Chancery Court Again Denies, at the Pleading Stage, New Safe Harbor Protection for a Conflicted Transaction—Cloudfare

In In re Cloudfare, Inc. Stockholder Litigation (Oct. 16, 2026), the Court of Chancery, on a motion for a preliminary injunction, found it was "reasonably probable" that the new Delaware safe harbor statute for conflicted transactions (the "Safe Harbor Statute") does not protect the founder-controlling stockholders (the "Founders") of Cloudfare, Inc. (the "Company"), or the Company's nine independent directors, from liability in connection with a planned recapitalization that would preserve the Founders' control of the Company (the "Recapitalization"). Vice Chancellor J. Travis Laster preliminarily enjoined the Recapitalization to preserve the status quo pending trial.

The Safe Harbor Statute (enacted as part of the 2025 amendments to DGCL Section 144) protects against liability in connection with conflicted transactions (other than take-private transactions) that were approved either by (i) a special committee of disinterested directors, acting in good faith and without gross negligence, or (ii) the disinterested stockholders, in an informed vote. The Statute thus provides an easier, more certain path to protection against liability for conflicted transactions than the common law MFW path to business judgment review of conflicted transactions, which requires both approvals.

In Cloudfare, the Recapitalization was approved by a special committee of disinterested directors (the "Committee"). However, based on the record developed on the plaintiffs' motion for a preliminary injunction, the court found it reasonably probable that the directors did not act in good faith in approving the Recapitalization, and therefore that the Statute's safe harbor protections may not be available. The court found that the Committee may have operated under a "controlled mindset" and prioritized the Founders' interests over the interests of the Company and its stockholders as a whole. The court noted evidence suggesting improper backchannel communications, including a Committee member telling a Founder that he expected the Committee would give the Founder what he wanted; and "bullying" of the Committee by the Founder when a Committee counter-proposal did not provide all that he wanted. Significantly, the court emphasized the "unique" fact that the defendants had "credibility problems," primarily based on their extensive use of Signal, with an auto-delete function, for their discussions.

Cloudfare is just the second case in which the court has considered the applicability of the new Safe Harbor Statute. The first case was Dodiya (Aug. 26, 2026), in which Vice Chancellor Lori W. Will found the Statute's protections unavailable in connection with a board-conflicted sale of the company because the plaintiff had adequately pled "extreme" flaws in the sale process. These two cases provide early reference points for the court's review of conflicted transactions under the new Statute.

Key Points

• In both decisions issued so far under the new Safe Harbor Statute, the court, at the pleading stage, has declined to apply the safe harbors to insulate directors and controllers from liability. Cloudfare and Dodiya underscore that, although the Statute provides an easier path to protection against liability for conflicted transactions than under common law principles, the committee-approval safe harbor will not be available if the board or committee approving the transaction failed to comply with their fiduciary duties-i.e., if directors were grossly negligent or acted in bad faith. Dodiya highlights that, even if safe harbor protection is not available due to directors' gross negligence, claims against independent directors will be dismissible based on exculpation under the company's charter (as gross negligence is a duty of care violation, which is exculpable); although claims against conflicted directors potentially may not be dismissed because the directors' self-interest could implicate the duty of loyalty (and duty of loyalty violations are not exculpable). Cloudfare highlights that, if safe harbor protection is not available due to directors' bad faith, claims against those directors, even if they are independent directors, will survive (as bad faith is a duty of loyalty violation and so not exculpable).
  
  
• In both cases, the court emphasized that the facts were "extreme" or "unique." Dodiya involved an "extreme scenario," the court stated, where a board allowed a deeply conflicted CEO-director to have continued access to sensitive information although he had previously leaked information to the company's buyer (who was the CEO's father) and then refused to enter into a confidentiality undertaking going forward. The leaked information apparently gave the CEO's father an insurmountable advantage over other potentially interested bidders and set the sale price. In Cloudfare, the court stressed the "unique fact" that the defendants had "credibility problems," based in large part on "extensive" use of Signal chats, which were auto-deleted-from which, the court stated, negative inferences could be drawn (critical at the pleading stage, we note, as bad faith turns on the directors' beliefs and intentions). "Those credibility issues," the court stated, "mean the court must hear the defendants testify at trial." Further, the court noted that there was contemporaneous evidence (including in texts) that a Committee member had told a Founder that "he expected the committee to give the founder what he wanted," and that the Founder had "bullied" the Committee.
  
