Fraud on the Board: Material Conflicts Must Be Disclosed to the Board to Warrant Business Judgment Review

Troutman Pepper

A recent decision [1] by the Delaware Supreme Court emphasizes the importance of fully disclosing material director and officer conflicts of interest in connection with proposed M&A transactions. Indeed, as the Court’s ruling makes clear, the business judgment rule can be rebutted—even if a majority of the board approving the transaction is independent, disinterested, and acts in good faith—if a single director or officer actively negotiating the transaction fails to disclose that he or she has a material interest in the transaction.

Because rebutting the business judgment rule in this manner triggers entire fairness review and can result in a years-long discovery effort by the defendants to prove the fairness of the transaction, the consequences of failing to disclose a material conflict can be quite substantial, even if the defendants ultimately prevail. The decision’s bottom line is simple, yet important—all material conflicts of directors and officers actively involved in negotiating a transaction must be disclosed to the board for the business judgment rule to apply, and to consequently achieve pre-discovery dismissal of a breach of fiduciary action challenging the fairness of a transaction.


In June 2015, Towers Watson & Co. and Willis Group Holdings Public Limited Company entered into a merger agreement, under which Willis stockholders were to receive 50.1 percent of the post-merger company and the Towers stockholders were to receive 49.9 percent of the post-merger company.

After announcing the merger, ValueAct Capital Management, L.P., an institutional stockholder of Willis, presented to Towers’ Chief Executive Officer (CEO) and lead negotiator of the merger a compensation proposal with the combined company that would potentially provide him with a fivefold increase in compensation. The offer was not binding. Towers’ CEO did not disclose this proposal to the Towers board.

Ultimately, Towers’ and Willis’ stockholders approved the merger, and the merger closed on January 2016. Towers’ CEO became an executive of the combined company and received a compensation package similar to the one offered to him pre-closing.

Upon closing of the merger, litigation ensued. Towers’ stockholders brought claims against Towers’ board of directors claiming that they breached their fiduciary duties by approving the transaction. The stockholder plaintiffs did not claim that the transaction involved a sale of control such that Revlon [2] enhanced scrutiny review applied, involved defensive measures such that Unocal [3] enhanced scrutiny review applied, or that there was a conflicted controlling stockholder or majority-conflicted board such that entire fairness review applied. Instead, the stockholder plaintiffs tried to rebut the business judgment rule by invoking the fraud on the board exception, arguing that Towers’ CEO and lead negotiator suffered a material conflict, which he failed to disclose to the Towers board, and which a reasonable board member would have regarded as significant in evaluating the proposed transaction. The defendants moved to dismiss the complaint.


The Delaware Court of Chancery granted the defendants’ motion, finding that the stockholder plaintiffs did not state a claim. But, a 4-1 majority of the Delaware Supreme Court reversed.

The Supreme Court explained that because the stockholder plaintiffs’ allegations focused on the conduct of just one board member and officer (i.e., Towers’ CEO), to rebut the business judgment rule, the stockholder plaintiffs were required to adequately allege that: (i) Towers’ CEO was materially self-interested in the transaction; (ii) Towers’ CEO failed to disclose his interest in the transaction to the board; and (iii) a reasonable board member would have regarded the existence of Towers’ CEO’s material interest as a significant fact in the evaluation of the proposed transaction.

The court concluded that the stockholder plaintiffs met this test because: (i) ValueAct’s proposal, which would have potentially provided Towers’ CEO a five-fold increase in compensation, was material information; (ii) Towers’ CEO had not informed Towers’ board of the proposal despite keeping it generally apprised of the merger negotiations; and (iii) a reasonable board member would have considered Towers’ CEO’s material interest in the proposal as a “significant fact” in evaluating the merger.

The court so held even though ValueAct’s pre-closing proposal was not binding on anyone at the time. Indeed, the court stated that:

We acknowledge that the Proposal was not binding. But that is not the point. The fact that the Proposal was a not concrete agreement and had milestones requiring “Herculean” efforts did not relieve Haley of his duty to disclose to the Towers Board the deepening of the potential conflict, particularly in an atmosphere of considerable deal uncertainty.

Based on these conclusions, the court found that the stockholder plaintiffs stated a claim and reversed the Court of Chancery’s decision granting defendants’ motion to dismiss.


The primary takeaway of the decision is that all directors and officers actively involved in negotiating a proposed transaction must fully and accurately disclose all potential conflicts of interest to the board of directors in order for the business judgment review to apply.

Typically, to rebut the business judgment rule outside of the controlling stockholder, sale of control, and defensive measure contexts, a stockholder plaintiff must allege that at least half the directors approving the transaction were interested, lacked independence from an interested party, or acted in bad faith. Absent that showing, the business judgment rule generally governs.

A seldomly applied exception to that rule, however, was applied by the court here. That is, even where there is no controlling stockholder, no sale of control, no defensive measures, and a non-conflicted board majority, the business judgment rule can still be rebutted if a single director or officer negotiating or approving the transaction:

  1. had a material interest in the transaction;

  2. failed to disclose that interest to the board; and

  3. a reasonable board member would have regarded the existence of that material interest as a significant fact in the evaluation of the proposed transaction.

Given that the failure to disclose a single director’s or officer’s material interest in a transaction can preclude the application of the business judgment rule and consequently pre-discovery dismissal of a fiduciary duty action, it is imperative that all directors and officers actively involved in the negotiating of a transaction fully and accurately disclose all actual or potential conflicts to the board of directors. In addition, the board should be sure to create a clear record memorializing that not only were such conflicts disclosed, but that they were also fully considered in connection with its approval of the transaction.

[1] City of Fort Myers General Employees’ Pension Fund v. Haley, No. 368, 2019 (Del. June 30, 2020). The court’s decision was made in connection with an early-stage motion to dismiss by the defendants. The court did not make any findings on the facts, but instead accepted the facts as alleged by the plaintiffs, as required to do at the motion to dismiss stage. The merits of this case will be decided during subsequent proceedings.

[2] Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1986).

[3] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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