Annual Survey of Judicial Developments Pertaining to Mergers and Acquisitions

Duty of Disclosure Claim

The plaintiffs also claimed that the CEO had breached his duty of disclosure in that the proxy statement disseminated in connection with the stockholder vote failed to disclose material facts related to the stockholders’ decision to vote on the transaction. Conversely, the defendants had argued that the vote was fully informed, that all material information had been disclosed, and that the fully informed, uncoerced approval of the Company’s stockholders should cleanse the CEO’s conflict for the Revlon claim under Corwin v. KKR Financial Holdings LLC. The court again sided with the plaintiffs.

In particular, the court noted that although there is no obligation under Delaware law to provide a “play-by-play” of all negotiations and events leading up to the signing of the merger agreement, the directors do have an obligation to provide an “accurate, full, and fair” account of the facts, once the directors have started down the path of “partial disclosure.” The court determined that, although many of the key events between the CEO and the PE Firm had been disclosed to stockholders, including the key first meeting in which the “tip” had been communicated, the directors had failed to provide an “accurate, full, and fair” characterization of the facts. As a key example, the proxy statement provided the following description of the key meeting:

[A] representative of [the PE Firm] emailed [the CEO], offering to meet for lunch, which took place on September 4, 2018, and at which [the CEO] provided the representative of [the PE Firm] with a general overview of [the Company] and its approach to the fitness beauty and wellness services industries as was typical for [the CEO] to present to potential investors.

The court described this language as “sterile” and seeming to convey that nothing of interest happened at the meeting, whereas the CEO had communicated he planned to retire in a few years and was looking for a “good home” for the Company.

The proxy statement also omitted the CEO’s interest in monetizing his stake in the Company and that the major stockholder on the board was also interested in selling its stake in the near future. Accordingly, the court held that the stockholder vote was not fully informed, the CEO had breached his duty of disclosure, and that any defense under Corwin was not available.

Joint and Several Liability of the Acquirer for Disclosure Breaches

The court also held the PE Firm jointly and severally liable for the breaches of the duty of disclosure. The court reasoned that the non-disclosure of the key facts of the early meetings between the CEO and the PE Firm was within the knowledge of the PE Firm, and the PE Firm had reviewed copies of the proxy statement before it was filed. The court also cited language from the merger agreement that the buyer had the right and obligation to correct any inaccuracies in the proposed SEC filings in holding the PE Firm liable.

Damages

As a measure of damages, the court awarded the class of stockholders either $1 per share for the Revlon violation, which the court determined was the appropriate measure of damages, or $1 per share for the disclosure violation, in the form of nominal damages.

With respect to the Revlon claims, the court rejected arguments from the plaintiffs that they should be entitled to the difference between the maximum price the PE Firm was authorized to pay ($40 per share, based on internal documents) and the deal price of $36.50. Instead, the court viewed the most likely price the PE Firm would have paid as $37.50, based on internal emails and text messages produced in discovery. The court also rejected arguments from the defendants that the stockholders are entitled only to a “fair price,” reasoning that the class is entitled to a “fairer price” if the plaintiffs were able to prove that a higher price would have been achievable, if the board had pushed harder to negotiate.

With respect to the disclosure claims, the plaintiffs argued that they were entitled to quasi-appraisal damages, up to $5.75 per share. The court rejected the plaintiffs’ argument that quasi-appraisal would be an appropriate remedy, which would have involved an analysis of what the company was actually worth and comparing that to the deal price. The court held that quasi-appraisal was not appropriate because the plaintiffs had failed to prove reliance or causation, which are essential elements of a quasi-appraisal damages theory. Instead, the court awarded nominal damages of $1 per share, citing precedent from Weinberger v. UOP, Inc.

Conclusion

Mindbody shows the breadth of discovery and the factual record presented to a court after a full trial and how that information can impact a court’s analysis of a board’s compliance with its fiduciary duties. The volume of contemporaneous documents, in the form of texts, emails, and presentations, played an outsized role in the court’s factual findings, and teach valuable lessons to deal lawyers and their clients (both sell-side boards and officers, as well as acquirers of all types) about the importance of setting and following proper procedures and guidelines for a deal process, and also providing full and complete disclosures to stockholders.

• 6. In re Columbia Pipeline Grp. Merger Litigation (Del. Ch. June 23, 2023) (Concluding Officers and Board of Target Breached Fiduciary Duties and Acquiror Aided and Abetted Those Breaches)

On June 23, 2023, the Delaware Court of Chancery issued the post-trial decision, In re Columbia Pipeline Grp. Merger Litigation, in which it found that officers of target company Columbia Pipeline breached their fiduciary duties in connection with a sale process by acting for personal gain, rather than to maximize stockholder value, that the target board breached its duty of care by failing to sufficiently monitor the officers’ conduct during the sale process, and that the acquiror aided and abetted the officers’ breaches by exploiting their conflicts of interest, reneging on an agreement in principle on the deal price and lowering the bid, and threatening to violate the standstill in the parties’ NDA if the reduced offer were not promptly accepted. The court also found a sell-side breach of the duty of disclosure, as the deal proxy statement omitted several interactions between the officers and the acquiror and failed to explain that those interactions were in violation of the standstill, and further found that the acquiror aided and abetted that breach by not fulfilling its obligation under the merger agreement to inform the target of those material omissions.

Background

The Columbia Pipeline case stems from a 2016 acquisition of Columbia Pipeline Group (“Columbia”) by another energy company (the “Acquiror”).

In connection with a prior 2015 spinoff, Columbia’s CEO and CFO (the “Officers”) were granted change-in-control benefits that would result in significant payments if Columbia were thereafter acquired. With an eye toward retirement, these individuals desired a near-term sale.

