Delaware Denies Corwin Deference to Sale During “Regulatory Storm”
By K. Tyler O’Connell, Morris James LLP
Under Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015), mergers and acquisitions transactions in which the acquirer is not a controlling stockholder are entitled to pleadings-stage deference under the business judgment rule so long as they are approved by a fully informed, uncoerced stockholder vote. Accordingly, if a plaintiff fails to plead facts suggesting that material facts were not disclosed or that stockholders were coerced to approve a transaction, a motion to dismiss will be granted.
Last year, in In re Saba Software, Inc. S’holder Litig., 2017 WL 1201108 (Del. Ch. Apr. 11, 2017), the Delaware Court of Chancery held that deferential review under Corwin was not available where fraud was discovered, the corporation failed to restate its financial statements and its shares were delisted. The Court refused to dismiss the case, reasoning that stockholders were coerced to approve the merger because the alternative was to hold illiquid shares indefinitely.
Recently, in In re Tangoe, Inc. S’holders Litig., 2018 WL 6074435 (Del. Ch. Nov. 20, 2018), the Court of Chancery similarly considered whether Corwin deference was available to a sale in the midst of a restatement process – what the Court described as a “regulatory storm.” The Court denied a motion to dismiss because Tangoe failed to disclose its plan and prospects to weather the storm if stockholders did not approve a sale.
By way of background, in early 2016, Tangoe announced that it overstated its revenue and would have to restate financial results. This prompted activist investors to express interest in a proxy contest and strategic transactions. In turn, Tangoe hired a financial advisor to explore a sale. Although Tangoe also hired a forensic accountant to help with the restatement, over the next year Tangoe missed restatement deadlines, resulting in its stock being delisted by NASDAQ. The SEC also threatened deregistration. Plaintiffs alleged that during this period Tangoe’s directors received additional compensation contingent upon Tangoe undergoing a change of control, and accordingly their focus was on completing a sale transaction as opposed to a restatement. Although management informed the board that the Company had reasonable prospects to continue operating on a standalone basis, in April 2017 the board approved a sale at $6.50 per share, down from the $8.32 per share trading price before Tangoe disclosed it would not meet the deadline for delisting. The holders of 78.2% of Tangoe’s common stock tendered into the deal, which upon closing resulted in Tangoe’s directors receiving roughly $5 million in contingent compensation.
After stockholders brought suit challenging the transaction, the defendants moved to dismiss under Corwin. The Court denied the motion, however, because the stockholders’ approval of the transaction was not fully informed. Among other things, the stockholders were provided only with unaudited financial statements larded with disclaimers stating they were unreliable. Tangoe elected not to provide other financial information, such as a quality of earnings report it had prepared for a potential acquirer. Perhaps more importantly, the board also failed to adequately explain the restatement process and the prospects for a successful restatement. The Court reasoned that, “when deciding whether to tender their shares, Tangoe stockholders did not know whether the Company would ever complete” that process, “let alone when.” The board’s failure to provide all available information in this regard deprived stockholders “of the opportunity to consider whether to stay the course” and allow the restatement to proceed, or to complete the sale. The Court also suggested that, to the extent the board did not take steps to ensure the company was poised to accomplish the restatement, this could render the vote on the sale coercive, as in Saba.
In closing, the Court emphasized that business judgment review under Corwin may be available to companies facing such a “regulatory storm.” But to achieve that, the board must “carefully and thoroughly” explain all material aspects of the causes and effects of the company’s difficulties, as well as “what alternative courses the company can take to sail out of the storm and the bases for the board’s recommendation that a sale of the company is the best course.” Absent such disclosures, directors approving a sale transaction in the midst of a similar “regulatory storm” may not benefit from Corwin deference.