What standard of review will Delaware courts employ to analyze a corporate director’s actions in a claim for breach of fiduciary duty against the director?

The starting point for analyzing fiduciary action is to determine the correct standard of review. Chen v. Howard-Anderson , 87 A.3d 648, 666 (Del. Ch. 2014). Delaware corporate law has three tiers of review: the business judgment rule, enhanced scrutiny, and entire fairness. Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (Del. Ch. 2011). The Merger is subject to enhanced scrutiny.

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1. The Possible Standards Of Review

Delaware's default standard of review is the business judgment rule, a principle of non-review that "reflects and promotes the role of the board of directors as the proper body to manage the business and affairs of the corporation." In re Trados Inc. S'holder Litig. (Trados I), 2009 WL 2225958, at *6 (Del. Ch. July 24, 2009). The rule presumes that "in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Unless one of its elements is rebutted, "the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation's objectives." In re Dollar Thrifty S'holder Litig., 14 A.3d 573, 598 (Del. Ch. 2010). "Only when a decision lacks any rationally conceivable basis will a court infer bad faith and a breach of duty." In re Orchard Enters., Inc. S'holder Litig., 88 A.3d 1, 34 (Del. Ch. 2014).

"Entire fairness, Delaware's most onerous standard, applies when the board labors under actual conflicts of interest." In re Trados Inc. S'holder Litig. (Trados II), 73 A.3d 17, 44 (Del. Ch. 2013). Once entire fairness applies, the defendants must establish "to the court's satisfaction that the transaction was the product of both fair dealing and fair price." Cinerama, Inc. v. Technicolor, Inc. (Technicolor Plenary III ), 663 A.2d 1156, 1163 (Del. 1995) (emphasis in original) (internal quotation marks omitted). "Not even an honest belief that the transaction was entirely fair will be sufficient to establish entire fairness. Rather, the transaction itself must be objectively fair, independent of the board's beliefs." Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del. Ch. 2006).

In between lies enhanced scrutiny, which is Delaware's "intermediate standard of review." Trados II, 73 A.3d at 43. It governs "specific, recurring, and readily identifiable situations involving potential conflicts of interest where the realities of the decisionmaking context can subtly undermine the decisions of even independent and disinterested directors." Id. Framed generally, enhanced scrutiny requires that the fiduciary defendants "bear the burden of persuasion to show that their motivations were proper and not selfish" and that "their actions were reasonable in relation to their legitimate objective." Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 810 (Del. Ch. 2007).

In the absence of Corwin cleansing, the court must evaluate whether the complaint's allegations state a claim for breach of fiduciary duty. The starting point is to determine the correct standard of review. See Chen, 87 A.3d at 666. Delaware corporate law has three

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tiers of review: the business judgment rule, enhanced scrutiny, and entire fairness. Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (Del. Ch. 2011).

Delaware's default standard of review is the business judgment rule, a principle of non-review that "reflects and promotes the role of the board of directors as the proper body to manage the business and affairs of the corporation." In re Trados Inc. S'holder Litig. (Trados I), 2009 WL 2225958, at *6 (Del. Ch. July 24, 2009). The business judgment rule presumes that "in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). Unless one of its elements is rebutted, "the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation's objectives." In re Dollar Thrifty S'holder Litig., 14 A.3d 573, 598 (Del. Ch. 2010). "Only when a decision lacks any rationally conceivable basis will a court infer bad faith and a breach of duty." In re Orchard Enters., Inc. S'holder Litig., 88 A.3d 1, 34 (Del. Ch. 2014).

"Entire fairness, Delaware's most onerous standard, applies when the board labors under actual conflicts of interest." In re Trados Inc. S'holder Litig. (Trados II), 73 A.3d 17, 44 (Del. Ch. 2013). Once entire fairness applies, the defendants must establish "to the court's satisfaction that the transaction was the product of both fair dealing and fair price." Cinerama, Inc. v. Technicolor, Inc. (Technicolor Plenary III), 663 A.2d 1156, 1163 (Del. 1995) (internal quotation marks omitted). "Not even an honest belief that the transaction was entirely fair will be sufficient to establish entire fairness. Rather, the transaction itself

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must be objectively fair, independent of the board's beliefs." Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del. Ch. 2006).

