frequently takes the

form of a Caremark claim, in which the plaintiff argues that the board did so little to oversee the corporation's operations and

exposure to risk that its failures amount to a conscious disregard of its duty to stay informed and oversee the company's

exposure to risk. As discussed in Breach Committed in Bad Faith, conscious disregard of a known duty to act is a recognized

element for establishing bad faith.

Two-Prong Test for a Caremark Claim

To satisfy its duty to stay informed and oversee the company's exposure to risk, the board must make good faith efforts to

implement an information and reporting system (In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 970 (Del. Ch. 1996)).

The Delaware courts established the boundaries of the duty of oversight in the Caremark and Stone v. Ritter decisions (see

In re Lear Corp. S'holder Litig., 967 A.2d 640, 653 (Del. Ch. 2008)). In both of those cases, the court held that directors

need to assure themselves in good faith that the corporation has reporting systems in place that are reasonably designed

to provide timely and accurate information to the board.

As demonstrated in subsequent cases, directors expose themselves to director oversight liability under Caremark if either:

• They utterly failed to implement any reporting or information system or controls. To avoid Caremark liability, the

board must make a good faith effort to put a reasonable board-level oversight system in place that:

• is designed to provide the board with timely and accurate information; and

• at a minimum addresses mission-critical compliance risks.

(City of Detroit Police and Fire Retirement Sys. v. Hamrock, 2022 WL 2387653, at *12-14 (Del. Ch. June 30, 2022).)

• Having implemented such a system or controls, the directors consciously failed to monitor or oversee its operations,

therefore disabling themselves from being informed of risks or problems requiring their attention (Ritter, 911 A.2d at

370). This basis for liability requires the plaintiff to demonstrate that:

• there was evidence of corporate misconduct (red flags) that put the directors on notice of problems, but which

were consciously disregarded (Teamsters Local 443 Health Servs. & Ins. Plan v. Chou, 2020 WL 5028065, at

*17 (Del. Ch. Aug. 24, 2020)); and

• the red flags were sufficiently connected to the corporate trauma, such that a reasonable observer would be

put on notice of the risk of the trauma that occurred (Hamrock, 2022 WL 2387653, at *20-21).

In both cases, where directors fail to act when there is a known duty to act, they breach their duty of loyalty by failing to

discharge it in good faith (Ritter, 911 A.2d at 370.) This requires a showing of scienter, that the directors knowingly acted for

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

reasons other than the best interests of the corporation. Therefore, a sufficiently plead Caremark claim implicates bad faith

and a breach of the duty of loyalty and is not exculpated by a Section 102(b)(7) provision (see Exculpation from Liability).

Facts That Are Not Sufficient to Establish a Caremark Claim

In general, Caremark claims are considered "possibly the most difficult theory in corporation law on which a plaintiff might

hope to win a judgment". To illustrate, in a decision regarding the General Motors board's conduct when it learned of the

company's ignition-switch failures, the court held that the plaintiffs had failed to plead sufficient facts to demonstrate bad faith,

because the board had not failed to establish any oversight plan. Allegations of the board's negligent controls and apathetic

culture were still not enough to establish bad faith. (General Motors, 2015 WL 3958724, at *14-15 (Del. Ch. June 26, 2015).)

Other examples of Caremark claims that failed because the plaintiff did not demonstrate that the board either failed to

implement a reporting system or consciously disregarded its duty to oversee the company's compliance with applicable laws

by ignoring red flags, include:

• Melbourne Mun. Firefighters' Pension Trust Fund v. Jacobs, 2016 WL 4076369, at *9 (Del. Ch. Aug. 1, 2016),

aff'd, 158 A.3d 449 (Del. 2017). The complaint alleged that the directors of Qualcomm Inc. allowed the company

to repeatedly violate international antitrust laws after being aware of previous violations. The court held that the

plaintiff did not adequately plead facts showing that the board's response to the red flags in question constituted bad

faith, noting that while the board may have responded insufficiently, it did not completely fail to act, and at all times

believed that the company’s conduct did not violate antitrust laws.

• Reiter v. Fairbank, 2016 WL 6081823 (Del. Ch. Oct. 18, 2016). The complained alleged that directors of Capital

One Financial Corporation failed to monitor the bank's check-cashing business for the risk of money laundering.

The court dismissed the claim because the plaintiff did not identify a key event or particular document that would

constitute a red flag that the board overlooked. The court observed that the documents made the directors aware

there was escalating compliance risk, but the documents did not state the company was involved in illegal or

fraudulent conduct. The court described the plaintiff's complaint as pleading "at most flags of a different hue, namely

yellow flags of caution…" (Reiter, 2016 WL 6081823, at *13).

• Horman v. Abney, 2017 WL 242571, at *11-14 (Del. Ch. Jan. 19, 2017). The complaint alleged that the directors

of United Parcel Service, Inc. failed to oversee the company's compliance with cigarette-transportation laws. The

court held that the plaintiff had failed to demonstrate that the board had overlooked any red flags, noting that it

is insufficient to allege that the board must have received the pertinent information since the officer charged with

passing that information to the board had received the information. Instead, the plaintiff must plead with particularity

that the officer actually reported the information to the board. The court also noted that when the board was

eventually made aware of the red flags, it was also informed of efforts underway to ensure compliance with the

relevant laws.

• Oklahoma Firefighters Pension & Ret. Sys. v. Corbat, 2017 WL 6452240 (Del. Ch. Dec. 18, 2017). The complaint

alleged that the directors of Citigroup, Inc. failed to prevent violations of money-laundering and other rules. In finding

that there were insufficient facts to demonstrate bad faith, the court relied on evidence showing that the board took

steps to address the compliance issues, even though the steps were ultimately unsuccessful. The court noted that

because the issue concerns the duty of loyalty, "a board's efforts can be ineffective, its actions obtuse, its results

harmful to the corporate weal, without implicating bad faith." (Oklahoma Firefighters, 2017 WL 6452240, at *17.)

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• Rojas v. Ellison, 2019 WL 3408812, at *8-13 (Del. Ch. July 29, 2019). The derivative complaint alleged the directors

of J.C. Penney failed to oversee the company's compliance with price-comparison advertising laws by ignoring a red

flag consumer class action settlement and failing to ensure the company complied with the terms of the settlement.

In finding that there were insufficient facts to support a reasonable inference of Caremark liability, the court noted

that the board had an audit committee to monitor compliance with laws. The court also determined that the class

action settlement was not a red flag because it did not notify the board of ongoing violations of law or contain an

admission of liability, and there were no facts alleging the directors knew the company was violating laws.

• In re LendingClub Corp. Derivative Litigation, 2019 WL 5678578, at *9-14 (Del. Ch. Oct. 31, 2019). The derivative

complaint alleged that LendingClub's board breached their fiduciary duties by failing to implement internal controls

and monitor the company's compliance with laws, after a whistleblower and internal investigations uncovered

several issues. In dismissing the claims because the complaint did not contain any facts that showed bad faith by

the directors, the Chancery Court relied on evidence that the company had an audit committee that met monthly and

an oversight system. The court also found it persuasive that the board took prompt remedial actions to address the

issues once discovered.

• Pettry v. Smith, 2021 WL 2644475, at *9 (Del. Ch. June 28, 2021). The derivative complaint alleged that the

Federal Express directors consciously ignored red flags regarding illegal cigarette shipments. The Chancery

Court dismissed the claims because the board was regularly updated on the status of the enforcement actions,

reprimanded employees permitting the shipments, formed a committee to investigate board misconduct, eventually

banned most tobacco shipments, and introduced training programs and implemented measures to detect illegal

shipments. Although the plaintiff argued these remedial measures came too late, the court noted that focusing

on the manner and timing of a board response to a red flag "misses the mark" and acknowledged the board had

rationale for waiting to implement remedial measures because the company was actively engaged in litigation

regarding the matter.

• Firemen's Retirement System of St. Louis v. Sorenson, 2021 WL 4593777, at *11-15 (Del. Ch. Oct. 5, 2021). The

derivative complaint alleged that the board breached their fiduciary duty by failing to remedy Starwood's deficient

information security system, which caused a security breach that exposed the personal information of Marriot

hotel guests. Under Caremark's first prong, the Chancery Court dismissed the claims because Marriot's board

audit committee received regular reports on cybersecurity issues and engaged outside consultants to audit their

cybersecurity practices. The court also dismissed claims that the board ignored red flags that the company was

violating the law because their data systems did not comply with industry standards. The court held that the board's

knowledge of the company's failure to meet non-binding industry standards did not rise to the level of Caremark

liability because the failure to meet those standards did not involve violations of positive law.

• City of Detroit Police and Fire Retirement System v. Hamrock, 2022 WL 2387653 (Del. Ch. June 30, 2022). The

derivative complaint alleged that energy company NiSource's board oversight system was not rigorous enough

to address the mission-critical risk of pipeline safety after a pipeline explosion caused a fatality and injuries and

significant property damage. The Chancery Court found, however, that the board made a good faith effort to put a

reasonable oversight system in place because it had a board committee that oversaw safety, the committee met

multiple times a year, and it received extensive reports from management. Regarding the second Caremark prong,

although the court found that the board generally knew of serious risks related to recordkeeping requirements and of

specific recordkeeping issues at other subsidiaries, the plaintiff did not show the board knew of specific near-misses

at the subsidiary involved in the explosion. The court found that the board's knowledge of general risks and issues

at other subsidiaries was too attenuated from the corporate trauma.

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Facts That Are Sufficient to Plead a Caremark Claim

Even though Caremark claims often fail, they are possible to establish.

In Marchand v. Barnhill (Blue Bell) the company's board members were sued for a breach of fiduciary duty after a listeria

outbreak resulted in the death of several customers who ate the company’s ice cream. The Delaware Supreme Court held

that for a company that relied solely on one product (ice cream), the board's failure to establish a board committee or

board-level process overseeing food safety and the lack of established protocol to advise the board about food safety were

sufficient facts to support a reasonable inference that the company's board had breached its duty of loyalty by failing to

implement an oversight system and then monitor it. In coming to that conclusion, the Court specifically noted that if "a board

has undertaken no efforts to make sure it is informed of a compliance issue intrinsically critical to the company’s business

operation," then the board has not met the good faith effort required by Caremark. (212 A.3d 805, 822-23 (Del. 2019).)

While Blue Bell focused on the first prong of the Caremark test, In re Clovis Oncology, Inc. Derivative Litigation focused

on the second prong of the Caremark test. In Clovis Oncology, the company's board members were sued for a breach

of fiduciary duty for failing to adequately oversee a clinical trial of the company's flagship experimental lung cancer drug.

The complaint alleged that the Clovis Oncology board knew that the company was incorrectly calculating and inaccurately

reporting the drug's clinical trial results in violation of the established clinical trial protocol and associated U.S. Food and Drug

Administration (FDA) regulations, but ignored and failed to correct these problems. This placed the drug's FDA approval

in jeopardy.

The Delaware Chancery Court held that these facts supported a reasonable inference that the company's board had

breached its duty of loyalty by consciously ignoring red flags of non-compliance. The court distinguished between "board

oversight of the 'company's management of business risk' from board oversight of the 'company's compliance with positive

law – including regulatory mandates.'" The court emphasized that "when a company operates in an environment where

externally imposed regulations govern its 'mission critical' operations, the board's oversight function must be more rigorously

exercised." (2019 WL 4850188, at *12-13 (Del. Ch. Oct. 1, 2019).)