At the initial stages of the sale process, Columbia entered into non-disclosure agreements with multiple bidders. The NDAs contained “don’t-ask-don’t-waive” standstills that prohibited the bidder from seeking to buy Columbia without the permission of Columbia’s board of directors (the “Board”), from contacting the company without invitation after termination of discussions, and from asking the company to waive the standstill. After receiving expressions of interest that it viewed as “too low to pursue,” the Board ended the sale process. However, despite the standstill, a representative of Acquiror—who had previous ties to the CFO—promptly contacted the CFO to express Acquiror’s continued interest. The CFO indicated that management continued to want to sell the company.

Thereafter, the Officers “showed extraordinary solicitude toward” Acquiror, which engaged in “a series of contacts” with the Officers that “blatantly breached the [s]tandstill.” The Officers, however, made “no effort to enforce” the standstill. It was not until after Acquiror made an oral expression of interest did the Officers finally go to the Board to obtain permission to engage in exclusive negotiations. Subsequently, Acquiror made an offer of $24 per share, below its indicative range, which offended the Officers; the Acquiror “immediately upped” its bid to $25.25, which the Board rejected. The Officers then proposed a price of $26 per share, a price that the parties agreed on, and the sides believed they had reached an agreement in principle. After news of the deal talks broke, the Officers recommended to the Board that it renew Acquiror’s exclusivity, despite the fact that the Company had been contacted by a potential second bidder. Acquiror then dropped its offer to $25.50 per share and threatened to publicly announce that negotiations had ceased if the offer were not accepted promptly. The Board accepted the lowered offer at the Officers’ recommendation.

Plaintiffs filed suit alleging that the Officers and the Board breached their fiduciary duties and that Acquiror aided and abetted such breaches. The members of the Board (other than the CEO) were eventually dropped as defendants and the Officers settled. Trial proceeded on the plaintiffs’ aiding and abetting claim against Acquiror.

Analysis

In a lengthy, fact-intensive post-trial decision, the court held that the Officers breached their duty of loyalty by prioritizing their own interests in a sale over the interests of the company’s stockholders, and that their desire to trigger their change-in-control benefits influenced them to take actions “outside the range of reasonableness.” According to the court, the Officers “behaved in ways that undercut Columbia’s negotiating leverage, led to lower offers from [Acquiror], and resulted in [Acquiror] reneging on the $26 deal.” The court also determined that the Board inadvertently breached its duty of care by not sufficiently monitoring the Officers or managing their conflicts.

The court also found that the Officers and Board breached their duty of disclosure because the proxy statement omitted or misleadingly portrayed the Officers’ interactions with Acquiror, and failed to disclose Acquiror’s violations of the standstill or the parties’ agreement in principle.

The court then held that Acquiror aided and abetted the Officers’ breach of the duty of loyalty by knowingly exploiting the Officers’ desire for a sale, explaining that Acquiror’s knowledge of the Officers’ conflicts emboldened Acquiror to renege on the parties’ agreement and threaten to publicly announce that the negotiations had concluded if the lowered offer was not accepted. The court found Acquiror liable for damages of $1 per share—the difference between the merger price and the $26 price agreed to in principle.

The court further held that Acquiror aided and abetted the disclosure breach by “[choosing] not to correct the material misstatements or omissions in” the Columbia proxy, in violation of Acquiror’s obligation to do so under the merger agreement. With regard to the claim of aiding and abetting the disclosure breach, the court awarded $0.50 per share as damages, but made clear that damages for the two aiding and abetting claims were not cumulative.

Conclusion

Columbia Pipeline provides a cautionary tale for directors, officers, and acquirors on the type of deal process conduct to avoid to effectively exercise their fiduciary duties and avoid liability for aiding and abetting breaches of fiduciary duties. As to directors, if a board is not vigilant, conflicted managers could commence (or resume) a sale process or steer it toward a preferred bidder. Indeed, the court noted that, if the board had more information about management’s conflicts, “[t]hey would have realized that [the Officers] were not the right people to lead the sale process.” The case also provides an important reminder that officers have an obligation to provide the board with information needed to carry out its duties and should also follow any procedural guidelines established by the board regarding the sale process. Finally, as to acquirors, Columbia Pipeline makes evident, where an acquiror “create[s], exacerbate[s], or exploit[s]” a sell-side fiduciary, the acquiror may face a possible aiding and abetting claim. Moreover, the case makes clear that failure by an acquiror to identify and correct material misstatements or omissions in the target’s proxy relating to the acquiror’s interactions may subject the acquiror to a claim of aiding and abetting a sell-side fiduciary breach of the duty of disclosure.

• 7. In re Oracle Corporation Derivative Litigation (Del. Ch. May 12, 2023) (Post-Trial Opinion Concluding that a Transaction Involving an Influential, Interested Fiduciary and Minority Blockholder Was Not a Controlled Transaction)

In this post-trial opinion, the Delaware Court of Chancery assessed a derivative claim brought by the plaintiff stockholders of Oracle Corporation (“Oracle”), in which the plaintiffs alleged that Oracle overpaid to acquire NetSuite Corporation (“NetSuite”). At the heart of the litigation was Lawrence J. Ellison, the founder of Oracle and co-founder of NetSuite. At the time of the transaction, Ellison was chief technology officer and a director of Oracle, as well as a substantial blockholder of Oracle common stock and NetSuite stock, owning 28.4 percent and 39.8 percent of each respectively. The plaintiffs alleged that Ellison, although a minority stockholder of Oracle, was a controller of the company who had a financial interest in Oracle overpaying for NetSuite because of his substantial equity position in the latter and his belief that Oracle would eventually drive NetSuite out of business. If Ellison was a conflicted controller standing on both sides of the transaction, the plaintiffs argued, then his conduct as a fiduciary of Oracle should be reviewed under the entire fairness standard. The court disagreed that Ellison was a controller either generally or for purposes of the transaction. Citing a vigorous independent special committee process free from the influence of interested parties, the court found that business judgment rule applied.

In another attempt to bring the transaction within the purview of the entire fairness standard, the plaintiffs claimed that Ellison and Oracle co-CEO Safra Catz breached their fiduciary duties by committing a fraud on the board in manipulating the Oracle special committee to overpay for NetSuite. The court found these allegations to be unsupported by the evidence.

