The following is a case update written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, analyzing a recent decision of interest:
The Nevada Supreme Court held that shareholder suits against directors for breach of fiduciary duty must proceed under NRS 78.138(7) and, even for interested party transactions, the shareholder must rebut the business judgment rule and demonstrate the breach involved intentional misconduct, fraud or knowing violation of law. Guzman v. Johnson, 2021 WL 1152875 (Nev. 3/25/21).
To view the full opinion, click here.
RLJ Entertainment, Inc. (RLJE) entered into an investment agreement with Digital Entertainment Holdings, LLC (Digital), a subsidiary of AMC Networks, Inc. (AMC). Digital loaned RLJE $65 million in exchange for an option for AMC to own 50.1% of RLJE common stock, for AMC to have the right to designate two directors on RLJE’s board, and for AMC to designate a majority of the board upon exercise of all of the warrants. After AMC offered to purchase the outstanding shares of stock for $4.25 per share, RLJE formed a special committee to consider the offer and negotiated a final share price of $6.25 per share. Aspects of the transaction raised potential issues, including that AMC stated that “attempting to solicit other offers would be futile.” The merger was approved and AMC acquired RLJE.
Guzman filed a class action suit against RLJE’s directors, AMC and its subsidiaries for breach of fiduciary duties owed to Guzman and minority shareholders, alleging among other things that AMC owed a fiduciary duty to ensure that the sale was fair. The directors and AMC moved to dismiss the suit. The motion to dismiss asserted that Guzman failed to rebut the business judgment rule codified in NRS 78.138. Guzman argued that she did so by including allegations that the directors were interested parties to the transaction, and that the burden therefore shifted to the directors to demonstrate good faith given that it was an interested party transaction. The district court dismissed the suit with leave to amend, determining that Guzman failed to state facts showing that the special committee was not disinterested and therefore the business judgment rule applied. However, rather than filing an amended complaint, Guzman requested entry of judgment so that she could immediately appeal the decision. The Nevada Supreme Court affirmed the district court’s dismissal of the claims.
The Nevada Supreme Court’s opinion focused on whether the “inherent fairness” standard for interested director transaction controls, as provided for in Foster v. Arata, 74 Nev. 143 (1958) and Shoen v. SAC Holding Corp., 122 Nev. 621, 640 n.61 (2006), or if the plain language of NRS 78.138(7) codifying the business judgment rule (and its presumption of good faith) controls, as held in the court’s recent opinion in Chur v. Eighth Judicial District Court, 136 Nev. 68 (2020). Chur and the plain text of NRS 78.138 figured heavily in Guzman (a footnote in the opinion notes that the arguments in the district court took place before the Nevada Supreme Court’s opinion in Chur was published). At the outset, the court stated that “[i]n Chur, we explained that a litigant who sues directors or officers of a corporation individually for breach of fiduciary duty must satisfy both requirements of NRS 78.138(7)(2017), which provides the sole method for holding individual directors liable for corporate decisions.” The court further stated that, notwithstanding Foster and Shoen, the statute “plainly requires the plaintiff to both rebut the business judgment rule’s presumption of good faith and show a breach of fiduciary duty involving intentional misconduct, fraud, or a knowing violation of the law.” The court stated that “[o]ur recent decision in Chur guides our analysis here.”
Citing again to Chur, the court stated that applying Foster and Shoen would result in “confusing and blurring the plaintiff’s burden under NRS 78.138(7)” and that “we now conclude that the inherent fairness standard cannot be utilized to rebut the business judgment rule and shift the burden of proof to the individual directors. Such a standard would contravene the express provisions of NRS 78.138(7) and render meaningless the statute’s requirement that the plaintiff must establish a breach involving intentional misconduct, fraud, or a knowing violation of law.”