In another case involving the highly regulated pharmaceutical industry, in the demand futility context, the Delaware Chancery

Court found that there was substantial likelihood of Caremark liability, where AmerisourceBergen Corporation (ABC) had

a subsidiary that illegally filled syringes of cancer drugs and to avoid FDA oversight, it sold the syringes using sham

prescriptions. The court focused on the fact that for ABC, drug health and safety was a mission critical compliance risk.

Applying the second prong of the Caremark test, it explained that the red flags must be "visible to the careful observer," and

a careful observer in this context is "one whose gaze is fixed on the company's mission critical regulatory issues." The court

determined that it was reasonably conceivable that the board knew of red flags putting the board on notice that the company

was engaged in illegal conduct. The red flags included a law firm report that identified deficiencies in ABC's compliance

program, a whistleblower action from a former executive, and a FDA subpoena. Notably, the court inferred the board knew of

the whistleblower action and FDA subpoena because they were described in the 10-K the board signed. However, there was

no evidence of board follow-up on, and "nothing to show tangible action taken to remedy," the underlying issues, including

no references in the board or audit committee meeting minutes or materials, causing the court to find that the plaintiff had

adequately pled that the board in bad faith consciously ignored these reg flags. (Chou, 2020 WL 5028065, at *17-25.)

In Hughes v. Hu on a motion to dismiss, the Delaware Chancery Court upheld a Caremark claim that the company’s audit

committee failed to adequately oversee its financial reporting, after the company publicly announced material weaknesses

in its financial reporting and oversight system and restated three years of financial statements. The court found sufficient

evidence to support a reasonable inference that the company's board failed to use good faith efforts to implement a

reasonable board-level system of oversight for the company's financial statements and related-party transactions. Factors

that the court found persuasive, included that the audit committee only met about once a year when required for securities

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

law purposes, the meetings were less than an hour, and the meetings overlooked important issues, even though the board

had clear notice there were serious accounting irregularities regarding related-party transactions. This pattern of behavior

indicated the board was blindly deferring to management, instead of separately establishing its own information and reporting

system that would "allow management and the board, each within its own scope, to reach informed judgments concerning

both the corporation's compliance with law and its business performance." (2020 WL 1987029, at *13-16 (Del. Ch. Apr. 27,

2020) (quoting Caremark, 698 A.2d at 970).) For a discussion of this case, see Legal Update, Hughes v. Hu: Delaware Court

of Chancery Finds Substantial Likelihood of Caremark Liability from Failure of Audit Committee's Duty of Oversight.

Most recently, in In re The Boeing Company Derivative Litigation, in the demand futility context, the Delaware Chancery

Court denied a motion to dismiss by upholding Caremark claims regarding the safety of Boeing's 737 MAX airplanes after two

planes crashed killing everyone on board. The court held there were sufficient facts to support a Caremark claim under the

first prong of the Caremark test. Comparing this case to Blue Bell, the court emphasized the fact that although airplane safety

(like food safety in Blue Bell) was "mission critical" and "externally regulated," there was no board committee specifically

charged with, or regularly allocated board time spent, monitoring airplane safety. There was also no established protocol for

management to report known safety issues to the board. The court noted that management's discretionary ad hoc safety

reports to the board were insufficient for mission-critical safety issues, particularly when the board did not require the reports,

passively relied on the reports, and did not request additional information. Further, the company's nominal compliance with

FAA regulations did not fulfill its obligation to monitor airplane safety at the board level. The court also found the plaintiff pled

sufficient facts to support a Caremark claim under the second prong, because after the first airline crash (a red flag), the

board did not request information about the crash from management, and when it received information about it, the board

passively accepted management's position that the airplane was safe, despite a contrary media report. (2021 WL 4059934

(Del. Ch. Sept. 7, 2021).)

Notably, while in recent years an increasing number of Caremark claims have survived dismissal, many issues remain open

about what is necessary to actually establish Caremark liability, because as observed by the Hamrock court, "[n]o Caremark

case has yet gone to trial, or proceeded meaningfully past the pleading stage" (Hamrock, 2022 WL 2387653, at *20).

Practical Caremark Guidance

To reduce the likelihood of a successful Caremark claim, directors should:

• Establish a board-level oversight system. Directors should not just rely on management or outside regulators for

oversight.

• Ensure the oversight system focuses on mission-critical compliance with law or regulatory mandates.

• Actively monitor and use the oversight system to identify red flags of non-compliance.

• If there are red flags, follow-up on and take actions to try remedy the red flags.

• Maintain an adequate board record of the oversight system and response actions, including a record showing the

directors:

• established an oversight system or protocols;

• reviewed and discussed compliance issues;

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• followed-up on red flags; and

• implemented and monitored remediation efforts.

Oversight liability is a risk for all companies, but based on recent cases, particularly rigorous oversight is required of directors

for companies operating in highly regulated industries where regulatory compliance is critical to their operations or that

involve personal health and safety (such as the pharmaceutical, airline, and food industries).

Emerging Areas of Oversight Claims

Emerging areas of potential oversight claims include:

• ESG issues (see Practice Note, Best Practices for Establishing ESG Disclosure Controls and Oversight: Board

Oversight).

• Cybersecurity risk.

In Sorenson, although the Chancery Court dismissed the Caremark claims because it found no violation of law, it

acknowledged the increasing cybersecurity risks faced by companies and the emerging regulatory and legal frameworks

governing cybersecurity. The court observed that the "corporate harms presented by non-compliance with cybersecurity

safeguards increasingly call upon directors to ensure that companies have appropriate oversight systems in place." (2021

WL 4593777, at *11-12.) However, this does not necessarily mean there will be an increase in successful cybersecurity-

related Caremark claims. Similar to the result in Sorenson, the Chancery Court has recently observed that absent violations

of positive law, cybercrimes by third parties is a business risk and the Delaware courts have been cautious about applying

Caremark liability to business risks (Constr. Indus. Laborers Pension Fund v. Bingle, 2022 WL 4102492, at *7 (Del. Ch.

Sept. 6, 2022)).

Other Reasons for Oversight

Apart from the analysis of the board's fiduciary duties, directors have compelling reasons to monitor the company's business

and risks closely. A corporation can be held responsible for the actions of its management and employees. Since the

board of directors is charged with overseeing those managers and employees on behalf of the corporation, the board

needs a functioning oversight and compliance system in place. The Federal Sentencing Guidelines impose large penalties

on corporations for violation of federal criminal laws, but these penalties can be significantly reduced if corporations put

appropriate oversight and compliance programs in place.

For a public corporation, the board must consider the additional compliance requirements of the SEC and the applicable

stock exchange. Federal regimes of corporate governance have their own standards of review that may be stricter on

directors than Delaware corporate law. These regimes require their own compliance procedures. For more information on

the obligations of directors under those regimes, see Practice Note, Corporate Governance Standards: Board of Directors.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Caremark Claims Against Directors of Foreign-Based Corporations

The Delaware Court of Chancery has more readily found a basis for a Caremark claim when directors of foreign-based

Delaware corporations fail to oversee their corporations' activities, particularly when they do little more than hold a handful

of telephonic meetings. In In re Puda Coal, Inc., the court refused to dismiss a claim against the independent directors of a

China-based corporation, holding that it was "perfectly conceivable" that the directors had failed to make a good-faith effort

to monitor the company's management. The court advised that to meet the bare minimum for avoiding personal liability

under Caremark, a director must:

• Be frequently present in the country the corporation is based.

• Have in place a system of adequate controls and retain accountants and lawyers who are equipped to maintain

those controls.

• Have "the language skills to navigate the environment in which the company is operating."

(In re Puda Coal, Inc. S'holders Litig., 2013 WL 769400 (Del. Ch. Feb. 6, 2013) (TRANSCRIPT).)

The court further developed this guidance in Rich ex rel. Fuqi Int'l, Inc. v. Chong. There the court held that although the

corporation nominally had controls in place, its own disclosures of its material weaknesses showed that it had no "meaningful"

controls. Moreover, although the board had regular meetings, it had no system at all for regulation of the company's

operations "in China" (emphasis in original). The court also highlighted the board's repeated failure to identify and respond

to red flags that should have warned of the company's material weaknesses in its controls, which rose to the level of a

conscious failure to monitor. (Rich, 66 A.3d 963, 982-85 (Del. Ch. 2013).)

Nonresident Directors

The other side of the situation in which courts review the conduct of directors of Delaware corporations based overseas is

the situation in which Delaware courts review the conduct of nonresident directors. Foreign-based directors cannot evade

Delaware courts just because they are not resident in Delaware, or even in the United States. Under Delaware’s long-arm

statute, non-resident directors and officers of Delaware corporations implicitly accept personal jurisdiction in Delaware

courts in:

• Any action or proceeding against the individual for violation of a duty in their capacity as a director or officer (an

action for breach of fiduciary duty).

• Any civil action or proceeding brought in Delaware, by or on behalf of, or against the corporation, in which the

individual is a necessary or proper party.

(10 Del. C. § 3114.)

Nonresident officers and directors are exposed to liability as a necessary or proper party if:

• The claim is brought against the corporation.

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• The director or officer is either a necessary or proper party to the case.

• The director's or officer's actions were taken in their capacity as such a representative.

(Hazout v. Tsang Mun Ting, 134 A.3d 274, 289-90 (Del. 2016).)

Therefore, Delaware courts have jurisdiction over the officer or director of a Delaware corporation even if the plaintiff does

not allege a breach of fiduciary duties, if the traditional minimum-contacts test set out in International Shoe and its progeny

is met (Hazout, 326 134 A.3d at 291 referring to Int'l Shoe Co. v. Wash., Office of Unemployment Comp. & Placement, 326

U.S. 310 (1945)).

Conflict Transactions and Entire Fairness

The entire fairness standard of review applies in three general circumstances:

• Conflicted-board transactions. If a majority of the directors who approved the transaction were not disinterested

and independent. See Conflicted-Board Transactions: Director Disinterest and Independence for further discussion.

• Controlling-stockholder transactions. When a controlling stockholder has a conflict. For example, when a

controlling stockholder:

• stands on both sides of the transaction (In re KKR Fin. Hldgs. LLC S'holder Litig., 101 A.3d 980, 990 (Del.

Ch. 2014), aff'd sub nom. Corwin v. KKR Fin. Hlds. LLC, 125 A.3d 304 (Del. 2015) (citing Williamson v. Cox

Commc'ns Inc., 2006 WL 1586375, at *4 (Del. Ch. June 5, 2006))); or

• receives different consideration from the other stockholders or a unique benefit (In re Crimson Exploration Inc.

S'holder Litig., 2014 WL 5449419, at *12 (Del. Ch. Oct. 24, 2014)).

See Conflicted Controlling-Stockholder Transactions for further discussion.

• Fraud on the board. If a self-interested fiduciary (such as a director or officer) manipulates or withholds material

information from the board, and this causes the board to act or not act in an outcome-determinative way. See Fraud

on the Board for further discussion.

The Delaware courts have traditionally applied the entire fairness review to conflicted-board transactions and controlling-

stockholder transactions. The Delaware courts' application of the entire fairness standard of review when there is fraud on

the board is not a new concept, but it has recently become a focus area.

Entire Fairness Standard of Review

When the entire fairness review applies the defendant directors must establish both:

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• Fair dealing. This evaluates how the transaction was timed, initiated, structured, negotiated, disclosed by

management to the directors, and approved by the board and stockholders.

• Fair price. This evaluates the economic and financial considerations, including all relevant factors: assets, market

value, earnings, future prospects, and any other elements that affect the intrinsic value of the stock.

(Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983).)

Although demonstrating entire fairness is an onerous burden, for a discussion of a case where the Delaware Chancery

Court found that a transaction satisfied entire fairness despite process flaws, see Practice Note, Fiduciary Duties in M&A

Transactions: Entire Fairness Standard of Review.

Even if a transaction passes an entire fairness review, if the board's actions interfere with corporate democracy or

disenfranchise the stockholders, the Delaware courts may require an additional review (see Interference with Stockholder

Vote).

Unitary Conclusion on Process and Price

The distinction between price and process is "not always neatly distinguishable" (Hamilton Partners, L.P. v. Highland Cap.

Mgmt., L.P., 2016 WL 612233, at *5 (Del. Ch. Feb. 2, 2016)). The inquiry is not bifurcated. The court conducting an entire

fairness review examines the transaction for both procedural and substantive fairness and reaches a "unitary conclusion" (In

re Nine Systems Corp., 2014 WL 4383127, at *47 (Del. Ch. Sept. 4, 2014), aff'd sub nom, Fuchs v. Wren Holdings, LLC, 129

A.3d 882 (Del. 2015) (Table)). Usually, a fair process results in a fair price, and evidence of fair dealing can help convince

the court that the board obtained a fair price (Americas Mining Corp. v. Theriault, 51 A.3d 1213, 1244 (Del. 2012)). However,

this is not always the case.

For example, in one decision, the Delaware Chancery Court concluded that a merger satisfied entire fairness in spite of

an unfair process that led to it. The court held that the directors were personally interested in the transaction and that the

board had wrongfully considered only the interests of the preferred stock, to the exclusion of the interests of the common

stockholders. However, the court deemed the deal fair based on price, because the value of the common stock in the

company as a going concern would have been worthless. (In re Trados Inc. S'holder Litig., 73 A.3d 17, 78 (Del. Ch. 2013)

(Trados II).)

By contrast, in Nine Systems, the Delaware Chancery Court held that a recapitalization transaction whose price was fair to

the common stockholders still failed entire fairness review because of an unfair process. To rationalize the apparent conflict

with Trados II, the court distinguished recapitalizations, in which the company's stockholders remain on as stockholders

in the company, from third-party mergers, where price might be the more critical element. (In re Nine Systems, 2014 WL

4383127, at *46.)

Liability for Failing to Satisfy Entire Fairness Review

Directors are not automatically liable if entire fairness is not met. Courts analyze each director's conduct to determine if they

breached the duty of care or loyalty. (Firefighters' Pension Sys. of City of Kansas City, Mo. Tr. v. Presidio, 251 A.3d 212,

250-51 (Del. Ch. Jan. 29, 2021). Directors have a defense against liability for breach of the duty of care if the corporation's

charter contains an exculpation clause under Section 102(b)(7) of the DGCL (see Exculpation from Liability). Alternatively,

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

the directors may be able to claim that in spite of a failure to satisfy the price prong of entire fairness review, the directors

themselves justifiably relied on their advisors, as authorized by Section 141(e) of the DGCL.

Breaches of the duty of loyalty, however, cannot be exculpated. If a transaction subject to the entire-fairness review has been

found unfair and the corporation has an exculpatory provision, the directors can still be found liable in three primary ways:

• Self-interest. A director may be liable and cannot have a claim dismissed at the pleading stage under an

exculpatory provision if the director harbored self-interest adverse to the stockholders' interests (see Director

Disinterest).

• Lack of independence. A director may be liable and cannot have a claim dismissed at the pleading stage under an

exculpatory provision if the director acted to advance the self-interest of the interested party from whom the director

is not independent. This is a two-part test. Lack of independence alone is not sufficient. The director must also have

taken steps to further the conflicted party's interest. Therefore, a director can have their claim dismissed under an

exculpatory provision if the director either:

• is independent from the conflicted party; or

• did not act to advance the conflicted party's self-interest.

(In re BGC Partners, Inc. Deriv. Litig., 2021 WL 4271788, at *10 (Del. Ch. Sept. 20, 2021).)

For a discussion on determining director independence, see Director Independence.

• Bad faith. Directors that are disinterested and independent can be held liable only if they are found to have

approved the transaction in bad faith. This finding requires an inquiry into each director's state of mind (see Breach

Committed in Bad Faith). Furthermore, if facts are not pled supporting a reasonable inference of bad faith, the

disinterested and independent directors can win dismissal of the complaints against them at the pleading stage

without having to remain as a defendant until the ultimate conclusion of the litigation.

(Cornerstone, 115 A.3d 1173, at 1179-81.)

Conflicted-Board Transactions: Director Disinterest and Independence

If a majority of the directors approving a transaction are not disinterested and independent, the decisions of the board are

reviewed for their entire fairness. If a majority of the directors approving a transaction are disinterested and independent, the

board remains entitled to the presumptions of the business judgment rule, unless the business judgment rule is otherwise

rebutted (see Rebutting the Business Judgment Rule).

To determine whether a majority of directors approving the transactions are disinterested and independent, the court

conducts a director-by-director analysis. (Trados II, 73 A.3d at 43-45).

Director Disinterest

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Under Delaware law, the test for finding a disabling interest on the part of a director is met if either:

• The director has a material financial interest in a transaction (a material personal benefit that is not shared equally

by the stockholders).

• A corporate decision has a detrimental impact that applies solely to the director, not the corporation or other

stockholders (such as a substantial likelihood of director liability).

(Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993); Orman v. Cullman, 794 A.2d 5, 23 (Del. Ch. 2002).)

• The transaction involves any self-dealing on the part of the director, in which case no materiality standard applies.

Director self-dealing is traditionally a situation where the director is on both sides of a transaction (for example,

payment of compensation to themselves). (Cambridge Ret. Sys. v. Bosnjak, 2014 WL 2930869, at *4 (Del. Ch. June

26, 2014).)

The materiality of a financial benefit to a director is determined in the context of the director's personal financial

circumstances. The benefit must make it improbable that the director could perform their fiduciary duties without being

influenced by their overriding personal interest (N.J. Carpenters Pension Fund v. infoGROUP, Inc., 2011 WL 4825888, at

*9 (Del. Ch. Sept. 30, 2011)).

For there to be a disabling interest, the benefit must cause the director's personal interest to diverge from the stockholders'

interests at large. The fact that a director owns shares in a company being sold and would stand to gain from the sale does

not itself represent a disabling interest, absent a a compelling or idiosyncratic need for liquidity (Crimson Exploration, 2014

WL 5449419, at *19-20).

A disabling interest may also be present if a director is a dual fiduciary, owing fiduciary duties to more than one entity, and

the interest of the beneficiaries diverge (Trados II, 73 A.3d at 46-47) (referencing Weinberger, 457 A.2d 701 at 710)). In the

context of a Revlon review involving a director that was a dual fiduciary of both the target company that was sold and a hedge

fund that owned stock in the company, the Chancery Court acknowledged that the activist director had a disabling conflict

because the plaintiff pled that the director acted according to a known playbook that implemented a short-term investment

strategy (Goldstein v. Denner, 2022 WL 1671006, at *32 (Del. Ch. May 26, 2022) (Goldstein I).)

The Delaware courts have found that certain factors, standing alone, do not automatically render directors conflicted, such as:

• The mere threat of a proxy contest.

• The possibility of change-in-control benefits from a pre-existing agreement. However, this has recently been

questioned (Goldstein I, 2022 WL 1671006, at *43; see the following paragraph for further discussion).

• Appointment to directorship by stockholders.

• Interest in post-closing employment with a potential acquiror where no employment discussions take place.

(See Rudd v. Brown, 2020 WL 5494526, at *7-12 (Del. Ch. Sept. 11, 2020).)

Though several Delaware cases have stated that change-of-control benefits from pre-existing agreements do not create a

conflict of interest as a matter of law, this is an open question. In Goldstein I, the Chancery Court held that those cases

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

went too far, and reasoned that a director may be conflicted based on severance payments or change-of-control benefits

the director is eligible to receive from a transaction, even if the benefits are pursuant to a pre-existing agreement and are

not triggered by the specific transaction. In Goldstein I, the court relied on the fact that the severance payments were equal

to several years of the director's annual salary in finding a disabling conflict. (Goldstein I, 2022 WL 1671006, at *43).

Directors, however, are considered to be conflicted when the board decision concerns the director's own compensation

(Cambridge Ret. Sys., 2014 WL 2930869, at *3).

Director Independence

Director independence means a director's decision is based the corporate merits of the transaction or issues before the

board, and not on outside influences or considerations. Under Delaware law, there is a rebuttable presumption of director

independence. A director is presumed to be independent even when appointed by a controlling stockholder or other allegedly

interested party. (Aronson, 473 A.2d at 816.)

To successfully challenge a director's independence, plaintiffs must show that the director is so beholden to the controller

or so under its influence that "the director's discretion would be sterilized" (Rales, 634 A.2d at 936). Bare allegations that

a director is friendly with or has had past business relationships with the controller who is a proponent of the transaction

are not enough to rebut the presumption of independence (Kahn v. M & F Worldwide Corp., 88 A.3d 635, 649 (Del. 2014)

overruled on other grounds by Flood v. Synutra Int'l, Inc., 195 A.3d 754 (Del. 2018) (MFW)). The mere fact of compensation

from the corporation is also not enough (In re The Limited, Inc. S'holders Litig., 2002 WL 537692, at *5 (Del. Ch. Mar. 27,

2002)). Rather, the director's ties to the controller must be sufficiently substantial, from a subjective point of view, that the

director could not have objectively evaluated the transaction (see MFW, 88 A.3d at 648-49 (Del. 2014)).

Determining whether a director is independent is often a fact-specific inquiry. For example, in various contexts, the Delaware

Court of Chancery has held that:

• A director was independent from the CEO of the corporation even though the director maintained a 15-year long

professional and personal relationship with the CEO (Crescent/Mach I Partners, L.P. v. Turner, 846 A.2d 963, 981

(Del. Ch. 2000)).

• Where a director had served on the boards of two other companies owned by a venture capital firm with a financial

interest in the challenged transaction and served as a high ranking executive in other companies owned by that

firm, there was a reasonable doubt regarding the director's independence (Goldman v. Pogo.com, Inc., 2002 WL

1358760, at *3 (Del. Ch. Jun. 14, 2002)).

• The members of a compensation committee were independent even though they had been appointed by the

controlling stockholder, had served on the board for many years, served on the boards of other entities controlled by

the stockholder, and were otherwise retired (Friedman v. Dolan, 2015 WL 4040806, *6-7 (Del. Ch. Jun. 30, 2015)).

• Back-channel communications between a director and the controller regarding a proposed recapitalization

transaction during the transaction negotiations between the board's special committee and the controller, were a

factor in finding that the director lacked independence from the controller for demand futility purposes. However, for

another director, the court found that a shared interest in philanthropy and a shared belief in the benefits of founder

control were insufficient to support a finding of non-independence. The court also held that for another director, the

mere allegation that a director affiliated with a venture capital firm may rely on the controller for "deal flow," without

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

additional allegations, was insufficient to rebut the presumption of independence. (United Food and Com. Workers

Union v. Zuckerberg, 250 A.3d 862, 893-96 (Del. Ch. 2020) aff'd, 262 A.3d 1034 (Del. 2021).)