This decision illustrates how a company may conduct an effective M&A process that garners business judgment by sufficiently empowering an independent special committee to negotiate the transaction and by insulating interested parties who, even if not majority blockholders, could have an outsized influence on the deal and render it a controlled transaction.

Background

Oracle is a technology company in the business of selling hardware, software, and cloud computing products. Ellison founded Oracle in 1977 and served as its CEO until September 2014, when he assumed the role of CTO. At the time of the NetSuite transaction, Ellison had been a director of Oracle since its founding, becoming executive chairman concurrent with assuming the CTO role. In 1998, Ellison co-founded NetSuite, another software company, with Evan Goldberg, a former Oracle employee. Oracle’s primary offering was customized products to large customers, while NetSuite mainly sold off-the-shelf cloud-based software to smaller customers.

Oracle utilized a growth-by-acquisition strategy and actively monitored potential target companies, one of which was NetSuite. As a blockholder of NetSuite, Ellison’s support was necessary to complete a transaction between the two companies. For market and operational reasons, in February 2015 Ellison had opposed an initial proposal to acquire NetSuite. Circumstances had changed in early 2016, however, and Oracle management, not hearing any opposition from Ellison, proposed NetSuite to the Oracle board as a potential target. The board instructed Catz to reach out to NetSuite’s CEO Zachary Nelson to gauge his interest in a transaction without discussing price. Goldberg subsequently called Ellison, who assured Goldberg that Oracle’s intention was to retain NetSuite’s management team with Goldberg continuing at the helm.

With NetSuite accepting its invitation to make an acquisition offer, the Oracle board (other than Ellison who recused himself ) established a special committee of three independent directors with authority to, among other things, negotiate a transaction with NetSuite and evaluate alternatives to it. The special committee hired independent legal and financial advisors. After a series of in camera meetings and sessions with management, the special committee authorized its financial advisor to make an initial offer to NetSuite. The special committee also adopted formal rules of recusal, which prohibited Ellison from discussing the transaction with anyone but the committee, required Oracle employees brought into the process to be made aware of Ellison’s recusal, and forbade Oracle officers and employees from participating in the negotiation process absent special committee direction. Catz also spoke with Goldberg and assured him that Oracle intended to operate NetSuite independently. Neither Catz’s nor Ellison’s assurances were reported to the special committee.

The two companies were far apart on price at the outset, with Oracle initially offering $100.00 per share and NetSuite countering with $125.00. Unable to agree on price after several rounds of counteroffers, Catz advised the committee not to provide a final counter, and the committee resolved to let the deal die. NetSuite returned to the bargaining table and, after further diligence undertaken by the committee, the parties agreed to a transaction at $109.00, a dollar less than the committee’s ceiling price. A merger agreement was executed on July 28, 2016.

Analysis

Relying on Delaware’s extant principles on controlled transactions, the court noted that where a stockholder enjoys a level of control over the corporation’s directors that “diminishes the directors’ ability to bring business judgment to bear on the exercise of their duties,” such stockholder “exercises dominion over the property of others—the minority stockholders—and thus becomes a fiduciary herself.” A shareholder owning less than 50 percent of a corporation’s stock is not, however, a controlling shareholder unless it can be shown that the stockholder “in actuality dominated the corporate conduct, either generally or with respect to the transaction in question.”

The court found that Ellison did not exercise control generally in regard to Oracle’s operations. The court cited indicia of “general control” previously articulated by the Delaware Supreme Court in Paramount Communications, Inc. v. QVC Network, Inc., which include the ability to: (a) elect directors; (b) cause a break-up of the corporation; (c) merge it with another company; (d) cash out the public stockholders; (e) amend the certificate of incorporation; (f ) sell all or substantially all of the corporate assets; or (g) otherwise alter materially the nature of the corporation and the public stockholders’ interests. For a stockholder to be found to exercise general control over a corporation, the effect of these factors or other indicia of control “must be such that independent directors cannot freely exercise their judgment for fear of retribution.” Notwithstanding Ellison’s clout within the organization, the court found the evidence did not demonstrate the founder’s control over the day-to-day operations of the company. To the contrary, the record demonstrated that the Oracle board regularly challenged Ellison and that Catz openly disagreed with him on strategic matters.

The court also found that, while Ellison could have exerted control over a particular Oracle transaction, he did not attempt to do so with the NetSuite acquisition. Once Catz determined that Ellison would not oppose the deal and that NetSuite was open to one, the Oracle board mandated the special committee to run the acquisition process with the assistance of independent advisors. Throughout the process, Ellison “scrupulously” avoided any discussion of the transaction with the committee. Also favorable to the defendant were the carefully deliberative process followed by the committee and its hard-nosed style of negotiations in which it resolved to let the deal die and then secured a price below the committee’s ceiling (contrary to Ellison’s alleged interest).

The plaintiffs also argued that Ellison controlled the transaction through his conversation with Goldberg. They alleged that his assurance to Goldberg compromised the special committee’s bargaining power because, from it, Goldberg understood that Oracle’s desire to maintain NetSuite’s management foreclosed the possibility that Oracle would abandon negotiations in favor of a hostile offer. The court, however, found no evidence that the special committee knew of Ellison’s discussion. Similarly, there was no evidence that Ellison sought to control the transaction through Catz who, the plaintiffs alleged, was beholden to the founder for her employment.

The court then considered the claim that Ellison and Catz perpetrated a fraud on the board. To make out a claim for a fraud on the board, the following must be established: (a) the impugned fiduciary was materially interested; (b) the board was inattentive or ineffective; (c) the fiduciary deceived or manipulated the board; (d) the decision was material; and (e) the deception tainted the decision-making process of the board. At a minimum, the court noted, “for a fraud on the board claim to result in entire fairness, a defendant must have manipulated a supine board.”

