Orman v. Cullman
794 A. 2d 5, 2002 WL 416957 (2002)
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Rule of Law:
To overcome the business judgment rule's presumption of validity at the pleading stage, a plaintiff must allege particularized facts that create a reasonable doubt that a majority of the board of directors was disinterested and independent with respect to the challenged transaction.
Facts:
- General Cigar Holdings, Inc. was a premium cigar manufacturer controlled by the Cullman Group, which held approximately 67% of the company's voting power.
- In the fall of 1999, an unaffiliated third party, Swedish Match AB, approached the Cullman Group about purchasing the shares owned by the public shareholders of General Cigar.
- The Cullman Group, assisted by director Peter Solomon's financial advising firm, negotiated a proposed transaction with Swedish Match.
- The proposed transaction involved the Cullman Group selling about one-third of its equity to Swedish Match, while the public shareholders would be cashed out at a set price per share.
- Under the deal, the Cullman Group would retain a 36% equity stake, maintain their executive positions (Chairman and CEO), and retain the power to appoint a majority of the board in the surviving company.
- The Cullman Group also agreed that if the deal fell through, it would vote against any other business combination for an 18-month period.
- After the basic deal structure was determined, the General Cigar board formed a Special Committee of three outside directors, which negotiated a price increase for public shareholders from $15.00 to $15.25 per share.
- The final merger agreement was conditioned on approval by a majority vote of the unaffiliated public shareholders.
Procedural Posture:
- Joseph Orman, a shareholder, filed a class action lawsuit against General Cigar and its 11-member board in the Delaware Court of Chancery.
- Orman alleged breaches of the fiduciary duties of loyalty and disclosure in connection with a proposed merger.
- The defendants filed a motion to dismiss the complaint under Court of Chancery Rule 12(b)(6) for failure to state a claim upon which relief can be granted.
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Issue:
Does a shareholder plaintiff state a cognizable claim for breach of the duty of loyalty, sufficient to rebut the business judgment rule presumption on a motion to dismiss, by pleading facts that raise a reasonable question as to the independence or disinterestedness of a majority of the board of directors?
Opinions:
Majority - Chancellor Chandler
Yes. A shareholder plaintiff states a cognizable claim for breach of the duty of loyalty by pleading sufficient facts to question the independence or disinterestedness of a majority of the board. The court found that the plaintiff successfully pleaded facts raising a reasonable doubt about the disinterestedness and independence of six of the eleven board members. The four members of the controlling Cullman Group were conceded to be interested because they received unique benefits not shared with other shareholders, such as continued employment, board control, and a continuing equity stake. The court then found that plaintiff sufficiently alleged that director Bernbach lacked independence because his material consulting contract (paying $75,000 annually) made him 'beholden' to the Cullman Group for its renewal. Furthermore, the court found director Solomon was interested because his financial advisory firm stood to gain a material $3.3 million success fee contingent upon the merger's consummation. Because these allegations implicated a majority of the board (6 of 11), the business judgment rule presumption was rebutted for the purposes of the motion to dismiss, and the duty of loyalty claim was allowed to proceed to discovery.
Analysis:
This decision provides a clear framework for analyzing director conflicts of interest at the pleading stage. It demonstrates that financial benefits do not have to be direct payments from the transaction itself; significant consulting fees or success fees paid to a director's firm can be sufficient to create a material interest or a lack of independence. The opinion reinforces the use of a subjective, 'actual person' standard, focusing on whether a particular benefit is material to the specific director's circumstances. By allowing the duty of loyalty claim to survive, the case serves as an important precedent for shareholders challenging transactions where a controlling shareholder receives benefits different from those of the public stockholders.
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