• Court of Chancery holds that conflicted transactions involving a potential controller may still be considered under the deferential business judgment rule, rather than entire fairness, if the evidence does not establish the potential controller exercised actual control.
• Procedural safeguards isolating a potential controller from the Board’s decision-making process can preclude a finding of actual control.

The Delaware Court of Chancery issued its Post-Trial Memorandum Opinion in In Re Oracle Corporation Derivative Litigation on May 12, 2023.¹ Despite having earlier held that Plaintiffs pled sufficient facts to allege that Larry Ellison was a conflicted controller of Oracle in its acquisition of NetSuite, the Court determined that the evidence at trial fell well short of proving control. Namely, the Court held that the evidence (1) did not show Ellison’s actual control over the acquisition, and (2) established that a special committee was empowered to, and actually did, vigorously negotiate the acquisition. As a result, Ellison was not a controller in fact, thereby making the procedural safeguards for a conflicted controller transaction unnecessary. Further, the Court found that Plaintiffs failed to prove a fraud on the board. As such, with the business judgment rule standard restored, the Court ruled for Defendants.

Background

Oracle Corporation (the “Company”) was founded by Ellison in 1977 and has become a commercial juggernaut in the business of selling hardware, software, and cloud computing products. Ellison operated as the Company’s CEO from its founding until 2014, and since stepping down has remained the Company’s Chief Technology Officer and Executive Chairman of the Company’s Board of Directors (the “Board”). Ellison also co-founded NetSuite, a company that sold cloud-based financial software to commercial customers. Over time, Ellison had varied between advocating for the Company acquiring NetSuite and believing such an acquisition would not be prudent.

Discussions that led to the Company acquiring NetSuite did not begin in earnest until early 2016. At that time, the Court found that Ellison had recused himself from the Board’s informal deliberations related to the potential acquisition.

In March 2016, once discussions moved towards an actual acquisition process, the Board formed a Special Committee. The Special Committee was empowered to fully negotiate the NetSuite transaction, including by retaining its own independent legal counsel and business consultants. Moreover, in May 2016, the Special Committee put in place “rules of recusal” prohibiting Ellison from discussing the transaction with anyone but the Special Committee, requiring Company employees working on the transaction to be made aware of Ellison’s recusal, and forbidding Company officers and other employees from participating in the negotiating process absent the Special Committee’s direction. In the eight months between its creation and the closing of the NetSuite acquisition, the Special Committee met fifteen times. The Company ultimately acquired NetSuite in a tender offer valued at $109.00 per share that closed on November 7, 2016.

Plaintiffs filed their derivative complaint on May 3, 2017, alleging that: (i) Ellison controlled the Company, (ii) the Board, including its Special Committee, lacked independence from Ellison, and (iii) because Ellison held more of NetSuite’s outstanding stock (39.8% as opposed to 28.4% of the Company), Ellison caused the Company and its Special Committee to overpay for NetSuite to benefit himself personally. Plaintiffs advanced two theories why the transaction should be reviewed for entire fairness and not under the business judgment rule. First, and most importantly, Plaintiffs alleged that Ellison was a controller who sat on both sides of the transaction. Second, Plaintiffs alleged that Ellison and current CEO Safra Catz misled the Board and the Special Committee, rendering the NetSuite acquisition a product of fraud.

The Court noted Plaintiffs’ claims were intensely litigated for five years. The Court denied Ellison’s motion to dismiss in January 2018, finding that Plaintiffs had adequately alleged that Ellison was a controller, a majority of the Board lacked independence from Ellison, and that he and Catz had acted disloyally with respect to the NetSuite acquisition. The Court similarly denied Ellison’s motion for summary judgment and the case ultimately proceeded to a month-long trial that concluded in August of 2022. But after trial, the Court ruled that the evidence did not support Plaintiffs’ claims.

The Decision

Ellison Was Not a Controller in Fact Because He Was Insulated from the Transaction

When a plaintiff alleges that a minority stockholder, such as Ellison, exercises control over a company, the plaintiff must prove that the minority stockholder dominated the company through the “actual control of corporation conduct.”² The Court found that Ellison did not exercise such control for three reasons.