The court found that neither Ellison nor Catz had defrauded the board. The plaintiffs argued that each individually withheld information from or otherwise misled the board, including, they alleged, by: withholding their views that NetSuite’s business was doomed to be overtaken by Oracle; Ellison refraining from sharing his post-closing plans for NetSuite that ran contrary to the projection inputs used by management to evaluate the deal; and Catz providing the special committee with inflated projections. The court found that the special committee was fully briefed on NetSuite’s competitive place in the market and had come to an informed view that the acquisition would be accretive to Oracle. Oracle had applied a well-used corporate development strategy for evaluating target companies, without deviation or manipulation by either Ellison or Catz.

Conclusion

The court acknowledged that Ellison was “a force at Oracle.” Without actual control, however, a conflicted fiduciary’s general influence and clout is insufficient to subject a transaction to an entire fairness review: “The concept that an individual—without voting control of an entity, who does not generally control the entity, and who absents himself from a conflicted transaction—is subject to entire fairness review as a fiduciary solely because he is a respected figure with a potential to assert influence over the directors, is not Delaware law, as I understand it.”

Ellison’s and Catz’s conversations with key figures at NetSuite had the potential to taint the special committee’s process had they been reported to the committee—which the court stated should have been done—highlighting the importance in a conflicted transaction of arming a special committee with a robust mandate to run the process, set recusal rules, and control communications as early as practicable.

• 8. In re Straight Path Communications Inc. Consolidated Stockholder Litigation (Del. Ch. Oct. 2, 2023) (Post-Trial Opinion Applying Entire Fairness Review and Concluding There Were No Damages Despite Unfair Process that Was Influenced by Controller).

In In re Straight Path Communications Inc. Consolidated Stockholder Litigation, the Delaware Court of Chancery issued a post-trial opinion awarding only nominal damages under an entire fairness analysis in a transaction the court determined was not entirely fair because of the controller’s flagrant breach of fiduciary duty. The stockholder plaintiffs alleged that IDT Corporation and its Chairman Howard Jonas (“Howard”) diverted the proceeds from the sale of Straight Path Communications, a company spun off from IDT, by coercing the independent directors of Straight Path to settle an indemnification claim Straight Path had against IDT under the separation and distribution agreement governing the spin off.

Howard had a controlling interest in both companies. Vice Chancellor Glasscock determined that Howard used his position as a controlling stockholder of Straight Path to drive an unfair transaction in settling the indemnification claim, but that no damages resulted from his breach of fiduciary duty because a fair process would not have produced a more favorable outcome for Straight Path’s stockholders. The court also determined that Straight Path’s indemnification claim was not viable because of its failure to follow the indemnification procedures of the separation and distribution agreement.

Background

IDT was a publicly traded company founded by Howard, who maintained a controlling interest. IDT spun off Straight Path to its stockholders pro rata and, as a result, Howard received a controlling interest in Straight Path.

Among its other assets, Straight Path held broadcast spectrum licenses issued by the FCC. After the spin off from IDT, the FCC launched inquiries into the handling of the licenses by IDT and Straight Path, citing potential violations of the FCC’s rules. During the course of those inquiries and after negotiation, Straight Path entered into a settlement agreement with the FCC.

Under the terms of the settlement, Straight Path paid a $15 million fine and forfeited 196 licenses. It also had to choose to either forfeit its remaining licenses, sell those licenses, or pay an additional fine of $85 million. If it elected to sell the remaining licenses, it would have to pay a penalty in the amount of 20 percent of the sale proceeds.

Straight Path determined that the best course of action was to sell the company. While an auction process for the sale of Straight Path was beginning, Straight Path’s board formed a special committee of three independent directors that began focusing on Straight Path’s indemnification claim for the FCC penalties under the separation and distribution agreement. The special committee expressed an interest in preserving and pursuing the indemnification claim against IDT for the benefit of Straight Path’s stockholders. While it unanimously concluded that a settlement of the claim would benefit Straight Path’s stockholders, it also determined that it was worth considering other options, such as the creation of a trust to preserve the value of the claim for Straight Path’s stockholders. The special committee resolved that an auction process letter sent to potential purchasers of the company would indicate that the indemnification claim would be excluded for the sale.

Howard was upset when he learned of the special committee’s intentions and launched what the court characterized as a “campaign of abuse and coercion” directed at the members of the special committee in an effort to force a settlement. He bombarded them with calls. He threatened one of the independent directors whose law firm handled FCC matters for IDT and Straight Path to place blame on that firm. He verbally abused the members of the special committee, calling them “bullshit directors.” He made it clear that he could exercise his voting power to remove them as directors of the company. Finally, he led the special committee to believe that he would torpedo the sale of the company unless they quickly settled the indemnification claim. The special committee concluded that it had to settle the indemnification claim on Howard’s terms or risk an even less favorable outcome for the company.

As a result, the special committee approved the settlement of the indemnification claim for the payment of $10 million. At the time of the settlement, the highest price bid in the auction for the sale of the company would have required Straight Path to pay a $175 million penalty under the terms of its settlement with the FCC. The court determined that this amount, when added to the $15 million penalty already paid by Straight Path and the value of the forfeited 196 licenses, would have supported a $293.4 indemnification claim, if the claim were viable.

Analysis

Since Howard owned 70 percent of the voting power of Straight Path and was involved in the settlement process, the court determined that he was a controller having fiduciary duties to the Straight Path minority shareholders and that the settlement of the indemnification claim was subject to an entire fairness review. This placed the burden on the defendants to demonstrate both a fair process and a fair price.

Observing that Howard made every effort to bully the special committee into his desired outcome, the court concluded that the defendants failed to establish that the settlement of the indemnification claim was the result of a fair process.

In assessing fair price, the court determined that the indemnification claim was economically worthless due to Straight Path’s failure to observe the indemnification procedures of the separation and distribution agreement requiring written notice to an indemnified party of a third-party claim.

