Firefighters' Pension System of The City of Kansas City, Missouri Trust v. Foundation Building Materials, Inc.Firefighters' Pension System of The City of Kansas City, Missouri Trust v. Foundation Building Materials, Inc.
Michael Hanrahan, Samuel L. Closic, Jason W. Rigby, Seth T. Ford, PRICKETT, JONES & ELLIOTT, Wilmington, Delaware; Lee D. Rudy, J. Daniel Albert, Kevin M. Kennedy, KESSLER TOPAZ MELTZER & CHECK, LLP, Radnor, Pennsylvania; Counsel for Plaintiff Firefighters’ Pension System of the City of Kansas City, Missouri Trust.
Daniel A. Mason, Elizabeth Wang, PAUL, WEISS, RIFKIND, WHARTON & GARRISON LLP, Wilmington, Delaware; Andrew G. Gordon, Alexia D. Korberg, PAUL, WEISS, RIFKIND, WHARTON & GARRISON LLP, New York, New York; Counsel for Defendant Evercore Group L.L.C.
Bradley R. Aronstam, S. Michael Sirkin, Elizabeth M. Taylor, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; John A. Neuwirth, Evert J. Christensen, Jr., Matthew S. Connors, Tania C. Matsuoka, WEIL, GOTSHAL & MANGES LLP, New York, New York; Counsel for Defendants Foundation Building Materials, Inc., American Securities LLC, and ASP Flag Intermediate Holdings, Inc.
A. Thompson Bayliss, Daniel G. Paterno, ABRAMS & BAYLISS LLP, Wilmington, Delaware; Barry G. Sher, Kevin P. Broughel, PAUL HASTINGS LLP, New York, New York; Counsel for Defendant RBC Capital Markets, LLC.
William B. Chandler III, Brad D. Sorrels, Leah E. León, WILSON SONSINI GOODRICH & ROSATI, P.C., Wilmington, Delaware; Counsel for Defendant Ruben D. Mendoza.
Elena C. Norman, James M. Yoch, Jr., YOUNG CONAWAY STARGATT & TAYLOR, LLP, Wilmington, Delaware; Brian M. Lutz, George B. Adams III, GIBSON, DUNN & CRUTCHER LLP, San Francisco, California; Colin B. Davis, GIBSON, DUNN & CRUTCHER LLP, Irvine, California; Counsel for Defendants Chris Meyer, Rafael Colorado, Chad Lewis, Chase Hagin, Maureen Harrell, LSF9 Cypress Parent 2 LLC, and Lone Star Fund IX (U.S.), L.P.
LASTER, V.C.
Changes in federal tax law reduced the value of the payments the fund could expect under the tax receivable agreement. A sale of the company, however, would trigger an early termination payment. That payment would be calculated using favorable valuation assumptions that made it worth more than the present value of the reduced payment stream.
Soon afterward, the fund began to explore its exit options. Not coincidentally, the company’s board of directors began exploring a sale. Fund representatives on the board led the sale process.
Well after the sale process was underway, the board created a special committee to address the conflict created by the early termination payment. The board charged the committee with determining whether a sale was advisable and gave the committee the power to say “no.” Despite those powers and its charge, the committee was passive. Its members repeatedly went months without convening, including during busy periods when the fund’s representatives were negotiating the terms of a sale. The committee also took specific actions that smack of deference to the fund.
The plaintiff sued on behalf of a putative class of minority stockholders. The plaintiff claims that the fund and the directors breached their fiduciary duties by (i) selling the company to secure an early termination payment for the fund, (ii) diverting merger consideration to the fund through the early termination payment, and (iii) employing an unreasonable sale process. The plaintiff also claims that the fund and the directors breached their duty of disclosure. The plaintiff asserts that the two financial advisors and the buyer aided and abetted those breaches of fiduciary duty. The plaintiff also advances claims under the appraisal statute.
Six groups of defendants filed and briefed separate motions to dismiss. This decision is overly long because of all the arguments the defendants raised.
The motions are granted in part and denied in part. The complaint states a claim for breach of fiduciary duty against the fund, the six directors affiliated with the fund, and the CEO. Those defendants faced a conflict of interest for purposes of deciding between continuing to operate the company as an independent entity versus selling the company and triggering the early termination payment. It is reasonably conceivable that those defendants will have to prove that the merger was entirely fair relative to the alternative of having the company remain independent.
The complaint does not state a claim for breach of fiduciary duty against the fund, the fund directors, or the CEO for allegedly using the early termination
The complaint also does not state a claim for breach of fiduciary duty against the fund, the fund directors, or the CEO for following an unreasonable sale process. Any sale of the company would trigger an early termination payment, so the fund, the fund directors, and the CEO did not face a conflict of interest when pursuing a sale transaction or choosing among sale transactions. They only faced a conflict when deciding between selling the company and having it remain independent. It is possible to quibble with aspects of the sale process, but the fund, the fund directors, and the CEO did not take any steps which, absent a conflict of interest, could cause the process to fall outside the range of reasonableness.
The complaint states claims against all of the director defendants for breach of the duty of disclosure. The complaint fails to state a claim against the fund for breach of the duty of disclosure.
The CEO seeks dismissal on the basis of exculpation. The complaint states a non-exculpated claim against the CEO given his status as a highly paid officer of a controlled company and the conflict that he and the fund faced regarding whether to sell.
The special committee members do not argue that the complaint fails to state a claim against them, only that they are entitled to dismissal on the basis of exculpation. The complaint barely states a non-exculpated claim against the special
The complaint states claims for aiding and abetting breaches of fiduciary duty against the two financial advisors. Their engagement letters provided for success fees calculated using a formula that included both the merger consideration and the early termination payment. Those arrangements aligned their interests with the fund, rather than with the unaffiliated stockholders. The advisors therefore faced the same conflict of interest as the fund, and the complaint pleads facts supporting an inference that they acted to pursue the fund’s interests.
The complaint fails to state a claim for aiding and abetting breaches of fiduciary duty against the buyer. The complaint suggests only that the buyer wanted to acquire the company, understood the fund was insisting on its contractual right to an early termination payment, recognized that the fund had that right, and went forward with the deal.
The complaint states a claim for a violation of the appraisal statute. The company mailed a notice of appraisal rights to stockholders which stated that it was “first” mailed to stockholders “on or about” December 4, 2020. The notice identified
I. FACTUAL BACKGROUND
The facts are drawn from the operative complaint and the documents incorporated by reference.1 At this stage of the proceedings, the court must accept the complaint’s allegations as true and give the plaintiff the benefit of all reasonable inferences.
A. The Company
Defendant Foundation Building Materials, Inc. (the “Company”) distributes building materials in the United States and Canada. On October 9, 2015, Lone Star2 acquired the Company in a going-private transaction. Less than eighteen months later, Lone Star took the Company public again.
After the IPO, Lone Star owned shares carrying 65.4% of the Company’s outstanding voting power, giving it hard control at the stockholder level. Lone Star also controlled the Company at the board level. Six of the ten members of the Company’s board of directors (the “Board”) were Lone Star principals or employees. A seventh was the Company’s CEO.
B. The Tax Agreement
In connection with the IPO, Lone Star and the Company entered into a tax receivable agreement (the “Tax Agreement” or “TRA”). Under the Tax Agreement, Lone Star was entitled to a payment equal to 90% of any benefit the Company received from using a tax asset generated while the Company was privately held. The Company estimated that over fifteen years, it would pay Lone Star between $190 million and $220 million under the Tax Agreement.3
Lone Star had the right to terminate the Tax Agreement under specified circumstances. One trigger for Lone Star’s termination right was a “Change of
The formula for the Early Termination Payment favored Lone Star. Among other things, the Early Termination Rate called for discounting the projected payment stream at “the lesser of (i) 6.50% per annum, compounded annually, and (ii)
The Valuation Assumptions also favored Lone Star. Among other things, they assumed that the Company would generate taxable income sufficient to fully utilize all of its tax assets, subject to applicable limitations, during the relevant tax year. That meant none of the benefits would be deferred because of insufficient taxable income, which could happen in real life.
C. The Tax Act
On January 1, 2018, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) took effect. It reduced the federal corporate income tax rate from a maximum rate of 35% to 21%. That in turn reduced the value of corporate tax assets by 40%.7 Before the Tax Act, a tax asset that would lower corporate income by $1 generated 35 cents of benefit. After the Tax Act, the same $1 generated only 21 cents of benefit.
By reducing the federal rate, the Tax Act reduced the payments Lone Star could expect under the Tax Agreement. To generate the same level of payments for Lone Star, the Company would have to generate more income that could be offset by more tax assets. Before the Tax Act, a $1 reduction in taxable income would generate 35 cents of benefit. After the Tax Act, it would take a $1.67 reduction in taxable income to generate the same 35 cents of benefit. In any given year, the Company
The real-world effect on Lone Star was significant. In its 2017 annual report, the Company reported a $68 million reduction in the anticipated payments under the Tax Agreement.8 The Company had previously estimated that it would pay Lone Star between $190 million and $220 million under the Tax Agreement. The Tax Act cut those amounts by approximately one third.
Compared to the alternative of receiving payments under the Tax Agreement, the Tax Act made the Early Termination Payment more attractive. The Valuation Assumptions called for assuming that the Company would generate enough income in each taxable year to use the tax benefits to the greatest extent permitted by law, resulting in the maximum possible payment. And the Early Termination Rate called for using a low discount rate to calculate the present value of the payments.
D. The Sale Process Begins.
It is reasonable to infer that after the Tax Act, Lone Star recognized that it could generate more value for itself by selling the Company and triggering an Early Termination Payment than by managing the Company as an independent entity, receiving annual payments under the Tax Agreement, and selling off its position over timе. Consistent with that inference, in early 2018, Lone Star began to explore its options for exiting the Company.
On May 23, 2018, Beacon sent Meyer a written expression of interest in a transaction at $16.75 per share.11 The expression of interest did not reference the Tax Agreement or the possibility of an Early Termination Payment.
Meyer convened a special meeting of the Board on May 24, 2018. According to the minutes, Meyer proposed that the Board authorize him to contact “a representative of a major investment bank who is familiar with both the Company and Beacon.”12 The Board agreed. During the meeting, another director affiliated with Lone Star observed that a transaction involving an Early Termination Payment would likely need special “review and authorization procedures . . . in light of the potential conflicts of interest applicable to certain members of the Board that might be found to exist.”13
Meyer also contacted Jeffrey Chapman, an attorney with Gibson, Dunn & Crutcher, LLP. Chapman and Lone Star were particularly close. Chapman has described his work for Lone Star as “a career-altering relationship,” and Gibson Dunn has acknowledged that “Lone Star has been a real hit for us.”14 Gibson Dunn had advised Lone Star on deals worth billions of dollars, including its $7.6 billion acquisition of Home Properties, Inc. and its $1.4 billion acquisition of Hanson Building Products.
The Company retained Chapman and Gibson Dunn to advise the Board, but Meyer introduced Chapman to RBC in an email as “our partner from Gibson Dun [sic] who has worked extensively with us across our portfolio.”15 When Meyer referred to Chapman as “our partner . . . who has worked extensively with us across or portfolio,” he meant Lone Star’s partner, not the Company’s partner.
After retaining RBC and Gibson Dunn to advise the Company, Meyer called a special meeting for June 4, 2018. Before the meeting, RBC sent its discussion materials and proposed engagement letter to Meyer and another Lone Star-affiliated
During the Board meeting, the directors authorized Meyer to tell Beacon that its expression of interest “was not sufficient to warrant further consideration.”19 But the Board was not terminating the sale process. To the contrary, at RBC’s suggestion, the Board instructed management to “prepare a three-year budget and plan to be shared with third parties as may be appropriate in the near future.”20
During June and July 2018, Meyer engaged with American. On July 24, 2018, American submitted a written expression of interest in a transaction at $18.00 to $19.50 per share. Like Beacon’s expression of interest, American’s letter did not reference the Tax Agreement or the possibility of an Early Termination Payment.
Two months later, on September 3, 2018, the Board acted by written consent to form a special committee (the “Special Committee”). It comprised the three members of the ten-member Board who were not affiliated with Lone Star: Matthew J. Espe, Fareed A. Khan, and James F. Underhill. Espe served as Chair.
The written consent contained recitals that provided the following background:
WHEREAS, seven of the ten members of the Board of the Company are employees of or persons otherwise affiliated with [Lone Star], a majority stockholder of the Company and a party to [the Tax Agreement];
WHEREAS, upon the occurrence of the Change of Control (as defined in the [Tax Agreement]), all obligations of the Company under the [Tax Agreement], including the Company’s obligation to make significant payments to Lone Star, may, at the election of Lone Star be accelerated;
. . . .
NOW, THEREFORE, BE IT RESOLVED, that the Board hereby designates the Special Committee . . . .21
The Board thus created the Special Committee because of the issues created by the prospect of an Early Termination Payment. At the time, none of the bidders had expressly referenced a payment under the Tax Agreement. The creation of the Special Committee suggests that Lone Star intended to seek a deal that would include one.
In the resolutions creating the Special Committee, the Board committed not to approve any transaction without a prior favorable recommendation from the Special
- retain its own advisors at the Company’s expense;
- investigate possible transactions,
- evaluate the terms of any possible transactions,
- participate in negotiations with relevant third parties regarding any element of a possible transaction,
- participate in negotiations of the terms of any definitive agreement with respect to any possible transactions (the execution of which was subject to Board approval),
- report its recommendations and conclusions to the Board, and
- determine not to pursue any possible transaction.22
The resolutions thus gave the Special Committee broad authority over the sale process.
By the time the Special Committee was formed, Meyer and Mendoza had already engaged in significant discussions with Beacon and American, and the Board had received expressions of interest from both bidders. The Board had considered and rejected Beacon’s proposal, and American had signed a confidentiality agreement and started diligence. The Special Committee therefore started well behind in the transaction process. Unfortunately, the Special Committee made no real effort to catch up.