• In denying a motion to dismiss, the Delaware Chancery Court found it was reasonably conceivable that the directors

were not independent of the controller, in part because the controller had a history of removing directors who were

disloyal to the controller. The court asserted that it could infer that a stockholder's willingness to take retributive

action affects a director's independence, regardless of how material the directorship was to the director, when

coupled with other facts. The court also considered that the directors were of a "controlled mindset" because the

controlling stockholder dominated the board committee and how the board committee negotiated the transaction. (In

re Viacom Inc. S'holders Litig., 2020 WL 7711128, *21-25 (Del. Ch. Dec. 29, 2020, corrected Dec. 30, 2020).)

• In reviewing the independence of members of a special committee in an MFW analysis, a director who served

as a director or employee of the controller or its affiliates for over 20 years, who relied on the controller for his

primary employment, and who made at least $58 million from his work with the controller and its affiliates, was not

independent (In re Match Grp., Inc. Derivative Litig., 2022 WL. 3970159, at *19-20 (Del. Ch. Sept. 1, 2022))

The Delaware Supreme Court has cautioned that a director's personal and business ties to an interested party cannot be

analyzed separately from each other, but must be considered in their totality. The Sanchez court also held that a long-term

friendship supports a greater inference of compromise of independence than do "thin, social-circle friendships." As a result,

the Sanchez court held, for purposes of demand futility, that a director deriving primary employment and income from the

company and having a close friendship of more than 50 years with the company's chairman and largest stockholder was

not independent. (Delaware Cty. Emps. Ret. Fund v. Sanchez, 124 A.3d 1017, 1021-1022 (Del. 2015).)

In a similar vein, in reviewing demand futility, the Delaware Supreme Court ruled that a network of business relationships

and venture capital investments between two directors and the company's controlling stockholder and co-ownership of an

airplane between the controlling stockholder and another director, raised a reasonable doubt as to those directors' impartiality

(Sandys v. Pincus, 152 A.3d 124, 129-134 (Del. 2016) (Zynga)).

In a series of cases over several years, the Delaware Chancery Court considered the independence of directors in In re BGC

Partners, Inc., Derivative Litigation both for purposes of demand futility and dismissal under a Section 102(b)(7) exculpatory

provision. Most recently, the court held that one director was not independent for demand futility purposes because his

gratefulness for the directorship, which allowed him to support his family and pursue his passions, would likely impair his

ability to consider a litigation demand against the controller who appointed him. (In re BGC Partners, Inc. Derivative Litig.,

2022 WL 3581641, at *15-16 (Del. Ch. Aug. 19, 2022).)

Although the Sanchez, Zynga, BGC and other recent decisions may signal a greater willingness on the part of Delaware

courts to question a director's independence, at least in the context of demand futility, the Delaware Supreme Court has

confirmed there is still a strong presumption of director independence.

The Court explained that to overcome this presumption, the plaintiff must plead facts showing that the director's relationship

to the interested party is of a "bias-producing nature" showing either a personal or financial connection or that the directorship

was of substantial material importance to the director. In McElrath, the plaintiff argued that the interested party, Uber's ex-

CEO, could nominate and remove the director, and suggested the director might be loyal to him because the director was

appointed during a power struggle. The Delaware Supreme Court found that in a demand futility context, without more this

was not enough to show a bias-producing nature because the plaintiff did not present any facts to show a personal or financial

connection or that the directorship was of substantial material importance to the director. (224 A.3d 982, 995-96 (Del. 2020).)

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While Delaware courts have often considered how the receipt of past benefits influence a director's independence because

the director may feel a sense of owingness to the person who granted the benefits, the Chancery Court has also discussed

the possibility that the prospect of future directorships and financial rewards could render a director not independent.

In deciding dismissal under a Section 102(b)(7) exculpatory provision, the court in Goldstein I held there was a reasonable

inference a director was not independent from an activist investor who had responsibility for naming directors to the board,

where the transaction terms were questionable, it was the investor's practice to reward supportive directors with lucrative

directorships, the director had previously supported a similar transaction coordinated by the activist investor and financially

benefitted from it, and shortly thereafter was appointed by the investor to the board. The court also found it was reasonably

conceivable that another director was not independent, who was unemployed before being put on the board by the investor

and then was later placed on another of the investor's boards resulting in a financial gain. Although the court noted these

were both close calls, this may indicate a willingness of the courts to consider questioning the independence of directors

placed on board by activist investors or other repeat players (such venture capital and private equity firms) with a pattern of

rewarding directors that support their transactions. (Goldstein I, 2022 WL 1671006, at *46-50.)

These cases do not necessarily demonstrate shifting positions of the Delaware courts, but may be a reflection that any

case can only be determined on its own specific facts, taking into account the specific context for which independence is

being considered.

The context in which the court evaluates independence may affect the analysis. For example, independence can be reviewed

to determine whether a director is independent for purposes of either:

• Evaluating a transaction.

• Considering a pre-suit demand in the context of demand futility. For an explanation of demand futility and for further

discussion of decisions from the Delaware judiciary on director independence in the context of demand futility, see

Practice Note, Shareholder Derivative Litigation: When Demand Requirement Is Excused.

Some Delaware cases have suggested that it may be easier for a plaintiff to successfully dispute a director's independence

in the demand futility context than in the context of voting on a transaction because directors are naturally reluctant to

sue fellow directors. (Sciabacucchi v. Liberty Broadband Corp., 2022 WL 1301859, at *13- *15 (Del. Chan. May 2, 2022).)

Hence, a court may find a director is independent for purposes of approving a transaction but not for demand futility. For

example, in BGC Partners, the Chancery Court found a director was not independent for demand futility because the personal

importance of the directorship to the director could have clouded his consideration of a litigation demand against the person

who appointed him. However, in evaluating the independence of a special committee during an entire fairness analysis the

court found no evidence that the same director was not acting independently when negotiating against the controller. (BGC

Partners, 2022 WL 3581641, at *20-*21).)

An exception to the presumption of director independence is special litigation committees. Directors on special litigation

committees do not enjoy a presumption of independence but have the burden of establishing their independence. For

a discussion of special litigation committees, see Practice Note, Special Litigation Committees in Shareholder Derivative

Litigation.

Ratification for a Conflict of Interest

Although entire fairness presumptively applies to review of transactions in which half the directors are not disinterested and

independent, the business judgment rule can be restored if the stockholders ratify the action taken by the board.

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A common scenario in which stockholder ratification arises is in the context of equity incentive awards to directors, because

directors are considered to be interested in their own compensation, with no materiality standard (see Director Disinterest).

The Delaware Supreme Court has recognized three scenarios that involve the ratification defense in connection with

stockholder-approved equity incentive plans and awards made under those plans:

• When the stockholders approve the specific director awards.

• When the plan is "self-executing," meaning that the directors have no discretion when making the awards.

• When the directors exercise discretion and determine the amount and terms of the awards after stockholder

approval.

(In re Investors Bancorp, Inc. S'holder Litig., 177 A.3d 1208, 1222 (Del. 2017).)

The first two scenarios, in the court's words, "present no real problems" (Investors Bancorp, 177 A.3d at 1222). But in the

third scenario, the ratification defense cannot be used to extinguish the entire fairness standard of review when a breach

of fiduciary duty has been properly alleged, despite the incentive plan's limits. The board must still exercise its authority

equitably, consistent with its fiduciary duties.

Controlling-Stockholder Transactions

A transaction does not trigger entire fairness review just because the company has a controlling stockholder. The controller

must engage in a conflicted transaction. (In re Crimson Exploration, 2014 WL 5449419, at *12.)

Conflicted Controlling-Stockholder Transactions

The application of the entire fairness review typically arises in transactions where the controller is conflicted because the

controller either:

• Stands on both sides of the transaction. The transaction is with the company's controlling stockholder, even if

a majority of the directors are disinterested and independent (Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d 1110,

1117 (Del. 1994)). The entire-fairness review applies if there is a conflicted controlling-stockholder transaction,

even if there is no proof of actual coercion by the controlling stockholder, because the transaction is presumed to

be inherently coercive under Delaware law (In re Tesla Motors, Inc. S'holder Litigation, 2020 WL 553902, at *4-7

(Del. Ch. Feb. 4, 2020)). However, in Viacom, the Chancery Court discussed in dicta whether it is settled law that

the mere presence of a controller on both sides of a transaction is enough to trigger the entire fairness review.

Although the court discussed the arguments presented by both sides for whether the presence of a controller alone

is sufficient to require the application of the entire fairness test, the court ultimately held that it did not have to decide

this issue as a matter of law because the plaintiffs had sufficiently pled facts indicating that the controller received a

non-ratable benefit. (Viacom, 2020 WL 7711128, at *12-15).)

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• Competes with the other stockholders for consideration. This occurs when the controller receives a non-

ratable benefit because it receives different consideration or a unique benefit not shared with the other stockholders

(Crimson Exploration, 2014 WL 5449419, at *12). For examples of non-ratable benefits, see Non-Ratable Benefits.

Even in a transaction in which the controlling stockholder's interests conflicted with the minority stockholders', the plaintiff

must allege that the controller used their power in an unfair manner for there to be a breach of fiduciary duty (In re Molycorp.,

Inc. S'holder Deriv. Litig., 2015 WL 3454925, at *7 (Del. Ch. May 27, 2015)). A transaction between a controlling stockholder

and the company is not per se invalid under Delaware law. A controller transaction is perfectly acceptable if it satisfies entire

fairness (Monroe Cnty. Emp. Ret. Sys. v. Carlson, 2010 WL 2376890, at *2 (Del. Ch. June 7, 2010)).

For a discussion of whether the entire fairness review applies to non-transformative transactions in which the controlling

stockholder receives a non-ratable benefit (such as executive compensation), see Non-Transformative Controlling-

Stockholder Transactions.

Non-Conflicted Controlling-Stockholder Sale Transactions

It is presently not clear which standard of review applies in a sale of control transaction if the target company has a

non-conflicted controlling stockholder (when the controller is not the buyer, receives the same consideration as the other

stockholders, does not receive any other side benefits, and its interests do not otherwise diverge from the other stockholders).

One line of cases, the Synthes safe harbor line, seems to indicate that the business judgment rule is the applicable standard

of review for non-conflicted controlling stockholder sale of control transactions (In re Synthes, Inc. S'holder Litig., 50 A.3d

1022, 1033 (Del. Ch. 2012); In re Morton's Rest. Grp. Inc. S'holders Litig., 74 A.3d 656, 666 n. 53 (Del. Ch. 2013)). A recent

case seems to indicate that enhanced scrutiny under Revlon is the proper standard of review (unless Corwin cleansing

applies; see Practice Note, Fiduciary Duties in M&A Transactions: Restoring the Business Judgment Rule with a Stockholder

Vote: Corwin and its Progeny) (see Presidio, 251 A.3d 212, at 265-67). Therefore, until the Delaware Supreme Court decides

this issue it may remain an open question.

For a more detailed discussion of this issue, see Practice Note, Fiduciary Duties in M&A Transactions: Non-Conflicted

Controlling-Stockholder Transactions (Controller Is Not the Buyer and No Differential Consideration).

Non-Ratable Benefits

Non-ratable benefits that can create a conflict of interest arise in a variety of scenarios, including when the controller receives:

• Greater monetary consideration than the other stockholders.

• A different form of consideration than the other stockholders.

• A unique benefit that is uniquely valuable to the controller.

(Flannery v. Genomic Health, Inc., 2021 WL 3615540, at *17 (Del. Ch. Aug. 16, 2021)).

