June 30, 2010
Loyalty Pleading Standards
Chancellor Chandler reminds us in a letter opinion in Monroe County Employee Retire. Sys. v Carlson, et al (H/T Morris James) that at the pleading stage it isn't enough for plaintiffs to simply point to a transaction where directors or insiders sit on both sides. Plaintiffs also have to plead some facts to suggest that the transaction itself is unfair before the defendants are required to shoulder the exacting entire fairness burden.
[The parties] agree about defendants’ burden at the proof stage of the proceedings. The parties sharply disagree, however, about plaintiff’s burden at the pleading stage of the proceedings; the stage in which we find ourselves situated. Plaintiff argues that to survive a motion to dismiss the complaint need only allege that a transaction between the controlling shareholder and the company exists. Defendants argue that this is insufficient, that plaintiff must make factual allegations in its complaint that, if proved, would establish that the challenged transactions are not entirely fair. Defendants have the winning argument on this point. Delaware law is clear that even where a transaction between the controlling shareholder and the company is involved—such that entire fairness review is in play—plaintiff must make factual allegations about the transaction in the complaint that demonstrate the absence of fairness. Simply put, a plaintiff who fails to do this has not stated a claim. Transactions between a controlling shareholder and the company are not per se invalid under Delaware law. Such transactions are perfectly acceptable if they are entirely fair, and so plaintiff must allege facts that demonstrate a lack of fairness.In the context of a going private transaction, it isn't enough that the plaintiffs plead that there is a controlling shareholder on both sides of the transaction. In order to survive the pleading stage, the plaintiff will also have to plead some facts that demonstrate the unfairness of the transaction. That's not the same as proving unfairness, but you have to have some facts. Remember entire fairness includes both fair dealing and fair price. Facts that demonstrate a flawed process are helpful in making the case, but if the flawed process nevertheless resulted in a fair price as a plaintiff you might find yourself out of luck.
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