  
• The court emphasized the deference to board determinations of director disinterestedness required under the Safe Harbor Statute's "heightened presumption" of disinterestedness. The court, applying the heightened presumption to the Committee members, concluded that they were disinterested. The court stated that, where a director's relationships "straddle the line," such that "reasonable minds could debate the point," the Statute's heightened presumption of director disinterestedness applies. It is only if no reasonable board could conclude that a director was disinterested that the director would not be entitled to that status under the heightened presumption.
  
  
• The court held that plaintiffs cannot "side-step" the Safe Harbor Statute simply by seeking injunctive relief. The court interpreted the Statute's "injunction exclusion" provision narrowly, and held that it did not apply to the Recapitalization. The exclusion applies only to "narrow categories" of measures that would trigger enhanced scrutiny review, the court held.

Background. The Founders have voting control of the Company through a typical construct. They own high-vote Class B common stock carrying ten votes per share, while the public owns low-vote Class A common stock carrying one vote per share. Over time, the Founders had sold some of their high-vote shares to achieve liquidity and meet personal tax-related and estate-planning goals, and the Company had issued low-vote shares for employee compensation and other corporate purposes. As a result, the Founders faced losing majority control by the end of 2026. The Company has been "immensely successful" under the Founders' control. As is not unusual, the Founders wanted to preserve their control, while achieving their liquidity, tax and estate planning goals, and while enabling the Company to continue to use equity for corporate purposes.

The Company's board of directors (the "Board"), which was comprised entirely of independent directors, formed the three-person Committee to consider the issue. The Founders, the Committee, and the Board eventually agreed on the multi-step Recapitalization. In the first step, the Founders would exchange each of their high-vote common shares for one low-vote common share plus a share of preferred stock carrying nine votes (but only nominal equity value). In the second step, the Company would distribute a new share of non-voting Class C common stock for each outstanding share of low-vote common stock, effectively splitting the equity value of the Company between the two. Thus, going forward, the Founders could divest, and the Company could issue, non-voting shares without affecting the Founders' control, and low-vote shares without meaningfully eroding the Founders' control.

The stockholder-plaintiffs brought suit, claiming the Founders breached their fiduciary duties as controlling stockholders "by extracting an unfair deal" and the directors breached their fiduciary duties by approving the deal. After discovery, briefing and oral argument on the plaintiffs' motion for a preliminary injunction, the court granted the motion, finding that: (i) there was a threat of harm that would occur before trial that the court could not effectively remedy after trial (for example, by awarding damages) if the Recapitalization was consummated; (ii) the equities weighed in favor of issuing the injunction, as preserving the status quo pending trial would not do more harm than good; and (iii) the plaintiffs have a reasonable probability of success on the merits at trial.

Discussion

The Committee was not grossly negligent. The court noted that the Committee "hired competent advisors, held eighteen meetings over six months, and generated hundreds of pages of detailed minutes and presentation materials." The plaintiffs argued that the Committee was grossly negligent in acting without important information, as it did not seek a fairness opinion. The court stated that a fairness opinion is not required, and noted that, over the past two decades, "Delaware decisions have shown greater deference to a decision not to secure a fairness opinion, even for purposes of a controller recapitalization."

The Committee may have acted in bad faith, however. The court stated that there was evidence that the Committee, although engaging in a "seemingly sound process" with "all the outward signs of diligent and careful effort," had actually "acted under a controlled mindset, deferred to the Founders' needs, and sought to placate [the Founders'] desires rather than pursuing what was in the best interests of the Company." The court stated that the plaintiffs provided "contemporaneous evidence" suggesting that: (i) from the outset, the Committee members "intended to do what the Founders wanted," focusing on a structure that the Founders preferred and failing to consider alternatives (such as not preserving the Founders' control); (ii) the Committee members were focused on establishing a record and "figur[ing] out the narrative" to defend themselves in litigation; (iii) there were unauthorized, substantive backchannel communications between one of the Founders ("P") and certain directors, including one in which a Committee member told P that "he thought the Committee would give [P] what he wanted" and one in which a non-Committee director told P that he would "fix" the issues P had identified that he did not like in the Committee's counterproposal to him; (iv) P "got his way" in the negotiations by "bullying" the Committee after the Committee did not immediately accede to his demands; and (v) during the negotiations, the Committee "regularly deferred" to the Founders and obtained no meaningful concessions.

