May 24, 2017

Ten Recent Delaware Merger and Acquisition Cases Applying Corwin

Learn how stockholder approval insulates directors and officers from post-closing fiduciary duty claims under the landmark 2015 decision

Albert H. Manwaring IV, Albert J. Carroll, William M. Lafferty, and Peter Adams

The Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), reaffirmed the power of disinterested, uncoerced, and fully informed stockholder approval to invoke the business judgment rule and immunize merger and acquisition (M&A) transactions from breach of fiduciary duty claims. Under Corwin, where a transaction “not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders,” Delaware courts will avoid second-guessing the stockholders by applying the business judgment rule, leaving waste as the only feasible claim to challenge the transaction. Id. at 305–6.

Because a court would have to make the dubious finding that stockholders approved an irrational deal to uphold a waste claim, a Corwin-qualifying vote should result in dismissal. Corwin therefore sets a very high bar for post-closing fiduciary duty claims against the merger target’s directors and officers (and any alleged aiders and abettors) in M&A transactions.

Delaware courts have applied Corwin to dismiss a number of post-closing challenges, and these decisions, discussed below, illustrate the significance and scope of the protection that stockholder approval affords M&A transactions under Delaware law.

Singh v. Attenborough, 137 A.3d 151 (Del. 2016) (en banc)
Singh affirmed the dismissal of post-closing fiduciary duty claims against a target’s directors and aiding and abetting claims against their banker. In re Zale Corp. Stockholders Litig. (Zale I), 2015 WL 5853693 (Del. Ch. Oct. 1, 2015), op. amended on reargument, In re Zale Corp. Stockholders Litig. (Zale II), 2015 WL 6551418 (Del. Ch. Oct. 29, 2015). The relevant claims concerned the banker belatedly disclosing a potential conflict to the board.

The Court of Chancery decided Zale I just before the Delaware Supreme Court’s opinion affirming Chancellor Bouchard’s ruling in Corwin. In Zale I, Vice Chancellor Parsons declined to follow Chancellor Bouchard’s opinion in Corwin, finding that it conflicted with the Delaware Supreme Court’s opinion in Gantler v. Stephens. As a result, Vice Chancellor Parsons instead applied enhanced scrutiny under Revlon (despite stockholder approval of the merger) and, under that standard of review, held that the plaintiffs had sufficiently alleged that the directors breached their duty of care in handling the banker’s potential conflict. The directors’ alleged breach also provided the predicate for an aiding and abetting claim against the banker. But, because the company’s charter exculpated the directors from monetary liability for a breach of the duty of care, the court dismissed the plaintiffs’ fiduciary duty claim against the directors, while upholding the aiding and abetting claim against the banker.

Zale II revisited Zale I following the Delaware Supreme Court’s decision in Corwin. On reargument, the Court of Chancery held that the fully informed vote by a majority of disinterested stockholders invoked the business judgment standard of review under Corwin, replacing the otherwise applicable enhanced scrutiny standard under Revlon. The court then analyzed whether the plaintiffs had rebutted the business judgment rule by adequately pleading director gross negligence (the standard for pleading a duty of care breach). It held that, under a gross negligence standard, the plaintiffs failed to adequately allege a duty of care claim against the directors. Thus, because there was no longer a predicate duty of care claim against the directors, the court dismissed the aiding and abetting claim against the banker.

The Delaware Supreme Court upheld the dismissal on appeal in Singh but disagreed with the Zale II decision in one significant respect. The supreme court explained that while the Court of Chancery correctly found that the stockholder vote invoked business judgment review under Corwin, it erroneously asked whether the plaintiffs had rebutted the business judgment rule by pleading a duty of care claim under the gross negligence standard. The supreme court explained the erroneous circularity in the Court of Chancery’s decision as follows:

Absent a stockholder vote and absent an exculpatory charter provision, the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence, even if the transaction was a change-of-control transaction. Therefore, employing the same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review-shifting effect to the vote. When the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result.

Singh, 137 A.3d at 151–52.

The Delaware Supreme Court concluded that the Corwin-qualifying vote invoked the business judgment rule, thereby cleansing the potential duty of care claim. For that reason, the only question remaining was whether the plaintiffs had adequately pled waste, a claim they had not alleged.