The Special Committee met for the first time on September 7, 2018. Chapman from Gibson Dunn and Richard J. Tilley, the Company’s general counsel, attended. Tilley kept the minutes. The Special Committee discussed the Tax Agreement, “potential outcomes that may occur in the event of the completion of” a transaction, and the need to hire legal counsel.23
The Special Committee held its second meeting on September 21, 2018. In the meantime, the Special Committee had hired Richards, Layton & Finger, P.A. (“RLF”) as its counsel, and RLF provided an overview of the Special Committee members’ fiduciary duties. The Special Committee “determined that, particularly in light of the [Tax Agreement], it was advisable to retain its own independent financial advisor.”24 The Special Committee directed RLF to contact potential candidates.
On October 1, 2018, Beacon submitted a revised expression of interest in a transaction at $17.00 per share, plus a $93 million Early Termination Payment. That was the first offer explicitly referencing the Tax Agreement.
The Special Committee met the next day, but it did not discuss the Beacon offer. Instead, the Special Committee only discussed RLF’s role and the possibility of hiring a financial advisor. The Special Committee also reviewed the terms of RBC’s engagement letter and discussed “the potential incentives created by the structure of
The Special Committee instructed RLF to contact management and Gibson Dunn “to explore the possibility of agreeing to an alternative compensation structure with RBC.”27 It is not clear what happened to that effort, but RBC’s compensation structure never changed.
G. The Special Committee Interviews Financial Advisors, Then Goes Into Hibernation.
The Special Committee held several additional meetings before the end of 2018, but it did not accomplish much. On October 4 and again on October 15, the Special Committee received updates on the deal negotiations that Lone Star and RBC were conducting.28 On October 17, the Special Committee interviewed two potential financial advisors.29
Evercore Group LLC was one candidate. Evercore stressed its “extensive experience in dealing with tax receivables agreements and other similar tax
In its pitch book, Evercore described “The Role and Function of the Special Committee,” including:
- “Remain objective and maintain independence.”
- “Consider other strategic alternatives including remaining independent.”
- “Effectively negotiate on behalf of Foundation Building Materials and the unaffiliated shareholders.”
- “Create negotiating leverage, where possible, and exercise bargaining power.”
- “Make a good faith attempt to negotiate for the best possible price under arm’s length terms.”32
The Special Committee did not heed that advice.
In its presentation, Evercore identified six precedent transactions involving tax receivable agreements. In one transaction, the tax receivable agreement did not provide for an early termination payment, and the agreement remained in place after the transaction. In a second transaction, there was “[n]o early termination consideration paid per transaction negotiation.”33 The other four transactions
H. Lone Star Considers Taking The Company Private.
Lone Star’s interest in a third-party transaction waned in late 2018. The discussions with Beacon and American slowed to a halt. After learning of Lone Star’s fading interest, the Special Committee decided not to hire a financial advisor until Lone Star’s plans became clearer.34
It turned out that Lone Star was thinking about being a buyer rather than a seller, and on March 6, 2019, Meyer informed the Special Committee that Lone Star was interested in acquiring the Company’s minority shares.35
Meyer asked the Special Committee to waive any conflicts so that Gibson Dunn and RBC could represent Lone Star. The Special Committee met on March 8, 2019, to discuss the request. Tilley, the Company’s general counsel, attended the meeting and represented that Gibson Dunn “had not been [the Company’s] principal outside counsel for nearly a year.”36 Yet Gibson Dunn’s proposed waiver letter disclosed that the firm had been representing the Company since May 2018 in connection with a
The Special Committee did not react negatively when Gibson Dunn and RBC asked to change teams. But as it turned out, the Special Committee did not have to act on the waiver requests. Shortly after the meeting, Meyer notified the Special Committee that Lone Star had decided not to pursue a take-private transaction.
The plaintiff alleges that the waiver request should have been a red flag for the Special Committee. According to the plaintiff, the effort by RBC and Gibson Dunn to switch sides revealed where their true loyalties lay.
In fall 2019, Lone Star engaged with Clayton, Dubilier & Rice (“CD&R“), another private equity firm, about buying Lone Star‘s shares. CD&R had a significant ownership stake in Beacon, and CD&R was interested in combining the Company with Beacon‘s interior products division (the “Beacon Combination“). Meyer told CD&R that Lone Star was not interested in a stock-for-stock deal. Lone Star wanted cash.
In September 2019, in the midst of these discussions, Lone Star sold 4.75 million shares in a secondary offering. That reduced Lone Star‘s aggregate ownership to 52.6%. RBC served as one of three joint bookrunners for the оffering.
Lone Star and CD&R continued talking into the next year. The pleading-stage record supports an inference that Gibson Dunn and RBC worked together with Lone Star to pursue a sale of its shares. Lone Star did not inform the Board or the Special Committee about its efforts, nor did Lone Star ask for waivers to work with Gibson Dunn and RBC.
On January 21, 2020, the Board met for thirty minutes. Gibson Dunn attended as “legal counsel to Lone Star.”39 Meyer reported on the Beacon Combination and the potential sale of Lone Star‘s shares to CD&R. Meyer presented a resolution to expand the Special Committee‘s mandate to include the Beacon Combination. Like the original written consent establishing the Special Committee, the resolution cited the
The Special Committee met immediately after the full Board meeting. It was the first Special Committee meeting in more than ten months. In a brief fifteen-minute meeting, the Special Committee approved a non-disclosure agreement between the Company, Lone Star, and CD&R.
A few days later, Meyer send the Chair of the Special Committee a proposed amendment to RBC‘s engagement letter to include the Beacon Combination. The Special Committee promptly approved it. That was the last action the Special Committee would take for another seven months.
J. Apollo Engages And CD&R Bumps.
In February 2020, Meyer spoke with Apollo Global Management, Inc. about acquiring the Company or Lone Star‘s shares. Neither the Board nor the Special Committee met to discuss Apollo‘s interest.
On February 13, 2020, CD&R proposed to acquire Lone Star‘s shares for $17.90 per share. CD&R acknowledged that the transaction would not trigger a Change of Control payment under the Tax Agreement, but its proposal provided for a payment to be made anyway, subject to Special Committee approval. Meyer forwarded the offer to two other Lone Star directors (Lewis and Colorado), commenting: “[P]rice is a non-
RBC created a presentation for Lone Star analyzing the returns CD&R could generate. RBC also created other work product for Lone Star and effectively acted as Lone Star‘s financial advisor. Lone Star never obtained a waiver to work with RBC.
On February 21, 2020, Lone Star made a counteroffer to CD&R. It called for the parties to agree that a sale of Lone Star‘s shares would trigger an Early Termination Payment under the Tax Agreement.
K. Discussions Pause, Then Resume.
In March 2020, as the COVID-19 pandemic swept across the United States, Lone Star and CD&R paused their discussions. They resumed in June 2020. Mendoza met with CD&R‘s CEO, and Lone Star and CD&R exchanged terms.
On July 24, 2020, Mendoza contacted American about re-engaging. The Company‘s second quarter 2020 results showed it was weathering the COVID-19 pandemic well, and its stock price had risen from $13.73 on July 31, 2020, to $15.54 on August 4, 2020. On August 4, without approval from the Board or the Special Committee, the Company entered into a new confidentiality agreement with American. That same day, Lone Star told CD&R that its price did not warrant further consideration.
On August 17, 2020, the Special Committee held its first meeting in over seven months. Two Lone Star directors (Meyer and Colorado) and Gibson Dunn attended. Gibson Dunn had been assisting Lone Star for the past eight months and had appeared at the Board meeting on January 21, 2020, as “legal counsel to Lone Star.”42 Yet Gibson Dunn purportedly attended the Special Committee meeting as “counsel to the Company.”43 Meyer reported that American would make an offer to acquire the Company for $18 per share in cash, “with the amounts payable by the Company in connection with the Tax Receivable Agreement with the Lone Star Funds to be respected.”44 Meyer estimated that the Early Termination Payment would be “approximately $78 million.”45
Meyer then recommended that the Special Committee retain a financial advisor to assist with potential market checks and render a fairness opinion. Everyone left the meeting except the Special Committee members and RLF.46 At that
Between August 20 and August 26, 2020, Meyer, Colorado, and Company management revised RBC‘s engagement letter to remove its obligation to provide a fairness opinion. RBC‘s percentage-based transaction fee remained the same and still included the Early Termination Payment.
On August 26, 2020, American submitted a formal proposal to acquire the Company for $17 per share, conditioned on thirty days of exclusivity. The proposal did not mention the Tax Agreement. It thus differed significantly from what Meyer had described to the Special Committee.
Two days later, CD&R submitted a proposal to acquire the Company for $18 per share, still contingent on the Beacon combination. The proposal specified that the transaction would trigger acceleration and payment under the Tax Agreement. Meyer forwarded the offer to Mendoza, commenting: “Right things coming together.”47
L. The Board And Special Committee Consider The Proposals.
The Board met later on August 28, 2020. The directors approved RBC‘s revised engagement letter. Meyer reported on the offers from American and CD&R. The Board instructed RBC to reject American‘s request for exclusivity and tell both bidders that RBC would follow up with them on their offers.
Notwithstanding the Special Committee mandate, the Special Committee did not envision taking an active role in the sale process. According to the minutes, “[t]he Committee discussed the fact that the Company‘s investment bank, [RBC], would be taking the lead on behalf of the Company on dealing with potential bidders and advising the full Board of Directors.”49 At the end of the meeting, the Special Committee decided to engage Evercore.
Evercore asked for a fee of $1.5 million to issue a fairness opinion, plus a transaction fee equal to 0.4% of the transaction value and a potential discretionary bonus of $1.5 million. Like RBC, Evercore wanted the transaction value to include both the per-share consideration plus any Early Termination Payment.
The Special Committee had authority to hire its own advisors. Yet RLF forwarded Evercore‘s proposal to Gibson Dunn, the Company‘s counsel. Gibson Dunn
M. American Raises Its Bid.
On September 4, 2020, American raised its offer to $18 per share and reiterated its request for thirty days of exclusivity. The proposal again did not mention the Tax Agreement.
The Board met on September 8, 2020. The first topic of discussion was the Tax Agreement.51 Up to that point, the Board had distinguished between proposals that explicitly contemplated a payment under the Tax Agreement and those that did not. At the September 8 meeting, the Board agreed that even American‘s offer would trigger a full Early Termination Payment.
The Board next discussed the relative merits of the two offers. CD&R proposed a sign-and-consent structure under which Lone Star would approve the transaction by written consent one day after the deal was executed. CD&R‘s proposal was conditioned on accomplishing the Beacon Combination, but the Board thought that
The Special Committee met on September 10, 2020, ostensibly to review the proposals that the full Board had reviewed two days earlier. Nothing new came out of that discussion. It was the last time the Special Committee would meet for two months.
N. Meyer Negotiates A Deal.
Between September 12 and September 23, 2020, Meyer negotiated with CD&R and American, resulting in a series of bids.
- On September 12, 2020, American submitted an updated proposal that explicitly called for a payment under the Tax Agreement.
- On September 14, 2020, CD&R raised its offer to $19 per share, still contingent on the Beacon Combination and still contemplating a payment under the Tax Agreement.
- On September 17, 2020, American withdrew its September 12 offer because it was not granted exclusivity.
- On September 23, 2020, CD&R submitted a revised proposal that added a ticking fee. If CD&R could not close by January 31, 2021, then the purchase price would increase by $0.005 per share per day, starting on February 1, 2021. That equated to $6.5 million per month.
The Board next met on September 25, 2020. Meyer reported that because the Company had rejected American‘s request for exclusivity, American was “no longer in the process.”55 RBC then reported on a “targeted market check” involving five potential buyers.56 That minimal effort produced four additional interested bidders: Apollo, Bain Capital Private Equity, LP, Blackstone Management Partners L.L.C., and One Rock Capital Partners, LLC. All four had signed confidentiality agreements and started due diligence.57 Neither the Special Committee nor the Board had been involved.
As Chair of the Special Committee, Espe reported on the status of the Special Committee‘s work, such as it was. He said that Evercore was working with Tilley, the Company‘s general counsel, “on due diligence and was continuing to stay updated on potential transactions.”58
Ten days later, on October 18, 2020, Meyer emailed the Board that CD&R‘s efforts to complete the Beacon Combination had run into difficulties. The next day, CD&R told Meyer that it wanted to buy the Company regardless. The following day, American sought to reengage. That same day, Apollo submitted a proposal to acquire the Company for a price of $18.50 to $20.50 per share, plus an Early Termination Payment. The Special Committee did not meet to consider these developments.
On October 21, 2020, Meyer, Lewis, and RBC told CD&R, One Rock, and Apollo that there were multiple bidders for the Company. They asked Apollo to confirm that its offer included a “full buyout of the [Tax Agreement].”59 They asked CD&R to submit a revised proposal before October 28, 2020. No one consulted the Special Committee.
Later that night, RBC reported to Meyer and Lewis that CD&R was “advancing significantly” on the Beacon Combination.60 The next day, Meyer emailed the Board about recent developments. He reported that all of the participants had been asked to submit updated proposals the following week.
On October 27, 2020, Meyer told American that the Company would grant exclusivity if the purchase price was “sufficiently compelling.”62 American said it was considering a price of $19.25 per share but would not go higher. American also shifted to the same sign-and-consent structure that CD&R had proposed. American continued to contemplate a full payment under the Tax Agreement. Meyer said he would take that offer to the Board.
The Board met later that day. RBC informed the Board that Blackstone and Bain had withdrawn from the process. According to the information statement later sent to stockholders, the Board instructed RBC to tell other potential acquirors to submit best and final offers by October 30, 2020.63 The minutes, however, do not reflect that instruction.64 They reflect that RBC had already asked CD&R to submit
American submitted an updated proposal on October 28, 2020. The terms tracked its oral proposal from the day before but added a closing condition that would fail if more than 10% of the Company‘s stockholders exercised their appraisal rights.
One Rock submitted a revised proposal the same day at $18.50 per share. The proposаl contemplated a full payment under the Tax Agreement.
On October 29, 2020, the Board met to discuss the sale process. The minutes do not provide any meaningful details, and the information statement does not mention the discussion. At that point, the Special Committee had not met in roughly a month and a half.