First, the Court found that Ellison lacked traditional factors exhibiting direct control. Although Plaintiffs focused on Ellison’s status as the Company’s founder and strategic leader, they were unable to prove that Ellison acted as a controller such that independent directors did not “freely exercise their judgment” for fear of retribution.³ Instead, the Court noted that the Board “was not afraid to stand opposed to Ellison” and that Plaintiffs’ allegations only established that Ellison had “clout” as opposed to exercising actual control over the Company.⁴

Second, the Court found that Ellison was absolutely removed from the acquisition process. While Plaintiffs alleged that Ellison had proposed the transaction, the Court found that Ellison had actually expressed views against the transaction in 2015 and that the Company had long viewed NetSuite as a potential takeover target. When the transaction was first broached in earnest by the Board in its January 2016 Board meeting, Ellison left the meeting. Further, when NetSuite signaled it was open to being acquired, the Board formed a Special Committee fully empowered to negotiate an acquisition and consider alternatives, including not purchasing NetSuite, without any involvement from Ellison. During the NetSuite negotiation itself, the Court found that Ellison “scrupulously avoided any discussion of the transaction with the Special Committee.”⁵ The Court likewise rejected Plaintiffs’ allegations that Ellison applied control through Catz due to a lack of evidence demonstrating such control—including that the Special Committee, and not Catz, ran the negotiation process, and that Catz (as Ellison’s purported surrogate) “did not take actions to advance Ellisons interests.”⁶

Third, the actual “hard-nosed” negotiating by the Special Committee suggested that Ellison did not improperly influence the acquisition’s negotiation.⁷ Throughout the negotiation, the Special Committee investigated alternatives and thoroughly weighed the transaction itself. In fact, evidence at trial suggested that the deal appeared to be dead after NetSuite had countered at a price deemed unsuitable by the Special Committee. The Court highlighted the fact that the Special Committee was willing to let the deal die in June 2016 as important evidence demonstrating Ellison’s lack of control. Even after negotiations resumed, the Special Committee reaffirmed its non-bid and the deal only proceeded when NetSuite bid against itself. The acquisition was ultimately consummated at $109.00 per share, which was a dollar below the Special Committee’s initial price ceiling.

Under Delaware law, conflicted transactions involving a controller must be given the dual protections of MFW—namely, approval by an independent committee of the board and an uncoerced, informed majority vote of the corporation’s disinterested stockholders—to avoid entire fairness review.⁸ Here, the Board did not implement MFW procedures, and that decision was vindicated by the Court’s finding, based on the evidence at trial, that Ellison “did not function as a controller.”

The Court Finds No Evidence of Fraud on the Board

Plaintiffs argued that entire fairness review was still warranted because Ellison and Catz allegedly defrauded the Board by failing to disclose their beliefs about NetSuite to the Special Committee and other discussions about NetSuite’s post-merger management. Under a “fraud on the board” theory, Plaintiffs must prove that “(1) that the fiduciary was materially interested, (2) that the board was inattentive or ineffective, (3) that the fiduciary deceived or manipulated the board, (4) that the deception was material, and (5) that the deception tainted the decision-making process of the board.”⁹

The Court rejected Plaintiffs’ contentions, holding that Ellison’s critiques of NetSuite’s business strategy were immaterial. The Court likewise determined that the Special Committee made its own independent determinations consistent with the Company’s past deals, and not as a result of any deception by Ellison or Catz.

Because Ellison was not a controller, and there was no fraud perpetrated on the Board, the Court held the acquisition was subject to the deferential standards of the business judgment rule. The Court entered judgment for Defendants.

Takeaways

The Oracle decision is a useful reminder that a plaintiff-friendly, pleading stage inference of control in fact does not foreclose review under the business judgment rule at trial. Parties engaging in a conflicted transaction involving a potential controller should recognize that both form and function matter; recusing the potential controller and naming a special committee provide the right form, but both must function as intended to isolate the potential controller from having actual control over the transaction.

1. No. 2017-0337-SG, 2023 WL 3408772, at *1 (Del. Ch. May 12, 2023).
2. Id. at *19 (quoting Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, 1114 (Del. 1994)).
3. Id. (quoting In re Morton’s Rest. Grp., Inc. Shareholders Litig., 74 A.3d 656, 665 (Del. Ch. 2013) (internal citations omitted)).
4. Id. at *20.
5. Id. at *27.
6. Id. at *24.
7. Id. at *22.
8. Kahn v. M & F Worldwide Corp., 88 A.3d 635, 645 (Del. 2014).
9. Id., at *27 (citing In re Pattern Energy Grp. Inc. Stockholders Litig., 2021 WL 1812674, at *33 (Del. Ch. May 6, 2021)).