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The Delaware Supreme Court has issued opinions in two shareholder cases that experts say bolster the ability of responsible corporate directors to make decisions regarding their businesses without fear of being second-guessed by the courts. In the opinions, both written by Chief Justice E. Norman Veasey, the five-member supreme court en banc affirmed judgments by the Court of Chancery to dismiss the shareholder lawsuits on the pleadings, saying neither met threshold provisions necessary to move to discovery and trial. Since a large percentage of major corporations are chartered in Delaware, which means they are subject to the state’s corporate law, the opinions send an important message to business, some lawyers say. The most recent decision, White v. Panic, 2001 Del. Lexis 421, is a derivative action involving sexual harassment claims against the founder of ICN Pharmaceuticals Inc. of Costa Mesa, Calif. The earlier ruling, Malpiede v. Townson, 2001 Del. Lexis, 371, involves a challenge to a merger of Los Angeles-based Frederick’s of Hollywood into Knightsbridge Capital Corp. Both decisions indicate the willingness of Delaware courts to winnow out at the earliest stage less promising shareholder cases, said A. Gilchrist Sparks of Morris, Nichols, Arsht & Tunnell in Wilmington, Del., which represented defendant directors in the Frederick’s action. “I think this is a reaction to a flood of [shareholder] suits — that are on the margin — that are just fee actions,” said Charles M. Elson, director of the Center for Corporate Governance at the University of Delaware. “If every action of the board is challenged, you’re not going to get good people to serve on boards.” Shareholder suits with little chance of ultimate success can cost companies hundreds of thousands of dollars to defend just through the discovery process. Jesse Finkelstein, a partner with Wilmington’s Richards, Layton & Finger, which represented the defendant directors in the ICN Pharmaceuticals action, said the decisions set a high bar for shareholders who seek to “surmount the normal deference given to the exercise of business judgment by disinterested directors.” In White v. Panic, which was handed down on Oct. 3, a shareholder of ICN Pharmaceuticals, a maker of antibiotics, painkillers and tranquilizers, sued the directors and the company for decisions regarding the founder and chairman, Milan Panic, 71. ICN discovered and developed Ribavirin, a drug used in combination with interferon to fight hepatitis C. According to the complaint, the directors breached their fiduciary duties by failing to take measures to stop or sanction alleged sexual harassment of female employees by Panic. The board “turned a blind eye” to a corporate culture at ICN that “unabashedly fostered a hostile working environment,” the complaint said. The complaint based its knowledge of Panic’s behavior on an article in U.S. News and World Report, according to court documents. Failure by the board to monitor and curb Panic’s behavior opened the company to civil liability, the complaint alleged. ICN and Panic settled a lawsuit with one employee, who claimed Panic fathered her child, after she filed a harassment suit in 1995. Panic paid the woman $3.6 million using a loan guarantee from the company, according to court documents. But there was no allegation in the complaint that Panic, who served as prime minister of Yugoslavia from 1992 to 1993, admitted any wrongdoing. Vice Chancellor Stephen P. Lamb dismissed the case in January 2000, saying plaintiff Andrew White did not meet the test of Court of Chancery Rule 23.1, a procedural gatekeeping provision that spells out what is necessary in a derivative action or in cases where a shareholder plaintiff seeks to bring suit on behalf of the corporation. Rule 23.1 is a facet of the business judgment rule, which holds that courts don’t second-guess decisions made by independent, informed and disinterested directors. Instead, they rely on the “presumption that in making a business decision, the directors acted on an informed basis, in good faith and in the best interests of the company.” PLEADING REQUIREMENTS The Delaware Supreme Court upheld Lamb, ruling that the allegations in the White complaint did not meet the heightened pleading requirements to excuse the presuit demand in a derivative suit as required by Rule 23.1. The high court agreed with Lamb that the plaintiff could have used the “tools at hand,” including information from disclosure documents filed with the U.S. Securities and Exchange Commission, to show that demand should be excused. The state supreme court noted, as did Lamb, that under Delaware law (8 Del. C. Sec. 220) a shareholder can obtain books and records to provide facts. “We agree with the holding of the Court of Chancery that the complaint does not allege sufficient particularized facts to raise reasonable doubt that the board’s actions were the product of valid business judgment,” the opinion says. Warren L. Dennis of the Washington, D.C., office of New York’s Proskauer Rose, who argued White v. Panic, said the supreme court’s ruling has “sutured off one avenue of the strike suit.” Strike suits are so-called because lawyers file suit (or strike) as soon as a transaction is announced. “It’s put teeth in the business judgment rule,” he said. Irving Bizar, a partner with New York’s Ballon Stoll Bader & Nadler and the attorney who argued the case before the supreme court for White, declined to comment. ‘MALPIEDE’ CASE The second decision, Malpiede v. Townson, involves a class action brought by shareholders against the directors of Frederick’s of Hollywood. Shareholders alleged that the retailer of women’s lingerie and intimate apparel breached its duty of care and duty of loyalty in a 1997 merger with Knightsbridge Capital Corp. because it did not conduct an auction with a “level playing field.” Vice Chancellor Jack B. Jacobs dismissed the case in January 2000, finding that the plaintiffs’ allegations in the suit challenging the merger did not support the claims of breach of duty of loyalty or disclosure. The supreme court affirmed Jacobs’ decision on Aug. 27. The high court found that the Chancery Court was correct in dismissing the plaintiffs’ claim under Court of Chancery Rule 12(b)(6), another procedural gatekeeping rule that covers motions to dismiss based on failure to state a claim for which relief can be granted. This rule was applied in the context of Delaware law that allows companies to include exculpatory provisions in their charters that bar any claim for money damages against directors based solely on allegations of breach of duty of care. Frederick’s charter has such a provision. Norman M. Monhait of Rosenthal & Monhait in Wilmington, the lawyer who argued the case for the plaintiffs, said he did not “have time to talk about history.” “These cases are bookends,” said Proskauer’s Dennis. “They put procedural teeth in the business judgment rule.” But Elson of the University of Delaware said the opinions should not be read as a shield for nonindependent or “slothful” boards. “These opinions don’t suggest to me an anti-shareholder bias at all,” he said.

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