For example, the Delaware Chancery Court applied the entire fairness standard after it concluded that a company's decisions

to accumulate cash conferred a non-ratable benefit on a controlling stockholder, where the controlling stockholder had a

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

preferred stock redemption that required the company to have cash available for the redemption (Frederick Hsu Living Trust

v. Oak Hill Cap. Partners III, L.P., 2020 WL 2111476, at *33 (Del. Ch. May 4, 2020)).

The non-ratable benefit does not need to be extracted from the minority stockholders for entire fairness to apply (for

example, tax benefits that the controller received but that were never available to, and therefore were not taken from,

the minority stockholders). Entire fairness "presumptively applies whenever a controller extracts a non-ratable or unique

benefit" (emphasis in the original) (In re Tilray, Inc. Reorganization Litig., 2021 WL 2199123, at *13-14 (Del. Ch. June 1,

2021)).

Even if all stockholders receive the same basic consideration, a non-ratable benefit can arise if:

• The controller eliminates something bad for it and good for the other stockholders. For example, the elimination of

derivative claims can be a non-ratable benefit.

• All parties suffer a reduced price, but the controller receives cash needed to solve an idiosyncratic liquidity issue.

For example, the Chancery Court has inferred a unique benefit to a controller, based among other factors, on the

timing of a sale where a private equity fund stockholder was under pressure to sell the company quickly so it could

close its fund (Manti Holdings, LLC v. Carlyle Grp. Inc., 2022 WL 1815759, at *9 (Del. Ch. June 3, 2022)).

• The controller perpetuates its control. For example, in litigation involving the Viacom and CBS merger, the Delaware

Chancery Court found that the entire fairness review should apply because it was reasonably conceivable that the

controlling stockholder of Viacom received a unique benefit at the expense of the minority stockholders where the

plaintiff alleged that the controlling stockholder of both companies used the merger in question to consolidate control

of the two companies and install management and directors loyal to it to lead ViacomCBS, ensuring the controller

could retain and expand its control position. The controlling stockholder held around 80% of the voting power,

but only around 10% of the economic value of the companies and Viacom made a significant price concession in

exchange for the controller's governance demands for the combined company. (In re Viacom, 2020 WL 7711128, at

*16-18.)

Defining Control for Entire Fairness

The threshold issue in the court's review of the board's conduct in controlling-stockholder transactions is whether the

controller was in fact a controlling stockholder. Delaware law defines a controlling stockholder as a stockholder who either:

• Owns 50% or more of the voting power of the corporation.

• Exercises control over the business and affairs of the corporation.

(Kahn, 638 A.2d at 1113-14.)

A person can have voting power in a corporation even if they do not own the stock that the voting power relates to. For

example, in Blue v. Fireman, a proxy that gave an entity the ability to exercise a majority of a corporation's voting power

was sufficient to establish controller-status, even though the entity did not own the stock associated with the proxy (2022

WL 593899, at *16 (Del. Ch. Feb. 28, 2022).)

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In addition to determining whether a stockholder is a controlling stockholder for purposes of triggering the entire fairness

review, a determination that a stockholder is a controlling stockholder is also relevant to determining whether:

• That controlling stockholder owes fiduciary duties to the minority stockholders (see Who Owes Duties to Whom).

• Corwin can be used to restore the business judgment rule with a fully informed, uncoerced voted of a majority of

the disinterested stockholders. Corwin cannot cleanse a transaction that has a conflicted controlling-stockholder

(Larkin v. Shaw, 2016 WL 4485447, at *13 (Del. Ch. Aug. 25, 2016). For more information, see Practice Note,

Fiduciary Duties in M&A Transactions: Restoring the Business Judgment Rule with a Stockholder Vote: Corwin and

its Progeny and Corwin Cleansing.

Control by Minority Stockholders

Based on the control test, a stockholder can be a controlling stockholder and owe fiduciary duties to the other stockholders

even if it owns only a minority of the company's shares. However, a minority stockholder is not considered a controlling

stockholder unless it "exercises control over the business affairs of the corporation" (KKR Fin. Holdings, 101 A.3d 980 at 991).

To plead that a minority stockholder exercises actual control, a plaintiff must show facts that support that the stockholder

has "such formidable voting and managerial power" that, as a practical matter, it is no differently situated than if it had

majority voting control. The Delaware Chancery Court reaffirmed this standard in In re Essendant, Inc. Stockholder Litigation,

explaining that the court must be able to conclude that the minority stockholder's position was "so potent that the independent

directors [could not] freely exercise their judgment." In this case, the court found none of the markers of control, and noted

it would have been difficult for the minority stockholder to achieve these markers of control when two other entities had

larger voting blocks. (2019 WL 7290944, at *8-9 (Del. Ch. December 30, 2019).) For a discussion of some of the markers

of control, see Markers of Control for Minority Stockholders.

The question of whether a stockholder should be deemed controlling can only be answered on the facts of the particular

case. For example, in different cases:

• A 27.7% stockholder with two representatives on a board with ten members was not considered a controlling

stockholder (Morton's Rest. Grp., 74 A.3d at 661).

• A 49.7% stockholder with two representatives on a board with nine members was not considered a controlling

stockholder (Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1344 (Del. 1987)).

• A 43.3% stockholder with five representatives on a board with 11 members was considered a controlling stockholder

(Kahn, 638 A.2d at 1114).

In Crimson Exploration, the Delaware Chancery Court surveyed several previous decisions that had addressed the definition

of control and concluded that there is no "linear, sliding-scale approach whereby a larger share percentage makes it

substantially more likely that the court will find the stockholder was a controlling stockholder" (Crimson Exploration, 2014

WL 5449419, at *10).

Rather, the test for control is whether the stockholder exercised actual control over the board, not just management (see In

re Sanchez Energy Deriv. Litig., 2014 WL 6673895, at *8 (Del. Ch. Nov. 25, 2014), rev'd on other grounds by Delaware Cnty.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Emps. Ret. Fund, 124 A.3d at 1024); KKR Fin. Holdings, 101 A.3d at 995). A minority stockholder is deemed a controlling

stockholder if they either:

• Controlled the corporation, its board, or the transaction deciding committee by dominating the board's "corporate

decision-making process" while it considered the transaction.

• Controlled a majority of the board generally. A board's awareness of the minority stockholder's ability to make board

changes or take other coercive actions if they are displeased with the board or its decisions is evidence of general

board control.

(In re GGP, Inc. S'holder Litig., 2021 WL 2102326, at *13 (Del. Ch. May 25, 2021), aff'd in part and rev'd in part and remanded

on other grounds, 2022 WL 2815820 (Del. July 19, 2022).)

The exercise of "day-to-day managerial supremacy" has also led to a finding of general control (see In re GGP, 2021 WL

2102326, at *23 (noting In re Cysive, Inc. S'holder Litig. (836 A.2d 531, 552 (Del. Ch. 2003)), as an aggressive example

of Delaware controller jurisprudence, where managerial supremacy along with other factors led to a finding of control in

that case)).

For more detailed examples of cases where minority stockholder were controllers, see Examples of Minority Stockholders

as Controlling Stockholders.

Markers of Control for Minority Stockholders

Minority stockholders ordinarily are not considered controllers, but certain factors weigh in favor of a finding of control,

including:

• Board member nominations.

• Outsized influence by the stockholder.

• Past actions indicating exertion of control.

• Acknowledgments by the company in its SEC filings of the stockholder's influence.

• Whether the board took steps to neutralize the stockholder's control.

• Personal relationships with board members.

• Commercial relationships with the corporation that would give it leverage (such as status as a key customer or

supplier).

• Threats of removal, challenges, or retaliation against board members.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• Coercive contractual rights. For example, the Delaware Chancery Court has suggested that a stockholder's

separate contractual rights, when combined with significant stock holdings, can support a finding that a particular

stockholder is controlling, especially if the contractual right is used to induce the board to take, or refrain from taking,

certain actions (Superior Vision Servs. Inc. v. ReliaStar Life Ins. Co., 2006 WL 2521426, at *5 (Del. Ch. Aug. 25,

2006)).

Indications of a stockholder's general control over the board include, but are not limited to, the ability to:

• Elect directors.

• Amend the certificate of incorporation.

• Take other transformative actions (such as, break-up the corporation, merge the corporation, cash-out the public

stockholders, or sell all or substantially all of the corporation's assets).

• Materially alter the nature of the corporation and the public stockholders' interests.

(In re GGP, 2021 WL 2102326, at *20.)

Examples of Minority Stockholders as Controlling Stockholders

Examples of situations where Delaware courts have found that at the pleading stage it was reasonably inferred that a minority

stockholder is a controlling stockholder, include:

• A 39% stockholder who was also the CEO and chairman of the board and who "used his influence on the

corporation ... to his own benefit and to the detriment of the interests of the minority stockholders" (La. Mun. Police

Emp. Ret. Sys. v. Fertitta, 2009 WL 2263406, at *7 (Del. Ch. July 28, 2009)).

• A stockholder who held 48% of a corporation's stock, 82% of its debt, and entered into short-term forbearance

agreements with the corporation to time the corporation's restructuring (Hamilton Partners L.P. v. Highland Cap.

Mgmt., L.P., 2014 WL 1813340, at *13 (Del. Ch. May 7, 2014)).

• A 26% stockholder with significant veto rights over the company's ability to raise new debt financing or file for a

voluntary bankruptcy (Calesa Assoc., L.P. v. Am. Cap., Ltd., 2016 WL 770251, at *10 (Del. Ch. Feb. 29, 2016)).

Notably, the Calesa court distinguished Superior Vision Services and discounted the stockholder's contractual rights

in its analysis, even though those rights gave the stockholder effective control over the company's decision-making.

The decisions can potentially be reconciled in light of the fact that the Calesa stockholder's 26% stake may not be

significant enough even under Superior Vision Services.

• Elon Musk, as CEO, Chairman, and 22.1% stockholder, who was the company's "visionary" and whose own

"outsized influence" over Tesla and its stockholders had been acknowledged in the company's SEC filings (In re

Tesla Motors, Inc., 2018 WL 1560293, at *13-19 (Del. Ch. Mar. 28, 2018)).

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• Two brothers who together owned 15% of the target and who were also founders and controlling stockholders

of the asset management firm that managed the target company. In finding that the brothers were controlling

stockholders despite their minority ownership, the court relied on a majority of the special committee's directors' lack

of independence from the brothers as proof that the brothers had dominated and controlled the negotiations and

special committee's approval of the transaction. (FrontFour Cap. Grp. LLC v. Taube, 2019 WL 1313408 at *22-25

(Del. Ch. March 11, 2019).)

• A less than 35% stockholder because among other factors:

• the stockholder had the ability to nominate 4 of the 12 directors (along with proportionate representation

on board committees) and had longstanding ties with two other directors (who worked for, and served as

directors on, other portfolio companies of the stockholder, where the income received for these positions was

material to them);

• the director CEO was hired when the stockholder was a majority owner and the compensation from his

position was a bulk of his income;

• the existence of certain blocking rights in the stockholders agreement gave the stockholder more power than

a majority owner normally has; and

• the stockholder had existing relationships with the company's advisors.

(Voigt v. Metcalf, 2020 WL 614999, at *13-22 (Del. Ch. Feb. 10, 2020).)

• Minority members of a limited liability company that exercised actual control of the company when they used

blocking rights to block all of the company's efforts to finance its operations, leading to the company's bankruptcy

and the subsequent sale of the company to the minority members at a discounted price. Although a blocking right

by itself is not enough to find control, because the company was financially struggling, the blocking rights gave the

members "the unilateral power to shut [the company] down," which they used in a scheme to advance their own

interests. (Skye Mineral Inv., LLC v. DXS Cap. (US) Ltd., 2020 WL 881544, at *26-27 (Del. Ch. February 24, 2020).)