The Company had told CD&R to submit a revised proposal by October 30, 2020. CD&R reaffirmed its price of $19 per share, but raised the ticking fee to $0.007 per share per day, resulting in an additional $2.6 million per month. CD&R said that depending on the outcome of its negotiations over the Beacon Combination, it could increase its purchase price above $19 per share. That same day, American submitted a revised offer at $19.25 per share that removed the appraisal condition.
The Board met on October 31, 2020. Meyer dismissed Apollo‘s range as too wide. Evercore, which had not presented to the Board since its retention, commented on contingencies associated with the CD&R offer. The minutes do not reflect any discussion of the increased ticking fee. Meyer and RBC then presented the revised American offer and the exclusivity agreement.
O. The Special Committee Gets Back Involved.
Ten days later, on November 10, 2020, the Special Committee met for the first time in two months. The meeting appears scripted to set up the eventual approval of a deal with American.
RLF kicked off the meeting with a recap of the history of the sale process as it had unfolded over the two prior years. Evercore then presented on the financial terms of American‘s proposal. Evercore also discussed “the impact of the [Tax Agreement] on Evercore‘s valuation analysis.”65
In its presentation, Evercore explained that it was “uncertain whether public investors account for tax assets and TRAs in IPOs and how TRA liabilities may impact company valuations.” Elaborating, Evercore stated:
- “Because TRAs are disclosed in public SEC documents, one might expect public shareholders to pay less for a company with a TRA than they would for an identical company without a TRA.”
- “However, there is limited evidence that public shareholders typically adjust the price they are willing to pay for shares in a public company due to the presence of a TRA.”
- “Pre-IPO shareholders generally believe investors tend to ignore tax attributes . . ., [so a TRA] enables the selling shareholder to retain those benefits.”
- “Evercore reviewed 30 recent IPOs with TRAs [and] only identified one situation where the TRA liability was regularly treated as a debt-like item by analysts to derive respective price targets.”
“When reviewing Wall Street research of [the Company], we observed that three of the seven equity research analysts explicitly incorporated the company‘s TRA liability to derive their price targets.”66
In other words, Evercore believed Lone Star had taken the Company public without paying a discount for the overhang of the Tax Agreement.
Evercore conducted two separate analyses of the Company‘s value. One assumed that “the [Tax Agreement] had been factored into the Company‘s stock price.”67 The other assumed that “the [Tax Agreement] had not been factored into the Company‘s stock price.”68 Evercore combined the analyses when presenting its ranges, such that the high end of the range factored in the effect of the Tax Agreement, while the low end of the range did not.
Evercore wrapped up its presentation by informing the Special Committee that it would be prepared to present a fairness opinion by November 13, 2020. The Special Committee resolved to meet again on November 13 and then adjourned.
Two days later, on the evening of November 12, 2020, Meyer emailed Espe to recommend that the Special Committee decline to pay Evercore its $1.5 million discretionary bonus. Meyer suggested that the bonus go to RBC instead.
Later that night, RLF sent a draft of a Tax Receivable Termination Agreement (the “Termination Agreement“) to the Special Committee. The Termination
P. Special Committee Approval
On November 13, 2020, the Special Committee met for the final time to consider a proposed merger agreement between the Company and a subsidiary of American (the “Merger“). Evercore opined that the consideration was fair to the Company‘s minority stockholders. Evercore reviewed the financial terms of the Merger, including that American would fund 100% of the purchase price and the Early Termination Payment.69
The Special Committee adjourned, and its members immediately reconvened in a joint meeting of the Special Committee and the Company‘s Audit Committee. The joint committee meeting was necessary because the Termination Agreement was a related party transaction between the Company and Lone Star, which required Audit Committee approval. Acting as members of the Audit Committee, the members of the Special Committee unanimously approved the Termination Agreement. The members also reviewed and unanimously approved the draft merger agreement (the “Merger Agreement“).70
Q. Board Approval.
On November 14, 2020, the full Board met and approved the Merger Agreement. Immediately after the meeting, Lone Star approved the Merger by written consent.
Later, one of the Lone Star directors (Colorado) circulated a draft of the “Background of the Merger” section for the information statement to be sent to the Company‘s stockholders (the “Information Statement“). Lone Star, the Company directors, RLF, Evercore, RBC, and Gibson Dunn reviewed it.
Also on November 14, 2020, the Company and Lone Star entered into the Termination Agreement. Unlike the version that the Special Committee approved, the final version included the spreadsheet showing the calculation of the Early Termination Payment. American had received the spreadsheet the day before. Neither the Special Committee nor the Audit Committee ever approved a version of the Termination Agreement with the spreadsheet.
The Company mailed out the Information Statement “on or about December 4, 2020.”71 The Information Statement notified stockholders that they had until December 24 to demand appraisal (the “Appraisal Notice“).
On December 21, 2020, the Company issued a Form 8-K that substantially revised the Information Statement (the “Supplement“).72 The Company did not mail the Supplement to stockholders. The Company also did not extend the date for filing demands for appraisal.
The Merger closed on January 29, 2020. American acquired the Company using two subsidiaries: ASP Flag Intermediate Holdings, Inc. (“Holdings“), and its wholly owned subsidiary, ASP Flag Merger Sub Inc. (“Merger Sub“). In the Merger, the Company merged with Merger Sub, with the Company as the surviving corporation. The Company emerged from the Merger as a wholly owned subsidiary of Holdings, which in turn was wholly owned by American.
After the Merger closed, Lone Star received an Early Termination Payment of $74.8 million, plus a payment of $8.6 million for tax benefits used through January 29, 2021. The Company made the Early Termination Payment after becoming a wholly owned subsidiary of American.
The plaintiff sought books and records, then filed this lawsuit. The operative complaint spans 119 pages and contains 280 paragraphs. It names as the “Lone Star Defendants” the six individual directors affiliated with Lone Star (the “Lone Star Directors“), the Company‘s CEO Mendoza (who also served as a director), and Lone Star itself. It names as the “Special Committee Defendants” the three members of the Special Committee. It also names as defendants: RBC, Evercore, American, Holdings, and the Company.
The operative complaint has six counts. In Count I, the plaintiff asserts violations of the appraisal statute. The plaintiff asserts this count against the Company and Holdings, each of which had obligations under the appraisal statute. Strangely, the plaintiff also asserts Count I against the Lone Star Defendants, the Special Committee Defendants, and American. Count I alleges that (i) the named defendants failed to give stockholders the statutorily required twenty days to demand appraisal, (ii) the Supplement constituted a new appraisal notice that resulted in stockholders only having three days to demand appraisal, and (iii) as a statutory matter, the Appraisal Notice had to contain all information material to the stockholders’ appraisal election. As if asserting a claim for breach of the duty of disclosure, Count I asserts six categories of information that the Appraisal Notice allegedly failed to disclose properly.
In Count II, the plaintiff asserts a claim for breach of fiduciary duty against the Lone Star Defendants. The plaintiff alleges that Lone Star and the Lone Star Directors owed the same fiduciary duties, which they violated by engaging in the
In Count III, the plaintiff asserts a claim for breach of fiduciary duty against the Special Committee Defendants. The plaintiff alleges that the Special Committee Defendants breached their duties by failing to take an active role in the sale process, relying entirely on Lone Star and on conflicted advisors, and failing to take action to protect the unaffiliated stockholders. The plaintiff also alleges that the Special Committee Defendants breached their duties by timing the Appraisal Notice and the issuance of the Supplement to interfere with the stockholders’ ability to assert their appraisal rights.
In Count IV, the plaintiff asserts a claim against Evercore for aiding and abetting the breaches of fiduciary duty by the Special Committee Defendants. The plaintiff contends that Evercore agreed to a compensation arrangement that aligned its interests with Lone Star, then passively went along with the Special Committee Defendants. The plaintiff also asserts that Evercore aided and abetted breaches of the duty of disclosure by the Special Committee Defendants.
In Count V, the plaintiff asserts a claim against RBC for aiding and abetting the breaches of fiduciary duty by the Lone Star Defendants. The plaintiff contends that RBC was hired to serve as the financial advisor for the Company and the Board. Instead, RBC agreed to a compensation arrangement that aligned its interests with
In Count VI, the plaintiff asserts a claim against American and Holdings (the “Buyer Defendants“) for aiding and abetting breaches of duty by the Lone Star Defendants. The plaintiff asserts that the Buyer Defendants participated knowingly in both the breaches of duty related to the Merger itself and in the breaches of the duty of disclosure in connection with the Information Statement and the Supplement.
Six different groups of defendants filed and briefed separate motions to dismiss. The six opening briefs totaled 214 pages. The plaintiff filed a single omnibus answering brief totaling 150 pages. The six reply briefs totaled another 131 pages. In addition to the 495 pages of briefing, the defendants submitted 48 exhibits that added another 1,196 pages. The oral argument on the motion to dismiss lasted almost two hours. This opinion is long because the parties raised so many issues.
II. THE RULE 12(B)(6) STANDARD AND A ROADMAP
The defendants have moved to dismiss the complaint in its entirety under
First, this decision analyzes the contention that the Lone Star Defendants and the Special Committee Defendants breached their duties by (i) pursuing a Change of Control transaction that would trigger the Early Termination Payment rather than operating the Company as an independent entity, (ii) diverting merger consideration from the public stockholders through the Early Termination Payment, and (iii) following an unreasonable sale process (the “Sale Process Claims“). Only the first theory states a claim on which relief cаn be granted.
Second, this decision analyzes the contention that the Lone Star Defendants and the Special Committee Defendants breached their duty of disclosure (the “Disclosure Claims“). The plaintiff advances its disclosure claim against the same two groups of defendants: the Lone Star Defendants and the Special Committee Defendants. Several disclosure theories state claims on which relief can be granted.
Third, this decision analyzes the claims against other participants in the sale process for aiding and abetting the breaches that are the subject of the Sale Process Claims and the Disclosure Claims (the “Aiding and Abetting Claims“). The claims against RBC and Evercore survive pleading-stage review. The claim against the Buyer Defendants does not.
Last, the decision analyzes the claims related to the appraisal statute (the “Appraisal Claims“). One of the Appraisal Claims survives pleading-stage review.
The plaintiff nominally advances the Sale Process Claims against two distinct groups of defendants: the Lone Star Defendants and the Special Committee Defendants. The former category lumps together three different types of sell-side fiduciaries: directors affiliated with a controller (the Lone Star Directors), a CEO who also served as a director (Mendoza), and a controller (Lone Star). The latter category adds another type of sell-side fiduciary: notionally independent directors.
There are potentially significant differences between the duties owed by the different types of fiduciaries. Delaware corporate law is the most developed on the subject of director duties. Our law rests on the statutory foundation that “[t]he business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors.”74 That grant of authority forms the bedrock for Delaware’s board-centric model of governance.75 The board’s possession of nigh
A similar picture of broad alignment plus particularized divergence exists for director duties and controller duties. Historically, Delaware cases equated the two.83 Yet controllers owe fiduciary duties in at least two different settings. One is when the controller exercises general or transaction-specific control over the board, takes over the corporate machinery, and effectively substitutes its wishes for those of the
Happily, the parties gloss over these nuances, taking the position that Lone Star, the directors, and Mendoza owed the same duties and breached them in the same way. For purposes of the Sale Process Claims, the defendants do not take issue with that framing. The only divergence arises because Mendoza and the Special Committee Defendants invoke an exculpation defense.
A. The Sale Process Claims Against The Lone Star Defendants
Whether the plaintiff has stated Sale Process Claims against the Lone Star Defendants depends on whether the complaint alleges facts supporting a reasonably
1. Determining The Standard Of Review
The standard of review is the test that a court uses to determine whether a corporate fiduciary has breached its duties. Entity law generally deploys three standards of review: a default standard that is highly deferential to the fiduciary, an intermediate standard under which the fiduciary must show that its actions were reasonable, and an onerous standard under which the fiduciary must show that its actions neither harmed the beneficiary nor conferred any undeserved benefit on the fiduciary.86
Delaware’s default standard of review is the business judgment rule.87 The business judgment rule presumes that “in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”88 Unless one of the elements is rebutted, “the court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the
Delaware’s intermediate standard of review is enhanced scrutiny.91 Delaware courts deploy enhanced scrutiny in specific, recurring situations marked by two features. First, there is an identifiable decision-making context where the realities of the situation can subtly undermine the decisions of even an independent and disinterested fiduciary.92 “Inherent in these situations are subtle structural and situational conflicts that do not rise to a level sufficient to trigger entire fairness review, but also do not comfortably permit expansive judicial deference,” under the business judgment rule.93 Second, the decision under review involves the fiduciary
Delaware’s most onerous standard is the entire fairness test.97 It applies when the corporate fiduciary labors under an actual conflict of interest.98 Entire fairness is a unitary standard that has both substantive and procedural dimensions. Although the two aspects may be examined separately, they are not separate elements of a two-part test. “All aspects of the issue must be examined as a whole sinсe the question is one of entire fairness.”99
The procedural dimension matters because the substantive dimension is often contestable. “The concept of fairness is of course not a technical concept. No litmus paper can be found or [G]eiger-counter invented that will make determinations of fairness objective.”105 Instead, a judgment concerning fairness “will inevitably constitute a judicial judgment that in some respects is reflective of subjective reactions to the facts of a case.”106 Thus, if fiduciaries successfully replicate arm’s length bargaining, then that evidence of fair dealing can validate a debatable outcome. But the opposite is also true: a dubious process can call into question a low
To determine whether the complaint pleads a claim for breach, a court must determine what standard of review applies, then evaluate the complaint’s allegations using that standard of review. If the business judgment rule applies, then the court will not second guess the fiduciary’s decision, and the claim will be dismissed. If enhanced scrutiny applies, then the court must determine whether the complaint sufficiently pleads facts supporting an inference that the defendants could not satisfy the enhanced scrutiny standard of review. “The possibility that the entire fairness standard of review may apply tends to preclude the Court from granting a motion to
2. The Claim Based On The Decision To Pursue A Change Of Control Transaction
The plaintiff alleges that the Lone Star Defendants faced a conflict of interest and acted disloyally when pursuing and approving the Merger. The plaintiff contends that entire fairness applies to that decision. That theory supports a claim on which relief can be granted.
