Nevada Splits from Delaware, Applies Business Judgment Rule Broadly
One focus of this blog has been identifying trends in other state’s corporate law that compares or contrasts with Delaware’s. Nevada in particular has long been in competition with Delaware as a potential place of incorporation. A new decision by the Nevada Supreme Court may further cement Nevada’s status as a potential competitor to Delaware for certain corporations by demonstrating the difficulty of rebutting the business judgment rule.
In Guzman v. Johnson, the Nevada Supreme Court held that a plaintiff cannot rebut the business judgment rule as a matter of law simply by challenging an interested fiduciary’s corporate dealings. Instead, to hold a director liable for corporate decisions, a plaintiff must “both rebut the business judgment rule’s presumption of good faith and show a breach of fiduciary duty involving intentional misconduct, fraud, or a knowing violation of the law.” Because the mere allegation that a director was an interested party was not sufficient to shift the burden to the director to show entire fairness, and the plaintiff had not pled facts showing that the relevant directors were motivated by self-interest, the Nevada Supreme Court affirmed the dismissal of the plaintiff’s complaint.
The Allegations
The dispute at issue in Guzman began with an investment agreement under which AMC Networks, Inc., through a subsidiary, loaned RLJ Entertainment, Inc. (“RLJE”) $65 million. In exchange, AMC became the controlling shareholder, designated directors on RLJE’s board, and obtained a “No-Shop Provision” prohibiting RLJE from considering any other acquisition proposal. Two years later, AMC offered to purchase the outstanding shares of common stock for $4.25 per share. The RLJE Board of Directors created a Special Committee to consider and negotiate the terms of the proposed acquisition. The Board refused the Special Committee’s request to allow it to solicit and consider offers from third parties, however, based on the No-Shop Provision in the AMC investment agreement and AMC’s position that it would not support any other transaction (which, because of AMC’s position as controlling shareholder, effectively made impossible any other deal). The Special Committee then negotiated only with AMC, eventually agreeing to a price of $6.25 per share. The Special Committee and its financial advisor determined that the proposed merger was fair and in the best interests of RLJE and its stockholders. The stockholders approved the merger, and AMC acquired RLJE.
One stockholder filed a proposed class action, claiming that the RLJE directors, AMC, and AMC subsidiaries had breached their fiduciary duties. The defendants moved to dismiss, arguing that the plaintiff had failed to rebut the business judgment rule. The plaintiff, on the other hand, contended that the business judgment rule was rebutted as a matter of law because the plaintiff was challenging an interested fiduciary’s corporate dealings. The district court granted the motion to dismiss, and the case made its way to the Nevada Supreme Court.
The Court’s Decision
The Nevada Supreme Court rejected the plaintiff’s argument that she had rebutted the business judgment rule as a matter of law, shifting the burden to the defendants to prove the inherent fairness of the transaction. The Court explained that Nevada has codified the business judgment rule, which provides that directors and officers “are presumed to act in good faith.” According to that statute, directors and officers may be held liable for their actions on behalf of a business only if the plaintiff rebuts that presumption and proves a breach of fiduciary duty involving intentional misconduct, fraud, or knowing violation of the law. In reaching that decision, the Court abrogated two of its earlier cases to the extent they suggested an “inherent fairness standard” could rebut the business judgment rule. “Such a standard,” the Court said, “would contravene the express provisions of NRS 78.138(7) and render meaningless the statute’s requirement that the plaintiff must establish a breach involving intentional misconduct, fraud, or a knowing violation of law.”
Having laid out the appropriate legal standard, the Court examined whether the plaintiff had alleged facts sufficient to overcome the statutory standard, including by rebutting the business judgment rule.
As to the directors who were not members of the Special Committee, and therefore did not negotiate or approve the merger, the Court held that the plaintiff failed to allege facts showing that those directors’ interests actually affected the transaction. The plaintiff also failed to allege facts indicating that those directors engaged in intentional misconduct, fraud, or knowing violation of the law related to the merger.
As to the two members of the Special Committee, the Court held that the plaintiff failed to allege facts showing that they were acting in their own self-interest. The plaintiff had alleged that the Special Committee members were incentivized “to protect themselves from being ousted from RLJE’s board” and that they held so few shares of RLJE that they profited more by serving on the Special Committee than negotiating a higher sale price. The plaintiff also faulted the Special Committee members for refusing to include a “majority of the minority provision” in the merger agreement (despite a recommendation to do so from the law firm advising the committee), and revising RLJE’s long-term revenue projections downward in the midst of negotiations. Nevertheless, the Nevada Supreme Court held that these allegations did not overcome the business judgment rule. It noted that the plaintiff’s allegation that the Special Committee members were at risk of being ousted was “speculation,” and emphasized that the members had negotiated the price upwards, even above RLJE’s stock price at the time. As a result, the allegations “f[e]ll short of the demanding standard set forth in” Nevada state law.
Finally, the Court affirmed the dismissal of the plaintiff’s claims against AMC, the majority shareholder (to which the business judgment rule did not apply). The Court held that the plaintiff failed to allege facts demonstrating a lack of fair dealing or lack of fair price. To be sure, the Court recognized that AMC leveraged its contractual rights to prevent competing offers from other potential buyers, but the plaintiff did not allege that AMC forced the merger or otherwise improperly influenced the decision.
One Justice concurred in part and dissented in part. That Justice disagreed with the majority only as to whether the claims against AMC and a director who had negotiated his post-merger equity position with AMC prior to AMC’s bid should be dismissed. As to the other directors, including those on the Special Committee, the Justice agreed with the majority that the plaintiff’s allegations failed to overcome the statutory protections available to directors, reasoning that the complaint did not allege the intentional misconduct, fraud, or knowing violation of law necessary to subject directors to liability.
The Takeaway
The Nevada Supreme Court’s director-friendly position may have implications for where companies decide to organize themselves. Delaware courts are increasingly likely to find that the mere presence of a controller on both sides of a merger is sufficient to trigger entire fairness review, at least in the absence of an independent special committee and approval by a majority of the minority stockholders (known as MFW dual protections). “Absent these protections,” a Delaware court recently explained, “a conflicted controlled standing on both sides of a transaction cannot avoid entire fairness review of that transaction.” In Guzman, the Nevada Supreme Court disagreed, reasoning that the “plain language” of Nevada’s statutory business judgment rule required that result. Companies—and shareholders—should be mindful of these differing standards moving forward.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.