(This case involved members of a limited liability company, and not stockholders, but the court applied the same

common law fiduciary duty analysis.)

Legal Standard for a Control Group

Even if no individual stockholder owns enough shares or exerts enough control to qualify as a controlling stockholder, two

or more stockholders, working in tandem, may collectively be considered a control group for purposes of the standard of

review for controlling-stockholder transactions.

For a control group to exist there must be both:

• A legally significant connection between the members of the group.

• An exercise of actual control of the board by the group, either generally or regarding the transaction in question.

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(In re Pattern Energy, 2021 WL 1812674, at *41.)

To constitute a control group, allegations of mere "parallel interests" between the stockholders are insufficient (Cox

Commc'ns, 2006 WL 1586375, at *6). In Sheldon v. Pinto Tech. Ventures, L.P., the Delaware Supreme Court adopted the

"legally significant connection" standard to determine whether a control group exists. This standard requires showing the

stockholders are connected in a legally significant way to work together toward a common goal. Examples of a legally

significant connection include a contract or agreement, common ownership, or other arrangement. (220 A.3d 245, 251-52

(Del. 2019).)

To show that there is a legally significant connection, there must be an actual agreement, though it does not need to be a

formal or written agreement. (Garfield v. Blackrock Mortg. Ventures, LLC, 2019 WL 7168004, at *8 (Del. Ch. Dec. 20, 2019)

(citing Sheldon, 220 A.3d at 251-52).) The agreement should require the parties to work toward a common goal related to

the transaction at issue, not merely govern the parties' relationship if it has no bearing on the transactions (see Riskin v.

Burns, 2020 WL 7973803, at *17 (Del. Ch. Dec. 31, 2020), cert. denied, 2021 WL 303999 (Del. Ch. Jan. 29, 2021), and

appeal refused, 2021 WL 640552 (Del. Feb. 18, 2021)). This is a fact-intensive inquiry that reviews both:

• Historical ties.

• Transaction-specific ties.

Examples of cases where plaintiffs have pled sufficient facts for Delaware courts to infer a control group, include:

• In re Hansen Medical, Inc., where the Delaware Chancery Court found that among other factors, a long history of

cooperation and coordination between the group members in their investments in multiple entities, self-description

as a group in SEC public filings, and direct negotiation with the acquiring company and concurrent entry into the

principal documents for the transaction in question was sufficient to infer the existence of a control group (2018 WL

3030808, at *7 (Del. Ch. Jun. 18, 2018)).

• Garfield, where the Delaware Chancery Court found that two stockholders' ten-year history of co-investment in

the subject company, description in public offering documents as "strategic partners," and direct "collective unit"

negotiation with management about a restructuring was sufficient to infer the existence of a control group (2019 WL

7168004 *9-10 (Del. Ch. Dec. 20, 2019)).

By contrast, examples of cases where Delaware courts have found that at the pleading stage there were not sufficient facts

to infer a control group, include:

• Van der Fluit v. Yates, where the Chancery Court held that agreements executed by the stockholders did not

support the existence of a control group because the agreements did not relate to the challenged transaction and

the agreements were signed by all of the stockholders, not just the stockholders that were alleged to be part of the

control group. Regarding the two co-founders, the court noted there were no facts pled showing they acted together

or had a personal relationship or that described their working relationship. The facts pled only demonstrated the

existence of a concurrence of self-interest, not a control group. (2017 WL 5953514, at *6 (Del. Ch. Nov. 30, 2017).)

• Patel v. Duncan, where the Chancery Court found there was no legally significant connection to establish a control

group in part due to the historical ties between the venture capital defendants being weaker than in Garfield, where

other than the co-investment in the subject company the venture capitalists were "alleged to have crossed paths

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

only once" in another investment. In arriving at this conclusion, the court specifically noted that "[a]llegations that

'venture capital firms in the same sector crossed paths in a few investments' are insufficient to show the 'long history

of cooperation and coordination'" necessary to establish a legally significant connection constituting a control group.

(2021 WL 4482157, at *12 (Del. Ch. Sept. 30, 2021) (quoting Sheldon v. Pinto Tech. Ventures, L.P., 2019 WL

336985, at *9 (Del. Ch. Jan. 25, 2019), aff'd, 220 A.3d 245 (Del. 2019)).

Control Group That Includes a Controlling Stockholder

It is theoretically possible for a control group to include both a controlling stockholder (who on its own is a controlling

stockholder) and one or more minority stockholders. The Delaware Chancery Court recently considered this issue and

applied a two-part test (both parts of which must be met) for determining whether a control group exists when one of the

group members on its own is a controlling stockholder:

• The "legally significant connection" standard that applies to determine whether a control group is present when

there is no individual stockholder that qualifies as a controlling stockholder (see Legal Standard for a Control

Group).

• The independent controlling stockholder agrees "to share ... or to impose limitations on, its own control power (such

as through a voting agreement) for some perceived advantage as part of [that] legally significant relationship.”

(Gilbert v. Perlman, 2020 WL 2062285 at *7 (Del. Ch. Apr. 29, 2020) (quoting Almond v. Glenhill Advisors LLC, 2018 WL

3954733, at *26 (Del. Ch. Aug. 17, 2018), aff'd, 224 A.3d 200 (Table) (Del. 2019)).)

As evidenced by the court's decision in Gilbert v. Perlman, however, pleading the second part of the test is difficult because

entering into a voting agreement alone is insufficient. Instead, the plaintiff must also show that the independent controlling

stockholder limited its control power with the minority stockholders as part of an exchange to obtain their necessary

participation in the transaction (Gilbert, 2020 WL 2062285 at *8-9).

Control by Non-Stockholders

It is an open question under Delaware law whether non-stockholders that have and use soft power (non-voting power) to

control the board can be controllers with fiduciary duties and that can trigger an entire fairness review. Examples of soft

power include:

• Relationships with directors or key advisors.

• The exercise of contractual rights that direct the company to a particular outcome.

• Commercial relationships that provide leverage over the company (for example, a key customer or supplier).

In Pattern Energy, the Chancery Court suggested that the exercise of soft power by a non-stockholder may be sufficient to

trigger an entire fairness review in certain cases, but declined to make a decision on control without additional facts. The

Chancery Court explained that the non-stockholders in a potential control group had three sources of soft power, including

long historical relationships between the non-stockholders and corporate officers, control of an entity that was an essential

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

part of the company's supply chain, and a contractual consent right over the company's major transactions that it actively

inserted into discussions regarding the transaction (In re Pattern Energy, 2021 WL 1812674, at *37-46.)

Controllers and Exculpation

It is unclear if exculpatory provisions benefit controlling stockholders in their role as controllers under current Delaware

law. Several Chancery Court decisions have held that exculpatory provisions do not benefit the controlling stockholders

themselves in their role as controllers (In re Dole Food Co., Inc. S’holder Litig., 2015 WL 5052214, at *39 (Del. Ch. Aug.

27, 2015) (citing In re Emerging Commc'ns, Inc., 2004 WL 1305745, at *38 (Del. Ch. May 3, 2004))). However, in Presidio,

the Chancery Court described this as an open question that it need not decide given that it found that the controller had not

breached its duty of care, after noting that in Shandler v. DLJ Merchant Banking, Inc., the court had held that a controlling

stockholder could not have breached its duty of care if its director representatives had been exculpated from duty of care

liability (2010 WL 2929654 (Del. Ch. Oct. 1, 2014)). Therefore, until the Delaware Supreme Court decides this issue it may

remain an open question (Presidio, 251 A.3d at 285).

A controller engaging directly or indirectly in an interested transaction is potentially liable for breach of fiduciary duty even if

it participated in the transaction through intervening entities. The plaintiff does not have to make a case that the controller

aided and abetted breaches committed by the directors (In re EZcorp Inc. Consulting Agreement Deriv. Litig., 2016 WL

301245, at *9 (Del. Ch. Jan. 25, 2016), reconsideration granted in part, 2016 WL 727771 (Del. Ch. Feb. 23, 2016).)

Non-Transformative Controlling-Stockholder Transactions

The extent to which the entire fairness review is applied to non-transformative transactions in which the controlling

stockholder receives a non-ratable benefit is unsettled in Delaware law. In one line of cases, the Delaware Court of Chancery

has held that decisions that are not transformative, such as decisions over annual compensation to a controlling stockholder,

are entitled to more deference than entire fairness, even without a full set of procedural protections (In re Tyson Foods, Inc.

Consol., 919 A.2d 563, 587 (Del. Ch. 2007)). The Dolan court held that absent concerns of an informational advantage on

the part of the stockholder or concerns that the controller will exercise leverage over the other stockholders, the business

judgment rule applies, even to a decision involving the controlling stockholder, if the decision was made by a body composed

of a majority of independent directors (Dolan, 2015 WL 4040806, at *6).

In another line of cases, the Chancery Court ruled that the weight of authority demonstrates that despite Dolan, the entire

fairness framework applies not only to squeeze-out mergers (the context in which it arises most frequently), but to any

transaction in which the controller extracts a non-ratable benefit, including compensation arrangements. In contrast to Dolan,

the EZcorp court stated that the approval of either an independent board committee or a majority of the minority stockholders

was insufficient to justify the application of the deferential business judgment rule, and instead would only result in a burden

shift to the plaintiff to show that the transaction was not fair. (In re EZcorp, 2016 WL 301245, at *11-12.)

In a more recent case, Tornetta v. Musk, the Chancery Court sided with the EZcorp line of cases, finding that the entire

fairness review standard applied to decisions of executive compensation for a controlling stockholder who was also the

chief executive officer. In reaching its decision, the court focused on the potential for coercive influence by an "800-pound

gorilla," (Elon Musk) over directors and unaffiliated stockholders. (250 A.3d 793, 708-800 (Del. Ch. 2019).) The court also held

that if the board's decision had complied with the dual procedural protections set out in In re MFW Shareholders Litigation,

, the business judgment rule would have applied, instead of the entire fairness review (67 A.3d 496 (Del. Ch. 2013), aff'd,

Kahn v. M&F Worldwide Corp. 88 A.3d 635 (Del. 2014)). To comply with these procedural protections, the transaction must

have been conditioned up front on the approval of both:

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• An independent, fully functioning special committee of the board.

• An uncoerced and informed vote by a majority of the minority stockholders.

Notably, these dual protections previously only applied in the context of transformational transactions, such as mergers.

(Tornetta, 250 A.3d at 800).)

For a detailed discussion of the application of the dual procedural protections of MFW in transformational transactions, see

Practice Note, Fiduciary Duties in M&A Transactions: Business Judgment Rule Using Procedural Protections.

Fraud on the Board

The standard of review if there has been fraud on the board is entire fairness. The application of the entire fairness standard

of review when there is fraud on the board has recently become an increased focus area of the Delaware courts. The fraud

on the board theory of fiduciary duty liability requires that only one director (or other corporate fiduciary) be conflicted.

A recent case, In re Pattern Energy, outlines the requirements to show fraud on the board at the pleading stage, which

include:

• A self-interested fiduciary. The fiduciary (such as director or officer) committing the alleged fraud on the board

must be materially interested (a material conflict) in the transaction or matter (for example, if the transaction is a

merger, and the fiduciary committing the alleged fraud is trying to seek control or a benefit from the company post-

merger). The court noted in dicta that fraud on the board can also be committed by an advisor.

• An inattentive or ineffective board. The board must be "inattentive or ineffective" and permit the manipulation.