In re Volcano Corp. Stockholder Litigation, 143 A.3d 727 (Del. Ch. 2016) (Montgomery-Reeves, V.C.)
Like Singh, Volcano dismissed post-closing fiduciary duty claims against the target’s directors and banker based on stockholder approval of the merger. Unlike Singh, however, the underlying deal was a two-step transaction, where instead of voting, the target’s stockholders expressed approval by tendering their shares in the first-step tender offer pursuant to section 251(h) of the Delaware General Corporation Law. As a matter of first impression, the Court of Chancery determined that Corwin may apply after a successful first-step tender offer. The court reasoned that the stockholders’ acceptance of a tender offer in a section 251(h) transaction replicates a stockholder vote to approve a long-form merger. Therefore, the court concluded that a tender of shares by a majority of the outstanding, fully informed, uncoerced, and disinterested stockholders invokes business judgment review under Corwin. However, the court did not resolve the question of whether a similar tender offer would have the same effect under Corwin if the tender offer had been made outside the merger process as described in section 251(h).

Beyond extending Corwin’s cleansing effect to section 251(h) transactions, Volcano is also notable for first styling the business judgment rule invoked under Corwin as “irrebuttable.” In doing so, Volcano followed the logic of Singh to its natural conclusion because the Delaware Supreme Court in Singh corrected the Court of Chancery in Zale II for improperly asserting that a claim could survive if premised on facts demonstrating gross negligence, notwithstanding stockholder approval. Thus, by describing the business judgment rule standard as “irrebuttable” in Volcano, the Court of Chancery articulated the extreme unlikelihood that a challenge to a merger can survive after stockholder approval that meets the requirements of Corwin.

To attempt to avoid Corwin’s cleansing effect, the plaintiffs in Volcano and subsequent cases have focused their efforts on challenging three of Corwin’s requirements—(1) the absence of a conflicted controller, and a (2) fully informed, (3) uncoerced stockholder vote. In Volcano, the plaintiffs unsuccessfully argued that the stockholder vote was uninformed because they had amended their complaint after the company issued supplemental disclosures mooting their original disclosure claims.

On February 9, 2017, the Delaware Supreme Court affirmed the Volcano decision by summary order. Although the supreme court raised questions at oral argument suggesting that it did not endorse the Court of Chancery’s use of the word “irrebuttable,” the court did not address that issue in its order and instead “affirmed for the reasons stated” in the Court of Chancery’s opinion.

City of Miami General Employees Retirement Trust v. Comstock, 2016 WL 4464156 (Del. Ch. Aug. 24, 2016) (Bouchard, C.)
Like Volcano, Comstock also dismissed post-closing fiduciary duty claims against a target’s directors and banker under Corwin. In Comstock, after rejecting the plaintiffs’ argument that the stockholder vote was uninformed, the court held that Corwin applied and invoked the business judgment rule. However, despite finding that Corwin applied to invoke the business judgment rule, the court then analyzed whether the plaintiffs had rebutted the business judgment rule by invoking the entire fairness standard of review based on their allegations that a majority of the directors were either self-interested in the deal or manipulated by an executive’s alleged deceit. Neither theory was adequately pled, and the plaintiffs thus failed to rebut the business judgment rule invoked under Corwin. But importantly, by asking this question, the court’s analysis arguably suggests that the business judgment rule invoked under Corwin is rebuttable if entire fairness review is applicable based on a board-level conflict or a fraud on the board, rather than irrebuttable, as Volcano held.

On March 23, 2017, the Delaware Supreme Court affirmed Comstock in a short three-page order. The supreme court limited its discussion to issues surrounding the disclosure allegations: The supreme court did not fully embrace the Court of Chancery’s disclosure analysis but agreed that the plaintiffs failed to plead material omissions.

Larkin v. Shah, 2016 WL 4485447 (Del. Ch. Aug. 25, 2016) (Slights, V.C.)
Like Volcano, Larkin also applied Corwin to dismiss post-closing fiduciary duty claims against the target’s directors where the transaction involved a two-step merger (i.e., a first-step tender offer pursuant to Title 8, section 251(h) of the Delaware Code, followed by a back-end merger). In Larkin, the court applied Corwin after rejecting the plaintiffs’ argument that the deal involved a conflicted, controlling stockholder.

Also, as in Volcano, Larkin took a more expansive view of Corwin than Comstock arguably did. Larkin expressly held that the only transactions that stockholder approval cannot cleanse are those involving a conflicted controlling stockholder. In those scenarios, Delaware law presumes coercive influence, and the court applies the heightened entire fairness standard of review ab initio. Thus, under Larkin, absent a conflicted controller, a Corwin-qualifying vote invokes the business judgment rule irrebuttably (leaving only a waste claim), even if director conflicts might have otherwise triggered entire fairness review.