The notice provision of the indemnification clause required Straight Path to provide IDT with written notice of a third-party action or claim for which it may seek indemnification. IDT had actual notice of the FCC claims and the settlement discussions and observed in an SEC filing that if the FCC imposed liability on Straight Path, IDT could be subject to a claim from Straight Path related to that liability. However, the court determined that the notice provision served not only to inform IDT of the presence of a third-party claim or action, but also that Straight Path intended to seek indemnification for that claim. If the contractual notice had been given, IDT would have had the right to defend the FCC claims and Straight Path would have been required to obtain IDT’s consent to its settlement with the FCC. The court determined that Straight Path did not provide the required notice because it did not want IDT involved in the settlement of the FCC claims.

As a result, because the indemnification claim was not viable, the $10 million paid in the settlement of that claim was fair. However, because the entire fairness standard of review requires both a fair price and a fair process, the court then examined whether the flagrant process violations caused IDT to pay less than the value the stockholders would have received if a reasonable process were followed. To accomplish this, the court calculated what the reasonable value of what a settlement of the indemnification claim would have been if negotiated on an arm’s-length basis and concluded that amount ($8.4288 million) was less than the $10 million paid to settle the indemnification claim.

As a result, the court determined that while the transaction was not entirely fair, the Straight Path shareholders suffered no damages, and it awarded only nominal damages against Howard.

Conclusion

In re Straight Path Communications indicates that even where there is a flagrant violation of fair process in a transaction subject to entire fairness review, there may be no damages awarded if a reasonable process would not have produced a more favorable outcome for a corporation’s stockholders. It also highlights the need for a party seeking contractual indemnification to closely follow an agreement’s indemnification procedures.

• 9. In re Edgio, Inc. Stockholders Litigation (Del. Ch. May 1, 2023) (Corwin Cleansing Does Not Apply to Claims Seeking Injunctive Relief Under Unocal)

In In re Edgio, Stockholders Litigation, the Delaware Court of Chancery denied a motion to dismiss a claim of breach of fiduciary duty seeking to enjoin certain provisions set forth in a stockholders’ agreement that restricted an investor’s voting and transfer rights. After concluding that Corwin does not apply to claims for injunctive relief under Unocal, the court held that it was reasonably conceivable that the provisions in the stockholders’ agreement were negotiated as a defensive measure against a perceived threat of stockholder activism.

Background

In 2021, Limelight Network, Inc. (the “Company”) experienced a significant decrease in its financial performance. As the Company’s financial performance continued to decline, market commentators speculated that the Company may be a target for activist investors, and the Company was named in a list of top ten potential activist targets in The Deal. Although no activist investor emerged, Apollo Global Management, Inc. (“Apollo”) approached the Company regarding a combination of one of Apollo’s investments, Edgecast, Inc. (“Edgecast”), and the Company. Pursuant to the proposal, Edgecast, which was a subsidiary of College Parent, L.P. (“College Parent”) (an entity that was 90 percent owned by funds affiliated with Apollo), would be acquired by the Company in exchange for common stock of the Company representing approximately 35 percent of the Company’s outstanding stock.

In connection with the acquisition, College Parent entered into a stockholders’ agreement with the Company. Stockholders of the Company then challenged three provisions set forth in the stockholders’ agreement. First, the stockholders’ agreement required College Parent to vote in favor of the recommendations of the Company’s board of directors (the “Board”) with respect to director nominations and College Parent must vote against any nominee not recommended by the Board. Second, for all non-routine matters presented to the stockholders, College Parent must either (i) vote in accordance with the Board’s recommendation or (ii) pro rata with all of the Company’s other stockholders. Third and finally, College Parent was restricted from transferring its shares for two years without the Board’s written consent and was further restricted from transferring its shares for a third year to any competitor of the Company or any investor on the most recently published “SharkWatch 50” list, which is a compilation of the fifty most significant activist investors.

In connection with the acquisition of Edgecast, the Company was required to obtain stockholder approval for the issuance of the shares of common stock. The terms of the acquisition as well as the stockholders’ agreement were summarized in the proxy statement provided to the stockholders. The stockholders of the Company approved the stock issuance on June 9, 2022, and the transaction closed on June 15, 2022.

Plaintiff stockholders brought a direct claim for breach of fiduciary duty against the directors of the Company, alleging that the directors used the aforementioned provisions in the stockholders’ agreement to entrench themselves or interfere with the stockholder franchise.

Analysis

At the outset, the Court of Chancery considered defendant’s argument that the claim must be dismissed under Corwin because a fully informed, uncoerced majority of the Company’s disinterested stockholders approved the transaction, which included the stockholders’ agreement. The court found that Corwin was not intended to, and did not, cleanse the type of claim at issue—a claim seeking to enjoin “enduring entrenchment devices[.]” Corwin, by its plain language, is limited to post-closing damages claims when fully informed, disinterested stockholders have an opportunity to decide on the economic merits of a transaction. Unocal, on the other hand, provides, at its core, “a framework for evaluating whether an injunction should issue against defensive measures.” “Unocal scrutiny is inspired by concerns that directors may act to ‘thwart the essence of corporate democracy by disenfranchising shareholders,’ which prototypically causes irreparably injury.” As a result, the court concluded that the underlying rationale for Corwin is not served in the context of a Unocal claim seeking to enjoin enduring entrenchment devices.

After determining that Corwin cleansing was not available, the court considered whether the plaintiffs adequately pled a claim that triggered Unocal enhanced scrutiny. In order to trigger Unocal enhanced scrutiny, pleadings must set forth facts to support a reasonable inference that the board of directors perceived a threat to corporate control and, in response, took defensive measures. The plaintiffs, by not directly pleading a perceived threat, effectively asked the court to infer that the board was motivated by entrenchment based on the Company’s underperformance, the market commentary that the Company was a target for activist investors, and the entry into the challenged provisions. The court explained that, collectively, the challenged provisions would likely deter an activist investor as it would be difficult to launch a successful proxy context when 35 percent of the vote was guaranteed to vote against the nominees or other non-routine proposals. Further, the restriction on transfers to activist investors eliminated one route for activist investors to target the Company. Viewed, either together or separately, the challenged provisions have defensive effects. The court determined that, collectively, under the plaintiff-friendly standard utilized for a motion to dismiss, the allegations supported that the challenged provisions were negotiated with the subjective motive of defending against an activist threat and therefore Unocal enhanced scrutiny applied. Accordingly, the court denied defendants’ motion to dismiss.