• Deception or manipulation of the board. The fiduciary must deceive or manipulate the board. For example, if the

fiduciary:

• deceives the board into favoring a certain bidder; or

• fails to disclose its conflict of interest in the transaction to the board.

• A material misstatement or omission. The deception must be material. An omission is material "if the undisclosed

fact is relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in

decisionmaking."

• The effect is outcome-determinative. It must be reasonably conceivable that the deception tainted the

decisionmaking of the disinterested and independent directors and caused the board "to take action or inaction that

was outcome-determinative."

(In re Pattern Energy, 2021 WL 1812674, at *33.)

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Two of these factors involve materiality, a self-interested fiduciary (resulting from a material conflict) and a material

misstatement or omission. Generally, if the conflict is material to the conflicted fiduciary, the board will view the information

as material to its decisionmaking (In re Mindbody, Inc., 2020 WL 5870084, at *24 (Del. Ch. Oct. 2, 2020)).

In the context of a sale of control, these factors are distinguishable from the factors that trigger enhanced scrutiny review

under Revlon (see Sale of Control). Revlon enhanced scrutiny applies in situations where because of the situational dynamics

potential conflicts exist as compared to entire-fairness review which applies if actual conflicts exists. Therefore, the conduct

that triggers the entire fairness review must be more egregious than the conduct that triggers a Revlon enhanced scrutiny

review. The Chancery Court explained this difference in In re Pattern Energy, by stating that to find fraud on the board that

triggers an entire fairness review, as compared to an enhanced scrutiny review:

• The conflicted fiduciary must be more than overweening, they must be fraudulent or outright manipulative.

• The board must be more than supine, it must be deceived and allow the deception.

• The deception must affect the outcome.

The Chancery Court determined there were not sufficient facts to find fraud on the board and elevate the standard of review

from enhanced scrutiny to entire fairness because there was not "outcome-determinative deception." The court explained

that the belated half-truths by the officer did not appear to have an effect on the sales process and that although the board

did not vigorously enforce its instructions or manage conflicts, these deficiencies did not facilitate the officer's deception. (In

re Pattern Energy, 2021 WL 1812674, at *33-36.)

Delaware courts have, however, applied or considered an entire fairness standard of review based on fraud on the board

allegations in other cases. For example:

• In Mills Acquisition Co. v. Macmillan, Inc., self-interested officers did not disclose that they tipped off their favored

bidder in a way that tainted and manipulated the board's process. Not only was there deception by the officers, but

the board's lack of oversight of the auction process allowed the officers to engage in the misconduct. The court

explained that this "illicit manipulation of the board's deliberative processes by self-interested corporate fiduciaries"

triggered the entire fairness review. (559 A.2d 1261, 1279-1280 (Del. 1989).)

• In Fort Myers Gen. Emps'. Pension Fund v. Haley, allegations of a director's failure to disclose his post-closing

compensation discussions with the other merger party to the company's board, when the director was negotiating

the transaction on behalf of the company during a time of deal uncertainty, was sufficient to rebut the business

judgment rule (235 A.3d 702, 719-24 (Del. 2020)).

• In In re Mindbody, allegations of undisclosed material conflicts by an officer to the board, along with other evidence

that it was reasonably conceivable the board did not adequately oversee the officer, led the Chancery Court to note

that it was an open question as to whether entire fairness, rather than Revlon may ultimately apply at trial (In re

Mindbody, 2020 WL 5870084, at *23-25, n.229).

Avoiding Entire Fairness Review with Procedural Protections

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

In virtually all cases where entire fairness presumptively applies, the parties can structure the transaction either to shift the

burden of proof of the transaction's fairness back to the plaintiff or to qualify for the presumptions of the business judgment

rule.

For example, if a corporation does not have a controlling stockholder, and the board lacks an independent and disinterested

majority, the board can potentially still qualify for business judgment review by empowering a committee of independent

and disinterested directors to make the relevant decision (DGCL § 141(c)). If the board delegates its full power to address

an issue to a board committee, then the judicial analysis focuses on the committee. A decision made by a disinterested,

independent, and informed majority of the committee is protected by the business judgment rule. (Frederick Hsu Living Trust,

2017 WL 1437308, at *33; Trados II, 73 A.3d at 65 n.39.). For a more detailed discussion on how the business judgment

rule may be restored in conflicted-board transactions, see Practice Note, Fiduciary Duties in M&A Transactions: Restoring

the Business Judgment Rule in Conflicted-Board Transactions.

These structures are used most frequently in the context of M&A transactions between a corporation and its controlling

stockholder and are discussed in depth in Practice Note, Fiduciary Duties in M&A Transactions: Lowering the Standard

of Review or Burden of Proof with Procedural Protections. The use of procedural protections in the context of executive

compensation for a controlling stockholder is a more recent expansion of these protections (see Non-Transformative

Controlling-Stockholder Transactions).

Intermediate Standard of Review: Enhanced Scrutiny

In certain situations, the possibility of a conflict of interest triggers heightened scrutiny of the board's conduct when

determining if the directors carried out their fiduciary duties. This means the business judgment rule is not available until

certain standards are met, because the directors' action or inaction could potentially have a more damaging effect on the

stockholders.

Defensive Measures Against Takeovers

In a successful contested takeover, management and the board of directors are frequently replaced by the hostile actor.

Because of the possibility that the directors will act to save their seats on the board rather than in the best interests of the

corporation, Delaware courts apply a heightened test when examining anti-takeover defensive measures (Unocal v. Mesa

Petroleum Co., 493 A.2d 946, 954-55 (Del. 1985)). When implementing defensive measures, the directors must show:

• Reasonable grounds for believing a danger existed to the operation or policies of the corporation. Because the

Unocal analysis is fact-intensive, the board of directors should ensure that there is a reasonable and good faith

investigation by non-management directors (if possible) before any defensive measures are put in place.

• Defensive measures were reasonable in relation to the threat. Defenses that preclude all offers for the corporation

or coerce stockholders to approve a management-sponsored bid are generally considered unreasonable in relation

to a threat.

If the directors fail to prove the two elements above, they must show that the actions they took were entirely fair to the

corporation (Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1377 n.18 (Del. 1995)).

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

For further discussion of defensive measures in the context of hostile takeovers, see Practice Notes, Defending Against

Hostile Takeovers and Poison Pills: Defending Against Takeovers/Stockholder Activism and Protecting NOLs.

Interference with Stockholder Vote

Stockholders can influence the management of the corporation by:

• Electing (or withholding votes for) directors.

• Selling their shares of stock.

The right to elect directors is important because it allows stockholders to influence the management of the corporation

without selling their shares. Therefore, the Delaware courts apply special standards of review, and sometimes multiple levels

of review, to board actions affecting corporate elections. However, Delaware courts have struggled to define the standard

of review the courts should use to evaluate this type of director action (Coster v. UIP Cos., Inc., 2022 WL 1299127, *8 n.58

(Del. Ch. May 2, 2022)).

Inequitable Purposes: Schnell

One standard of review Delaware courts have used to evaluate director action impacting director elections is based on

Schnell v. Chris-Craft Indus., Inc. Under Schnell, Delaware courts may invalidate board actions taken for inequitable

purposes, even if the board's actions are legally authorized (285 A.2d 437, 440 (Del. 1971)). The Chancery Court

has explored the meaning of inequitable purposes and held that in the context of stockholder-franchise challenges,

Schnell should be applied sparingly in the limited scenario where directors have no good faith reason for approving the

disenfranchising action (Coster, 2022 WL 1299127, at *9).

Compelling Justification: Blasius

In Blasius Indus., Inc. v. Atlas Corp., the Delaware Chancery Court held that even if the board is acting in good faith, if the

board acts with the primary purpose of interfering with the fundamental right to elect directors, the board must show it had

compelling justification for doing so (564 A.2d 651, 661 (Del. Ch. 1988)). If the board can show it had a compelling justification,

then the business judgment rule applies. Meeting the compelling justification standard is difficult, so courts typically apply it

only when the board truly acts with the primary purpose of disenfranchising the stockholders (see Rosenbaum v. CytoDyn

Inc., 2021 WL 4775140, *14 (Del. Ch. Oct. 13, 2021)). Although uncommon, Delaware courts have found circumstances

where a board has a compelling justification. For example, on remand from the Delaware Supreme Court, the Chancery

Court in Coster found that there was a compelling justification for the board to issue stock to a new stockholder to break a

deadlock for the election of directors, based in part on the fact that the stock issuance:

• Both rewarded an essential employee and was part of a succession plan the original stockholders desired prior to

the deadlock.

• Avoided a custodial action that would have put the company in default under key contracts.

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(Coster, 2022 WL 1299127, at *11-14.)

Modified Unocal Standard

In Mercier v. Inter-Tel, Inc., the Delaware Chancery Court proposed another standard for reviewing the board's postponement

of a stockholder vote to get more votes for a merger that was going to be voted down. Deciding that Blasius was too strict

a standard, the court applied a modified Unocal standard that required the directors to show that:

• They pursued a legitimate corporate objective motivated by a good faith concern for the stockholders' best interests

and did not preclude the stockholders from their right to vote or coerce them to vote in a particular way.

• Their actions were reasonable in relation to the legitimate objective.

Although the court applied a modified Unocal standard, it also found that the directors had a compelling justification for their

actions. (929 A.2d 786, 810-11 (Del. Ch. 2007).)

For a discussion of how the modified Unocal standard has been applied in the context of enforcing advance notice by-law

provisions, see Board's Enforcement of Advance Notice By-Laws.

Additional Review May Be Required Even if the Action Satisfies Entire Fairness

An additional review of the board's actions may be necessary in circumstances involving stockholder disenfranchisement,

particularly a stockholder's right to elect directors, even if the board's actions survive an entire fairness review. In reversing

and remanding Coster to the Chancery Court, the Delaware Supreme Court held that even though a stock issuance to break

a deadlock passed an entire fairness review, the board's actions must still be reviewed to show:

• The board did not act for inequitable purposes (based on Schnell).

• If the board acted in good faith but for the primary purpose of disenfranchisement, the board had a compelling

justification to do so (based on Blasius).

(Coster v. UIP Co., Inc., 255 A.3d 952 (Del. 2021) (calling this a Schnell/Blasius review).)

Fitting the Standards Together

It is unclear how the various standards of review work together.

The Chancery Court has suggested that Schnell should only apply if there is no good faith basis for approving the action

and that Blasius should apply if there is a good faith basis for approving a disenfranchising action. However, the court

acknowledged that it remains unclear whether Blasius and Schnell are two sides of a unified standard or if Schnell is an

independent standard. (Coster, 2022 WL 1299127, at *8-9, n.59.)

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

The Delaware Supreme Court in Coster did not consider how a Unocal analysis should fit in with the Schnell/Blasius review

(Coster, 255 A.3d at 963 n.66). The Delaware Chancery Court has further noted the need to bring the Blasius and Unocal

standards together. (Coster, 2022 WL 1299127, at *8 n.58).

Board's Enforcement of Advance Notice By-Laws

Delaware courts have also applied enhanced scrutiny to review the board's enforcement of advance notice by-law provisions

(provisions requiring stockholders to follow certain procedures to nominate directors for election; see Standard Clause, By-

Laws (DE Public Corporation): Advance Notice). Even if stockholders do not technically comply with unambiguous advance

notice by-laws that were adopted on a clear day, Delaware courts may still review the conduct to determine if the board

was justified in enforcing the by-law against the stockholder or whether it should have waived compliance (Strategic Inv.

