In the wake of its decision in In re Novell, Inc. Shareholder Litigation last month, the Court of Chancery of the State of Delaware has continued to examine the factors for a finding of "bad faith" when a board of directors fails to satisfy its Revlon duties in a change-of-control transaction. The Novell case will also be stayed while the Delaware Supreme Court determines whether to take up the issue.

In Novell, the Court of Chancery denied in part a motion to dismiss brought by the defendant directors of target company Novell, Inc., Novell's buyer Attachmate Corporation and a minority stockholder of Novell, Elliott Associates LP. The Court ruled that the plaintiff stockholders had made a "reasonably conceivable" claim that the Novell board had breached its duty of care and acted in bad faith by knowingly giving preferential treatment to the eventual buyer Attachmate over another bidder for Novell who had made a comparable offer. Because, at the pleading stage, the board had not offered any evidence to explain why it had treated the two bidders unequally, the Court found the board's conduct to be sufficient to support an inference of bad faith. For a full discussion of the Court's ruling in Novell, see Legal Update, In re Novell: Delaware Court of Chancery Finds Potential Bad Faith by Target Board.

After the ruling, the director defendants in Novell moved for certification of an interlocutory appeal to the Delaware Supreme Court on the charge of bad faith. The Court of Chancery denied the motion, indicating that it would certify an interlocutory appeal only where a ruling would substantively affect the merits of the case or change the parties' status. The Court stated that this was not such a case, as the Novell defendants would still have the opportunity to offer evidence that would explain their disparate treatment of the two bidders and show that the plaintiffs' claim was meritless. Of note, the Court of Chancery did stay the proceedings pending appeal of its denial of certification and the Delaware Supreme Court's consideration of the matter. This indicates that the Delaware Supreme Court will soon have a chance to weigh in on the standard for a finding of bad faith by a board of directors when in Revlon mode.

In a separate case, the Court of Chancery recently shed more light on its preliminary finding of bad faith in Novell. On January 31, 2013, the Court of Chancery issued an opinion in In re BJ's Wholesale Club, Inc. Shareholders Litigation, dismissing a class action lawsuit that alleged that the former board of directors of BJ's had disregarded its Revlon duties in connection with the September 2011 leveraged buyout of BJ's (for a summary of the merger agreement in the sale, see PLC What's Market, Leonard Green & Partners/CVC Capital Partners and BJs Wholesale Club, Inc. Merger Agreement Summary). Somewhat similarly to Novell, the class plaintiffs had asserted that the board of BJ's had improperly ignored a third-party bidder who was prepared to make an offer for the company. The Court, in contrast to its Novell decision, ruled that the plaintiffs' attempts to infer bad faith on the part of the BJ's board were not reasonable considering the rational explanations for the board's conduct in favoring one bidder over another. In particular, the Court emphasized that in Novell, the board had adversely and unjustifiably ignored a third-party bidder after it had already determined that the bidder was a serious participant in the process. The board in BJ's, by contrast, had used its business judgment in making an initial assessment at the outset that pursuing the third-party bidder's interest was not in the best interest of the company and could raise regulatory issues. This, in the Court's words, was "[p]erhaps the crucial difference" (see footnote 75).

The BJ's decision provides more clarity on the circumstances in which the Court of Chancery will find that a board breached its fiduciary duties in bad faith. As discussed in Article, Delaware Courts Tackle Standards of Review for Directors; Results May Vary, the difference between Novell and other cases reduces to a question of the standard of review that is applicable to the board's conduct. If the Delaware Supreme Court takes up the matter, further clarity will be forthcoming.

In the interim, target-company boards should continue to take care to conduct sales processes in a way that keeps all bidders identified as serious on an equal footing so that they may avoid this type of litigation.

To learn more about the fiduciary duties of directors, see Practice Note, Fiduciary Duties of the Board of Directors.