In my first post today, I wrote about VC Laster’s opinion in In re Cloudflare Stockholder Litigation and its implications for future similar transactions.
Now I turn to a separate question: How should DGCL 144’s safe harbor be applied to conflicted controller deals?
Here, I have to say, I disagree with VC Laster’s interpretation of the text of the statute – and I’m more in line with Professor Steve Bainbridge’s view but I don’t completely agree with him either. We shall call this, “certainty.”
Anyway, this is going to be a long and extremely technical reading of DGCL 144, for the nerds who like that sort of thing. You have been warned.
So let’s start with – draft in haste, repent at leisure.
The drafters of SB 21/DGCL 144 wanted to ensure that all conflict transactions, other than take-privates, could be cleansed at the board level via independent committees.
But the drafters had two separate issues they wanted to address from prior caselaw. First, a generally searching inquiry into independence that was conducted in at least some cases.
And second, the fact that boards often constructed what they thought – maybe in good faith, I don’t know – independent committees that, when challenged in litigation, turned out to be not independent as determined by a court.
Which led to an awkward requirement of two distinct determinations by the board of whether a particular director is disinterested.
Let’s put aside issues concerning controlling shareholders – I’ll get to that in a moment. Pretend this is just a conflicted board issue.
First, there’s what I call “general disinterest.” DGCL 144 provides “Any director of a corporation that has a class of stock listed on a national securities exchange shall be presumed to be a disinterested director with respect to an act or transaction to which such director is not a party if the board of directors shall have determined that such director satisfies the applicable criteria for determining director independence from the corporation…under the rules (and interpretations thereof) promulgated by such exchange …which presumption shall be heightened and may only be rebutted by substantial and particularized facts …”
Now, understand, any corporation that is publicly traded and listed on a stock exchange is required, as a listing condition, to identify directors who are “independent” of the company. This is done perpetually, in order to demonstrate that the company is in compliance with various rules about majority independent boards (in non-controlled companies), independent audit committees, and so forth. These designations of independence are made in advance, before any particular transaction comes up that needs cleansing. They are consistent over time. And that is how I interpret these provisions – they refer to the board members who are designated as such for exchange listing purposes.
Second, there is what I call the “specific interest” provision. That provision states that if in a particular transaction, the board is not majority disinterested, any board-level cleansing requires the creation of a committee, consisting of at least two persons “each of whom the board of directors has determined to be a disinterested director with respect to the act or transaction.”
See? Two separate board determinations of interest. Except one comes perpetually, as part of exchange listing requirements, outside the context of any particular transaction. And the other comes when a particular cleansing committee is constructed, with a particular transaction in mind.
After that committee is constructed – consisting of directors that the board determines are specifically disinterested – a conflict transaction is cleansed by “the affirmative votes of a majority of the disinterested directors then serving on the … committee.” Which I read to mean, in the context of a shareholder challenge, the court may evaluate whether the directors on the committee were actually disinterested, not withstanding the board’s specific designation of disinterest, based on the board’s judgment. At that time, the general disinterest provision creates a heightened – but not irrebuttable – presumption of disinterest, for any committee members who had previously been identified as independent for the purposes of exchange listing requirements. And, once the court identifies who was actually disinterested, in the face of the heightened presumption, then the court must determine whether a majority of those actually disinterested directors approved the deal. If so, it is cleansed, and if not, not.
In other words, the committee must be constructed by a board in order to be disinterested in light of specific facts before it; but all directors are generally presumed disinterested (heightenedly) if – acontextually – they were designated as such for listing purposes. That general presumption of disinterest both assists the board when it makes specific designations, and serves as a bulwark in the context of any stockholder challenge to the disinterest of committee members.
That was how SB 21 was originally drafted, and those were the only relevant provisions.
But, those of you who were there for the drafting fights may remember, there was an objection, namely, what about transactions concerning controlling shareholders?
SB 21 also contemplated having controlling shareholder deals be cleansed solely at the board level, outside the context of take-privates. And controlling shareholder deals would be cleansed by committees, exactly the same way as they would in a director-conflict situation, where a majority of the board is not disinterested.
But the listing standards for determining general disinterest only concern independence from the company. They do not concern independence from the controlling shareholder. So the general independence standards did not seem to be on point, when a controlling shareholder conflict is at issue.
