Chancery Court Determines Appropriate Standard of Review for Cash Flow “Tunneling” by Controlling Stockholder
By David Forney and Eric Taylor
In In Re EZCorp Inc. Consulting Agreement Derivative Litigation, C.A. No. 9962-VCL (Del. Ch. January 25, 2016) (Laster, V.C.) the Delaware Court of Chancery granted in part and denied in part a 12(b)(6) motion to dismiss for failure to state a claim, but at its heart the ruling addressed the proper standard of review in a case alleging self-dealing by a controlling stockholder for “tunneling” cash flow and receiving non-ratable benefits from related-party services agreements. After a detailed and extensive analysis, the court held that the entire fairness standard of review, and not the business judgment standard of review, applied to non-merger business transactions where controlling stockholders can exact non-ratable benefits from the company, regardless of the type of transaction or method of extraction.