Entire fairness applies at the pleading stage when it is reasonably conceivable that a controller has a conflict of interest that causes its interests to diverge from those of the stockholders as a whole. Entire fairness also applies at the pleading stage when the challenged decision was not made by directors comprising an independent and disinterested majority of the board. The decision to pursue and approve the Merger presents a straightforward scenario that satisfies both triggers.
The Lone Star Directors also faced a conflict. Six of them were affiliated with Lone Star, and the seventh was the CEO of a company Lone Star controlled. Entire fairness applies for the additional reason that the Board lacked a majority of disinterested and independent directors.
The nature of the Early Termination Payment meant that the Lone Star Defendants faced a conflict of interest when making certain decisions but not others. The Company had paths available that would not have given Lone Star the right to claim an Early Termination Payment. Most notably, the Company could have continued to operate as an independent entity and paid Lone Star lower amounts over time. When choosing between that path and a transaction that would trigger the
The allegations of the complaint support a reasonably conceivable inference that the Lone Star Defendants acted self-interestedly by initiating a sale process to secure both consideration for its shares and the Early Termination Payment, then approving the Merger to secure both forms of consideration.113 The complaint supports a reasonably conceivable inference that the Lone Star Defendants only began pursuing a sale of the Company after the Tax Act reduced the stream of contractual payments Lone Star could expect to receive. The complaint’s allegations support a reasonably conceivable inference that for the Company and its minority stockholders, continuing to operate the firm as an independent entity and paying lesser amounts to Lone Star represented the value-maximizing option. In other words, it is reasonable to infer that faithful fiduciaries would not have sold the Company at all. The Lone Star Defendants, however, initiated a sale process with the goal of securing the Early Termination Payment, which was inferably more
Under this theory, Lone Star must prove that the Merger was entirely fair relative to the alternative of operating the Company as a standalone entity. That theory states a claim on which relief can be granted.
3. The Claim Based On The Alleged Diversion Of Merger Consideration
The plaintiff also contends that the Lone Star Defendants must prove that the Merger was entirely fair because the Lone Star Defendants diverted consideration to Lone Star through the Early Termination Payment. That theory neither triggers entire fairness review nor states a claim on which relief can be granted. Once Lone Star made the decision to approve the Merger, Lone Star had a contractual entitlement to the Early Termination Payment. The Company’s stockholders did not have any entitlement to a proportionate share of the proceeds generated by the Merger free from Lone Star’s contractual right. The Lone Star Defendants therefore do not have to defend the fairness of the Merger relative to a hypothetical merger in which all of the consideration went to the Company’s stockholders pro rata with no consideration attributed to the Early Termination Payment.
The plaintiff frames its attack on the Early Termination Payment as involving the diversion of merger consideration. As dealmakers know, there are numerous channels in every deal through which value can pass from a buyer to a seller. The topline consideration per share is only the most visible method. Other examples
a. The Martha Stewart Case
Recognizing that side deals can be legitimate or illegitimate, this court has rejected bight-line rules under which side-payments either always support an inference of unfairness or never do.114 In Martha Stewart, this court framed the challenge as one of distinguishing between “an improper diversion” of consideration
Both sides have relied on the Martha Stewart decision. There, a third-party buyer acquired Martha Stewart Living Omnimedia, Inc. in a transaction that featured side agreements with Martha Stewart, Omnimedia‘s controller. The court held that the defendants properly deployed the two-step MFW process, resulting in a business judgment rule dismissal. But the court also held that entire fairness was not the proper standard of review in the first place because Stewart had not improperly diverted consideration from the minority stockholders.
The key to understanding the Martha Stewart decision is the plaintiff‘s failure to plead any reasonably conceivable benefit for Stewart compared to potential alternatives, including continuing to operate the company as a standalone entity. Before the transaction, Stewart and Omnimedia were parties to three agreements. One was Stewart‘s employment agreement as CEO. The other two were license agreements under which Omnimedia paid Stewart for the use of her name and other
Subject to the special committee‘s approval, Stewart and the buyer agreed to license agreements that were substantially identical to the existing agreements between Stewart and Omnimedia, albeit with extended terms. Those deals effectively maintained the status quo and did not represent a diversion of consideration. Stewart also secured a registration rights agreement to ensure that she could sell an agreed upon number of the shares she received in the transaction, which contemplated that all of the sell-side stockholders would receive half of the consideration in stock. Although the opinion did not dilate on this point, the existence of that agreement suggests that while the minority stockholders received freely tradable shares, Stеwart agreed to restrictions on at least some of her shares. That suggests that Stewart accepted a detriment relative to the minority stockholders and that the registration rights agreement partially mitigated that detriment. That was not a diversion of consideration either.
The court then turned to the new employment agreement. As initially described, the new agreement seems to have provided Stewart with somewhat
That left only a final arrangement under which the buyer agreed to pay Stewart $4 million as reimbursement for transaction expenses. The court noted that because Stewart owned half of Omnimedia‘s equity, eliminating that payment and distributing the consideration across all of the stockholders pro rata would have resulted in an additional $2 million going to Stewart. On net, therefore, Stewart at most received a side payment of $2 million. The court declined to infer that a $2 million side payment, representing 0.5% of the merger consideration, could inferably render the transaction unfair.118
On the facts of Martha Stewart, that conclusion makes sense. A net expense reimbursement of $2 million does not seem facially excessive in absolute terms. Meanwhile, litigating an entire fairness case to judgment over a potential $2 million recovery would be economically irrational for the defendants and likely for the
The Martha Stewart decision also cited other factors that offer less meaningful guidance at the pleading stage. First, the Martha Stewart decision noted that the buyer raised its bid after negotiating with Stewart and treated that as an indication that the negotiations had not diverted merger consideration.120 But that is an ambiguous signal, because a buyer can easily choreograph its approach to fit that pattern. Assume a buyer is willing to pay up to $1 billion for a company, anticipates that the controller will seek to extract a package of side agreements valued at $50 million, and wants to be able to increase its bid by up to 10% during the negotiations to make the sell-side negotiators feel good about the deal and fit within the Martha Stewart paradigm. If the buyer opens at $850 million, the buyer can negotiate a package of side agreements with the controller worth the targeted $50 million, then increase its bid from $850 million to $935 million. The total deal consideration would be $985 million ($935 million for stockholders plus $50 million for the side agreements), still below the reserve value of $1 billion. Any moderately sophisticated buyer will understand that a seller will not want to go backward on price, so even
Second, the Martha Stewart decision noted that the buyer proposed the side agreements, rather than Stewart demanding them.121 Buyers can choreograph that too, and a sophisticated buyer who sees that an insider has existing agreements will naturally seek to address them. To the extent that side-payments become standard features of transactions, buyers would offer them as a matter of course. Here too, a court might consider who offered what as part of a post-trial analysis. At the pleading stage, who made the offer provides an ambiguous signal, so the plaintiff gets the benefit of the doubt.
Third, the Martha Stewart decision acknowledged the legitimacy of Stewart asking for her side deals, stating:
[The buyer] was acquiring the Martha Stewart brand and, in part, the continued commitment of Martha Stewart‘s time, energy and talent to keep the brand alive and thriving. It was entirely proper for [the buyer] to pay, and for Stewart to accept, extra consideration (just as [Omnimedia] had paid before the Merger) to secure the immeasurable value of that commitment.122
Fourth, the Martha Stewart decision questioned whether Stewart had any incentive to divert consideration to herself through side deals given that “she herself was a stockholder who had by far the largest stake in the Merger consideration.”123 True, but Stewart‘s 50% ownership meant she received fifty cents of any dollar that went to the stockholders as a whole, but one hundred cents of any dollar that went to her through a side payment. Stewart‘s large stockholdings gave her an incentive to police side deals involving payments to others (because she would foot half the bill), but it did not mitigate her incentive to favor side payments for herself.
These secondary points do not undermine the outcome in Martha Stewart or its core rationale. The pleading-stage dismissal ultimately resulted from the court‘s conclusion that Stewart‘s deals with the acquiror tracked “to reasonable degrees . . . the structure, value and obligations of the side deals she had in place before the Merger.”124 They thus maintained the status quo and did not divert consideration.
Compared to Martha Stewart, this is a much easier case. In Martha Stewart, the controller negotiated new agreements. The court therefore had to assess whether it was reasonably conceivable that the new agreements reflected improved terms for the controller. This case does not require a before-and-after comparison. The Tax Agreement was an existing agreement, put in place before the Company‘s IPO and part of its operative reality. No one disputes that the Tax Agreement called for the Early Termination Payment. The complaint does not allege that Lone Star received more than what the contract called for.
Instead, the plaintiff seeks to distinguish Martha Stewart on its facts. The plaintiff observes that unlike the acquirer in Martha Stewart, who wanted Stewart to play a role with Omnimedia going forward, American did not need Lone Star‘s good will to support the Company after the Merger. The plaintiff also observes that Lone Star demanded the Early Termination Payment, rather than American offering it. Those distinctions fixate on secondary aspects of the Martha Stewart decision. They represent the flipside of the argument that defense lawyers now routinely make, in which they maintain that an entire fairness claim cannot arise as long as (i) the buyer proposed a side deal in the first instance and (ii) the seller negotiated the bidder up from its initial offer. Both are overly reductive readings of Martha Stewart. Here, as in Martha Stewart, there was no material change between what Lone Star received and what Lone Star was entitled to receive under its pre-existing contract.
The plaintiff next argues that Lone Star could not insist on the full measure of its existing contractual rights under the Tax Agreement, because the Early
The fiduciary calculus does not turn on what others might have asked for, but what duties the Lone Star Defendants owed. Delaware law does not require that a fiduciary engage in altruism. Chancellor Allen rejected a similar argument when considering whether a stockholder controller that had lent money to the controlled corporation could exercise its creditor rights against the firm:
[F]iduciary obligation does not require self-sacrifice. More particularly, it does not necessarily impress its special limitation on legal powers held by one otherwise under a fiduciary duty, when such collateral legal powers do not derive from the circumstances or conditions giving rise to the fiduciary obligation in the first instance. Thus one who may be both a creditor and a fiduciary (e.g., a director or controlling shareholder) does not by reason of that status alone have special limitations imposed upon the exercise of his or her creditor rights.126
That bright-line assertion represents something of an overstatement, because there are settings in which a controller‘s exercise of contract rights could give rise to a fiduciary breach,127 but such a scenario requires meaningfully more than a fiduciary‘s insistence on being paid an amount due to them. The general proposition holds.
Here, Lоne Star was entitled to stand on the terms of the Tax Agreement. That agreement was a commercial contract that contained provisions designed to compensate Lone Star for the Company‘s use of tax assets created while Lone Star was the sole owner of the Company. The agreement provided for the Early Termination Payment. Just as a controller who loaned money to the controlled corporation could insist on full payment following an event of default, Lone Star could similarly insist on the Company fulfilling its contractual obligations.
Taking a different approach, the plaintiff suggests that the Early Termination Payment is suspect because Lone Star entered into the Tax Agreement with the Company before its IPO, when Lone Star could simply impose the arrangement. A stockholder can challenge the enforceability of an agreement if the fiduciary breached its duties when entering into it.128 But the plaintiff has not asserted that claim.
Finally, the plaintiff contends that fiduciary duties come into play because the Company made the Early Termination Payment under the Termination Agreement after the Merger closed. The plaintiff argues that by entering into the Termination Agreement, Lone Star and the Buyer Defendants created a new side deal, separate from the Tax Agreement, that the court must analyze independently.130
That contention elevates form over substance. When applying principles of equity for purposes of a claim like breach of fiduciary duty, a court looks to the substance rather than the form.131 In substance, the Termination Agreement paid out the amount due under the Tax Agreement and confirmed that the Company‘s obligations under the Tax Agreement were satisfied. Arguably, the Termination Agreement was unnecessary, because the Tax Agreement already called for that
Even accepting the plaintiff‘s contention, the only implication of treating the Termination Agreement as a new transaction would be to bring the case on all fours with Martha Stewart. That case involved the replacement of old agreements with substantively identical new ones. Here, the court would conduct the same analysis with the same result. The plaintiff has not pointed to anything that would distinguish the terms of the Termination Agreement from the outcome under the Tax Agreement. Assuming for purposes of analysis that Lone Star bargained for a new side deal to replace the Tax Agreement, Lone Star replaced its existing deal with an identical deal. That does not divert merger consideration; it maintains the status quo.
The plaintiff‘s claim that the Lone Star Defendants diverted merger consideration from the minority stockholders thus does not implicate the entire fairness test. It does not even state a claim on which relief can be granted.
4. The Claim Based On The Conduct Of The Sale Process
The Sale Process Claims next attack the Lone Star Defendants for how the sale process unfolded. According to the plaintiff, Lone Star “conducted the negotiations with bidders (using their favored advisors [Gibson Dunn] and RBC) to extract the structure that resulted in Lone Star receiving $74.8 million under the [Termination Agreement].”132 In substance, the plaintiff contends that by controlling the sale
The analysis again starts with the proper standard of review. For reasons explained at length elsewhere,133 enhanced scrutiny governs a challenge to a sale process when a controller engineers a sale of the controlled company to a third-party for cash.134 The fact that the controller conducts the sale and has an economic incentive to obtain the best price does not, standing alone, reduce the standard of review to the business judgment rule.135 Fully informed approval by disinterested stockholders could reduce the standard of review to the business judgment rule under Corwin,136 but Lone Star approved the Merger unilaterally by written consent.
To plead a claim for breach of fiduciary duty under the enhanced scrutiny standard of reviеw, a plaintiff must plead facts supporting a reasonably conceivable inference that the sale process fell outside the range of reasonableness. When evaluating a sale process led by a fiduciary with a substantial stock position, the court can give weight to the economic alignment between the fiduciary‘s economic interests
Here, the complaint fails to plead facts suggesting a reasonable inference that the Lone Star Defendants engineered a sale process that fell outside the range of reasonableness. The Lone Star Defendants were fully incentivized to maximize the total consideration Lone Star received in a sale. Because the Early Termination Payment was fixed, Lone Star had an incentive to maximize the sale price. And if there is one thing that a private equity firm should be good at, it‘s extracting maximum value for an asset.