In between lies enhanced scrutiny, which is Delaware's "intermediate standard of review." Trados II, 73 A.3d at 43. It governs "specific, recurring, and readily identifiable situations involving potential conflicts of interest where the realities of the decisionmaking context can subtly undermine the decisions of even independent and disinterested directors." Id. Framed generally, enhanced scrutiny requires that defendants "bear the burden of persuasion to show that their motivations were proper and not selfish" and that "their actions were reasonable in relation to their legitimate objective." Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 810 (Del. Ch. 2007).

In Revlon, the Delaware Supreme Court applied the intermediate standard of review to the sale of a corporation. See Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173, 179-82 (Del. 1986). Enhanced scrutiny applies in this setting because "the potential sale of a corporation has enormous implications for corporate managers and advisors, and a range of human motivations, including but by no means limited to greed, can inspire fiduciaries and their advisors to be less than faithful." In re El Paso Corp. S'holder Litig., 41 A.3d 432, 439 (Del. Ch. 2012). Put differently,

[t]he heightened scrutiny that applies in the Revlon (and Unocal) contexts are, in large measure, rooted in a concern that the board might harbor personal motivations in the sale context that differ from what is best for the corporation and its stockholders. Most traditionally, there is the danger that top corporate managers will resist a sale that might cost them their managerial posts, or prefer a sale to one industry rival rather than another for reasons having more to do with personal ego than with what is best for stockholders.
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Dollar Thrifty, 14 A.3d at 597 (footnote omitted). Consequently, "the predicate question" of the fiduciary's "true motivation" comes into play, and "[t]he court must take a nuanced and realistic look at the possibility that personal interests short of pure self-dealing have influenced" the fiduciary's decision. Id. at 598.

[...]
The Transaction involved a sale of the Company for cash. Accordingly, enhanced scrutiny applies. See QVC, 637 A.2d at 45. The plaintiff thus can state a claim for breach of duty by pleading facts supporting a reasonable inference that the Transaction and the process that led to it fell outside the range of reasonableness. Id.

B. Breach Of Fiduciary Duty

The plaintiff separately alleges that the defendants breached their fiduciary duties. The plaintiff asserts that the directors who approved the Challenged Awards breached their fiduciary duties by knowingly violating the Performance Share Limitation. The plaintiff asserts that Smith breached his fiduciary duty by accepting the Challenged Awards

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knowing that they violated the Performance Share Limitation. And the plaintiff asserts that the directors who refused plaintiff's demand that the Company remedy the unauthorized grant of the Challenged Awards breached their fiduciary duties by failing to correct the Challenged Awards. At the pleading stage, these theories state claims on which relief can be granted.

1. The Attempt To Invoke The Business Judgment Rule

The defendants assert that the plaintiff has failed to state a claim for breach of fiduciary duty against any defendant because the business judgment rule protects the Committee's decisions from challenge. The defendants argue that "the Committee made two business judgments, both of which are protected by the business judgment rule." Dkt. 6 at 17. Those business judgments were (i) the decision to approve the Challenged Awards and (ii) the decision to interpret the Performance Share Limitation using the Target Award Policy. Id. at 18-19. The defendants maintain that the plaintiff failed to rebut the presumptions of the business judgment rule as to either decision, resulting in the plaintiff failing to plead an actionable claim. Id. at 17-18. This argument conflicts with two lines of established precedent.

First, the business judgment rule only applies when directors make a discretionary judgment that falls within the scope of their authority. The business judgment rule does not protect a decision that exceeds the directors' authority. Instead, allegations that the directors knowingly exceeded their authority are sufficient to state a claim that the directors breached their duty of loyalty. Allen, 90 A.3d at 1108 ("The possession of discretionary authority is a prerequisite for the policy-based deference of the business judgment rule.

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Without authority to take the action in question, a board has no business judgment to exercise.").

As noted in the breach of contract discussion, the plain language of the Performance Share Limitation caps the maximum number of Performance Shares that can be made subject to Awards to a single participant in a single fiscal year. The business judgment rule therefore does not protect the decision to grant the Challenged Awards.

[...]

The business judgment rule does not apply in this case. First, it does not apply because the case involves clear limitations on director authority. Second, it does not apply because it is reasonable to infer at this stage that the directors acted in bad faith by violating those clear limitations, thereby rebutting the business judgment rule.