Opportunities LLC v. Lee Enter. Inc., 2022 WL 453607, at *14-15 (Del. Ch. Feb. 14, 2022); CytoDyn, 2021 WL 4775140,

at *15).

In CytoDyn, dissident stockholders submitted their board nomination notice one day before the deadline, which the board

rejected a month later claiming the notice was deficient. The Chancery Court indicated that Blasius could apply to advanced

notice by-law disputes, but did not apply Blasius to the case because it found no evidence of manipulative conduct. Instead,

after applying a contractual analysis to find that the notice was deficient the court reviewed the board's rejection of the

nomination under Schnell, but found no inequitable conduct. The court focused on the fact that the dissident shareholders

waited until the day before the deadline to submit the notice, leaving them no time cure a deficient notice. The court suggested

that the stockholders would have had a stronger argument that the board's conduct was inequitable if they had submitted

the notice well in advance of the clear deadline. (CytoDyn, 2021 WL 4775140, at *14-22.)

In Lee, the Chancery Court applied the modified Unocal standard used in Mercier to review the board's rejection of a

nomination notice. The court reasoned that it could not "ignore the defensive mindset" the board was operating under when

it rejected the notice because the rejected nominations were part of a hostile takeover bid. In finding that the board's actions

were reasonable, the Chancery Court relied on the fact that:

• The by-laws were unambiguous and were adopted on a clear day.

• The by-law requirements were reasonable.

• There was no evidence of bad faith or manipulative or inequitable conduct by the board.

• It was the stockholder's own delay that prevented it from satisfying the requirements.

(Lee, 2022 WL 453607, at *15-18.)

Sale of Control

Once a change of control of the corporation becomes inevitable, both the focus of the directors' efforts and the standard

of review under which the directors' conduct is judged change. The business judgment rule ceases to be available until

certain hurdles are met, because the specter of a conflict of interest exists in which the directors will take action to benefit or

entrench themselves at the expense of the stockholders. The burden is on the board of directors to obtain the highest value

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

reasonably available to the stockholders ("Revlon duties") (Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173,

182 (Del. 1986)). Usually the highest value is interpreted to mean the highest purchase price, but the board of directors can

consider other factors such as certainty of completion in light of required financing and governmental consents.

Revlon duties attach only once the directors have initiated an active bidding process or decided to sell the company in a

change-of-control transaction or if a sale of control or break-up of the company has become inevitable. The board is not

subject to Revlon duties merely because the corporation is in play or a candidate for takeover (see Lyondell Chem. Co. v.

Ryan, 970 A.2d 235, 242 (Del. 2009)).

For detailed discussion of Revlon scrutiny in change-of-control transactions, including the types of transactions that trigger

Revlon, satisfying enhanced scrutiny, liability for failure to satisfy Revlon, and restoring the presumptions of the business

judgment rule under the Corwin decision, see Practice Note, Fiduciary Duties in M&A Transactions: Sale of Control.

No Enhanced Scrutiny for Dissolutions

The Delaware Chancery Court has held that a board's decision to adopt and implement a plan of dissolution does not

trigger enhanced scrutiny under Revlon or Unocal (Huff Energy Fund, L.P. v. Gershen, 2016 WL 5462958, at *13 (Del. Ch.

Sept. 29, 2016)). The court explained that Revlon applies only to final stage transactions like a sale or break-up of the

company. Dissolutions, by contrast, require a three-year wind-up period during which the directors maintain their duty to act

in the best interests of the corporation (see Practice Note, Dissolving a Delaware Corporation: Continuation of Corporation

after Dissolution).

The court also rejected the argument that the dissolution constituted an unreasonable poison pill under Unocal since it

would prevent the plaintiff stockholder from buying any more shares of the company. Given that the company must wind up

its affairs following dissolution, there is not a specter of entrenchment on the part of the directors.

Subsidiary Duties

The duty of care and the duty of loyalty represent the two main fiduciary duties of the board of directors, but certain

components of those duties are sometimes singled out and discussed as stand-alone duties.

Duty of Good Faith

Good faith is not a separate fiduciary duty, but is a component of the duty of care and the duty of loyalty, as follows:

• Duty of care. A director must use good faith when exercising the duty of care. If a plaintiff can prove that the

director acted in bad faith, then the presumptions of the business judgment rule do not protect the director from

liability. Similarly, directors cannot seek limitation of liability under Section 102(b)(7) of the DGCL for actions taken in

bad faith. Consequently, if a corporation's charter exculpates the directors under Section 102(b)(7) for breaches of

the duty of care, a plaintiff must demonstrate bad faith on the directors' part to succeed on a fiduciary duty claim.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

• Duty of loyalty. A director acting in bad faith does not act in the best interest of the corporation. In Stone v. Ritter,

the Delaware court said the failure to act in good faith does not automatically result in a breach of duty, but becomes

a factor when determining a breach of the duty of loyalty (Ritter, 911 A.2d at 369-70).

Duty to Obey the Law

Directors have a duty to comply with the law. If a director knowingly breaks the law, which is evidence of bad faith, the

director is denied the protection of the business judgment rule and cannot benefit from limited liability under Section 102(b)

(7) of the DGCL. Breaking the law for the interest of the corporation is not an excuse. For example, directors breach their

fiduciary duties when they pay bribes to foreign officials even if it results in a large profit for the corporation (Metro Commc'n

Corp., BVI v. Advanced Mobilecomm Tech., Inc., 854 A.2d 121, 131 (Del. Ch. 2004)).

Duty of Disclosure

Directors also hold a fiduciary duty to communicate honestly with the stockholders and to make full and fair disclosures.

The duty of disclosure is a specific application of the directors' fiduciary duties of care and loyalty (In re GGP, Inc. S'holder

Litig., 2022 WL 2815820, at *16 (Del. July 19, 2022)). This duty, also referred to as a duty of candor, does not obligate the

board to provide all of the corporation's financial or business information to the stockholders. Rather, the information must

meet a materiality standard of a substantial likelihood that the disclosure of the omitted fact would have been viewed by

the reasonable stockholder as having significantly altered the total mix of information made available (Rosenblatt v. Getty

Oil Co., 493 A.2d 929, 944 (Del. 1985)).

Delaware law does not require the board of directors to disclose information simply because that information "might be

helpful" (Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170, 1174 (Del. 2000)). The courts have similarly admonished against "the

fallacy that increasingly detailed disclosure is always material and beneficial disclosure" (Zirn v. VLI Corp., 1995 WL 362616,

at *4 (Del. Ch. June 12, 1995), aff'd, 681 A.2d 1050 (Del. 1996)). The board is also entitled to keep certain information

confidential in order for the corporation to succeed (Stroud v. Grace, 606 A.2d 75, 89 (Del. 1992)).

The Delaware Court of Chancery has identified four recurring scenarios where the duty of disclosure may arise:

• When the board of directors seeks a statutorily required stockholder approval for an action, directors have a

fiduciary duty to disclose fully and fairly all material information that the board controls. For example, a proxy

statement for the approval of a merger would be misleading if it failed to disclose a CEO's personal financial

interest in the merger (In re Lear Corp. S'holder Litig., 926 A.2d 94, 114 (Del. Ch. 2007)).

• When the board of directors seeks a stockholder ratification that is not required by the DGCL of a transaction in

which a director or officer has a personal interest that conflicts with the corporation's interest, directors must disclose

all material facts that the board controls.

• When a director communicates publicly or directly with stockholders, with or without a request for stockholder

action, the director must not speak falsely so as to misinform the stockholders. In other words, if a director discloses

information, it must be truthful. The duty to disclose if the disclosure is not part of a request for stockholder action,

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

is only breached if the director deliberately misinforms the stockholders (In re Zimmer Biomet Hldgs., Inc., 2021 WL

3779155, at *12 (Del. Ch. Aug. 25, 2021)).

• When a director either directly buys or sells shares from or to an outside stockholder in a private stock sale, the

director must disclose any material information that qualifies as special facts or circumstances, including knowledge

of important transactions, prospective mergers and probable sales of entire assets or business. The duty to disclose

in this scenario only arises if the director also deliberately misleads the stockholder about those facts.

(In re Wayport, Inc. Litig., 76 A.3d 296, 314-15 (Del. Ch. 2013).)

In sales of public corporations, the SEC's rules promulgated under the Securities Exchange Act of 1934 govern much

of the disclosure that the target company is required to make. For information about these rules, see Practice Note, Proxy

Statements: Public Mergers. Beyond these required disclosures, stockholder plaintiffs frequently bring Revlon claims alleging

that the board of directors of the target company failed to disclose other material information to the stockholders in the proxy

statement, such as:

• Management's projections for the company on a stand-alone basis.

• The compensation and potential conflicts of the financial advisor.

• Details of the background to the transaction and how the board reached a decision to approve a sale.

The courts measure each of these claims against the reasonable-investor standard, with the analysis turning on the specific

facts of the case.

For further discussion of the requirements for disclosures to stockholders in the context of public merger transactions, see

Practice Note, Fiduciary Duties in M&A Transactions: Duty of Disclosure.

Abdication of Duty of Disclosure

The Chancery Court recently issued an opinion in the Pattern Energy case, at the motion to dismiss phase, finding it

reasonably conceivable that the board acted in bad faith by its total delegation of the preparation of a merger proxy statement

to conflicted management in violation of the directors' fiduciary duty of loyalty, and that therefore, the breach could not be

exculpated under DGCL § 102(b)(7).

A finding of bad faith is very rare. However, in this case, the board delegated full authority to prepare and execute the merger

proxy to officers that the board knew were conflicted and did not "reserve authority to review, alter, or discuss" the proxy

before it was filed. As a result the court held that it was reasonably conceivable that the board had abdicated its duty of

disclosure in violation of the duty of loyalty as "[b]ad faith is reflected in the choice of agent and the complete scope of

delegation." (In re Pattern Energy, 2021 WL 1812674, at *26, *60-61.)

Directors should take note of this decision and ensure that their board processes allow them to maintain oversight over the

disclosure in any merger proxy statement or other similar material disclosures to stockholders and that the related board

minutes sufficiently document their disclosure review process.

Fiduciary Duties of the Board of Directors, Practical Law Practice Note Overview...

Fiduciary Duties and Director Oversight During COVID-19

The outbreak of COVID-19 has significantly affected companies and the way they conduct business. Directors

should focus intently on their fiduciary duties as they navigate the complex issues and challenges caused by the

COVID-19 pandemic. The fiduciary duties of directors, and the protection of the business judgment rule, remain

unchanged. However, the weakened economic environment increases the likelihood that stockholders with the

benefit of hindsight, may try to bring derivative claims for breaches of fiduciary duties.

Boards should ensure they are implementing and maintaining the appropriate board-level reporting and oversight

systems (see Failure of Oversight). To accomplish this, among other actions, boards should consider:

• Creating new monitoring or oversight systems to respond to issues specific to the COVID-19 pandemic

or updating their existing monitoring or oversight systems to more effectively respond to the COVID-19

pandemic. Heightened areas focus will vary by business, but may include:

• employee health and safety;

• regulatory compliance;

• business continuity and supply chain issues;

• financial health; and

• technology and cybersecurity.

• Creating and tasking a separate board committee with overseeing COVID-19 issues.

• Meeting more frequently in order to respond quickly to a rapidly evolving environment.

• Ensuring that COVID-19 matters are discussed at each meeting.

• Keeping a detailed record of COVID-19 issues discussed during board meetings.

• Maintaining a robust record of all documents related to and reviewed in connection with its monitoring and

oversight systems.