As in any sale process, the Lone Star Defendants made debatable decisions. But the complaint does not identify any decisions, individually or in the aggregate, that would take the sale process outside the range of reasonableness given Lone Star‘s substantial economic alignment with the stockholders as a whole. To the extent the plaintiff seeks to challenge how the sale process unfolded, the complaint fails to state a claim on which relief can be granted.
5. Fund IX Is A Proper Fiduciary Defendant.
In addition to contesting the Sale Process Claims as pled, the Lone Star Defendants argue that Fund IX is not a proper defendant because only Cypress, the investment vehicle through which Fund IX acquired and held its investment in the Company, owed fiduciary duties as a controller. By taking that position, the Lone Star Defendants assert that any claim for breach of fiduciary duty against a controller cannot extend beyond the immediate entity that owns the stock that provides control,
“[T]he separate legal existence of juridical entities is fundamental to Delaware law, as are the correlative principles of limited liability and asset partitioning, but that does not mean that every legal doctrine stops at the corporate edge.”137 Those principles, however, operate to different degrees depending on the issue and type of entity.
Juridical entities regularly interact with the government (through regulation and taxation), with third parties through consensual transactions (through contract), and with third parties through nonconsensual transactions in (tort). Juridical entities also interact with internal constituencies, such as providers of capital, providers of labor, and the entities’ own internal decision-makers.138
The principles of separate legal existence and limited liability have different implications across these dimensions, and different entities implement the principles to differing degrees. When interacting with the federal government for purposes of taxation, a corporation typically is treated as a separate legal entity. Partnerships,
When making consensual commitments to third parties via contract, corporations and LLCs are typically treated as separate legal entities. In a general partnership, the partnership is obligated to perform, but in the event of default, the general partners are individually liable. In a limited partnership, the partnership is obligated to perform, but at least one general partner must be individually liable. The same is true for tort obligations.
Numerous legal rules and doctrines circumvent the general principles of corporate separateness and legal liability. A government may choose to impose liability directly on owners or managers for particular activities.140 By piercing the corporate vеil, courts can enable contractual creditors to reach the assets of the owners of an entity.141 Courts also may use piercing to benefit tort claimants, who additionally can recover from the individuals who committed the tort.142
The doctrine of piercing the corporate veil traditionally has not been applied to address equitable claims for breach of fiduciary duty. For claims against directors, it
Issues of corporate separateness arise because equity also imposes fiduciary duties on a party that controls a corporation generally or for purposes of a specific transaction. Breach of fiduciary duty is an equitable claim, and “equity regards substance rather than form.”144 Consequently, when imposing duties and potential accountability on a controller, it does not matter whether the control was exercised directly or indirectly through subsidiaries. Over a century ago, the Supreme Court of the United States rejected a corporate separateness defense similar to what Fund IX asserts here:
The Southern Pacific contends that the doctrine under which majority stockholders exercising control are deemed trustees for the minority should not be applied here, because it did not itself own directly any stock in the old Houston Company; its control being exerted through a subsidiary, Morgan‘s Louisiana & Texas Railroad & Steamship Company, which was the majority stockholder in the old Houston Company. But the doctrine by which the holders of a majority of the stock of a corporation who dominate its affairs are held to act as trustee for the minority does not rest upon such technical distinctions. It is the fact of control of the common property held and exercised, not the particular means by which or manner in which the control is exercised, that creates the fiduciary obligation.145
Fund IX is a proper defendant for the plaintiff‘s claims for breach of fiduciary duty. If the plaintiff had been able to identify another party that controlled Fund IX and plead sufficient facts to support the inference of control, then the plaintiff could have sued that party as well.
B. The Sale Process Claims Against The Special Committee Defendants
The plaintiff also asserts Sale Process Claims against the Special Committee Defendants. The Special Committee Defendants do not seek to dismiss those claims on the merits. They only seek dismissal on the basis of exculpation. That makes sense. The Special Committee Defendants approved the Merger, just as the Lone Star Defendants did. To the extent entire fairness applies, then subject to analyzing the exculpation defense, they must join the Lone Star Defendants in proving that the Merger was entirely fair relative to the alternative of remaining independent. Subject to the exculpation defense, therefore, the complaint states a claim against the Special Committee Defendants.
The complaint thus states one viable Sale Process Claim. The complaint sufficiently pleads that the Lone Star Defendants faced a conflict of interest that caused them to breach their fiduciary duties when deciding to pursue and ultimately approve a transaction that would trigger the Early Termination Payment, rather than continuing to operate the Company as an independent entity. The complaint sufficiently pleads that the Special Committee Defendants breached their fiduciary duties by deferring to the Lone Star Defendants and approving a sale, rather than saying “no” to the Merger. The Lone Star Defendants and the Special Committee Defendants must prove that the decision to sell was entirely fair compared to continuing to operate the Company as a standalone entity for the benefit of all of its stockholders. If they fail to prove that the decision was entirely fair, then they could be liable for the difference between (i) the greater value that stockholders could have obtained if the Company had remained indeрendent and paid lower amounts under the Tax Agreement over time and (ii) the consideration received in the Merger. Otherwise, the Sale Process Claims are dismissed.
IV. THE DISCLOSURE CLAIMS
The plaintiff next claims that the Lone Star Defendants and the Special Committee Defendants breached their duty of disclosure. Everyone agrees that the directors all owed the same duty of disclosure. No one argues that Mendoza, in his capacity as CEO, separately breached a distinct, officer-based duty of disclosure. The Lone Star Defendants do make a distinction for Lone Star: They contend that in a
A. The Disclosure Claim Against The Directors
The plaintiff alleges that the directors breached their fiduciary duties by failing to disclose material information in the Information Statement, then by failing to give stockholders sufficient time to consider the Supplement and demand appraisal. Both theories state claims on which relief can be granted.
“[D]irectors of Delaware corporations are under a fiduciary duty to disclose fully and fairly all material information within the board‘s control when it seeks shareholder action.”147 A board seeks stockholder action when it presents stockholders with a transaction that requires a vote or an investment decision, such as whether to tender their shares or whether to pursue appraisal.148 When a merger will trigger appraisal rights, the duty of disclosure applies even if the directors are not soliciting stockholder votes.149
“Delaware disclosure law also proscribes misleading partial disclosures. When fiduciaries undertake to describe events, they must do so in a balanced and accurate fashion, which does not create a materially misleading impression.”153 “[T]he disclosure of even a non-material fact can, in some instances, trigger an obligation to disclose additional, otherwise non-material facts in order to prevent the initial disclosure from materially misleading the stockholders.”154
1. The Materiality Standard When The Only Decision Is Whether To Seek Appraisal
The defendants argue that the court must evaluate the defendants’ disclosures in the context of a transaction where stockholders were not asked to vote. The defendants contend that while some disclosures might be material to stockholders when voting, those same disclosures would not be material to a stockholder when deciding whether to seek appraisal. That argument is misguided.
In Skeen v. Jo-Ann Stores, Inc.,158 stockholder plaintiffs advanced a version of this argument, contending that when a merger only involved a decision to seek appraisal, the fiduciary defendants must disclose a greater degree of valuation
That makes sense, because the economic decision is the same. In both settings, the choice is between the merger consideration or a pro rata share of the standalone value of the corporation. When voting on a merger, a vote in favor reflects a decision to opt for the merger consideration. A vote against reflects a decision to opt for a pro rata share of standalone value, which the stockholder would receive by keeping its shares. For appraisal, doing nothing reflects a decision to opt for the merger consideration. Demanding appraisal reflects a decision to opt for a pro rata share of standalone value, which the stockholder receives by pursuing the appraisal proceeding. If the legal system could operate perfectly, the outcomes would be identical. Because the economic decision is the same, the disclosure requirements are the same. That is what Skeen held.
The post-Skeen evolution of Delaware law has only reinforced the logic of using the same standard. In 2015, the Delaware Supreme Court held in Corwin that a fully informed stockholder vote will extinguish sale process claims that otherwise would be reviewed under enhanced scrutiny.160 The Corwin doctrine made it all the more
Starting in 2016, a trilogy of path-breaking Delaware Supreme Court decisions provided this court with pointed instruction about the relationship between the deal price in a third-party transaction and fair value in an appraisal.162 Under the trilogy,
It therefore does not matter for the duty of disclosure that stockholders were not asked to vote on the Merger. The same materiality standard applies.
a. The Failure To Disclose The Role Of The Tax Agreement
The complaint‘s allegations support a reasonable inference that the Information Statement failed to disclose the role that the Tax Agreement played in the sale process and the Merger. The “Background of the Merger” section does not refer to the Tax Act, the Tax Agreement, or the prospect for an Early Termination Payment as playing a role in the initiation of the sale process or the agreement to the Merger. The allegations of the complaint and the documents incorporated by reference support at least the following reasonable inferences:
- The Tax Act reduced the value to Lone Star of the ongoing stream of payments it would receive under the Tax Agreement and made the prospect of an Early Termination Payment more attractive. That combination caused the Lone Star Defendants to initiate the sale process.
- The Tax Agreement and the prospect of an Early Termination Payment prompted the creation of the Special Committee.
- The Tax Agreement and the prospect of an Early Termination Payment was a recurring focus of discussion during the sale process.
Yet the “Background of the Merger Section” does not refer to the Tax Agreement until potential buyers started referencing it expressly in their offers.
b. The Partial Disclosure Regarding RBC And Evercore‘s Fee Arrangements
The allegations of the complaint support a reasonable inference that the Information Statement failed to provide adequate disclosure regarding RBC and Evercore‘s fee arrangements. Recent Delaware Supreme Court decisions have stressed the importance of full and fair disclosure regarding financial advisor conflicts and compensation arrangements.166 “Because of the central role played by investment banks in the evaluation, exploration, selection, and implementation of
“[I]t is imperative for the stockholders to be able to understand what factors might influence the financial advisor‘s analytical efforts . . . . A financial advisor‘s own proprietary financial interest in a proposed transaction must be carefully considered in assessing how much credence to give its analysis.”168
RBC received a success fee calculated based on an amount that included the consideration Lone Star received under the Tax Agreement. The Information Statement did not disclose that. The Information Statement merely stated that RBC would receive an “aggregate fee currently estimated to be approximately $8.3 million, which is contingent upon the closing of the Merger.”169
Evercore received a similar success fee calculated based on an amount that included the consideration Lone Star received under the Tax Agreement. The Information Statement did not disclose that either. The Information Statement merely stated that Evercore would receive “a fee of $1.5 million upon delivery of the opinion to the Special Committee,” plus “an additional transaction fee, estimated to
The lack of disclosure is particularly significant for Evercore, which served as the Special Committee‘s advisor. As the Delaware Supreme Court recently emphasized, “[a] special committee‘s advisor‘s conflicts are uniquely important.”171 Unlike RBC, Evercore‘s job was not to get a transaction done. Evercore‘s job was to help the Special Committee make sure that the transaction was fair to stockholders. Instead, Evercore was contingently compensated using a fee arrangement that aligned its interests with Lone Star‘s, and the Information Statement failed to disclose that fact.
RBC and Evercore argue that the amount of the consideration tied to the Early Termination Payment was not material to them. But materiality is evaluated from the perspective of a reasonable stockholder, not from the perspective of the directors or the financial advisor.172 Regardless, “[i]t does not matter whether the financial advisor‘s opinion was ultimately influenced by the conflict of interest; the presence of an undisclosed conflict is still significant.”173 “There is no rule that conflicts of interest must be disclosed only where there is evidence that the financial advisor‘s opinion
c. The Partial Disclosure Of RBC and Gibson Dunn‘s Relationships To Lone Star
The allegations of the complaint support a reasonable inference that the Information Statement failed to provide adequate disclosure about RBC‘s relationships with Lone Star. “It is imperative that stockholders be able to decide for themselves what weight to place on a conflict faced by the financial advisor.”175 As the Delaware Supreme Court recently made clear, stockholders should also understand any conflicts faced by the lawyers involved in the deal.176
The Information Statement introduced RBC by identifying the firm as having “a long-standing relationship with the Company.”177 The Information Statement did not identify RBC‘s deeper relationship with Lone Star. In fact, Lone Star paid RBC
The Information Statement was similarly parsimonious regarding Gibson Dunn. The allegations of the complaint support a reasonable inference that the Information Statement failed to provide adequate disclosure about Gibson Dunn‘s relationships with Lone Star. As with RBC, the Information Statement introduced Gibson Dunn by identifying the firm as having “a long-standing relationship with the Company.”178 The Information Statement did not identify Gibson Dunn‘s deeper relationship with Lone Star, which warranted Meyer introducing the Gibson Dunn lead lawyer to RBC as “our partner . . . who has worked extensively with us across our portfolio.”179
The Information Statement also consistently described Gibson Dunn as the Company‘s counsel, without acknowledging that when Lone Star was considering a sale of its shares, Gibson Dunn acted as Lone Star‘s counsel. In particular, at the Board meeting on January 21, 2020, the minutes note that Gibson Dunn appeared as
d. The Other Disclosure Claims
The plaintiff has advanced other disclosure claims. Because the foregoing allegations are sufficient to state a claim on which relief can be granted, the court does not reach the other allegedly false or misleading statements or omissions in the Information Statement.
2. The Timing Of The Supplement
Directors not only have a duty to disclose information, they have a duty to provide stockholders with sufficient time to take the information into account. The plaintiff contends that stockholders did not have sufficient time to consider the Supplement before the appraisal deadline.
A court must exercise discretion when determining whether stockholders have had a sufficient opportunity to consider and receive information. The DGCL requires twenty days’ notice for a merger,180 making that amount of time presumptively sufficient under Delaware law.181 When enjoining a meeting of stockholders pending
The Company issued the Supplement on December 21, 2020. The deadline for demanding appraisal was December 24, just three days later. And the Supplement was issued during the holiday season and in the midst of the COVID-19 pandemic.
No decision supports such a short notice period. To the contrary, this court has issued a temporary restraining order where directors issued a Form 8-K containing additional information that gave stockholders just three days to consider it before voting.183 It is reasonably conceivable that the directors breached their fiduciary duties by failing to provide stockholders with sufficient time to act on the information included in the Supplement.