^[26] The effect of stockholder approval on claims for breach of fiduciary duty has evolved significantly over time, and this decision is not the place to provide a recapitulation. For present purposes, it suffices to say that Delaware cases have long recognized that when a plaintiff claims that the directors failed to exercise due care before committing the corporation to a transaction, then fully informed stockholder approval will extinguish the claim. See, e.g., Smith v. Van Gorkom, 488 A.2d 858, 889 (Del. 1985) (subsequent history omitted) ("[T]he merger can be sustained, notwithstanding the infirmity of the Board's action, if its approval by majority vote of the shareholders is found to have been based on an informed electorate."); Lewis v. Vogelstein, 699 A.2d 327, 336 n.13 (Del. Ch. 1997) (Allen, C.) ("[I]t has been held, on authority, that ratification of a transaction that is thereafter made the subject of a breach of care claim is effective to defeat such a claim completely."). Language in Van Gorkom created confusion about whether a valid stockholder ratification could extinguish a duty of loyalty claim. Ten years after Van Gorkom, this court rejected that concept. See In re Wheelabrator Techs., Inc. S'holders Litig., 663 A.2d 1194, 1205 (Del. Ch. 1995). In Wheelabrator, the court explained that in its survey of the law, "the ratification cases involving duty of loyalty claims have uniformly held that the effect of shareholder ratification is to alter the standard of review, or to shift the burden of proof, or both." Id. at 1202-03. Since Wheelabrator, the law governing the effect of ratification on loyalty claims has continued to develop. Most notably, in Corwin v. KKR Financial Holdings, LLC, the Delaware Supreme Court held that if a majority of disinterested stockholders acted on a fully informed basis to approve a merger with a party other than a controller, then the act of stockholder approval results in any claim for breach of fiduciary duty being reviewed using the business judgment rule rather than a more stringent standard of review. 125 A.3d 304, 308 (Del. 2015). The Delaware Supreme Court also has held that in a transaction between a controlled corporation and its controlling stockholder, the combination of disinterested committee approval and majority-of-the-minority stockholder approval results in any claim for breach of fiduciary duty being reviewed using the business judgment rule rather than a more stringent standard of review. Kahn v. M & F Worldwide Corp., 88 A.3d 635, 644 (Del. 2014) ("[B]usiness judgment is the standard of review that should govern mergers between a controlling stockholder and its corporate subsidiary, where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and the uncoerced, informed vote of the majority of the minority stockholders."), overruled on other grounds by Flood v. Synutra Int'l, Inc., 195 A.3d 754 (Del. 2018); see In re Tesla Motors, Inc. S'holder Litig., 2022 1237185, at *28-29 & n.365 (Del. Ch. Apr. 27, 2022); In re EZCORP Inc. Consulting Agreement Deriv. Litig., 2016 WL 301245, at *11 (Del. Ch. Jan. 25, 2016).

In a well-reasoned opinion, the Court of Chancery held that the business judgment rule is invoked as the appropriate standard of review for a post-closing damages action

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when a merger that is not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders.¹ For that and other reasons, the Court of Chancery dismissed the plaintiffs' complaint.² In this decision, we find that the Chancellor was correct in finding that the voluntary judgment of the disinterested stockholders to approve the merger invoked the business judgment rule standard of review and that the plaintiffs' complaint should be dismissed. For sound policy reasons, Delaware corporate law has long been reluctant to second-guess the judgment of a disinterested stockholder majority that determines that a transaction with a party other than a controlling stockholder is in their best interests.

Not all stockholder approvals of a transaction have a cleansing effect. Rather, "the [Corwin] doctrine applies only to fully informed, uncoerced stockholder votes, and if troubling facts regarding director behavior were not

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disclosed that would have been material to a voting stockholder, then the business judgment rule is not invoked."¹²⁴ Further, only disinterested stockholder expressions of approval are considered.¹²⁵

As Cinerama and Cede II themselves demonstrate, Gray's interest in the Wallingford and NAF Transactions implicates both the primary rationale for the entire fairness standard of review and the core concern of § 144 — "self-dealing." Cinerama, Del.Supr., 663 A.2d at 1168-1169. In Cinerama, the Supreme Court described self-dealing as existing when "a director deals directly with the corporation, or has a stake in or is an officer or director of a firm that deals with the corporation." Id. at 1169 (citing 8 Del.C. § 144(a)). "Traditionally, the term `self-dealing' describes the `situation when a [corporate fiduciary] is on both sides of a transaction ....'" Id. (quoting Sinclair Oil Corp. v. Levien, Del. Supr., 280 A.2d 717, 720 (1971)).

