Entire Fairness Review Explained
When you invest in a corporation, you place immense trust in the people running it. A corporate director holds a fiduciary duty to act in the best interests of the company and to protect your investment. However, a corporate insider sometimes pursues a transaction that benefits him or her at the expense of a minority stockholder and that stockholder’s financial interests. When this happens under Delaware law, the court applies a strict standard called entire fairness review.
Entire fairness review is the highest level of judicial scrutiny used to evaluate a corporate transaction involving a conflict of interest. The court requires the conflicted corporate insider to prove that both the process and the final price were completely fair to the minority stockholder and his or her investment. If you suspect that a director pushed through a conflicted deal to enrich himself or herself, understanding the entire fairness standard is essential for protecting your legal rights.
What Is Entire Fairness Review Under Delaware Law?
The entire fairness review is a rigorous judicial standard applied by the Delaware courts when a corporate director or controlling stockholder has a conflict of interest in a corporate transaction. The court requires proof that the deal was entirely fair to the minority stockholder with respect to both the price paid and the process used.
Delaware corporate law typically protects a board decision through a legal presumption known as the business judgment rule. This rule assumes a director acts in good faith. However, that presumption disappears when a transaction involves a clear conflict of interest. A conflict arises when a director or controlling entity stands on both sides of a transaction or receives a personal financial benefit that does not extend to all stockholders. When a stockholder challenges such a deal, the burden falls on the corporate defendant to prove the transaction was fair to the stockholder and his or her interests. Entire fairness is the most exacting standard in corporate law. The court looks very closely at the fiduciary’s actions.
How Do Delaware Courts Apply the Entire Fairness Standard?
In Delaware fiduciary duty litigation, the standard generally requires the conflicted fiduciary to prove two specific elements: fair dealing and fair price. However, the Delaware Supreme Court has established that entire fairness requires a comprehensive review of the transaction rather than isolating individual parts for analysis. Thus, Delaware Courts will examine both components together to determine the overall fairness of the transaction to the stockholder:
- Fair Dealing. This prong examines the process. The court asks how the transaction was timed, initiated, structured, negotiated, and disclosed to the stockholder. A fair process requires absolute candor and transparency from the very beginning. Did the controlling insider hide material financial projections from the rest of the board? Was the special committee of independent directors truly independent, or did a conflicted director secretly influence the committee? Furthermore, the court examines whether the committee had the actual authority to reject the deal and walk away. A flawed process usually harms the stockholder and his or her ability to realize the true value of the shares.
- Fair Price. This prong concerns the economic and financial considerations of the proposed transaction. The court considers all relevant factors affecting the intrinsic value of the shares, such as assets, market value, earnings, and prospects. The court frequently relies on a battle of financial experts. An expert will present a complex valuation model, including a discounted cash flow analysis, to prove what the company was actually worth on the day the deal closed. The price must be equivalent to what an independent, fully informed buyer would pay. If a corporate insider pays below market value, he or she violates the fair price requirement.
Frequently Asked Questions (FAQs) about Entire Fairness in Delaware
Who holds the burden of proof in an entire fairness claim?
Generally, the burden of proof rests on the conflicted corporate director or the controlling entity. He or she must prove to the court that the transaction was entirely fair to the minority stockholder and his or her financial interests.
Does a flawed process automatically mean the price was unfair?
Not automatically. A severely flawed and deceptive process strongly suggests that the resulting price is also unfair to the stockholder, but that is not necessarily conclusive on its own. To determine whether the price was fair, the court views the transaction as a whole.
Can a stockholder stop a conflicted merger before it happens?
In some cases, yes, a stockholder can prevent a conflicted merger from happening. However, you typically need to meet high legal standards, such as demonstrating that the merger would cause you irreparable harm. Because the harm caused by an improper merger can usually be remedied by money damages, Delaware courts will generally allow the merger to continue.
Do I participate in Delaware stockholder litigation if I live in a different state?
Yes, you do not need to live in Delaware to file a lawsuit. That is because proper jurisdiction is determined by where the corporation is incorporated. So, if a business is incorporated in Delaware, then Delaware courts have jurisdiction over the business.
Shlansky Law Group Can Help You in Delaware Corporate Litigation
Shlansky Law Group brings deep knowledge of Delaware corporate litigation to help an individual plaintiff hold a corporate fiduciary accountable. We investigate conflicted transactions, pursue structural remedies, and fight to ensure that every stockholder receives fair value for his or her investment.
The SLG team has decades of experience representing clients throughout all stages of Delaware business formation and litigation. Our team understands how the Court of Chancery operates and the legal standards they employ to resolve lawsuits. Our team leverages this experience and knowledge to help clients nationwide enforce their rights.
Call Shlansky Law Group today at 347.378.6990 so we can review your case and help you seek justice.