B. Lone Star‘s Status As A Defendant For The Disclosure Claims
Lone Star argues that despite being a stockholder controller that owed fiduciary duties, Lone Star did not owe an independent fiduciary duty of disclosure to the unaffiliated stockholders because the Merger was a third-party transaction. For the reasons stated in the Presidio decision, that assertion is correct.184 The
A different result might be warranted if the plaintiff alleged that Lone Star possessed material information that the Board did not, but that is not what the plaintiff contends. On the facts alleged, the Company‘s directors owed a duty of disclosure. Lone Star did not.
V. THE EXCULPATION DEFENSE
Mendoza and the Special Committee Defendants raise an exculpation defense. At the pleading stage, those defendants cannot rely on exculpation to defeat the limited claims for breach of fiduciary duty that survive pleading stage review. At a later stage of the case, the exculpation defense may well succeed.
The Delaware Supreme Court has instructed that if a plaintiff “seek[s] only monetary damages” from “a director who is protected by an exculpatory provision,” then to survive a motion to dismiss, the plaintiff “must plead non-exculpated claims against [the] director . . . , regardless of the underlying standard of review for the board‘s conduct—be it Revlon, Unocal, the entire fairness standard, or the business judgment rule.”185 “So applied, the existence of an exculpatory provision operates
The Company‘s certificate of incorporation contains an exculpation provision. It states: “To the fullest extent permitted by the DGCL as the same exists or as may hereafter be amended, no director of the corporation shall be personаlly liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director.”187
1. Mendoza
Mendoza argues that the claims asserting that he breached his duties must be dismissed because he is entitled to exculpation. Under Cornerstone, a plaintiff may
The complaint‘s allegations call into question Mendoza‘s independence. A fiduciary is not independent when “the fiduciary is ‘sufficiently loyal to, beholden to, or otherwise influenced by an interested party’ to undermine the fiduciary‘s ability to judge the matter on its merits.”191 “Under the great weight of Delaware precedent, senior corporate officers generally lack independence for purposes of evaluating matters that implicate the interests of either a controller or a conflicted board majority.”192 Mendoza was the CEO of a portfolio company that Lone Star controlled. He was not independent.
The complaint‘s allegations call into question Mendoza‘s disinterestedness. “A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders.”193 Mendoza held a 2.75% interest in any amounts received under the Tax Agreement. Mendoza attempts to rationalize his interest by observing that he held a greater equity stake in the Company. That misses the point. Like Lone Star, Mendoza stood to gain
To argue for dismissal, Mendoza cites a statement in one decision to the effect that “[s]uccessfully impugning a director‘s independence with respect to voting on transactions . . . should be more difficult than challenging that same independence with respect to assessing a demand.”194 Mendoza‘s counsel has taken that language out of context and presented the quotation as if it related to pleading-stage analysis, which it did not; the court was analyzing a motion for summary judgment to determine what standard of review would govern a transaction at trial.195 Transplanted to the pleading stage by defense counsel, the statement gets matters backwards. Rule 23.1 governs the analysis of demand futility and requires that the complaint plead particularized facts supporting a director‘s inability to consider a demand. When defendants move to dismiss a challenge to a transaction under Rule 12(b)(6), the notice pleading standard from Rule 8 applies. The proposition that a challenge to a transaction must clear a higher standard is also counter intuitive because the test for director disinterest and independence is the same in both
Mendoza also cites a case in which the court held that a CEO was entitled to exculpation under similar circumstances—a third-party sale in which the stockholder controller inferably extracted a side benefit. The court acknowledged that “[t]he contention is theoretically plausible given that [the defendant] was the CEO of [the target company] when the [t]ransactions were negotiated and he may have been motivated to curry favor with [the seller] or [the buyer] to maintain his position as
A claim for breach of fiduciary duty does not require a showing of inherently wrongful or disloyal conduct. Such a showing is sufficient, but not necessary. All that a claim for breach of fiduciary duty requires is a showing that the conflicted fiduciaries voted in favor of the interested transaction. At that point, if the complaint states a reasonably conceivable theory as to why the director was not disinterested or independent, then the complaint has stated a reasonably conceivable claim for a breach of the duty of loyalty, and exculpation is unavailable. When a court finds that a claim of disloyalty is “theoretically plausible,” that is more than enough to survive pleading stage review.
For purposes of the remaining claim for breach of fiduciary duty that survives pleading stage review, Mendoza is no different than the Lone Star Directors. The
2. The Special Committee Defendants
The Special Committee Defendants also argue for their dismissal based on the Exculpation Provision. At the pleading stage, exculpation is not available because the complaint‘s allegations, if proven, could support a breach of the duty of loyalty.
To implicate the Special Committee Defendants in a non-exculpated claim, the plaintiff alleges bad faith.200 The duty of loyalty requires that disinterested, independent directors act in good faith.201 A director fails to act in good faith when “the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation . . . .”202 A plaintiff can call into question a director‘s good faith by pleading facts supporting an inference that the director acted for some other purpose.203 “Bad faith can be the result of “any emotion [that] may cause a director to [intentionally] place his own interests, preferences or appetites before the welfare
Court of Chancery Rule 9(b) states that a person‘s “condition of mind may be averred generally.”206 That means the plaintiff must plead facts which, when viewed holistically, support a reasonable inference that the person could have acted with the requisite mental state. “Even after a trial, a judge may need to make credibility determinations about a defendant‘s subjective beliefs by weighing witness testimony against objective facts.”207 And even then, the members of the Court of Chancery “cannot peer into the hearts and souls of directors to determine their subjective intent with certainty.”208 “Without the ability to read minds, a trial judge only can infer a party‘s subjective intent from external indications. Objective facts remain logically
Althоugh lawyers routinely object that witnesses cannot speculate about someone else‘s state of mind, there is actually nothing special about it.
While “mind reading” might sound like a mentalist magic trick, for cognitive scientists it refers to the very pedestrian capacity we all have for figuring out what another human being is thinking . . . . Other people‘s minds are opaque to us, so we cannot observe them directly. And yet, when someone walks toward the water fountain on a hot day, we know she wants a drink. When someone yelps after stubbing her toe, we know she feels pain. When someone aims an arrow at a target, we know she intends to hit it. We take in observable data about a person and infer something about her unobservable mental life.210
To get at a person‘s unobservable mental state, we look at what the person did and the circumstances in which they did it.211
Cases involving allegations of bad faith are difficult where there is no smoking gun, but where there is evidence suggesting a problematic intent. As Chancellor Allen explained:
Rarely will direct evidence of bad faith—admissions or evidence of conspiracy—be available. Moreover, due regard for the protective nature of the stockholders’ class action, requires the court, in these cases, to be suspicious, to exercise such powers as it may possess to look
imaginatively beneath the surface of events, which, in most instances, will itself be well-crafted and unobjectionable.212
Chancellor Allen made those observations when ruling on a preliminary injunction application, after the plaintiff had the opportunity to conduct discovery and take depositions. At the pleading stage, his admonition carries even greater weight. Here, the plaintiff has pled enough, but only barely.
The plaintiff starts by alleging that the Board formed the Special Committee “to protect the interests of the minority stockholders in any sale transaction that might involve acceleration of the Tax Agreement because of Lone Star‘s conflict of interest . . . .”213 That is a reasonable inference.
The plaintiff next points to the resolutions that empowered the Special Committee to (i) investigate possible transactions, (ii) evaluate the terms of any possible transactions, (iii) participate in negotiations with relevant third parties regarding any element of a possible transaction, (iv) participate in negotiations of the terms of any definitive agreement with respect to any possible transactions (the execution of which was subject to Board approval), (v) report its recommendations and conclusions to the Board, and (vi) determine not to pursue any possible transaction. Read in conjunction with the Board‘s reason for creating the Special
The plaintiff alleges that the Special Committee Defendants “consciously disregarded their duties and affirmatively chose not to exercise any of the authority granted to them.”214 The plaintiff points to the following events:
- On September 21, 2018, the Special Committee resolved to hire its own financial advisor, yet the Special Committee did not follow through until September 10, 2020, nearly two years later.215
- On October 2, 2018, the Special Committee identified “potential incentives created by the structure of RBC‘s compensation and determined that it should attempt to renegotiate this structure so that no payments were dependent on amounts paid to settle the [Tax Agreement]”216 There is no record of any effort to actually do that.
- On October 17, 2018, before being retained, Evercore gave a presentation about precedent transactions involving tax receivable agreements. The presentation identified one transaction in which the parties negotiated to eliminate an early termination payment. In other precedents, Evercore identified amounts paid, but did not indicate that they were contractually determined. Evercore‘s presentation suggested that the amount of the Early Termination Payment could be negotiated, but the Special Committee made no effort to negotiate with Lone Star concerning the Tax Agreement payment.217
- In the middle of the sale process, on March 8, 2019, Lone Star asked the Special Committee to let Gibson Dunn and RBC switch sides and begin representing Lone Star against the Company in a squeeze-out. The Special Committee met
аnd adjourned without deciding whether to grant the request. There is no indication that the Special Committee had any objection.218 - After its March 2019 meeting, the Special Committee did not meet until January 2020, ten months later, when the Special Committee convened for fifteen minutes to approve a non-disclosure agreement between the Company, Lone Star, and CD&R.219
- After the January 2020 meeting, the Special Committee did not meet for another seven months. During that period, the Lone Star Defendants continued negotiations with CD&R and other potential acquirers.220
- On September 2, 2020, the Special Committee met and decided to reject American‘s request for exclusivity. The full Board had already rejected that request five days earlier.221
- On September 8, 2020, the Board decided that a full termination payment to Lone Star under the Tax Agreement would be a given in any transaction. That should have been an issue for the Special Committee to address.222
- On September 10, 2020, the Special Committee formally retained Evercore. The Special Committee approved the same compensation structure for Evercore that the Special Committee and its counsel had flagged as a problem for RBC.223
- After the meeting on September 10, 2020, the Special Committee went two months without meeting again. During that period, the Lone Star Defendants and RBC conducted the sale process.224
The Board, not the Special Committee, decided to end the sale process after receiving American‘s $19.25 offer.225 - The Board, not the Special Committee, approved the exclusivity agreement with American.226
- The Special Committee‘s advisor, Evercore, advised the Board about the superiority of American‘s offer before the Special Committee had met to evaluate it.227
- The Special Committee approved the Merger and recommended it to the Board without any changes.228
The plaintiff argues that those facts, taken as a whole, support an inference that the Special Committee acted as a pliant tool for Lone Star, happy to be of use.
The allegations state a claim for breach of the duty of care, but it is a closer call whether they rise to the level of bad faith. They describe a Special Committee that acted only when prompted by Lone Star and repeatedly went into hiding for months while the sale process was unfolding. More than once, the Special Committee acted as a retroactive rubber stamp by purporting to discuss or approve issues that the full Board had already addressed. The Special Committee strikingly opted to hire Evercore using the same compensation structure that the Special Committee had flagged as a conflict for RBC. At one point, the Chair of the Special Committee
At the pleading stage, close calls go to the plaintiff. The constellation of facts that the plaintiff has alleged supports an inference that the Special Committee Defendants consciously disregarded their responsibilities and acted to facilitate the transaction that Lone Star wanted.
The Special Committee Defendants made it easier for the court to rule against them at the pleading stage by misrepresenting the law and the factual record. When describing the legal standard, the Special Committee claimed that “the actions of the fiduciary alleged to have acted in bad faith must be ‘so beyond the bounds of reasonable judgment that it seems essentially inexplicable on any other ground.‘”229
The Delaware Supreme Court has rejected that standard. In Kahn v. Stern, the Delaware Supreme Court considered an appeal in which the Court of Chancery dismissed claims against directors for failing to plead bad faith.230 While agreeing with the result, Chief Justice Strine went out of his way to state that
to the extent that the Court of Chancery‘s decision might be read as suggesting that a plaintiff in this context must plead facts that rule out any possibility other than bad faith, rather than just pleading facts that support a rational inference of bad faith, we disagree with that statement.231
To be sure, showing that conduct is “inexplicable on any ground than bad faith” remains one means of establishing bad faith, but a plaintiff is not required to plead facts meeting that standard to survive a motion to dismiss. A plaintiff need not “plead facts that rule out any possibility other than bad faith.”234 At trial, a plaintiff need not rule out other explanations; the plaintiff need only show by a preponderance of the evidence that the fiduciary acted for a purpose other than the best interest of the corporation.235 Likewise, at the pleading stage, a plaintiff need only plead facts
The Special Committee Defendants did not cite Kahn v. Stern or Brinkerhoff. Those cases are not only pertinent authority in the controlling jurisdiction, they are controlling cases from the highest court in the controlling jurisdiction.
The Special Committee Defendants also misstated the facts. They devoted much of their brief to claiming that the plaintiff‘s allegations were inconsistent. According to the Special Committee Defendants, it cannot simultaneously be true that Lone Star excluded the Special Committee Defendants from the sale process, while at the same time be true that the Special Committee Defendants failed to involve themselves in the sale process or assert their authority. As the Special Committee Defendants sum it up, they allegedly “were both intentionally excluded from the process . . . and simultaneously missing in action.”237
Those allegations are not contradictory; they are consistent. The complaint alleges that the Special Committee had the authority to play a meaningful role in the sale process. The resolutions creating the Special Committee support that allegation. Yet the Special Committee did not engage meaningfully in those tasks. One reason was that the Special Committee did not assert itself. It deferred to Lone Star. Another
The Special Committee Defendants next try to argue that it is not reasonable to infer that the Board created the Special Committee to address the conflict of interest presented by the Tax Agreement. As noted, that was a reasonable inference. Indeed, the recitals in the written consent that created the Special Committee stated:
WHEREAS, seven of the ten members of the Board of the Company are employees or persons otherwise affiliated with [Lone Star], a majority stockholder of the Company and a party to [the Tax Agreement];
WHEREAS, upon the occurrence of the Change of Control (as defined in the [Tax Agreement]), all obligations of the Company under the [Tax Agreement], including the Company‘s obligation to make significant payments to Lone Star, may, at the election of Lone Star be accelerated;
. . .