Based on the court’s determination that the inherent fairness standard does not apply and the plaintiff bears the burden of rebutting the business judgment rule, the court rejected Guzman’s argument that she rebutted the business judgment rule by alleging that the transaction was an interested party transaction. The court further found that, as to the directors not on the special committee, the complaint did not “allege facts showing that those individual directors’ interests actually affected the transaction,” and “failed to allege specific facts showing those directors engaged in any intentional misconduct, fraud or knowing violation of the law in regard to the merger.” Further, as to directors on the special committee, the court found that the allegations were based on speculation and failed to show that the directors were motivated by self-interest. Finally, as to the claims against AMC, citing to Cohen v. Mirage Resorts, Inc., 119 Nev. 1, 13 (2003), the court stated that Guzman was required to allege wrongful conduct going to the approval of the merger, that “[f]raud-based challenges to the validity of a merger usually encompass a lack of fair dealing or lack of fair price, or both” and that “Guzman failed to allege particularized facts to demonstrate a lack of fair dealing or lack of fair price.” The court noted that “the final stock price of the sale was substantially above AMC’s initial offer and was higher than the 52-week high stock price.”
The court therefore affirmed the dismissal of the suit and held that “a shareholder seeking damages against individual directors and officers must proceed under NRS 78.138(7)” and further held that Foster and Shoen are abrogated “to the extent those cases adopted a standard that conflicts with NRS 78.138(7) and Chur v. Eighth Judicial District Court, 136 Nev. 68, 458 P.3d 336 (2020).”
In a concurrence in part and dissent in part, Justice Pickering stated that, as to claims against AMC and RLJE’s founder and board chair, the analysis in whether to dismiss the complaint is different given that “[a] majority shareholder owes minority shareholders fiduciary duties distinct from the fiduciary duties directors owe.” Justice Pickering therefore dissented in part, stating that the district court erred in dismissing those claims.
Guzman is an expansion of the Nevada Supreme Court’s recent opinion in Chur and creates a higher hurdle to pursue claims against directors and officers as to interested party transactions in Nevada. For a more detailed discussion on Chur, see 2020-13 Comm. Fin. News. NL 25. Following Guzman, for transactions that involve directors and officers as interested parties, the plaintiff cannot rely on allegations that the directors and officers were interested parties and instead must both rebut the business judgment rule and allege intentional misconduct, fraud or knowing violation of law. At the outset of a case and prior to discovery, that is a tall order unless information is public knowledge. The better view as to interested party transactions is the one stated in Shoen, which states that “[g]enerally, when an interested fiduciary’s transactions with the corporation are challenged, the fiduciary must show good faith and the transaction’s fairness,” citing to Foster and the U.S. Supreme Court opinion in Pepper v. Litton, 308 U.S. 295, 306 (1939).
Although the Nevada Supreme Court held that the plain text of NRS 78.138(7) must be given meaning, it is not clear as to why interested directors as fiduciaries should not be required to demonstrate fairness of the transactions to which they are interested parties, and why demonstrating a transaction is a related party transaction does not rebut the business judgment rule. However, even without a legislative fix to NRS 78.138(7) in the wake of Guzman, exceptions within NRS 78.138 provide for greater liability for directors and officers in certain situations, including if the articles of incorporation or amendments thereto provide for greater liability. This places increased importance on shareholders demanding articles of incorporation that provide for liability for gross negligence and a higher standard for interested party transactions. Without those protections, directors and officers will get a pass as to many decisions made that benefit them regardless of whether the transactions are in the best interests of the company. The biggest beneficiary following Chur and Guzman is insurance carriers providing directors and officers liability insurance to companies given that the coverage will continue to be purchased, but most shareholder lawsuits will either be dismissed as not meeting the standards set forth in NRS 78.138 or may be subject to a policy exclusion based on meeting the standards in NRS 78.138 as intentional misconduct, fraud or knowing violation of law.
These materials were written by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, a member of the ad hoc group and the Immediate Past Chair of the CLA Business Law Section, with editorial contributions by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.