Significantly, Larkin emphasized that the rationale for lowering the standard of review to business judgment from intermediate enhanced scrutiny under Revlon and Unocal also supports lowering the standard of review to business judgment from entire fairness in connection with board-level conflicts (and absent a controller’s implicit coercion). This opinion was not appealed.

Huff Energy Fund, L.P. v. Gershen, 2016 WL 5462958 (Del. Ch. Sept. 29, 2016) (Slights, V.C.)
Huff Energy applied Corwin outside the merger context to dismiss a challenge to a board’s adoption of a dissolution plan approved by the company’s stockholders. In Huff Energy, the plaintiff claimed that the board breached its fiduciary duties under Revlon, by not exploring more favorable alternatives, and under Unocal, by approving the dissolution as an unreasonable response to a perceived threat.

After rejecting the plaintiff’s argument that the vote was uninformed, the court applied Corwin. In accordance with Larkin and Volcano, Huff Energy held that even if Revlon or Unocal enhanced scrutiny might otherwise apply, fully informed and disinterested stockholder approval caused the business judgment rule to apply “irrebuttably” and only permitted the plaintiff to argue that the board’s adoption of the dissolution plan constituted waste, a claim plaintiff had not alleged.

In re Om Group, Inc. Stockholders Litigation, 2016 WL 5929951 (Del. Ch. Oct. 12, 2016) (Slights, V.C.)
Om Group is another instance of the Court of Chancery invoking the “irrebuttable” business judgment rule under Corwin. In Om Group, the court rejected the plaintiffs’ argument that the stockholder vote was uninformed, applied Corwin, and dismissed the plaintiffs’ post-close fiduciary duty claims against the target’s directors.

In re Solera Holdings, Inc. Stockholder Litigation, 2017 WL 57839 (Del. Ch. Jan. 5, 2017) (Bouchard, C.)
Solera also dismissed post-closing fiduciary duty claims against the target’s directors under Corwin. Most notably, Solera explained who has the burdens of pleading and proof regarding the sufficiency of disclosures under a Corwin defense: The plaintiff must first sufficiently plead one or more disclosure violations, and only then will the burden shift to the defendants to show that the stockholders were fully informed. Also of significance, Solera explained that Corwin did not change the disclosure standard—i.e., only material information must be disclosed to satisfy Corwin.

In re Merge Healthcare Inc. Stockholders Litigation, 2017 WL 395981 (Del. Ch. Jan. 30, 2017) (Glasscock, V.C.)
Merge Healthcare is another example of the Court of Chancery applying Corwin to dismiss post-closing fiduciary duty claims against the target’s directors. Merge Healthcare is unique in the line of Corwin cases because, aside from the usual disclosure and conflicted controller arguments, it involved non-exculpated breach of the duty of care claims. The target had an atypical charter that lacked a section 102(b)(7) exculpatory provision. Not surprisingly, the Corwin-qualifying vote cleansed the duty of care claims as well.

In re Saba Software, Inc. Shareholder Litig., 2017 WL 1201108 (Del. Ch. April 11, 2017) (Slights, V.C.)
Saba represents the first Court of Chancery decision to determine that Corwin’s prerequisites of an informed and uncoerced vote were not satisfied. Saba involved a company that the Securities and Exchange Commission claimed engaged in a fraudulent scheme to inflate its earnings, following which the company failed to timely restate its financials and its stock was deregistered. In the midst of the regulatory chaos, the stockholders were presented with the choice of approving a proposed merger at a price well below the company’s recent average trading price or continuing to hold now-deregistered, illiquid stock.

On the defendants’ motion to dismiss, the court found that the stockholder vote was uninformed and coerced, and thus declined to invoke the business judgment rule under Corwin. The court, instead, applied Revlon and found that the plaintiffs pled non-exculpated duty of loyalty claims. Accordingly, the court denied the directors’ motion to dismiss.

In re Paramount Gold and Silver Corp. Shareholder Litig., 2017 WL 1372659 (Del. Ch. April 13, 2017) (Bouchard, C.)
Paramount is the most recent Court of Chancery decision relying primarily on Corwin to dismiss post-closing fiduciary duty claims against the target’s directors. In Paramount, while finding that the stockholder vote was fully informed and uncoerced, the court flagged one of the last remaining wrinkles under Corwin—the “apparent tension” between Corwin and In re Santa Fe Pacific Corporation Shareholder Litigation, 669 A.2d 59 (Del. 1985), which engaged in Unocal review of deal protection measures despite stockholder approval. After observing that the Delaware Supreme Court “did not discuss or expressly overrule” Santa Fe in Corwin, the Paramount decision found it unnecessary to resolve “the apparent tension” between Corwin and Santa Fe because the alleged deal protection measures at issue satisfied Unocal enhanced scrutiny in any event.