Conclusion

Edgio offers guidance to transactional planners on the types of transactions that may be subject to Corwin cleansing. The opinion also contains clear guidance that Corwin cleansing is limited to post-closing claims for damages where disinterested stockholders have had an opportunity to weigh in on the economic merits of a transaction, not claims seeking injunctive relief under either Unocal or Revlon.

• 10. Atallah v. Malone (Del. Ch. July 19, 2023) (Actions by Controllers Concerning Their Call Rights on High-Vote Stock Triggered Entire Fairness Review)

In Atallah v. Malone, the Delaware Court of Chancery denied a motion to dismiss breach of fiduciary duty and unjust enrichment claims against two purported controllers who allegedly received a non-ratable benefit from a series of transactions that the company engaged in after the controllers allegedly colluded to force the company to exercise a call right on high-vote stock owned by one of the controllers that then caused the company to have to re-negotiate the other controller’s compensation and severance package. The court held that these actions by the controllers, taken in their capacities as fiduciaries, triggered entire fairness review. However, the court granted a motion to dismiss as to the director defendants, who had served on an independent committee that was formed to consider the call right, because plaintiffs had not adequately alleged a breach of the duty of loyalty by any of these directors.

Background

Qurate Retail, Inc. (the “Company”) is a Delaware-incorporated media conglomerate. John Malone has been a director of Qurate since its spin-off from Tele-Communications Incorporated (“TCI”) in 1991. Gregory Maffei has been a director of Qurate since 2005 and became chairman of the board of directors (the “Board”) in March 2018. At the time the derivative complaint was filed, Qurate had a total of ten Board members.

In February 1998, Malone and TCI entered into an agreement (the “Call Agreement”) giving TCI the conditional right to purchase high-vote Series B common stock from Malone or his affiliates (the “Call Right”). The Call Right could be triggered either by Malone’s death or an offer to purchase the high-vote stock from an outside investor (the “Acceleration Provision”). Simply put, once triggered, the Call Agreement gave TCI a short-lived option to buy out Malone’s control stake in the event of his death or a bona fide offer from an unaffiliated party. Malone received $150 million in exchange for the Call Agreement. The Call Agreement rights came to be held by the Company, as TCI’s successor-in-interest.

In May 2021, Maffei delivered to Malone an offer to acquire all of the high-vote stock beneficially owned by Malone at a price of $14 per share. The same day, Malone provided to the Company a written notice of his desire to accept the offer, subject to Board approval. Assuming the offer met the Call Agreement criteria, the Call Agreement then provided the Company with the right to purchase the shares. Two days later, the Board, including Malone and Maffei, met to discuss the offer. At this meeting, Malone expressed his preference to settle the Call Right in shares of common stock rather than cash.

The Board formed an independent committee comprised of all directors other than Malone, Maffei, and Malone’s son, Evan Malone. The independent committee met to consider whether the offer constituted a bona fide offer under the Call Agreement. The independent committee also delegated authority to examine the ramifications of the Call Right’s exercise on Maffei’s employment and compensation to a compensation committee.

The compensation committee met and discussed its concerns that, by exercising the Call Right, the Company would be allowing Maffei to trigger certain change-in-control provisions in his own contracts with the Company, giving rise to substantial severance payments. The compensation committee ultimately negotiated a deal with Maffei. In a series of transactions, the Company first notified Malone that it would be exercising the call right, payable in common stock, and entered into an exchange agreement with Malone to effectuate transfer of his high-vote stock for common stock. Because this purported exercise of the call right triggered a change in control sufficient for Maffei to resign with “Good Reason,” accelerating vesting of his outstanding and unvested equity (along with severance and penalties payable by the Company), the Company also entered into an agreement with Maffei to avert this outcome.

Under the agreement, Maffei waived his right to resign for “Good Reason” and gave up two stock option grants, which were allegedly underwater. In exchange, he received refreshed restricted share awards of high-vote stock and confirmation that certain future equity awards would be issued in high-vote stock. The Company also entered into an exchange agreement with Maffei under which he exchanged just over 5.3 million shares of common stock for an equivalent award of high-vote stock and the Company granted him the right to exchange subsequent awards of restricted stock for high-vote stock. Maffei agreed that until the end of 2024, he and his controlled affiliates would not exceed 20 percent of the Company’s voting power.

Analysis

The court first summarized plaintiffs’ theory “that Malone and Maffei colluded to create a phony offer in order to trigger the Call Agreement’s Acceleration Provision” and “then purportedly used their collective control of the Board to ensure that the Call Right was exercised,” even though it was not clear that the offer from Maffei was a bona fide offer under the Call Agreement due to his affiliations with Malone. According to plaintiffs, the exercise of the Call Right then triggered a series of transactions that delivered a non-ratable benefit to both controllers.

Because plaintiffs’ claims were pled derivatively, the court began its analysis by considering whether plaintiffs satisfied Court of Chancery Rule 23.1’s requirement of demand futility. With ten directors serving on the Company’s Board, plaintiffs were required to allege facts from which the court could reasonably infer that at least five members of the Board were not independent or disinterested. The court easily concluded that three of the directors (Malone, Maffei, and Evan Malone) were not disinterested and independent. Defendants did not contest that Malone and Maffei were interested in the challenged transactions. Defendants also did not contest that Evan Malone, John Malone’s son, lacked independence from Malone and Maffei.

Plaintiff only challenged four of the remaining directors’ independence. After considering the allegations regarding these four directors on a director-by-director basis, the court concluded that plaintiffs had pled particularized facts creating a reasonable doubt regarding the independence of two of these directors. Therefore, the court concluded that plaintiffs had pled sufficient allegations to call into doubt the impartiality of at least five of the directors on the Board, thereby excusing demand under Rule 23.1.

