On May 12, 2023, the Delaware Court of Chancery reaffirmed a key principle for transactions involving interested directors: process is everything. Vice Chancellor Sam Glasscock III, in his opinion in In re Oracle Corporation Derivative Litigation, provides reassurance that the Court will not rush to second-guess board decisions involving conflicted transactions as long as adequate safeguards are present.
Larry Ellison founded Oracle Corporation, a California-headquartered company in the business of selling hardware, software, and cloud-computing products, in 1977. Since then, he has served on its board and remained an officer of the company. Over 20 years later, Ellison co-founded NetSuite, a company providing cloud-based financials and enterprise resource planning software. In early 2015, Oracle considered acquiring NetSuite to “complement Oracle’s current offerings.” At this time, Ellison owned approximately 28% and 40% of Oracle and NetSuite, respectively. After much negotiation, Oracle’s board approved the transaction in July 2016.
In May 2017, plaintiff stockholders filed a derivative suit against Ellison, alleging that he caused Oracle to overpay by $3 billion in its acquisition of NetSuite. They put forth two arguments to support their claim that the Court should apply the stringent entire fairness review of the transaction, rather than the more lenient business judgment rule: (1) Ellison was a controller of Oracle because he was a “visionary leader,” long-time director, and significant stockholder; and (2) Ellison had defrauded the Oracle board by making material omissions regarding NetSuite. The Court found in favor of Ellison.
II. Controller Theory
In Delaware, a stockholder who owns over 50% of the voting stock of a company or who, due to a mix of voting power and other opportunities, has the ability to control the board’s actions may be deemed a controller. A transaction involving a controller is typically assessed under the entire fairness standard. While Ellison was undeniably a force at Oracle, the Court concluded that he was not a controller.
In determining whether Ellison had used his “outsized influence” to cause Oracle to overpay for its acquisition of NetSuite, the Court found that several factors mitigated against that claim. The Court found that Oracle’s board had properly formed a Special Committee of three other directors, all of whom were unconflicted and independent of Ellison. In addition, the Court noted that the board, and Ellison himself, “scrupulously avoided” a situation where Ellison would be involved in discussions surrounding the transaction. The evidence further demonstrated that the directors were not afraid of disagreeing with Ellison and that they had acted in a way that “demonstrate[d] loyalty to the company, not Ellison’s conflicted interests.” Throughout the bargaining process, the board displayed a willingness to walk away from the deal if that would have been in Oracle’s best interest. The Court also found that the Special Committee drove a hard bargain, ultimately reducing the deal price in a way that went against Ellison’s interest. Lastly, although the Court admitted that perhaps Ellison could have exerted control over the board if he truly wanted to, it focused solely on whether he had actually exercised control over the board.
After considering the board’s actions, the Court determined that Ellison had not actually exercised control over the board and could not be deemed a controller. As a result, the Court held that the appropriate standard of review was business judgment, not entire fairness.
III. “Fraud on the Board” Theory
According to the plaintiffs, Ellison misled the board by materially omitting certain facts, like his critiques of NetSuite’s business strategy and his beliefs regarding NetSuite’s bleak future. Thus, the plaintiffs argued that the board’s approval of the NetSuite acquisition was a product of fraud.
The Court rejected this argument. The record demonstrated that the Special Committee members were sophisticated and experienced. They also conducted their own diligence by requesting and attending hours-long presentations and discussions about the potential acquisition. They prepared and reviewed incremental models, discounted cash flow analyses, and multiples based on past transactions. As a result, the Court found that a “fraud on the board” theory was inappropriate as the Special Committee members were not “supine or naïve.”
IV. Key Takeaways
From the outside, the facts of the case show that the deck was stacked against Ellison; he was on both sides of the transaction and stood to gain financially at the expense of other Oracle shareholders if Oracle overpaid for its acquisition of NetSuite.
However, the Delaware Court of Chancery made it clear that it will not interfere with a board’s decision when good process exists. Specifically, as Oracle shows, good process can be established by a board disclosing the conflict early in the bargaining process, creating a Special Committee comprised of independent and disinterested directors, scrupulously negotiating for the company’s best interest, conducting its own diligence, and ensuring that interested directors remain insulated from its decision-making process.
For practitioners, it is key to remember:
- For a potential controller holding less than a voting majority, the mere potential for control over a company’s board is not necessarily dispositive. Rather, when determining whether a significant stockholder is a controller, the Court will look to whether the stockholder actually exerted control over the board.
- Oracle underscores the importance of implementing – and memorializing – good process in conflicted transactions. Demonstrating that stockholder interests were adequately safeguarded can mean the difference between business judgment review of the board’s decision and the protracted, expensive litigation that typically accompanies entire fairness review.