In a recent Delaware Chancery Court decision, In re Chelsea Therapeutics International Ltd. Stockholders Litigation, C.A. No. 9640-VCG (Del. Ch. May 20, 2016), Vice Chancellor Glasscock explained that the good faith requirement of the duty of loyalty offers an equity judge a “fiduciary out” to the application of the business judgment rule. According to the Vice Chancellor, the court can consider the presence of “bad faith” in connection with a board decision, even if the directors were disinterested and independent. But consideration of “bad faith” in this context is relevant only in the rare instance where the nature of the board action cannot be understood to be in the corporate interest. In this case, the court rejected plaintiffs’ “pursuit of that rare bird,” dismissing the claims brought by representative stockholders.
The plaintiffs—stockholders of Chelsea Therapeutics International, Ltd., which is a developmental biopharmaceutical company—filed a class action suit against five members of the Chelsea board of directors. They alleged breaches of fiduciary duty in connection with the sale of Chelsea to Lundbeck A/S through a tender offer and short-form merger.
Plaintiffs’ claims focused on the alleged failure of the board and its advisors to consider certain financial projections in opining on and recommending the merger to stockholders. The financial projections at issue addressed potential revenue scenarios in connection with Northera, a drug developed by Chelsea to treat symptomatic neurogenic orthostatic hypotension. One projection estimated the potential increase in Northera’s market share if the FDA removed Northera’s primary competitor from the market. The other projection anticipated profit increases under hypothetical circumstances in which Northera was approved by the FDA for treatment of other, currently unapproved, conditions.
Plaintiffs contended that the board acted in bad faith by instructing its financial advisors to ignore the projections related to the competitor drug in opining on the fairness of the transaction, and by disregarding the projections based on other possible medical uses for Northera. According to plaintiffs, these actions resulted in the under-valuation of the company in the sale transaction and were plainly against the stockholders’ interests. Thus, the directors—regardless of independence and disinterest—were liable for their bad faith breach of fiduciary duty.
Vice Chancellor Glasscock explained the high hurdle that plaintiffs must overcome to avoid dismissal: “that the action complained of is otherwise inexplicable, so that bad faith—a motive other than the interest of the Company—must be at work.” In other words:
[W]as the Chelsea Board’s decision to exclude the Projections so egregious on its face that—notwithstanding that there are no allegations that the directors are interested or lack independence—the Plaintiffs have stated a case that it is reasonably conceivable that the Defendants acted in bad faith?
Here, Vice Chancellor Glasscock found that the board’s decision to not use the projections to value the company was “readily explicable,” as both projections were “highly speculative.” Vice Chancellor Glasscock, therefore, concluded that plaintiffs failed to plead a breach of the directors’ loyalty-based duty to act in good faith, and granted defendants’ motion to dismiss.