NOW, THEREFORE, BE IT RESOLVED, that the Board hereby designates the Special Committee . . . .238
Unabashed, the Special Committee Defendants argued that “the [Tax Agreement] is not mentioned in even one of the ‘resolved further’ paragraphs setting forth the resolutions of the Board.”239 True. It was in the WHEREAS clauses that set the stage for the entire written consent, including the resolutions.240
The Special Committee Defendants also argued incoherently that the nature of the Special Committee‘s “supposed purpose has no bearing on the question of conscious disregard [of duty].”241 Whether a party has consciously disregarded its duty turns on whether the duty existed. Whether a duty existed depends on what the party has been charged with doing. The fact that the resolutions creating the Special Committee referenced the Tax Agreement and charged the Special Committee with participating in the sale process supports a reasonably conceivable inference about what the Special Committee was supposed to do. The complaint depicts a Special Committee that consciously failed to fulfill its charge.
Finally, and most bizarrely, the Special Committee Defendants contended that they could not shoulder any responsibility for the outcome of the sale process because they did not have any leverage. They tried to distinguish the plaintiffs’ precedents as
Those arguments are so off base that they reinforce the plaintiff‘s allegations about a Special Committee that never understood what it was supposed to do. If their brief is to be believed, neither the Special Committee Defendants nor their counsel (the same firm that advised them during the sale process) thought they could say “no” to the Merger or that they had any obligation to carry out any of the tasks set forth in the implementing resolutions. That is hard to credit, but it would help explain why the Special Committee acted as it did. For present purposes, it reinforces a pleading-stage inference of bad faith.
During the sale process and when evaluating the Merger, the Special Committee Defendants owed a duty of loyalty to the stockholders to seek the alternative that maximized the value of their residual claims without regard to the particular interests of Lone Star. That alternative could well have been no
VI. THE AIDING AND ABETTING CLAIMS
In addition to asserting claims for breach of fiduciary duty against the fiduciary defendants, the complaint asserts the Aiding and Abetting Claims against RBC, Evercore, and the Buyer Defendants. The complaint states an aiding and abetting claim against the financial advisors, but not against the Buyer Defendants.
To plead a claim for aiding and abetting, the complaint must allege facts to support four elements: (i) the existence of a fiduciary relationship, (ii) a breach of the fiduciary‘s duty, (iii) knowing participation in the breach by a non-fiduciary defendant, and (iv) damages proximately caused by the breach.244 To establish knowledge, “the plaintiff must demonstrate that the aider and abettor had actual or constructive knowledge that their conduct was legally improper.”245 “[T]he question of whether a defendant acted with scienter is a factual determination.”246 Under Rule 9(b), a plaintiff can plead knowledge generally; “there is no requirement that knowing participation be pled with particularity.”247 For purposes of a motion to dismiss under
A. RBC
The complaint contends that RBC aided and abetted the Lone Star Defendants in the breaches of fiduciary duty that gave rise to the Sale Process Claims. The plaintiff contends that while nominally working as the Company‘s banker, RBC actually served Lone Star‘s interests.
This decision has already held that the complaint pleads a claim for breach of fiduciary duty against the Lone Star Defendants based on the conflicted decision to pursue a Change of Control transaction and ultimately enter into the Merger. For the aiding and abetting claim against RBC, the key element is knowing participation.
“To show that a financial advisor acted with scienter, a stockholder plaintiff typically points to evidence of a conflict of interest diverting the advisor‘s loyalties . . . .”249 The conflict of interest can arise from multiple sоurces, including a long-standing relationship or a compensation arrangement.
RBC had both. The Company hired RBC to serve as its financial advisor, but RBC‘s longstanding relationship with Lone Star and the structure of its success fee aligned RBC‘s interests with Lone Star‘s interests. The complaint pleads facts
This court has recognized that “a merger advisor . . . with a preexisting personal relationship with key actors at the seller could cater to their interests” and that “[s]uch catering might privilege the insiders’ preferred deal over a more lucrative alternative that makes the shareholders better off.”250 RBC had a deep relationship with Lone Star. Between January 2016 and June 2018, RBC received $72.7 million in fees for services provided to Lone Star and its affiliates,251 plus another $5.9 million from the Company.252 Those engagements included serving as one of the book-running managers when Lone Star took the Company public in 2017253 and serving as one of three joint book-running managers for Lone Star‘s secondary offering of Company stock in 2019.254 The potential sale of the Company provided RBC with another opportunity to demonstrate its value to Lone Star and audition for future engagements from a repeated M&A and capital markets player.
RBC argues in response that including the Early Termination Payment in the calculation was immaterial because it only generated $448,000 in proceeds. If so, then why did Lone Star revise the engagement letter to include it? At this stage, it is reasonable to infer that Lone Star made the change believing it would affect RBC‘s behavior. If Lone Star simply wanted RBC to receive more money, Lone Star could have nudged up the percentage. At the pleading stage, those pled facts make it reasonable to infer that the change was material to both Lone Star and RBC.
RBC also tries to defeat the materiality of the payment by observing that Lone Star and RBC did not jump at an early offer in 2018. Accepting that argument would require drawing an inference in favor of the defendants on a fact-laden issue. At the pleading stage, it is not reasonable to infer from that one instance that the Early Termination Payment was immaterial. It is reasonable to infer that Lone Star and RBC had an incentive to maximize the combination of the per-share consideration and the Early Termination Payment. The early offer inferably did not do that. Lone Star and RBC could maximize the combination by keeping the Early Termination
The plaintiff has not pled that RBC took action that was independently wrongful, but that is not required. “The aider and abettor must knowingly assist another in committing a wrongful act. The means by which an aider and abettor provides assistance need not be independently wrongful.”255 The complaint depicts RBC working hand in glove with Lone Star to engineer a sale transaction that would trigger an Early Termination Payment. During the period when Lone Star explored selling its shares in the Company independent of a whole-company sale, RBC effectively worked as Lone Star‘s financial advisor, without receiving permission from the Special Committee.256 And in the final months of the process, as described more fully below, RBC worked closely with the Lone Star-affiliated directors to secure proposals that included a maximum Early Termination Payment.257
RBC played an integral part in the effort to sell the Company through a transaction that would trigger the Early Termination Payment. The complaint states a claim against RBC for aiding and abetting that alleged breach.
The complaint next contends that Evercore aided and abetted breaches оf fiduciary duty. The plaintiff asserts that Evercore knowingly participated in breaches giving rise to both the Sale Process Claims and the Disclosure Claims.
1. Aiding And Abetting The Sale Process Claims
The complaint contends that Evercore aided and abetted breaches of fiduciary duty by the Special Committee. The plaintiff contends that Evercore had a financial incentive to advance Lone Star‘s interests and that Evercore did so by joining the Special Committee members in doing nothing to check Lone Star‘s desire for a transaction that included the Early Termination Payment. Largely because of Evercore‘s compensation arrangement, this theory states a claim on which relief can be granted.
Under its engagement letter, Evercore agreed to “provid[e] advice to the Special Committee on the Company‘s design and implementation of an appropriate Transaction process, and . . . assist[] the Special Committee‘s consideration of one or more Transaction proposals received by the Company from third parties and recommend[] the appropriate course of action to the Special Committee.”258 In short, the Special Committee Defendants engaged Evercore to help them protect the Company and its minority stockholders against potential harm that might result from Lone Star‘s conflict of interest.
But when the Special Committee finally got around to retaining Evercore two years later, Evercore did not act like a financial advisor tasked with helping the Special Committee protect against Lone Star‘s conflict of interest. Despite identifying an accelerated payout as a source of conflict, Evercore demanded that its contingent fee include a percentage of the Early Termination Payment to Lone Star.261 That compensation agreement meant that Evercore, the financial advisor brought into the deal to guard against a transaction with an Early Termination Payment, had an incentive to support a transaction that included an Early Termination Payment over remaining independent. Rather than having a financial incentive to act independently, Evercore‘s engagement letter aligned its interests with Lone Star‘s and RBC‘s.
But even if Evercore were right about the ostensible virtues of contingent fee arrangements, those general platitudes do not validate a fee arrangement that builds in compensation for a divergent interest. Those general platitudes also do not speak to the appropriate compensation arrangement for a special committee. It is one thing to pay contingent compensation to thе financial advisor charged with securing the best deal reasonably available. It is another thing to pay contingent compensation to the financial advisor who is supposed to be willing to tell the special committee that the deal should not happen. Because of that different role, a special committee‘s financial advisor should not receive contingent compensation.264 A special committee‘s financial advisor certainly should not receive contingent consideration tied to the conflict that the special committee was created to address, using a compensation arrangement that the special committee and its counsel had flagged as problematic for the financial advisor representing the company.
The complaint pleads facts supporting an inference that Evercore acted consistent with the incentives that its engagement letter created. Evercore did not limit itself to preparing a valuation analysis for the Special Committee, as it now claims. To the contrary, during a meeting of the Board on October 31, 2020, Evercore criticized the CD&R, Apollo, and One Rock bids, which contributed to the Board granting exclusivity to American.265
The plaintiff also attacks Evercore‘s presentation to the Special Committee in support of the Merger. Evercore treated the Company‘s obligations under the Tax Agreement inconsistently by factoring them in for the high-end of the ranges in its valuations, while omitting them from the low-end of the ranges.266 That approach makes little sense. Either the Tax Agreement imposed contractual obligations, as the defendants now claim, or it did not.
The plaintiff asserts that Evercore manipulated its analysis for two reasons. First, it made American‘s bid look better relative to the top-end of the ranges. Second, it hid the fact that when the Tax Agreement obligations were included, Evercore‘s methodologies generated valuations well below the Company‘s trading price, which
Taken as a whole, those allegations state a claim against Evercore for aiding and abetting breaches of fiduciary duty.
2. Aiding And Abetting The Disclosure Claims
The complaint also contends that Evercore aided and abetted the breaches of fiduciary duty underlying the Disclosure Claims by authorizing the use of a different analysis in the Information Statement than what Evercore provided to the Special Committee. The complaint fails to articulate a reasonably conceivable claim. The Information Statement accurately described Evercore‘s analysis. The Information Statement did not use the precise words that the plaintiff wishes it had, but the plaintiff‘s editorializing is not sufficient to state a claim. Evercore‘s underlying analysis remains suspect, but the Information Statement described it fairly.
C. The Buyer Defendants
The complaint also contends that the Buyer Defendants aided and abetted breaches of fiduciary duty. The plaintiff asserts that the Buyer Defendants knowingly participated in breaches giving rise to both the Sale Process Claims and the Disclosure Claims. Neither states a claim on which relief can be granted.
The complaint alleges that the Buyer Defendants aided and abetted the breaches of duty underlying the Sale Process Claims by agreeing to allocate consideration to the Early Termination Payment. The complaint‘s allegations do not make that inference reasonably conceivable. The only rational inference is that Lone
The complaint alleges that the Buyer Defendants extracted a quid pro quo in which they accommodated Lone Star‘s desire for an Early Termination Payment in exchange for their own desire for a condition based on the number of stockholders who sought appraisal. That is not a reasonable inference. Lone Star had a contractual right to the Early Termination Payment. Lone Star did not need to give anything up to get it.
Turning to the Disclosure Claims, the complaint alleges that American had the right to review and comment on the Information Statement. The complaint also alleges that American helped draft the Information Statement and reviewed its contents. But the plaintiff has not pointed to any disclosures the Buyer Defendants inferably knew were false or misleading. The disclosure problems all concerned internal sell-side activity; there is no reason to believe that the Buyer Defendants had visibility into those issues.
The aiding and abetting claims against the Buyer Defendants are dismissed.
VII. THE STATUTORY CLAIMS
Section 262 of the DGCL governs appraisal. The statute imposes requirements that a corporation must meet when it engages in transaction that gives rise to
because it did not include all material information that stockholders needed to consider when deciding whether to assert their appraisal rights. The third contends that the Supplement constituted a new appraisal notice but did not allow additional time to seek appraisal. The plaintiff also asserts a claim for breach of fiduciary duty grounded in assertions about intentional interference with stockholders’ appraisal rights.
A. The Time To Seek Appraisal
The plaintiff contends that the defendants failed to comply with the requirements of
Any stockholder entitled to appraisal rights may, within 20 days after the date of giving such notice or, in the case of a merger approved pursuant to § 251(h) of this title, within the later of the consummation of the offer contemplated by § 251(h) of this title and 20 days after the date of giving such notice, demand in writing from the surviving, resulting or converted entity the appraisal of such holder‘s shares; provided that a demand may be delivered to such entity by electronic transmission if directed to an information processing system (if any) expressly designated for that purpose in such notice.
Lurking within this labyrinthine prose is a requirement that stockholders have twenty days after the giving of notice to submit their appraisal demands.
The Delaware Supreme Court insists that corporations and stockholders comply strictly with the appraisal statute.268
[F]airness requires that the corporation be held to the same strict standard of compliance with the appraisal statute as the minority shareholders. Our case law is replete with examples where dissenting minority shareholders that failed to comply strictly with certain technical requirements of the appraisal statute, were held to have lost their entitlement to an appraisal, and, consequently, lost the
opportunity to recover the difference between the fair value of their shares and the merger price. These technical statutory violations were not curable, so that irrespective of the equities the unsuccessful appraisal claimant could not proceed anew. That result effectively allowed the corporation to retain the entire difference between fair value and the merger price attributable to the shares for which appraisal rights were lost. The appraisal statute should be construed even-handedly, not as a one-way street.269
By requiring strict compliance, Delaware law “ensures the expedient and certain appraisal of stock.”270 The statute includes bright line requirements, but “it does so fоr the benefit of all parties to the appraisal proceeding.”271
The requirement of strict compliance extends to
In this case, Lone Star approved the Merger by written consent.
