A Corporate Odyssey: Navigating Delaware’s New Section 144(d)(2) Director Shield

The Delaware Court of Chancery recently issued its first interpretation of new General Corporation Law section 144(d)(2). Per our prior eAlert, section 144 governs “interested-director” transactions – i.e., where a director has a financial stake in a transaction involving the company, whether directly or through a related entity. 

Normally an investor or other disgruntled person can challenge an interested-director transaction simply because of the conflict, but amended section 144(a)(1) offers a safe harbor: The interested transaction is “shielded” if the company discloses the material facts and a majority of disinterested directors approve the transaction in good faith and without gross negligence. New section 144(d)(2) goes a step further for publicly traded corporations by creating a heightened legal presumption that directors are disinterested. Like Athena guarding Odysseus, that presumption is a powerful shield: Courts will assume director independence unless the plaintiff can point to “substantial andparticularized” evidence that the director has a material interest in the transaction or a meaningful relationship with someone who does.

Into the Storm: Two Transactions, Two Tests

The Chancery Court’s first ruling on section 144(d)(2) came in Ayers v. Foley, a derivative action by stockholder Patrick Ayers (Ayers) on behalf of Fidelity National Financial, Inc. (FNF). FNF was a title insurance and real estate services company in the process of re-domesticating from Delaware to Nevada, and Ayers filed suit just one day before the re-domestication took effect alleging breach of fiduciary duty and unjust enrichment. Defendants included William P. Foley II, FNF’s founder, non-executive chair, and 3.6% stockholder (Foley), along with nine other non-employee directors (NEDs) on the 11-member board.

Ayers challenged two compensation decisions. The first involved increases to FNF’s annual non-employee director compensation, approved by the Compensation Committee under FNF’s Amended and Restated 2005 Omnibus Incentive Plan. The second involved Foley’s one-time equity grant, ultimately approved by FNF’s Related Person Transaction (RPT) Committee. Ayers characterized the RPT Committee’s review as an empty formality, noting that its final approval came by email rather than by formal resolution, and argued that the Compensation Committee lacked authority to delegate to the RPT Committee in the first place.

The Chancery Court began by treating Foley’s equity grant and the annual director pay increases as two separate transactions. Here it distinguished the Delaware Supreme Court’s decision in In re Investors Bancorp, where the entire board had approved all compensation in a unified process. Here, by contrast, each transaction had its own separate discussion, deliberation, and vote, and went through different approval committees and timelines. Because the NED compensation had already been approved when the RPT Committee evaluated Foley’s grant, the committee’s consideration of his award could not “call into question” its members’ own compensation. In short: process separation creates legal separation.

For Foley’s $ equity grant, the court applied new section 144(d)(2) for the first time. Because the grant was approved by the RPT Committee and not by Foley himself, the dispositive question was whether those committee members were truly disinterested. Section 144(d)(2) elevated Ayers’ burden: Rather than merely pleading “particularized” facts (the traditional standard), he had to plead “substantial and particularized” facts demonstrating a material interest or relationship.

Ayers argued that overlapping board service and non-voting minority co-investments in sports teams showed the directors weren’t truly independent, but the Court rejected that argument. Interpreting “substantial” in section 144(d)(2) for the first time, the Court held the term carries a qualitative meaning: The pleaded facts must be significant enough to evidence a disabling conflict, and “volume alone cannot substitute for materiality.” Because the directors were presumed disinterested, section 144(a)(1)’s safe harbor kicked in: Given that the material facts were disclosed and a majority of disinterested directors approved the grant in good faith and without gross negligence, the transaction was protected.

But the defendants’ voyage wasn’t all smooth sailing. Unlike Foley’s equity grant, the annual NED compensation increases were not approved by a separate group of disinterested directors deciding someone else’s pay. The court noted that when the NEDs voted to increase their own compensation they were engaged in “self-compensation” under Delaware law which triggers a tougher standard of review: “entire fairness.” Under entire fairness, the directors bear the burden of proving that both the process (how the decision was made) and the price (what they paid themselves) were fair. Because none of the procedural safeguards of an arm’s-length transaction are present when directors set their own pay, the court approached the issue entirely on price. The court declined to take sides in Ayers’ and the defendants’ “battle of performance metrics” and held only that Ayers had pled enough facts to proceed on this claim.

Epic Lessons from the Decision

In addition to “document, document, document” (always good advice), we can take the following practical suggestions from Ayers.

• Separate the tracks. Even if multiple compensation matters come up at the same meeting, maintain separate discussion, separate deliberation, and separate votes. Give each transaction its own chart and course. Under Ayers, process separation creates legal separation.
• Build the right committee and confirm delegation authority. At least two genuinely disinterested directors should approve any interested transaction. Confirm that your equity incentive plans contain clear delegation authority, and consider referring significant related-party transactions to a specially constituted committee: Ayers treated the Compensation Committee’s referral to the RPT Committee as reflecting sound corporate governance. Retain independent compensation consultants and outside legal counsel, and document what each reviewed and how their analysis informed the decision.
• Negotiate Real negotiation creates the perception (and legal reality) of an arm’s-length transaction. In Ayers, the fact that the Compensation Committee knocked $10 million off Foley’s initial “ask” was a key factor. Document the back-and-forth, the risks considered, and the justifications for the final number.
• Benchmark and document why you chose the metrics you did. Don’t treat benchmarking as an afterthought. Ayers focused on how far compensation deviated from peer medians and declined to choose between the defendants’ and plaintiff’s preferred metrics. If a company outperforms on one measure but lags on others, that dispute will go to trial. Use compensation surveys that test multiple financial and performance metrics, and document why the committee selected the metrics it relied on.
• Try for stockholder ratification. If you can get a stockholder vote then do it – the safe harbor under section 144(a)(2) remains the clearest available course.
• Maintain an up-to-date exculpatory charter provision. FNF’s section 102(b)(7) provision gave its directors an additional layer of protection beyond the section 144 safe harbor, effectively requiring the plaintiff to plead bad faith to establish personal liability. If your company’s charter does not yet include an exculpatory provision, then consider putting an amendment for one to stockholders.