Having concluded that demand on the Board was excused, the court next turned to a Rule 12(b)(6) analysis of the claims. The court first considered whether there were sufficient alleged facts to conclude that Malone and Maffei, who collectively held 47.5 percent of the Company’s voting power, were controllers of the Company. The Court explained that “[b]ecause Malone and Maffei together own less than 50% of the Company’s combined voting power, the operative question is whether they exercise control over the business affairs of Qurate,” which can be demonstrated “in two ways: (1) that the minority blockholder actually dominated and controlled the corporation, its board or the deciding committee with respect to the challenged transaction or (2) that the minority blockholder actually dominated and controlled the majority of the board generally.” The court concluded that it was reasonable to infer that Malone and Maffei controlled the specific transactions at issue and that they were controllers, due to their significant voting block and the existence of the Call Agreement itself, which the court found supported an inference that the Company recognized the potency of Malone’s voting power.

The court also found that plaintiffs pled sufficient facts to support an inference that Malone and Maffei exercised their control, because “the impetus for the exercise of the Call Right came directly from [them]” and “[t]he two then failed to wall themselves off from the decision-making process.”

The court next analyzed whether plaintiffs had sufficiently pled a breach of fiduciary duty. The court reiterated that “it is established law that the stringent standards of entire fairness review apply to a transaction in which a controller, standing on both sides, breaches his duty of loyalty by extracting a benefit not shared by the other stockholders.” The court noted that, in response, “Malone argues that under Delaware law an individual who owns a contractual right, and who exploits that right—even in a way that forces a reaction by a corporation—is simply exercising his own property rights, not that of others, and is no fiduciary.” However, the court highlighted that “this proposition is limited to the exercise of contractual rights in the situations specifically contemplated by those contracts.” The court concluded that plaintiffs raised sufficient doubts that the Call Agreement was meant to apply to Maffei’s offer and that “because the subsequent exercise of the Call Right, and the ramifications of Maffei’s contract which resulted, conveyed non-ratable benefits to the controllers, plaintiffs’ fiduciary duty claims against Malone and Maffei must go forward.” In sum, the court held that the breach of fiduciary duty claims survived because of plaintiffs’ allegations that “Malone and Maffei, leveraging their position as controllers, used a contract provision as a pretext to push through a self-dealing transaction not actually contemplated by that contract.”

Finally, the court assessed the claims against the members of the independent committee that considered the Call Right. Avoiding dismissal under In re Cornerstone Therapeutics Inc, Stockholder Litigation required the plaintiffs to show that each director on the independent committee, “individually, was not independent and actively advanced the interests of Malone and Maffei.” The court noted that there was only one director on the independent committee whose independence the plaintiffs had successfully challenged. However, the court concluded that this director did not act to advance the self-interest of Malone/Maffei, because plaintiffs were required to plead sufficient facts to support a duty of loyalty claim against the director to survive dismissal, but plaintiffs pled no particularized allegations as to this director’s role on the independent committee.

The court similarly rejected plaintiffs’ arguments regarding the director’s role as chair of the compensation committee that negotiated with Maffei. Specifically, the court found that plaintiffs’ inference that the “Compensation Committee merely rubberstamped an unreasonably favorable transaction drawn up by Maffei’s management minions” was unreasonable. Rather the court concluded that “a simpler explanation of the same facts pled, consistent with Delaware courts’ presumption of independent directors’ fidelity to their fiduciary duties, is that the Compensation Committee adopted the deal after reviewing its structure and finding it to be in the Company’s best interests, given the options that would remain after the Company elected to exercise the Call Right.” Therefore, plaintiffs failed to plead a non-exculpated claim against the director.

Conclusion

This decision demonstrates that while it remains Delaware law that a holder of contractual rights, even if a fiduciary, can exercise those contractual rights without being held to fiduciary standards of conduct, Delaware courts will scrutinize whether the fiduciary’s exercise of contractual rights occurs in a situation specifically contemplated by the contract. If not, then—as this decision makes clear—the fiduciary should expect that, at least at the pleadings stage, courts may not excuse the fiduciary’s conduct taken in their capacity as a fiduciary based on a contract-based defense and will instead review the fiduciary’s conduct under traditional fiduciary standards of review, including entire fairness if the challenged transaction is one in which a controller, or control group, stands on both sides.

Statutory

• 11. Altieri v. Alexy (Del. Ch. May 22, 2023) (Sale of a Company’s “Crown Jewel” Business Line Did Not Constitute a “Sale of All or Substantially All” of the Company’s Assets from Either a Quantitative or Qualitative Perspective)

In Altieri v. Alexy, the Delaware Court of Chancery ruled that Mandiant, Inc.’s (“Mandiant”) sale of its FireEye business line, which accounted for 62 percent and 57 percent of Mandiant’s overall revenue in the two preceding years, did not constitute “substantially all” of Mandiant’s assets and thus did not require a stockholder vote under 8 Del. C. § 271. The decision underscores that there is no bright-line test for determining what constitutes a sale of “all or substantially all” of a company’s assets; rather, it involves a fact-intensive, contextual, and nuanced judicial analysis.

Background

Mandiant was formed in 2004 to provide incident response services to companies that had experienced data security breaches. In December 2013, Mandiant combined with FireEye, Inc. (“FireEye”) as part of a broader M&A strategy to grow Mandiant’s original business. FireEye’s business consisted of creating products designed to detect and prevent cyberattacks. Therefore, combining with FireEye would enable Mandiant to both detect as well as respond to attacks. Mandiant would go on to acquire other businesses in 2016 as well.

Between 2016 and 2020, Mandiant experienced an increase in revenue, and during this period of growth, FireEye was significant to Mandiant’s overall business. For example: FireEye accounted for 62 percent and 57 percent of Mandiant’s overall revenue in 2019 and 2020, respectively; approximately 50 percent (or $500 million) of the goodwill listed on Mandiant’s Form 10-Q for the fiscal quarter ended June 30, 2021, was allegedly attributable to the FireEye business; and the FireEye business had a strong social media presence in comparison to Mandiant’s other offerings.

