Cede & Co. v. Technicolor, Inc.

Supreme Court of Delaware
634 A.2d 345 (1993)

ELI5:

Rule of Law:

A shareholder plaintiff is not required to prove injury or monetary damages resulting from a board's breach of its duty of care to rebut the business judgment rule. A finding of gross negligence in the board's decision-making process is sufficient to shift the burden to the defendant directors to prove the entire fairness of the transaction.

Facts:

In the early 1980s, Technicolor, Inc. was facing financial difficulties and a declining stock price, partly due to a costly new venture named 'One Hour Photo.'
Ronald Perelman, chairman of MacAndrews & Forbes Group, Inc. (MAF), identified Technicolor as a takeover target and sought a friendly transaction.
Perelman initiated contact with Technicolor director Fred Sullivan, who, without informing the rest of the board, met with Perelman, learned of his acquisition interest, and subsequently purchased additional Technicolor stock for his own account.
Technicolor's CEO, Morton Kamerman, entered into secret, direct negotiations with Perelman over several weeks, excluding most of the board and senior management.
During these negotiations, Kamerman and Perelman agreed on key terms including a post-merger employment contract for Kamerman, a $150,000 'finder's fee' for Sullivan, and a stock option agreement that would give MAF significant control.
After Kamerman and Perelman agreed on a price of $23 per share, Kamerman called a special board meeting on only two days' notice, without disclosing its purpose in advance.
The majority of Technicolor's directors had no substantive prior knowledge of the proposed sale before the meeting.
Following a two-hour meeting with presentations from Kamerman, legal counsel, and an investment bank that had performed limited due diligence, the Technicolor board approved the merger agreement and the related self-interested transactions.

Procedural Posture:

Cinerama, a Technicolor shareholder, dissented from a cash-out merger and filed a statutory appraisal action in the Delaware Court of Chancery.
After discovering evidence of misconduct, Cinerama filed a second, separate personal liability action in the same court against Technicolor's directors for fraud and breach of fiduciary duty.
The actions were consolidated, and the Chancellor (trial judge) initially ruled that Cinerama had to elect a single remedy—appraisal or personal liability damages—before trial.
On an interlocutory appeal, the Delaware Supreme Court (Cede I) reversed, permitting Cinerama to pursue both claims concurrently through trial.
After a trial on remand, the Chancellor first issued a decision in the appraisal action, finding the fair value of Technicolor stock was $21.60 per share.
Subsequently, in a decision on the personal liability action, the Chancellor found that although the board likely breached its duty of care, Cinerama failed to prove it had suffered any monetary loss and thus entered judgment for the defendant directors.
Cinerama appealed the final judgments from both the appraisal and personal liability actions to the Delaware Supreme Court.

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Issue:

Does a shareholder plaintiff have to prove that a board's breach of the duty of care resulted in a quantifiable monetary injury in order to rebut the business judgment rule's presumption of due care and shift the burden to the directors to prove the transaction's entire fairness?

Opinions:

Majority - Horsey, Justice

No. A shareholder plaintiff does not have to prove quantifiable monetary injury to rebut the business judgment rule's presumption of due care. A breach of either the duty of care or the duty of loyalty is sufficient to rebut the presumption and require directors to prove the transaction was entirely fair. The trial court erred by injecting tort principles of proximate cause and damages into the threshold analysis of the business judgment rule. The purpose of this initial inquiry is to determine the proper standard of review (business judgment vs. entire fairness), not to adjudicate the ultimate merits of the case. Requiring proof of injury upfront would improperly relieve directors of their burden to demonstrate entire fairness once their decision-making process is found to be grossly negligent. Based on the trial court's own presumed findings—that the board failed to search for alternatives, was uninformed, and approved a 'lock-up' agreement after a hasty meeting—the board was grossly negligent, thereby breaching its duty of care. Therefore, the business judgment rule presumption is rebutted, and on remand, the directors must bear the burden of proving the merger was entirely fair to the shareholders.

Analysis:

This decision is a significant reaffirmation of the principles established in Smith v. Van Gorkom, clarifying that the duties of care and loyalty are independent pillars of the business judgment rule. The court firmly rejected the attempt to merge tort law concepts of causation and damages into the corporate fiduciary duty framework for burden-shifting purposes. By doing so, the decision reinforces that a flawed corporate process (a breach of the duty of care) is, by itself, enough to trigger the stringent 'entire fairness' standard of review, regardless of whether the transaction price was demonstrably 'unfair' at the outset. This holding strengthens shareholder protections by ensuring that director conduct is scrutinized for procedural integrity, preventing directors from using a seemingly fair price to shield a grossly negligent decision-making process from judicial review.

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