Zeroing in on the phrase “on or about,” the plaintiff argues that the Appraisal Notice may have been mailed to some stockholders after December 4. The plaintiff contends that it is reasonably conceivable that the Company violated
That is a reasonable inference, meaning that the complaint‘s allegations state a claim on which relief can be granted. The phrase “on or about” means that the person making the statement isn‘t sure exactly when an event happened. It might have been “on” that date. Or it might have been a little before or a little after, i.e.,
To defeat that inference, the Company could have relied on
To argue for dismissal, the Company relies heavily on the Court of Chancery decision in Skeen,277 where the corporation‘s information statement said that it was mailed “on or about April 1, 1998.” A meeting of stockholders was scheduled for April 21, 1998, and the plaintiffs in Skeen made the same argument: The use of “on or about” supported an inference that “not all of the notifications were mailed by April
The Skeen decision failed to give the plaintiff the benefit of a reasonable inference at the pleading stage. The opinion drew a defense-friendly inference that “on or about” meant “on.” That is contrary to how Rule 12(b)(6) operates. The Skeen decision also failed to apply the twenty-day notice even-handedly by enforcing it strictly against both corporations and stockholders. The Delaware Supreme Court‘s decisions require that stockholders strictly comply with the twenty-day window. The Delaware Supreme Court‘s decisions also require that corporations strictly comply with their notice obligations under the statute. Doubtless the Skeen court was worried about imposing a burden on the defendant corporation unnecessarily, but the
It is reasonable to infer that the Appraisal Notice was not mailed to every stockholder on December 4, 2020, particularly when the company was trying to
It should not be hard for the Company to determine when the mailing took place. If it was handled properly, the Company should be able to move for summary judgment. At this point, the plaintiff‘s allegations state a claim for a violation of
B. The Contents Of The Appraisal Notice
The plaintiff next contends that the Appraisal Notice violated Section 262 because it did not include all material information that stockholders needed to consider when deciding whether to assert their appraisal rights. That claim fails.
In particularly recondite language,
shall notify each stockholder of any class or series of stock of such constituent, converting, transferring, domesticating or continuing corporation who is entitled to appraisal rights of the approval of the merger, consolidation, conversion, transfer, domestication or continuance and that appraisal rights are available for any or all shares of such class or series of stock of such constituent, converting, transferring, domesticating or continuing corporation, and shall include in such notice either a copy of this section (and, if 1 of the constituent corporations or the converting, transferring, domesticating or continuing corporation is a nonstock corporation, a copy of § 114 of this title) or information directing the stockholders to a publicly available electronic resource at which this section (and § 114 of this title, if applicable) may be accessed without subscription or cost. Such notice may, and, if given on or after the effective date of the merger, consolidation, conversion, transfer, domestication or continuance, shall,
also notify such stockholders of the effective date of the merger, consolidation, conversion, transfer, domestication or continuance.281
Boiled down, the notice must inform the stockholders entitled to appraisal of “the approval” of a transaction triggering their appraisal rights. The notice also must include or provide access to a copy of the appraisal statue. That‘s it.
Later, in a perplexingly convoluted passage,
If such notice did not notify stockholders of the effective date of the merger, consolidation, conversion, transfer, domestication or continuance, either (i) each such constituent corporation or the converting, transferring, domesticating or continuing corporation shall send a second notice before the effective date of the merger, consolidation, conversion, transfer, domestication or continuance notifying each of the holders of any class or series of stock of such constituent, converting, transferring, domesticating or continuing corporation that are entitled to appraisal rights of the effective date of the merger, consolidation, conversion, transfer, domestication or continuance or (ii) the surviving, resulting or converted entity shall send such a second notice to all such holders on or within 10 days after such effective date; provided, however, that if such second notice is sent more than 20 days following the sending of the first notice or, in the case of a merger approved pursuant to § 251(h) of this title, later than the later of the consummation of the offer contemplated by § 251(h) of this title and 20 days following the sending of the first notice, such second notice need only be sent to each stockholder who is entitled to appraisal rights and who has demanded appraisal of such holder‘s shares in accordance
with this subsection and any beneficial owner who has demanded appraisal under paragraph (d)(3) of this section.
Notably, a corporation can choose to give the second notice containing the effective date only to stockholders who already demanded appraisal. That implies that the effective date of the transaction giving rise to appraisal rights is not statutorily required information that stockholders must have before seeking appraisal.
The complaint does not assert that the Appraisal Notice failed to inform stockholders that the Merger had been approved or failed to include or provide access to a copy of the appraisal statute. The Appraisal Notice therefore contained the two statutorily required items.
The complaint instead contends that the Appraisal Notice was insufficient because it failed to provide stockholders with all material information relating to the decision to assert appraisal rights. As a statutory claim, that theory fails. The statutorily required appraisal notice serves “mainly to notify the stockholders of the merger and of their appraisal remedy” and must “apprise the stockholders of their right to an appraisal, the effective date of the merger, and . . . provide a copy of [or access to] section 262.”282 Nothing in the appraisal statute requires that stockholders receive all information material to the decision to exercise appraisal rights. The plaintiff has asserted litigable disclosure claims, but they are claims for breach of the fiduciary duty of disclosure, not claims under the appraisal statute.
Third, the plaintiff contends that the Supplement constituted a new Appraisal Notice that triggered a new twenty-day notice period. As a statutory violation, that claim fails as well.
The Company filed the Supplement three days before appraisal demands were due. That filing consisted of four pages of disclosures, including nine separate items that replaced or added paragraphs spanning multiple pages of the Information Statement. The Company did not send the Supplement to stockholders or extend the time period for making appraisal demands. This decision has already addressed the plaintiff‘s claim that the Supplement contained additional information that stockholders did not have sufficient time to consider. As a statutory matter, the plaintiff contends that the Supplement also constituted a new notice and triggered a new twenty-day period.
Nothing in the appraisal statute requires that stockholders receive the information in the Supplement. As a statutory matter, the filing of the Supplement did not constitute a new appraisal notice, nor an amendment or supplement to the earlier Appraisal Notice. It did not trigger a new statutory period for appraisal demands. The statutory claim based on the Supplement is therefore dismissed.
D. The Proper Statutory Defendants
The plaintiff purports to assert its statutory claims against the Lone Star Defendants, the Special Committee Defendants, and the Buyer Defendants. The only proper defendants are the Company as the surviving corporation and Holdings as a constituent corporation.
either a constituent, converting, transferring, domesticating or continuing corporation before the effective date of the merger, consolidation, conversion, transfer, domestication or continuance, or the surviving, resulting or converted entity within 10 days after such effective date, shall notify each stockholder of any class or series of stock of such constituent, converting, transferring, domesticating or continuing corporation who is entitled to appraisal rights of the approval of the merger, consolidation, conversion, transfer, domestication or continuance and that appraisal rights are available for any or all shares of such class or series of stock of such constituent, converting, transferring, domesticating or continuing corporation . . . .
Put simply, one of the parties to the transaction giving rise to appraisal must send the appraisal notice.
For present purposes, that means the Company, Holdings, and Merger Sub are proper defendants for the statutory claim, with the qualification that the separate corporate existence of Merger Sub ceased when it merged with and into the Company. By operation of law, any liabilities that Merger Sub could have faced for the notice passed to the Company аs the surviving corporation.283 The Company is thus a trebly proper defendant for purposes of the statutory violation, once as a constituent corporation, once as the surviving corporation, and once as the successor-by-merger to Merger Sub.
The plaintiff also contends that the Company‘s directors are proper defendants because under
Although the plaintiff is correct that a corporation can only act through human agents, the plaintiff is wrong that the directors can be made directly responsible for a statutory violation. As a corporation, the Company is a juridical person—a “body corporate” with a separate legal existence.285 The Company‘s obligations are, in the first instance, its own obligations. The Company, not is directors, is the proper defendant for a claim under
E. The Appraisal Interference Claim
The plaintiff‘s effort to name the directors as defendants for a claimed violation of
This court regularly addresses Massey claims which assert that directors knowingly violated a statutory or regulatory regime. Just as directors could be personally liable for knowingly causing the corporation to violate mine safety
That said, a stockholder plaintiff cannot assert a Massey claim preemptively, whenever a plaintiff believes that a corporation is violating the law and that its directors may be knowingly causing the violation. Like its sibling theory, the Caremark claim,290 a Massey claim for breach of fiduciary duty operates conceptually as a claim for indemnification.291 Framed generally, indemnification shifts the burden of a loss from the party that suffered it to the party that should bear it,292 whether
An indemnification claim does not ripen until a loss triggering the indemnification obligation has been established. Thus, where one corporation had agreed to indemnify stockholders for the loss they suffered from the breach of an earn-out provision, the Delaware Supreme Court held that the claim for indemnification
Similar timing principles govern Massey and Caremark claims. Before a plaintiff can invoke those theories, the plaintiff must point to some sufficiently concrete corporate injury. Typically, that will require a prior adjudication that the statute or regulation was violated, the payment of a fine or penalty, or a settlement.
The existence of a predicate injury serves an important policy function by limiting the ability of plaintiffs to use Massey and Caremark claims as vehicles to litigate alleged violations of far-flung statutory and regulatory regimes. Without that type of gating requirement, a stockholder plaintiff could assert that directors had knowingly violated a statutory or regulatory scheme in another state or country, plead facts supporting a statutory violation, and then litigate that claim in the Court of Chancery. Take a recent example: A stockholder plaintiff alleged that a corporation had violated the Sherman Act, attempted to plead facts supporting the Sherman Act violations, alleged that the directors knowingly caused the corporation to commit the alleged Sherman Act violations, and sought to litigate the existence of the alleged Sherman Act violations in this court.299 The Delaware Court of Chancery has neither
By contrast, once there has been sufficient evidence of a concrete injury, a Caremark or Massey claim becomes viable. Using the example of the alleged Sherman Act violations, if a federal court determined that the corporation violated the Sherman Act, then a stockholder plaintiff could assert a derivative claim to shift the loss to the allegedly faithless fiduciaries who caused the corporation harm, as long as the plaintiff could plead facts supporting an inference that the directors knowingly caused the corporation to commit the violations and could overcome the pleading burdens imposed by Rule 23.1. At that point, this court would not be put in the position of adjudicating whether a violation of the Sherman Act occurred. The court would be adjudicating whether, under Delaware law, there had been a fiduciary breach.
Applied to this case, the foregoing principle means that the plaintiffs cannot presently bring a claim against the directors for knowingly violating the appraisal statute. If the plaintiffs prove a violation of the appraisal statute, and if the corporation suffers harm as a result, then a derivative claim for breach of fiduciary duty would become theoretically viable. The stockholder plaintiff would still need to plead that the directors violated the appraisal statute knowingly, and they also would have to be able to overcome Rule 23.1, but the claim would be ripe.
At present, that claim is not yet ripe. The plaintiff has only pled a straightforward failure to comply with a statutory notice requirement. That claim
VIII. CONCLUSION
For the reasons stated above, the defendants’ motion to dismiss is granted in part and denied in part. The complaint fails to state a claim for breach of fiduciary duty against Lone Star or the Lone Star directors for allegedly diverting merger consideration from the unaffiliated stockholders through the Early Termination Payment. The complaint also fails to state a claim for aiding and abetting breaches of fiduciary duty against the Buyer. To the extent the defendants sought dismissal of those claims, the motions to dismiss are granted. Otherwise, the motions to dismiss are denied.
Notes
- any person or group becoming the beneficial owner of sufficient Company stock to cast more than 50% of the votes eligible to be cast in an election of the Company’s directors;
- the Company’s stockholders approving a complete liquidation or dissolution of the Company, or the Company sells off all or substantially all of its assets, unless the sale is to an entity that is majority-owned by a majority owner of the Company; or
- a merger or consolidation of the Company if, immediately after the transaction, either (i) the pre-transaction directors did not make up a majority of the surviving company’s board or (ii) the pre-transaction stockholders owned 50% or less of the voting stock in the surviving company.
The appraisal statute is remarkably dense and unnecessarily cumbersome. The subsections at issue particularly so. One minor, non-substantive tweak that would improve the statute dramatically would be to include a few more defined terms. Section 262(a) already provides definitions of “stockholder,” “stock,” and “share.” Those definitions might be moved to a new subsection (g) that would include other helpful defined terms. One might define “transaction” as a “merger, consolidation, conversion, transfer, domestication, or continuance for which appraisal rights are provided under this section.” Another might define “transacting corporation” as a “constituent, converting, transferring, domesticating or continuing corporation in a transaction.”
By my count, the phrase “merger, consolidation, conversion, transfer, domestication, or continuance” appears thirty-six times in the statute. Substituting “transaction” every time that phrase appears would cut 252 words, offset by however many words the definition would add (perhaps twenty?). By my count, the phrase “constituent, converting, transferring, domesticating or continuing corporation” appears twelve times. Substituting “transacting corporation” would cut another eighty-four words, again offset by however many words the definition would add.
To illustrate, the principal clause of Section 262(b) currently states:
Appraisal rights shall be available for the shares of any class or series of stock of a constituent, converting, transferring, domesticating or continuing corporation in a merger, consolidation, conversion, transfer, domestication or continuance to be effected pursuant to § 251 (other than a merger effected pursuant to § 251(g) of this title), § 252, § 254, § 255, § 256, § 257, § 258, § 263, § 264, § 266 or § 390 of this title (other than, in each case and solely with respect to a converted or domesticated corporation, a merger, consolidation, conversion, transfer, domestication or continuance authorized pursuant to and in accordance with the provisions of § 265 or § 388 of this title) . . . .
Appraisal rights shall be available for the shares of any class or series of stock of a transacting corporation in a transaction under § 251 (other than a merger under § 251(g) of this title), § 252, § 254, § 255, § 256, § 257, § 258, § 263, § 264, § 266 or § 390 of this title (other than, in each case and solely with respect to a converted or domesticated corporation, a transaction under § 265 or § 388 of this title) . . . .
A subsection currently containing 117 words would become a subsection containing 85, for a reduction of 27%. It would be self-evidently easier to read.
Another easy simplification would be to define the term “stock” and “shares” to include depositary receipts. That would enable the statute to eliminate the nine times where the statute references shares “or depository receipts,” cutting another twenty-seven words.
These are simple improvements that would make everyone‘s lives easier. For other helpful ideas, see Holger Spamann, Simplified Codes (last updated 2021), https://simplifiedcodes.com.