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The morning after we wrote in Fortune about a controversial Chancery Court decision involving Cloudflare, Vice Chancellor J. Travis Laster moved with uncommon speed to certify an interlocutory appeal of his ruling to the Delaware Supreme Court. <\/p>\n
Corporate boards might read that as a sign the system is correcting itself. They shouldn\u2019t, at least not yet.<\/p>\n
The appeal was necessary because Laster used an unusually expansive reading of \u201cgood faith\u201d to enjoin the Cloudflare board\u2019s decision about its capital structure.<\/p>\n
A vague standard<\/p>\n
With corporate anchoring fees rivaling personal income taxes as Delaware\u2019s primary source of revenue, Delaware\u2019s wise leaders, including its governor and its legislature, saw this exodus coming, and tried to stem its root cause. In March 2025, Delaware passed Senate Bill 21 (SB 21), the most significant rewrite of its corporate code in a generation, to stop the flow of companies out of the state. SB 21 was generally recognized to have been a direct response to a run of activist rulings from the Court of Chancery, which were widely seen as blatant judicial overreach.<\/p>\n
The spirit of SB 21 is simple: if a board routes a possibly \u201cconflicted\u201d deal through a committee of independent directors with real power to reject it, the deal is considered \u201ckosher.\u201d This means no injunctions, no damages, no trial.<\/p>\n
Indeed, Laster\u2019s 142-page opinion concedes the legitimacy of SB 21 and its applicability to this case. He held the directors were independent. He held they were not negligent. He wrote that their process showed \u201call the outward signs of diligent and careful effort.\u201d By his own account, virtually every requirement the legislature wrote was met by the Cloudflare board.<\/p>\n
He enjoined the transaction anyway, on a novel basis. SB 21 does require that the committee act \u201cin good faith,\u201d but Laster\u2019s route was to re-define what good faith entails \u2013 even though the legislative intent of SB 21 and the surrounding debate in the legislature, clearly shows that the Delaware legislature intended SB 21 to be more deferential to independent boards, not less.<\/p>\n
The term \u201cgood faith\u201d was not a third level of diligence beyond the duty of care and duty of loyalty, but merely presumed to be the spirit of board actions. Before this, good faith had been previously generally assumed, in deference to independent boards, with nary any heightened review threshold, much less any invocation to enjoin a transaction.<\/p>\n
Instead, he pointed in part to the fact that the board used Signal to communicate about sensitive strategic information they presumably did not want competitors obtaining, irrespective of litigation, and to a CEO who was known to have a hot temper, even though the temperament of the entrepreneur is irrelevant to good faith and typical of creative businesses in technology, media, fashion and the like.<\/p>\n
From those disconnected scraps, the court inferred that the committee was serving the founders rather than bargaining against them, or what Laster, borrowing from the 2011 Southern Peru case, called \u201ca controlled mindset\u201d, as proof of possible lack of good faith by the committee.<\/p>\n
In analyzing Laster\u2019s novel interpretation of what \u201cgood faith\u201d means, readers might ask whether Laster was merely applying the statute, SB 21, rather than inventing a new standard. But that flies in the face of the legislative history of SB 21, which clearly suggests the intent of the Delaware legislature was to try to drive greater predictability and greater deference to independent boards, rather than drive more elevated scrutiny of those same boards. Against that backdrop, Laster\u2019s idiosyncratic, broader reading of \u2018good faith\u2019 substantively guts the protections SB21 was meant to provide.<\/p>\n
But even more importantly, and legally salient; Laster\u2019s interpretation of \u2018good faith\u2019 is far from what \u201cgood faith\u201d has always historically meant in Delaware, from a legal perspective. The existing Delaware definition of bad faith is grounded in scienter, the requirement of showing that individuals acted with knowledge and intent of wrongdoing, together with the requirement that each board member be assessed individually to determine whether a majority intentionally acted in bad faith. That is the Disney line of cases.<\/p>\n
\u00a0In 2006, the Delaware Supreme Court defined bad faith as \u201cintentional dereliction of duty, a conscious disregard for one\u2019s responsibilities,\u201d and held that gross negligence, \u201cwithout more, cannot constitute bad faith.\u201d Stone v. Ritter that same year made good faith a \u201csubsidiary element\u201d of the duty of loyalty rather than a freestanding duty. And Lyondell in 2009 held that directors who merely \u201cfailed to do all that they should have\u201d breached only their duty of care, while \u201conly if they knowingly and completely failed to undertake their responsibilities\u201d could they be found disloyal.<\/p>\n
