Farewell to Fairness: Towards Retiring Delaware’s Entire Fairness Review

Amir Licht is Professor of Law at the Interdisciplinary Center Herzliya. This post is based on a recent paper by Professor Licht and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Fixing Freezeouts by Guhan Subramanian.

The entire fairness doctrine occupies a central place in Delaware’s accountability tools for corporate directors. In a standard formulation, it calls on directors to establish “to the court’s satisfaction that the transaction was the product of both fair dealing and fair price” (Cinerama, Inc. v. Technicolor, Inc.). As Professor Lawrence Hamermesh and Chief Justice Leo Strine, Jr. recently pointed out, this doctrine undergoes constant transformation:

Like all common law doctrines, the Delaware law defining the fiduciary duties of corporate directors has evolved, often rapidly, in the face of commercial change and experience. It will continue to do so…, while reserving a role for active judicial scrutiny in situations in which such objective decision makers are either absent or impaired, through lack of pertinent information or otherwise, from making a truly voluntary decision (emphasis added).

This paper entertains the idea that Delaware’s corporate law is set on a trajectory that would eventually lead to reforming its doctrine of entire fairness as we now know it by retiring its substantive fairness review prong and insisting on fully-informed consent as the only way for validating tainted transactions. At first blush, this idea may strike one as folly. Entire fairness, after all, is Delaware’s gold standard for fiduciary loyalty in the corporation. It is the touchstone for examining corporate fiduciaries’ behavior in the face of conflict of interest. Delaware courts describe entire fairness as the “most onerous” and “more exacting” standard of review; they take pride in it as an emblem of their equitable jurisdiction, going as it does beyond following the letter of the law. Substantive fairness review is a key component in this doctrine. Why retire it, then?

In addressing this question one should recognize that it actually interweaves two elements—a positive aspect and a normative one. This paper highlights the positive aspect. Delaware courts in fact have already begun to reform the entire fairness doctrine as it has been traditionally structured. A growing array of cases, in which the centerpiece is the seminal ruling in Kahn v. M&F Worldwide Corp. (widely known as “MFW”), creates a legal sphere within which traditional entire fairness analysis has no application. Within this sphere, things rise or fall depending solely on the existence or absence of an uncoerced, fully-informed ratification. Business and legal practice exhibits an unmistakable preference for this approach, such that relevant transactions tend to concentrate within that sphere. The critical move, which could take some time to materialize, will take place when the courts deal the traditional doctrine the coup de grâce and abolish it entirely, if one may say so.

A separate issue has to do with the normative question—namely, whether substantive fairness review should be retired, or even confined as it is today. In this regard I confess a bias upfront: I am firmly in the camp of those who consider the substantive prong of entire fairness review—the “fair price” analysis—as deficient; in particular, as inferior to the approach that the MFW framework reflects, which affirms fully-informed consent as the appropriate response to breaches of fiduciary loyalty. Retiring this doctrine is therefore a desirable development. From this vantage point, review by the court of a tainted fiduciary action in order to verify its substantive fairness, and consequently to validate it, is foreign—indeed, inimical—to fiduciary loyalty and accountability as these legal institutions are understood throughout the common law world, Delaware included.

When stripped to its bare elements, substantive fairness review grants corporate insiders a license to expropriate with impunity, albeit at a fair price. As it happens, this part of the doctrine is a vestige of an historical legal accident, the ramifications of which Delaware courts have strived to contain by developing the entire fairness doctrine as we know it today. Granted, reasonable minds can differ on this point. One can subscribe to the view that entire fairness strikes an optimal balance in light of business needs. Several scholars have in fact cautioned against certain implications of MFW with varying degrees of alarm. Nevertheless, as the MFW-inspired trend gains momentum, the burden is shifting to proponents of substantive fairness review to justify its continuing existence in Delaware law.

This paper thus critically reviews the present, past, and possible future of the entire fairness doctrine. Next, it analyzes issues that could affect the future evolution of entire fairness. It first addresses both the feasibility of further reform, including the use of technology to ensure the integrity of informed consent through shareholder voting and the rise of institutional cross ownership, which may call for special attention to MFW-relevant settings. Finally, it deals with some normative justifications for implementing it.

The complete paper is available for download here.

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