On November 4, 2013, in In re Jefferies Group, Inc. Shareholders Litigation, No. 8059-CS (Nov. 4, 2013), the Delaware Court of Chancery considered the latest iteration of the entire fairness standard. In this oral ruling from the bench, Chancellor Leo Strine (now appointed to the Delaware Supreme Court) denied defendants’ motions to dismiss refusing to shift the burden of proof for entire fairness from defendants to plaintiffs. The transcript from this ruling can be found here.

The entire fairness standard is a standard, that when applied, switches the burden of proof from plaintiffs to defendants and requires defendants to demonstrate that the process leading up to the deal was fair and that consideration being paid to stockholders was fair. See In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013). In MFW, Chancellor Strine observed (which has now been affirmed by the Delaware Supreme Court in its opinion here) that if defendants satisfy several conditions, then defendants could avoid entire fairness review and be subject to the business judgment rule. Under MFW, the conditions defendants must satisfy include: (i) the transaction is contingent on the appointment of a special independent committee and a majority of the minority condition; (ii) the special committee is independent; (iii) the special committee independently selects its financial and legal advisors; (iv) the special committee meets the duty of care; (v) the vote of the minority is informed; and (vi) no coercion of the minority. Id. at 535. In affirming the Delaware Chancery Court, the Delaware Supreme Court made its holding very clear that if any or none of the following conditions were not satisfied in a majority-minority controller context, then defendants would still hold the burden of proof under entire fairness. But what about entire fairness in a conflicted non-majority shareholder context? Jefferies appears to have addressed this question.

In Jefferies, plaintiffs alleged that defendants Richard Handler (“Handler”) and Brian Friedman (“Friedman”), both Jefferies executives and members of the company’s board of directors (the “Board”), conspired with Leucadia National Corporation (“Leucadia”) then-CEO Ian M. Cumming (“Cumming”) and then President Joseph S. Steinberg (“Steinberg”) (collectively, the “Leucadia Defendants”) to effectuate a merger between their two companies for the sole purpose of satisfying Handler’s life-long dream of becoming the President of Leucadia and Friedman’s desire to become Handler’s second in command rather than obtaining a fair price for stockholders. Among other things, plaintiffs’ amended complaint further alleged that (i) Cumming, Steinberg, Handler and Friedman, for over three months had been negotiating a deal without informing Jefferies’ board members; (ii) Handler and Friedman directed Jefferies to provide Leucadia with nonpublic due diligence without receiving board approval; (iii) Handler and Friedman directed Jefferies to leak Jefferies’ second quarter financial results to Leucadia before they were made available to the public; and (iii) Handler, Friedman, Cumming and Steinberg negotiated a 0.81 exchange ratio during the course of a single day.  

After the filing of plaintiffs’ amended complaint, defendants filed a motion to dismiss. In their brief in support of their motion, Defendants argued, among other things, that because the Jefferies Board appointed an independent transaction committee advised by a team of independent financial and legal advisors, that the process had been properly cleansed of any possible taint or conflict of interest created between Cumming, Steinberg, Handler, and Friedman. Moreover, Cumming and Steinberg alleged that because they personally abstained from voting and did not participate in Jefferies board meetings that they were shielded from any underlying breach of fiduciary duty claim. Given the presence of these facts, defendants concluded that the corporate-friendly business judgment rule should be applied instead of the onerous entire fairness standard.

In their opposition, plaintiffs pointed the Court to the words of Vice Chancellor Jacobs, for the proposition that merely abstaining from voting and/or forming an independent special committee does not alone exculpate directors from breach of fiduciary duty claims.  In Tri-Star Pictures, Inc. Litig., Vice Chancellor Jacobs observed that:

I agree that no per se rule unqualifiedly and categorically relieves a director from liability solely because that director refrains from voting on the challenged transaction. One might, for example, imagine a scenario in which certain members of the board of directors conspire with others to formulate a transaction that is later claimed to be wrongful. As part of the conspiracy, those directors then deliberately absent themselves from directors’ meetings at which the proposal is to be voted upon, specifically to shield themselves from any exposure to liability. In such circumstances it is highly unlikely that those directors’ “nonvote” would be accorded exculpatory significance. 

Tri-Star, 1995 WL 106520, at *3 (Del. Ch. Mar. 9, 1995). Despite the appointment of a transaction committee to consider the merger, the Delaware Court of Chancery in denying the motion to dismiss refused to shift the burden of proof of entire fairness from defendants to plaintiffs.  

While the Delaware Court of Chancery has yet to decide whether Handler, Friedman, Cumming, and Steinberg satisfied the entire fairness standard, for the time being, this decision appears to create more tension with the formulaic approach adopted in MFW. In fact, this decision appears to show why a formulaic approach cannot be adopted in conflicted transactions. In Jefferies, the Court’s holding was clear, once directors breach their fiduciary duty to stockholders, forming a committee of independent directors to consider and vote on the transaction will not, by itself, shield directors from underlying breach of fiduciary duty claims. As this decision illustrates, taking a formulaic “form over substance” approach to conflicted transactions is not sufficient to switch the burden from defendants to plaintiffs in entire fairness transactions. If directors find themselves on both sides of a possible merger, as suggested in Tri-Star, conflicted directors must actively satisfy their fiduciary duties by immediately recusing themselves from most, if not all, negotiations in the merger. Merely forming a special committee, while allowing the conflicted directors to negotiate and lead the process, does not trigger the application of the business judgment rule.