In Cede II, the Supreme Court affirmed Chancellor Allen's holding that "[a]bsent evidence of self-dealing, ... evidence of any personal or special benefit accruing to a director ... in an otherwise arms-length transaction does not establish a lack of independence sufficient to rebut the business judgment rule unless the director's self-interest is also found to be `material.'" Cede II, 634 A.2d at 362 (emphasis added). In so ruling, the Court noted that the Chancellor had concluded that a "plaintiff's burden of proof of a director's self-interest in an arms-length third party transaction should be greater than in a classic self-dealing

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transaction where a director or directors stand on both sides of a transaction." Id. (emphasis added); see also Cede II, 634 A.2d at 363 ("Provided that the terms of 8 Del.C. § 144 are met, self-interest, alone is not a disqualifying factor even for a director."); Cinerama, Del. Supr., 663 A.2d at 1169 ("In Cede II, this Court distinguished classic self-dealing from incidental director interest. To be disqualifying the nature of the director interest must be substantial.").

Gray's undisclosed, buy-side interest in the Transactions is a classic case of self-dealing. Under Cede II and Cinerama, proof of such undisclosed self-dealing, in itself, is sufficient to rebut the presumption of the business judgment rule and invoke entire fairness review. See also 1 David A. Drexler et al., Delaware Corporation Law and Practice § 15.05[1] at 15-11 (1999) (indicating that where classic self-dealing exists the "business judgment rule automatically falls by the wayside").

Section 144 of the Delaware General Corporation Law dictates this conclusion. That statute is implicated whenever a corporation and "1 or more of its directors or officers ... or partnership ... or other organization in which 1 or more of its directors or officers ... have a financial interest" engage in a transaction. 8 Del. C. § 144.

The interests of Gray and Fieber in the Wallingford and NAF Transactions trigger the statute. Section 144 provides that a self-dealing transaction will not be "void or voidable solely for this reason" if the transaction is ratified by a majority of the disinterested directors or by a shareholder vote. 8 Del.C. § 144(a)(1), (2). Such ratification is valid, however, only if the "material facts as [to the director's] relationship or interest and as to the contract or transaction are disclosed or are known to the [relevant ratifying authority]...." Id. Neither Fieber nor Gray disclosed Gray's "interest" in the "[T]ransaction[s]" to the HMG Board. Id. In the absence of such disclosure, 8 Del.C. § 144(a)(1), the Transactions can only be rendered non-voidable if they were "fair as to [HMG] as of the time [they were] authorized."²⁴ 8 Del.C. § 144(a)(3); see also Cede II, 634 A.2d at 366 n. 34 (under § 144(a)(3), a "non-disclosing interested director can remove the taint of interestedness by proving the entire fairness of the challenged transaction"); 1 R. Franklin Balotti & Jesse A. Finkelstein, The Delaware Law of Corporations & Business Organizations § 4.35 at 4-237 (3d ed.1999) (same).

Furthermore, even if the Cinerama test to determine whether "an incidental director interest" rose to the level of materiality were applicable, Gray's interest satisfies it. Cinerama, Del.Supr., 663 A.2d at 1169. Gray invested $355,000 of his and his sister's money in the Transactions. His keen interest in maximizing distributions from the Joint Venture belies any contention that this investment was not "substantial" and of material importance to him. Id. Since Gray anticipated taking a buy-side interest in the Transactions at least as early as February 1986 and was HMG's lead negotiator in the Transactions, a reasonable director would have

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certainly wanted to know about his buy-side position in the Transactions.²⁵ See Mills Acquisition Co. v. Macmillan, Inc. ("Macmillan II"), Del.Supr., 559 A.2d 1261, 1279 (1989) (where disinterested majority was manipulated by a deceptive CEO, entire fairness was appropriate standard of review).

Indeed, one of the outside directors who voted to ratify the Transactions testified that he would not have done so had he been aware of Gray's buy-side interest. Tr. 269-270. Wiener gave similar testimony. Tr. 118-119. While I do not base my finding solely on this testimony, I found the testimony of these directors, particularly outside director Walter Arader, a man with extensive experience in matters of corporate governance and a record of distinguished public service, to be credible and to accord with common sense. Cf. Kendall v. State, Del.Supr., 726 A.2d 1191, 1193 (1999) (relying on testimony that homebuyers would not have purchased homes from a criminal defendant if the defendant had disclosed his prior misconduct to them in affirming criminal conviction). It supports my conclusion that any reasonable director would want to know about a buy-side interest on the part of a corporate officer and director who acted as a negotiator for the corporation in sales transactions in which the corporation was the seller. The proposition seems almost too obvious to need stating.