Startlingly, Laster largely set aside that definition in practice. A board\u2019s understandable use of Signal to communicate about sensitive strategic information, or a CEO known to have a hot temper, amounts to nothing even remotely resembling scienter, which is knowing or willful misconduct. The opinion likewise faults the committee for not obtaining a fairness opinion while conceding, in its own footnote, that \u201cDelaware courts have stated that there is no duty to obtain a fairness opinion.\u201d Under Lyondell, a process that could have been better is a question of care, not loyalty, and Laster found no failure of care.<\/p>\n
Most tellingly, he acknowledged that without what he called the defendants\u2019 \u201ccredibility problems,\u201d he \u201ccould have concluded\u201d the safe harbor applied. In other words, the statute\u2019s protection now turns on whether a trial judge likes the witnesses.<\/p>\n
If a board can be independent, informed, and diligent and still be found to have acted in bad faith, directors are left without a clear rule to follow. That uncertainty is exactly what is pushing companies to reincorporate elsewhere.<\/p>\n
A disputed record, headed to the Supreme Court<\/p>\n
Laster\u2019s certification also characterizes the facts in ways we believe are wrong, and it is the trial court\u2019s account of the record that the Supreme Court will review.<\/p>\n
He wrote that \u201cthe Committee looked for and found an academic who would say that\u2026maintaining founder control would be good for the Company.\u201d Our research, published for years in academic outlets and in Fortune, describes when dual-class shares fail as well as when they work. We have found that well-governed, founder-led companies with dual-class shares have, as a group, outperformed, and that such structures should expire when they no longer make sense or are abused. Laster also suggested that the company\u2019s financial advisors had data disputing our conclusions. However, in reality, the financial advisors did not, have any such counter evidence, \u00a0as their own presentations make clear.<\/p>\n
He also ruled on the credibility of parties he never met, relying on a one-hour hearing on the paper record alone. The Supreme Court therefore has no firsthand insight from the trial judge to which it could defer.<\/p>\n
Reversal without relief<\/p>\n
The Delaware Supreme Court has reversed Laster in more than 30 decisions, but it has repeatedly remanded those cases back to his courtroom. For example, the Boardwalk Pipeline litigation, stemming from Loews\u2019 2018 buyout of Boardwalk\u2019s public unitholders, has bounced between the two courts for eight years and remains unresolved. Litigation on that scale is a costly distraction for management and boards, on top of fees that can run from $60 million to more than half a billion dollars per company.<\/p>\n
For example, when the Delaware Supreme Court reversed him in his controversial Aruba decision in 2019, they issued a rare rebuke with withering criticism, noting that Laster\u2019s opinion \u201ccould be seen\u201d as \u201ca results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell,\u201d that the approach \u201cwas in no way dictated by a rational reading of Dell,\u201d that his agency-cost reasoning was \u201cnot grounded in the record,\u201d and that by injecting a valuation theory the plaintiff \u201chad not itself posited,\u201d he \u201cinjected due process and fairness problems into the proceedings.\u201d<\/p>\n
While that sounds like a promising development, the court had the power to reassign remanded cases to a different judge, and has not done so. This undermines their own reversal of the Chancery Court, repeatedly throwing the firm back into the arms of its previous judge to invent a serious of unique reasons to derail the deal.<\/p>\n
What boards should take from this<\/p>\n
Certifying an appeal is not the same as a predictable legal regime, and predictability is what boards cite when they leave Delaware. Until the Supreme Court clarifies what \u201cgood faith\u201d requires of an independent, diligent board in a predictable and non-arbitrary way, and until appellate reversals carry real consequences on remand, directors should assume that a sound process may not be enough to protect their decisions in Chancery.<\/p>\n
As the Roman poet Juvenal asked, \u201cQuis custodiet ipsos custodes?\u201d Who guards the guards?<\/p>\n
Disclosure: Cloudflare\u2019s special committee retained us, given our widely recognize expertise as governance scholars, to present our published research on when dual-class share structures help and hurt companies, as it deliberated its own structure based upon our analysis of the total universe of major firms with such arrangements. We were not asked to opine on the terms of Cloudflare\u2019s proposed reclassification, did not do so, and take no position on its design. We have no relationship with Vice Chancellor J. Travis Laster.<\/p>\n
The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.<\/p>\n
#Cloudflares #appeal #wont #fix #whats #broken #Delawares #Chancery #Court<\/p>\n","protected":false},"excerpt":{"rendered":"
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