Delaware Supreme Court applies business judgment rule in litigation claiming speculative benefits to the board

In Maffei v. Palkon, the Delaware Supreme Court found that a corporation's decision to reincorporate in another state did not provide a non-ratable benefit to the controller and boards of TripAdvisor, Inc. (TripAdvisor) and Liberty TripAdvisor Holdings, Inc., (Defendants) and therefore the business judgment rule, rather than entire fairness, was the proper standard of review.

Minority shareholders of Tripadvisor, a Delaware-based corporation, alleged that Defendants' breached their fiduciary duties when they decided to convert Tripadvisor's corporate domicile from Delaware to Nevada. The plaintiffs alleged that this conversion was motivated by the board's self-interest in protecting the directors from future legal liability, and therefore the transaction conferred a material, non-ratable benefit to the directors. The Delaware Court of Chancery agreed, denying Tripadvisor's motion to dismiss and holding that the transaction should be scrutinized under the entire fairness standard. Under the entire fairness standard, Defendants would carry the burden of establishing that the decision to relocate to Nevada was procedurally and substantially fair to the minority stockholders.

The Delaware Supreme Court granted interlocutory review and reversed the Court of Chancery's decision, finding that the entire fairness standard would apply only if the controlling stockholder received a material, non-ratable benefit. The Court defined “materiality” as “significant enough as to make it improbable that the director could perform his fiduciary duties to the shareholders.”

While the Court of Chancery previously rejected the idea that “Delaware precedent has a temporal distinction that distinguishes between cases based on existing versus future potential liability,” the Delaware Supreme Court found that in analyzing the materiality of an alleged benefit, temporality is crucial. Specifically, the Court found that “the absence of any allegations that any particular litigation claims will be impaired or that any particular transaction will be consummated post-conversion, weighs heavily against finding that the alleged reduction in liability exposure under Nevada's corporate law regime is material.” The Court also noted that Delaware precedent draws a “distinction between limitations of directors' liability exposure for past acts and future acts.” In other words, the Court distinguished between Delaware cases applying entire fairness when a litigated transaction would extinguish existing potential liabilities, and the present case, where “liability is speculative or hypothetical.” The Court also disagreed with the Court of Chancery that the temporal distinction is “arbitrary,” noting that courts will generally apply such a distinction because it requires litigants to base their claims on facts beyond mere speculation.

Further, the Supreme Court of Delaware noted its decision to evaluate Tripadvisor's reincorporation under the business judgment rule reinforced comity principles by avoiding a scenario where the Delaware court would need to make judgments about Nevada's corporate governance regime. The Court warned that “courts are ill-equipped to quantify the costs and benefits of one state's corporate governance regime over another's.” The Delaware Supreme Court ultimately held that such an analysis would risk “intruding on the value judgments of state legislators and directors of corporations,” and thus was improper here.

Palkon highlights that when directors and majority shareholders consider reincorporating, they should consider all consequences of the reincorporation, including whether they are facing existing or threatened litigation that would be extinguished through the transfer. If any exists, it is likely that they will not be entitled to the more lenient business judgment rule. On the other hand, stockholders may be empowered to carefully tailor their relocation lawsuits in accordance with Palkon and allege that their claims against boards and controlling shareholders in existing actions have been weakened or extinguished due to the increased legal protections provided by the corporation's new domicile.

Authored by Allison M. Wuertz, William (Bill) Regan, Jacey Gottlieb, and Gwendolyn Galt.