We just got our first decision about directors’ duties in the sale context of a public benefit corporation (PBC); I’m not even aware of any other cases about directors’ PBC duties at all, though I wouldn’t swear there aren’t any.
Honestly at the end of the day it largely comes down to, absent allegations of self-interest, no claims are going to succeed, but let’s unpack the decision anyway, because it raises interesting questions for other contexts.
MPower Financing is a privately-held PBC that issues student loans. Two of its own major lenders held 25% of the company’s stock, and one had rights to designate two board members.
The company was in urgent need of financing, and the lenders proposed to provide it, in exchange for the ability to convert the existing loans into stock, which would result in the lenders owning 85% of the company at a significant discount to the prior round of financing (four years earlier). The other stockholders urged the company to seek a shareholder vote to approve the transaction, and also offered an alternative proposal; the CEO and at least one director agreed the transaction should be subject to stockholder approval. But the board refused, and a special committee – whose disinterestedness was unchallenged, counseled by a financial advisor – approved the deal.
The now-minority stockholders brought a lawsuit alleging that this was, essentially, a Revlon transaction – the board had sold control – and that the board had breached its fiduciary duties in so doing. The board did not dispute that this was Revlon and, by the way, I note that, though there was a dispute among the parties as to whether these were direct or derivative claims, VC Cook analyzed them on the merits without weighing in – so this is an ongoing issue Delaware will have to address eventually.
Originally, the plaintiffs had sought injunctive relief, but after expedition was denied (I assume the deal went through) they apparently were seeking damages.
I should also note that, leaving aside the whole Revlon-PBCness of the dispute, defendants also argued that they were free of liability under DGCL 144(a)(1), which deals with cleansing of conflict transactions. VC Cook, almost as an aside, held that he would have dismissed the claims on these alternative grounds, but also – in footnote 110 – suggested that there was no conflict of interest here, because plaintiffs had not alleged facts to suggest that the lender designees on the board were non-independent. Which raises an interesting question: Does 144(a)(1) cleansing apply outside the context of conflicted transactions? On this, I note that VC David recently dismissed a challenge to a merger, not on DGCL 144(a) grounds, but on Corwin grounds, presumably because no conflict was alleged.
So, you know – awkward.
So, the first issue for VC Cook was whether Revlon is a standard of review or a standard of conduct. As a standard of conduct – that boards must maximize the immediate value of the equity – plaintiffs’ claims would fail right out of the gate, because the board’s fiduciary duty in a PBC is to balance the equity interests against the public interests. VC Cook did not weigh in on the review vs. conduct question (VC Laster has argued, and I agree, it’s review), because he concluded that plaintiffs’ claims failed even if you treated Revlon as a standard of review, and that’s where he devoted the bulk of his analysis.
So, if Revlon is a standard of review, that means you conduct enhanced scrutiny of a decision to sell the company, i.e., a range of reasonableness analysis. But whatever that means in the PBC context, there’s another wrinkle: In the context of a PBC specifically, there is a statutory safe harbor under DGCL 365(b) which provides:
A director of a public benefit corporation shall not, by virtue of the public benefit provisions or § 362(a) of this title, have any duty to any person on account of any interest of such person in the public benefit or public benefits identified in the certificate of incorporation or on account of any interest materially affected by the corporation’s conduct and, with respect to a decision implicating the balance requirement in subsection (a) of this section, will be deemed to satisfy such director’s fiduciary duties to stockholders and the corporation if such director’s decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve.
So, the question was whether the defendants satisfied the preconditions to this safe harbor with an “informed and disinterested” decision that was “not such that no person of ordinary, sound judgment would approve.”
The “not such” bit reads like a saving for waste claims; VC Cook held there was no waste pled here, which meant, defendants were entitled to the safe harbor if their decision was “informed and disinterested.” Since the plaintiffs did not dispute the disinterestedness of the committee, the relevant question was whether the defendants were “informed.” So that meant, what does “informed” mean in this context?
Here’s where things got interesting. VC Cook noted that in the context of 144 cleansing, there’s a very specific meaning given to informed. That meaning, however, was not included in DGCL 365, and so the common law would control.
A couple of things about this. First, though the situations are not directly comparable, I note that recently VC Will did import DGCL 144’s definitions into a separate question (demand excusal under 23.1). VC Cook did not.
The big issue being, how much do 144 standards migrate to other parts of Delaware law? VC Will held they do, at least in some circumstances; VC Cook held they do not, in the PBC context, and what on earth are we supposed to do with stockholder cleansing under Corwin, which – as I noted above – may or may not evade DGCL 144 when conflicts are not alleged? (This is not totally hypothetical; in addition to VC David’s decision above, see Chancellor McCormick’s Activision decision, which wasn’t decided under the new DGCL 144 but I don’t think that would have made a difference.). Or, stockholder cleansing under MFW, which may still be a thing? Do we have different standards for all these different scenarios, or does the Delaware Supreme Court clean everything up with unified standards? Thanks so much for the certainty, SB 21 drafters!
Anyhoo, VC Cook had to decide what “informed” meant, such that defendants would be entitled to the PBC safe harbor. And that required a decision as to whether the definition of “informed” should shift depending on whether this was a Revlon transaction.
And! He did not weigh in, because he concluded that, either way, plaintiffs had not shown the decision was uninformed. Under business judgment review, I mean, c’mon.
Under enhanced scrutiny review, since PBC directors are required to balance the interests of stockholders against the interests of the public and the specific interest for which the corporation is formed, VC Cook held that plaintiffs would have to show the directors failed to consider all three interests. Op. at 21. But, at best, plaintiffs had only alleged deficiencies with respect to stockholder interests; as the court put it, “this goes only to the stockholders’ pecuniary interests, which is just one of the three interests identified in Section 365(a). Plaintiffs do not allege that the Special Committee failed to take steps to inform itself of the other interests it was required to balance.”
So, not good enough, plaintiffs had not shown the directors’ decision was uninformed, therefore, directors were entitled to the safe harbor of DGCL 365(b).
Without commenting on the specifics of this particular complaint, I think that’s a weird holding. I.e., if directors are required to balance all three interests, it should be sufficient to allege that they failed to inform themselves as to one. Here, however, VC Cook suggested that plaintiffs must allege a deficiency as to all three before a decision would be deemed “uninformed” for the purposes of DGCL 365(b).
Not that it matters when damages are sought because DGCL 365(c) states that, absent a conflict, failure to conduct a balancing of relevant interests is neither disloyal nor bad faith. But apparently, no one argued for the applicability of DGCL 365(c) in this case, so it wasn’t part of the court’s analysis. See Op. at fn. 110.
All of which means, under the most stockholder-plaintiff friendly understanding, absent an uncleansed conflict, and absent a showing of waste, if one is not seeking damages – only injunctive relief (so 102(b)(7) doesn’t apply) – the plaintiff in a PBC case would have to show deficiencies as to consideration of all three interests, apparently, before any kind of breach could be shown entitling the plaintiff to relief.
I don’t expect this to come up a lot in the future, though, so really, the interesting bits are those about how all of these different standards interact with the new DGCL 144/SB 21, and the answer is – so far – ¯\_(ツ)_/¯