The defendants' "credibility problems." First, the court stated that the defendants' "deposition testimony and lawyer-created minutes" were challenged by the plaintiffs "with contemporaneous evidence" (including text messages). Second, the court stressed that the defendants' "extensive" use of Signal for its discussions, with the chats auto-deleted, "further damaged" their credibility. Several Signal chats were created at the beginning of the Committee process; some were created after P became irate over the negotiations; and P created one with the Committee members during the last days of the negotiations. The defendants could not provide an explanation for why auto-delete settings were shortened at times; and the court found the defendants' testimony relating to the deleted Signal chats to be "notably strained." The court wrote: "A party's failure to produce strong evidence that should have been available can support an inference that the absent evidence would have been adverse. Here, the strong evidence would have been the contemporaneous Signal messages." Finally, the defendants' credibility problems "grew worse" when they tried to renege on a commitment they had made to the court not to close the Recapitalization until after the court ruled. The court stated that its decision to issue the injunction "rest[ed] on the unique facts of the case." Specifically: "Without the defendants' credibility problems, the court could have concluded that the [Safe Harbor Statute] was so likely to apply as to negate the need for injunctive relief. With the defendants' credibility problems, the court cannot make that determination."

The Committee focused on maintaining the Founders' control. The court noted evidence indicating the following: The Committee met with the Founders and asked them to identify a capital structure that would meet their needs. The notes of a junior team member reflected that the charge was to "focus narrowly" on maintaining the Founders' control. The Committee identified a range of possible alternatives to pursue, but after P told the Committee he "loved" a particular structure, the Committee "fixated on that path." The day after P had met with the Committee, he created a Signal chat with the Committee members, that was later auto-deleted, titled with a "bus" emoji, from which the court inferred that the purpose of the deleted chat "was to get everyone 'on the bus' for purposes of achieving what the Founders wanted."

The Committee focused on creating a "narrative" to justify the Recapitalization. There court stated there was evidence indicating that, from the outset, the Committee was intent on establishing a "narrative" or "story" to justify the Recapitalization, based on an argument that "founder-controlled companies perform better." The Committee discussed that it would be "a good fact pattern" for record purposes if the Committee was "leaning but not convinced" with respect to maintaining the control block, and then was advised by an expert that maintaining the control block would be good for the Company. When the Committee's financial advisor would not substantiate the claim that founder-controlled companies perform better, a Committee member (who is an expert on AI) used an AI chatbot to identify academic experts who could speak to the benefits of founder control and the value of dual-class structures-but, the court noted, the Committee member did not inquire about "drawbacks." The court concluded that, in the context of the injunction-stage record as a whole, a "reasonably probable interpretation" of the Committee's focus on "narrative and story" was that the Committee wanted to "justify[] a pre-ordained result."

The court discredited the Committee's expert on the benefits of control blocks. Based on the AI search for experts, the Committee engaged a (well-known and distinguished) academic expert. "Eighteen hours after learning the Company's name," the expert presented to the Committee. He advised that "the right capital structure was situation dependent"; he "identified public companies with dual- and multi-class structures that had performed exceptionally well"; and he opined that the Company's "exceptional market performance suggested that its dual-class structure was working." The court noted, however, that the expert "did not analyze the terms of a potential recapitalization or the Founders' personal incentives"; he conceded that "he was not a statistician or an applied math person"; he based his "analysis predominantly on using a Bloomberg Terminal to compare historical annualized returns for single- and multi-class companies"; he "ran no controls, ignored survivor bias, and never tested his correlations for statistical significance"; and he "relied almost exclusively on his 'visual inspection' of the data."

The Recapitalization may not be entirely fair. If the Safe Harbor Statute does not apply, the Recapitalization will be subject to entire fairness review. With respect to procedural fairness, the court found that, at the pleading stage, there was a reasonable likelihood of success on the plaintiffs' claim that the Committee had prioritized the Founders' goals at the expense of the Company. With respect to substantive fairness, the court stressed that the Recapitalization "dramatically expanded the Founders' ability to divest equity without losing voting control"-with the Recapitalization, they could generate an additional $2.1 billion in proceeds from sales of their shares without losing control. The court noted that "[t]he Committee never sought a fairness opinion or otherwise analyzed the economic value of the Recapitalization"; and "never valued the tax or estate planning benefits that the Founders received or considered the valuation implications of widening the 'wedge' between the Founders' voting power and their cash-flow rights."