For all these reasons, Gray and Fieber must demonstrate the fairness of the Wallingford and NAF Transactions.

1. The Standard of Review

"The starting point for analyzing a fiduciary breach is to determine the correct standard of review."^[359] "Delaware has three tiers of review for evaluating director decision-making: the business judgment rule, enhanced scrutiny, and entire fairness."^[360] As noted, the battle line here is drawn between entire fairness

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(Plaintiffs' proffered standard)^[361] and the deferential business judgment rule (Elon's proffered standard).^[362] Neither party has advocated for enhanced scrutiny.^[363]

a. The Competing Standards of Review

To explain my decision to review for entire fairness, it is useful to identify the catalysts for the parties' competing legal arguments. To state it bluntly, the knock-on effects of two decisions of our Supreme Court--Corwin and MFW--frame the standard of review controversy here.^[364] These seminal decisions offer conflicted fiduciaries two pathways to the coveted deference afforded by the business judgment rule.^[365] Elon wants that deference; Plaintiffs want to deny him that deference.

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If Elon is deemed a controlling stockholder of Tesla, he cannot invoke Corwin to achieve business judgment deference.^[366] Not surprisingly, then, Plaintiffs argue that Elon is a controlling stockholder; Elon steadfastly maintains that he is not.^[367]In making their controlling stockholder argument, Plaintiffs, no doubt, are comforted by the fact that Elon, as controller, cannot invoke MFW to achieve business judgment review because the Tesla Board elected not to form an independent special committee, a predicate to the operation of MFW's ratchet from entire fairness down to the business judgment rule.^[368] If Elon is deemed a controlling stockholder of Tesla, therefore, his conduct will be subject to the "onerous" entire

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fairness review since there is no question he was conflicted with respect to the Acquisition.^[369]

If Elon clears the controlling stockholder hurdle, he still has to traverse the treacherous terrain of board-level conflicts to reach business judgment arcadia. When "properly reviewable facts reveal that the propriety of a board decision is in doubt because the majority of the directors who approved it were grossly negligent, acting in bad faith, or were tainted by conflicts of interest," the court will review the decision for entire fairness.^[370] On the other hand, if the Tesla Board was not conflicted, and Elon was not a controlling stockholder, then the business judgment rule is the standard of review.^[371] Thus, the parties understandably clash over the extent to which a majority of the Tesla Board was conflicted with respect to the Acquisition by way of self-interest or a lack of independence from those who were self-interested.

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Here again, the spirit of Corwin looms large. Even if the Acquisition was approved by a conflicted Tesla Board, assuming Elon is not a controlling stockholder, the uncoerced, fully informed vote of a majority of Tesla's disinterested minority stockholders will "cleanse" any breach of fiduciary duty by triggering business judgment deference.^[372] And so, the parties dispute whether Tesla's stockholders were given the full and accurate information they needed to cast an informed vote in favor of the Acquisition.

b. The Court Will Skip to Entire Fairness

As the above discussion reveals, the parties have explored all of the recesses of Delaware law regarding shifting standards of review, from controlling stockholder liability to stockholder ratification and all of the nooks in between.^[373]

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The parties' claims and defenses present provocative questions that could be debated at even the most fashionable corporate law conferences.^[374] Beyond satisfying idle

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curiosity, however, there is no point to be served by pondering these questions further here. And there is certainly no reason to answer them.^[375]

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The parties have proffered evidence on both sides of the controlling stockholder issue, the board-level conflicts issues, and the "Corwin cleansing" issue (particularly regarding the quality of the disclosures made to Tesla stockholders).^[376]This is not a case where business judgment deference is obviously justified from undisputed or clearly proven facts. Whether by virtue of Elon's control, ^[377] or by

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virtue of irreconcilable board-level conflicts, ^[378] there is a basis for assuming that entire fairness is the governing standard of review. Accordingly, I will give no deference to Elon (or his fellow Tesla Board members) and will review Plaintiffs' breach of fiduciary claim with the highest degree of scrutiny recognized in our law.