102(b)(7) Procedure

Francis Pileggi offers up a very informative post on a panel discussion at the ABA Annual meeting, in which he mentions in passing that prominent Delaware lawyer "Kurt Heyman added that in the Rule 12(b)(6) context, the court will take judicial notice of a Section 102(b)(7) provision in the corporation's charter to the effect that the directors are protected from claims for a breach of the duty of care."

This reminds me of a rather curious problem I've been wondering about for a while.

As I explained in my Corporation Law treatise:

... the Delaware supreme court held in Emerald Partners that a sec. 102(b)(7) provision is an affirmative defense. [Emerald Partners v. Berlin, 726 A.2d 1215, 1223n24 (Del.1999). See also McMullin v. Beran, 765 A.2d 910, 926 (Del.2000).] Defendant directors thus have the burden of proving that they are entitled to exculpation under the statute. If aggressively applied, Emerald Partners could mean that a sec. 102(b)(7) provision rarely will entitle directors to a dismissal on grounds that plaintiff's complaint fails to state a cause of action. Consequently, plaintiffs will be entitled to discovery, which some might call a fishing expedition, and the settlement value of such claims will go up. Thus far, however, the chancery court has continued to hold a sec. 102(b)(7) based motion to dismiss is appropriate pre discovery where plaintiff solely alleged violations of the duty of care. [See, e.g., McMillan v. Intercargo Corp., 768 A.2d 492 (Del.Ch.2000); In re Lukens Inc. Shareholders Litig., 757 A.2d 720 (Del.Ch.1999). A subsequent Delaware supreme court decision in the Emerald Partners litigation confirmed this approach, while emphasizing that limited discovery is available where plaintiff has adequately alleged a violation of the duty of loyalty or of good faith. Emerald Partners v. Berlin, 787 A.2d 85 (Del.2001).]

Am I thus correct in inferring that judicial notice of a 102(b)(7) exculpation provision is how the Chancery Court is getting around Emerald Partners' identification of such a provision as an affirmative defense? And, if so, does Emerald Partners have any teeth on that score?

Comments

[D]

In addition to 102(b)(7) being an affirmative defense, in most instances, if not all, judicial notice at the motion to dismiss stage is merely to note that some exists, not the truth of the matters contained. So, a defendant can notice that an articles of incorporation exists, but not that there really is a 102(b)(7) provision in there. In practice, Courts have ignored this distinction. Instead, 102(b)(7)'s are taken almost as a given (can you name a prominent company without one?), as many decisions do not even mention judicial notice of a document being taken. (I believe a matter decided just last week, Wayne County Employees Retirement System v. Corti, 2009 WL 2219260, is one such example, though admittedly i have not had the opportunity to thoroughly review it yet). In response to your actual question, in states besides Delaware, the approach you describe seems to be the one used often. It really turns 102(b)(7) on its head though, by making plaintiffs show that it does not apply, before treating it like a real affirmative defense and making defendants show that it does.

[Kurt Heyman]

Greetings from Disney World! I believe the way that Delaware courts have resolved the Emerald Partners dilemma is to limit the application of a Section 102(b)(7) defense on a Rule 12(b)(6) motion to situations in which it is clear from the pleadings that only a duty of care claim is stated and that there is no duty of loyalty claim that could possibly survive a 12(b)(6) motion under Delaware's notice pleading requirements. So in practical effect, there rarely is any discovery to support the "affirmative defense" of Section 102(b)(7) -- either the claim is dismissed because it is only a care claim, or it survives because it is a loyalty claim.