(They aren’t on point for director conflicts either, but, whatever).
So the draft of SB 21 was hastily amended. The general disinterest standards added some words. Now, a director would get a heightened presumption of general disinterest if “the board of directors shall have determined that such director satisfies the applicable criteria for determining director independence from the corporation and, if applicable with respect to the act or transaction, the controlling stockholder or control group, under the rules (and interpretations thereof) promulgated by such exchange (treating the applicable controlling stockholder and control group as if the controlling stockholder and control group were the corporation for purposes of applying such criteria to determine independence from a controlling stockholder or control group).”
In other words, if a controller conflict is at issue, the board is supposed to take the exchange listing standards for independence from the company, imagine those standards substituted the word “controller” for the word “company,” and determine if the director satisfies those standards.
Except we have a problem.
Boards as a matter of course have to identify independent directors for exchange listing purposes – they do that outside the context of any particular transaction. That’s why I call that “general disinterest.” Every year, in the proxy, the board identifies which directors it has determined to be independent.
But they do not ordinarily, as a matter of course, identify directors who are disinterested from controllers.
So what was unclear, after SB 21 passed, was whether these controller-independent-directors would have to be so designated generally, before any particular transaction was at issue, just as they would be for director-conflict transactions, or whether they would be so designated in the context of a particular transaction.
(Yes, the general disinterest provisions talk about independence from a controller mention “if applicable with respect to a particular transaction,” but I don’t think that necessarily means, “boards make the determination of disinterest from controllers only when that conflict arises.” I think it could just as easily mean, “when the presumption of disinterest is being applied in a courtroom, in the context of a particular transaction, what matters is that the board has made a determination of disinterest from a controller.”)
If boards can designate disinterest from a controller – under the general standards applicable to exchange listings – in the context of a particular transaction – then the designation would overlap with the specific designation provisions, which arise in the context of constructing an independent committee. Two things would happen at once: the board would simultaneously identify board members who get a heightened presumption of independence because they meet exchange-listing requirements for independence from controllers, if the exchange listing rules worked that way which they don’t, and also appoint directors to a committee who “the board of directors has determined to be a disinterested director with respect to the act or transaction.”
I think this is a mess. I think it presents an unpleasant disjunction where there are stronger independence protections for director-conflict deals (because, in those deals, there must be a general, acontextual, determination of independence to get a heightened presumption, before a conflict arises), and it also renders the specific determination provisions duplicative, when it comes to controllers.
So I think there’s a real interpretive question, namely, whether, in the context of a controller conflict transaction, the general independence standards should require advance designation, before any particular conflict arises. Just the way they operate for ordinary director conflicts.
VC Laster, however, assumed that both the general and the specific designations could occur in the context of a particular controller conflict transaction. In that sense, he seemed to conflate two separate statutory provisions – board determination of independence from the controller under listing standards, which leads to a heightened presumption of actual independence – and board determination of disinterested director status “with respect to the act or transaction” for the purposes of construction of a committee.
After conflating these two standards, he went on to hold that rebuttal evidence would also depend on the reasonableness of the board’s determinations:
The court asks whether a reasonable board presented with the information that the board possessed could have made the Disinterest Determination. The court does not ask whether the directors made what the court might regard as the correct decision. The court asks only whether the determination was a reasonable one that directors weighing the evidence could have reached.
But as I read the statute, once the board makes its specific determination of independence, the transaction can only be cleaned by “the affirmative votes of a majority of the disinterested directors then serving on the … committee.” Meaning, at this point, the court makes its own determination of actual disinterest, subject to any heightened presumptions that may or may not apply.
This is where I agree with Steve Bainbridge – he too believes that, at this point, the court is directed to count the actually disinterested directors (subject to the heightened presumption), and if a majority of them approved the deal, it’s cleansed.
Where I disagree with Steve is his conclusion that there can be no questioning the board’s determination of disinterest (either the general or the specific). On this, I agree with VC Laster; these are fiduciary acts, and they can be questioned. I’m not certain I agree they should be questioned for care, but they at least should be questioned for good faith. Which is how I heard the statute described, when it was still under consideration, at the Tulane CLI in 2025.
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