The court held that the Safe Harbor Statute's "heightened presumption" of director disinterestedness applies to the Committee members. The plaintiffs argued that the directors breached their fiduciary duties when making the determination that the directors appointed to the Committee were disinterested, as they failed to consider certain information about those directors' relationships with the Founders. The plaintiffs also argued that the Statute's heightened presumption applies only at the pleading stage of litigation. The court found that the information allegedly ignored by the directors was not material to the disinterestedness determination. Also, the court held that the heightened presumption applies at all stages of litigation. After the pleading stage, the court stated, the presumption can only be rebutted by "clear and convincing evidence that treating the director as disinterested was unreasonable"-that is, "the evidence must make it highly probable, reasonably certain, and free from serious doubt that the director was not disinterested to the point where no board could have reasonably concluded otherwise."

The court held that the Safe Habor Statute's "injunction exclusion" does not apply to the Recapitalization. The Statute provides that its safe harbors will not "[l]imit judicial review for purposes of injunctive relief of provisions or devices designed or intended to deter, delay, or preclude a change of control…." The defendants argued that the plaintiffs' suit is precluded under this exclusion because the plaintiffs seek only injunctive relief and the Recapitalization is concededly designed and intended to delay the Founders' losing control. The court held that the exclusion applies only to "narrow categories" of measures that would trigger enhanced scrutiny review-such as "(1) standalone defensive devices like a stockholder rights plan (Unocal), (2) the deal protection measures built into a merger agreement (Revlon), and (3) interference with director election contests (Blasius)." The court reasoned that the Recapitalization is the type of conflicted-controller transaction for which the legislature intended to provide protection against entire fairness review, and that the legislature did not intend that stockholders, simply by seeking injunctive relief, "would be able to sidestep the [Statute's] single-cleansing regime."

The court emphasized that its rulings may change at trial. The court noted numerous times that its rulings are pleading-stage rulings, and, at trial, the court can more fully evaluate the witnesses' credibility and weigh the evidence. Of note, the court offered the defendants the option to bifurcate the trial to consider the Safe Harbor Statute issues before any entire fairness issues-so that, if the Statute is found to apply, the entire fairness issues would not have to be considered.

Practice Points

• A special committee or board evaluating a transaction should consider whether there are alternatives that may be more advantageous to the company and its stockholders as a whole. If considering a controller-conflicted transaction, the committee or board should consider "just saying no" as one alternative.
  
  
• A special committee or board evaluating a conflicted transaction should consider obtaining a fairness opinion. A fairness opinion will not be appropriate for every transaction. Directors should consider, however, that, without one, plaintiffs may claim that the directors made their determinations without sufficient information; and, if the Safe Harbor Statute does not apply, a fairness opinion may bolster an argument by defendants that the transaction is entirely fair.
  
  
• AI must be used carefully. The court noted AI's "bias toward sycophancy," and indicated that the court may view AI search results as suspect depending on how the search inquiry was phrased and whether information on both sides of an issue was sought. The court's discussion also suggests that, when searching for an expert, a committee or board should identify and consider the views of experts on both sides of an issue before selecting an expert to be engaged.
  
  
• Signal must be used carefully. Auto-deleted Signal chats may undermine credibility and permit the court to draw negative inferences on substantive issues. A committee or board should consider whether, when and how Signal (or similar) chat platforms can be used during a process. The court's discussion suggests that consideration should be given to disabling auto-delete functions even before a litigation hold is issued. At a minimum, if auto-delete times are shortened, there should be a valid explanation for having done so. It should be kept in mind that titles to Signal chats are not deleted and the court may conclude from the titles that the chats related to the process at issue, particularly if the timing coincides with key developments in the process.
  
  
• Texts and emails must be drafted carefully. It should be kept in mind that texts and emails may be discoverable and provide critical contemporaneous evidence in litigation. Jokes, sarcasm, emojis, and other language that could be misinterpreted should be avoided.
  
  
• Directors should consider carefully the use of experts. Engaging experts may help a committee or board to evaluate a transaction, but courts may be skeptical if the scope of the expert's work is artificially constrained, the assignment requires work outside the expert's specific area of expertise, or it appears that the expert is selected to provide justification for a pre-ordained result.