Article courtesy of Edward J. McNeilly and David P. Simonds, each of Hogan Lovells US LLP
Nevada Supreme Court Holds That Shareholders Must Refute Business Judgment Rule and Demonstrate Intentional Misconduct, Fraud or Knowing Violation of Law in Director Fiduciary Duty Suit
In Guzman v. Johnson, 483 P.3d 531, 137 Nev. Adv. Op. No. 13 (Nev. 2021), the Nevada Supreme Court held that a shareholder who sues a corporate director individually for breach of fiduciary duty must, under NRS 78.138(7), rebut the business judgment rule and demonstrate that the alleged breach involved intentional misconduct, fraud, or a knowing violation of the law.
In August 2016, RLJ Entertainment, Inc. (“RLJE”) entered into an investment agreement with respondent Digital Entertainment Holdings, LLC (“Digital”), a subsidiary of respondent AMC Networks, Inc. (“AMC”). Under the investment agreement, AMC, through Digital, loaned RLJE $65 million and RLJE gave AMC the option of owning at least 50.1 percent of RLJE’s outstanding common stock, enabling AMC to become RLJE’s controlling stockholder. The investment agreement prohibited RLJE from considering any other acquisition proposal (the “No-Shop Provision”). The agreement also gave AMC the right to designate two directors to RLJE’s board and, upon the exercise of the warrants in full, AMC had the right to designate a majority of RLJE’s board. A majority of the shareholders voted in favor of the investment agreement.
In February 2018, AMC offered to purchase the outstanding shares of common stock for $4.25 per share. In the letter, AMC stated that it would “not sell [its] stake in RLJE or be party of any other process.” A special committee of RLJE’s board (the “Special Committee”), consisting of two directors, was formed to consider the AMC offer. The Special Committee sought authority from RLJE’s board to consider and solicit offers from third parties. AMC expressed that it would not support any other transaction and that any attempt at soliciting other offers would be futile considering AMC’s majority ownership and the No-Shop Provision in the investment agreement. RLJE’s board thereafter denied the Special Committee’s request. The AMC and RLJE merger was ultimately approved by RLJE’s shareholders at a price of $6.25 per share, with AMC voting all of its shares in favor of the merger.
One day before the shareholder vote on the merger, plaintiff Lisa Guzman (“Guzman”) filed a class action against, among others, several RLJE directors and AMC. Guzman alleged that the Directors and AMC breached their fiduciary duties to her and the other minority stockholders in connection with the transaction. The individual directors and AMC moved to dismiss Guzman’s complaint, relying on Nevada’s statutory business judgment rule NRS 78.138(7). The trial court granted the directors’ motion to dismiss, finding that Guzman had failed to provide sufficient facts to rebut the business judgment rule. The trial court likewise dismissed the claims against AMC.. The district court granted leave to amend the complaint, but Guzman instead requested entry of judgment and appealed.
On appeal, Guzman contended that the district court had erred in applying NRS 78.138 to the individual directors and AMC. She argued that, pursuant to Foster v. Arata, 74 Nev. 143, 325 P.2d 759 (Nev. 1958), as reaffirmed by Shoen v. SAC Holding Corp., 122 Nev. 621, 640 n.61, 137 P.3d 1171, 1184 n.61 (Nev. 2006), disavowed on other grounds by Chur v. Eighth Judicial District Court, 136 Nev. 68, 72, 458 P.3d 336, 340 (Nev. 2020), she had rebutted the business judgment rule as a matter of law by alleging that the directors and AMC were “interested fiduciaries” in the merger. The so-called “inherent fairness” standard should apply.
As to the claims against directors and officers, the Nevada Supreme Court rejected this argument, holding that, as set forth in Chur, the business judgment rule codified in NRS 78.138 provided the sole avenue to hold directors and officers liable for damages arising from official conduct. The inherent fairness standard could not be used to rebut the business judgment rule and shift the burden of proof to individual directors, as this would contravene the express provisions of NRS 78.138(7), which require the plaintiff to establish a breach involving intentional misconduct, fraud or a knowing violation of law. The Nevada Supreme Court explicitly abrogated Foster and Shoen to the extent they adopted a standard that conflicts with NRS 78.138(7) or Chur. Applying this standard to Guzman’s complaint, the Nevada Supreme Court ruled that, taking her claims as true, Guzman had not presented facts sufficient to rebut the business judgment standard and thus the district court correctly dismissed the claims against the directors. The Nevada Supreme Court also ruled that the district court had correctly dismissed Guzman’s claims against AMC because Guzman had failed to allege particularized facts to demonstrate a lack of fair dealing by AMC or payment of an unfair price.
This decision will render it more difficult for breach of fiduciary claims against directors and officers of Nevada corporations to survive motions to dismiss, as plaintiffs will have to plead facts showing intentional misconduct, fraud or knowing violation of law to overcome the business judgment rule.