The case arises from Mandiant’s June 2, 2021, sale of the FireEye business line for $1.2 billion, which Mandiant described as an opportunity to allow it to “concentrate exclusively on scaling our intelligence and frontline expertise[.]” Mandiant did not seek stockholder approval of the sale, and upon Mandiant’s announcement of the sale, its stock dropped by 17.62 percent, with financial analysts expressing concern about Mandiant’s “lower gross margin and stability” without the FireEye business.

Plaintiff, a Mandiant stockholder, challenged the FireEye sale under 8 Del. C. § 271, arguing that the sale constituted “all or substantially all” of Mandiant’s assets and alleging, therefore, that the board had been required, but had failed, to put the sale to a stockholder vote. Plaintiff also brought claims against the Mandiant directors, alleging breach of their fiduciary duties in knowingly failing to obtain a stockholder vote under section 271.

Analysis

In analyzing whether the sale constituted “all or substantially all” of Mandiant’s assets for the purposes of section 271, the court relied on Gimbel v. Signal Companies, which requires evaluation of “the quantitative and qualitative importance of the transaction at issue.” The court explained that the purpose of the Gimbel analysis is to determine whether the transaction “struck ‘at the heart of the corporate existence and purpose,’ in the sense that it involved the ‘destruction of the means to accomplish the purpose or objects for which the corporation was incorporated and actually performs.’”

As to the court’s quantitative evaluation, the court noted that no one factor is necessarily dispositive and that courts will consider data points such as the revenue generated by the assets sold as a percentage of total company revenue, the percentage of book value of the sale, the contribution of the assets sold to the company’s overall EBITDA, and future earnings potential. With respect to Mandiant, the court focused on the fact that the $1.2 billion FireEye sale was equal to 37.5 percent and 38.2 percent of Mandiant’s total assets as of 2020 and 2021, respectively. Therefore, even though FireEye was responsible for a majority of Mandiant’s overall revenue, based on the ratio of asset values, the sale did not satisfy the quantitative substantially-all test in the absence of persuasive qualitative factors.

In terms of the court’s qualitative evaluation, the court explained that the analysis focuses on “economic quality and, at most, on whether the transaction leaves the stockholders with an investment that in economic terms is qualitatively different than the one that they now possess.” In order for section 271 to apply, the sale must be “out of the ordinary” and “substantially” affect the corporation’s “existence and purpose.” With respect to the FireEye sale, the court highlighted that Mandiant had been a cybersecurity company before the sale and that it continued to be a cybersecurity company after the sale and that while the sale of FireEye may “alter [the] course” of how Mandiant operates, the change was not qualitatively significant enough as to “strike a blow” to Mandiant’s “heart.” Therefore, the court concluded that, although the sale was out of the ordinary, it did not satisfy the substantially-all test from a qualitative perspective.

The court distinguished each of the cases that plaintiff cited in support of her position that the FireEye sale satisfied the substantially-all test, namely Katz v. Bregman, Thorpe v. CERBCO, Inc., B.S.F. Co. v. Philadelphia National Bank, and Winston v. Mandor. The court focused on factors such as the fact that the FireEye sale did not represent a “stark departure” from Mandiant’s historic line of business, that no facts were pled indicating that Mandiant was unable to generate income without FireEye, and that Mandiant had not “fundamentally changed its core practice” in the cybersecurity space.

The court also cited the Hollinger decision in support of its dismissal of plaintiff ’s claims, noting that Hollinger had similarly involved the sale of a company’s “crown jewel” business line and “single most valuable asset” accounting for over half of the company’s overall asset value. Similar to the reasoning in Hollinger, the court noted that investors in Mandiant would still be left with an investment in a cybersecurity company even after the sale of FireEye, much like investors in Hollinger International, Inc. had retained their investment in a global media company even after the sale of its “crown jewel” business line. In both cases, the court explained that the sale was “important” but did not “strike a blow” to the company’s heart.

Conclusion

While the case reinforces that there is no bright-line test for determining whether the sale of “all or substantially all” of a company’s assets has occurred, the opinion does provide some guidance as to the factors courts view as most important to the “all or substantially all” analysis. For example, certain qualitative factors that may be relevant to a court’s Gimbel analysis include: the degree to which the company’s business post-transaction differs from that conducted pre-transaction; how tied the sold assets were to the company’s corporate identity; how central the sold assets were to the company’s ability to generate earnings and profits; and whether the remaining business is one of the company’s historic business lines. In addition, the decision appears to indicate that a helpful benchmark for determining whether there has been a sale of substantially all of the assets of a company is whether the sale involves the only substantial income-generating assets of the company and whether the company’s retained business would constitute a stark departure from the company’s historic business or a significant shift in overall business strategy.

Nicholas D. Mozal, of Potter Anderson & Corroon LLP, chairs the working group. Nathaniel M. Cartmell III, of Pillsbury Winthrop Shaw Pittman LLP, chairs the subcommittee. In addition to Mr. Cartmell, contributors of written summaries in this year’s survey are Beth Berg and Sacha Jamal of Sidley Austin LLP; Jonathan Bilyk of Davies Ward Phillips & Vineberg LLP; Chris Kelly and Justin Hymes of Potter Anderson & Corroon LLP; Ryan M. Lindsay of Chipman Brown Cicero & Cole, LLP; Brian S. North of Buchanan Ingersoll & Rooney PC; Amanda K. Pooler of Weil Gotshal & Manges LLP; Rebecca Salko of Potter Anderson & Corroon LLP; Caroline B. Shinkle of Cravath, Swaine & Moore LLP; Vinita Sithapathy of Freshfields Bruckhaus Deringer LLP; and Jacob S. Woodward of Winthrop & Weinstine, P.A. The working group wishes to thank Associate Editors Callan R. Jackson and Evan W. Hockenberger of Potter Anderson & Corroon LLP for their effort and excellent work revising and editing this year’s survey.