Directors’ Failure to Consider Speculative Projections in Recommending Tender Offer to Stockholders Insufficient to Plead a Claim for Breach of the Duty of Loyalty Based on Bad Faith

By: Michelle McCreery Repp and Benjamin Kendall

In In re Chelsea Therapeutics International Ltd. Stockholders Litigation, Consol. C.A. No. 9640-VCG (Del. Ch. May 20, 2016), the Delaware Chancery Court held that Plaintiffs, who alleged bad faith on the part of corporate directors based on a failure to adequately take into account speculative financial projections in evaluating the adequateness of an acquisition offer, had failed to state a claim on which relief could be granted.

Chelsea Therapeutics International, Ltd. (“Chelsea” or the “Company”) developed a FDA approved drug to treat symptomatic neurogenic orthostatic hypotension. Plaintiff stockholders brought a class action against several directors of Chelsea alleging that the directors acted in bad faith by recommending to the Chelsea stockholders a tender offer at a price substantially below the standalone value of the Company.  Specifically, the Plaintiffs alleged that the directors disregarded two sets of projections that indicated a higher value for the Company.  One projection assumed a higher market share for the Company’s drug if the FDA removed the Company’s primary competitor from the market — an outcome the board discussed but decided was unlikely.  The other projection predicted increased revenue streams to Chelsea if the FDA, in the future, approved the Company’s drug for the treatment of other medical conditions for which its use was not currently proven effective nor approved.

Additionally, Plaintiffs alleged that certain directors would be entitled to change in control payments if the Company was sold, but conceded that those directors held equity positions in the Company and Plaintiffs did not allege that the change of control payments exceeded the losses those directors would suffer from the Company’s alleged low sale price. Therefore, the Court determined that Plaintiffs had failed to plead an interested directors’ breach of loyalty claim, and Plaintiffs’ claims were limited to a bad faith claim.

Initially, the Court acknowledged that a successful bad faith claim against directors is a “rare bird” and suggested that the good faith component of a director’s duty of loyalty essentially functions to allow the equity judge a “fiduciary out” from the business judgment rule. The Court reiterated the rule that to state a bad faith claim, a plaintiff must show either “an extreme set of facts” establishing that disinterested directors had intentionally disregarded their duties, or that the directors’ decision was “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”  The Court framed the question in the case as whether the directors’ decision to disregard the two sets of projections in recommending the transaction to the Company’s stockholders was “so egregious on its face” that Plaintiffs had stated a case that it is reasonably conceivable that the directors acted in bad faith, notwithstanding that the Plaintiffs did not allege that the directors were interested or lacked independence.  The Court determined the answer was no and held that the directors’ decision was “readily explicable,” because both sets of unused projections were highly speculative and involved contingencies over which the directors had no control.  Because Plaintiffs did not plead any other grounds conceivably leading to a finding of bad faith, the Court dismissed the Plaintiffs’ complaint.

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