Key Takeaways          

Fully informed, uncoerced stockholder approval invokes the business judgment rule and insulates a Corwin-qualifying transaction from all fiduciary duty claims except waste. Volcano, Larkin, Huff Energy, and Om Group all applied the business judgment rule irrebuttably under Corwin and dismissed post-close challenges to a merger. Thus, this line of authority effectively cleanses board-level conflicts and lapses in care, and makes dismissal of post-close fiduciary duty claims virtually certain, following Corwin-qualifying stockholder approval. See Volcano, 143 A.3d at 738; Larkin, 2016 WL 4485447, at *10–12; Huff Energy, 2016 WL 5462958, at *15; Om Group, 2016 WL 5929951, at *10; see also Chester Cty. Ret. Sys. v. Collins, C.A. No. 12072-VCL, ¶¶ 4–5 (Del. Ch. Dec. 6, 2016); Merge Healthcare, 2017 WL 395981, at *6.

On the other hand, the Comstock decision arguably leaves the door open for plaintiffs to rebut the business judgment rule, even after Corwin-qualifying stockholder approval, if they can adequately allege a board-level conflict sufficient to invoke entire fairness review. The Delaware Supreme Court’s summary affirmance of Comstock did not clarify this issue.

Stay tuned to see how the Delaware courts will apply Corwin in the future to non-controller transactions when entire fairness review is otherwise invoked based on a board-level conflict. In at least one recent unpublished decision, the Court of Chancery favored the irrebuttable view and held that Corwin-qualifying approval cleansed an otherwise sufficiently pled duty of loyalty claim based on the board’s alleged self-interest regarding certain change-of-control benefits. See In re Columbia Pipeline Grp., Inc. Stockholder Litig., C.A. No. 12152-VCL (Del. Ch. Mar. 7, 2017) (“The allegations of the complaint in support of this theory are sufficiently detailed to state a pleadings-stage claim for breach of the duty of loyalty against the defendants. But if stockholders approved the conflict of interest after full disclosure, then the business judgment rule applies.”).

Delaware courts will apply the traditional test for stating a disclosure violation to an allegation that stockholder approval was uninformed under Corwin. Volcano, Huff Energy, Om Group, Solera, Merge Healthcare, and Saba all considered challenges that the stockholder approval of the transaction was uninformed, thereby negating its cleansing effect. Each case applied the traditional standard for stating a disclosure violation under Delaware law: a “material” misrepresentation or omission. See Volcano, 143 A.3d at 748; Huff Energy, 2016 WL 5462958, at *15; Om Group, 2016 WL 5929951, at *11–12; Solera, 2017 WL 57839, at *9; Merge Healthcare, 2017 WL 395981, at *9; Saba, 2017 WL 1201108 at *8.

Delaware courts will apply the traditional test for invoking entire fairness review based on allegations of control under Corwin. Larkin considered an argument that a controller’s presence took the case outside the Corwin rule. In determining whether a conflicted controller was present, Larkin applied the traditional test for invoking entire fairness review based on a controller: (1) a controller or control group (majority ownership, or minority ownership with actual board-level control), (2) who engaged in a conflicted transaction (as a counterparty or the recipient of a non-ratable benefit). See Larkin, 2016 WL 4485447, at *8–9 (citing In Crimson Expl. Inc. S’holder Litig., 2014 WL 5449419 (Del. Ch. Oct. 24, 2014)); see also Merge Healthcare, 2017 WL 395981, at *7–9.

Delaware courts likely will apply the traditional test (under Williams v. Geier, 671 A.2d 1368 (Del. 1996)) instead of enhanced scrutiny (under Unocal) to determine whether stockholder approval was coerced under Corwin. Delaware courts have yet to expressly rule on which test applies in all circumstances under Corwin when plaintiffs allege that stockholder approval was coerced. Under Williams v. Geier, the traditional test for stockholder coercion is whether a party took actions “which have the effect of causing the stockholders to vote in favor of the proposed transaction for some reason other than the merits of that transaction.” 671 A.2d 1368, 1382–83 (Del. 1996). Mere influence is insufficient under Williams; instead, the coercion must impair and wrongfully induce the stockholders’ decision. See Gradient OC Mater, Ltd. v. NBC Universal, Inc., 930 A.2d 104, 117 (Del. Ch. 2007). In Saba, the Court of Chancery applied Williams to find that the stockholder vote was coerced under the circumstances: Because the board was bent on selling the company in the midst of the company’s self-imposed regulatory crisis, the stockholders were stuck choosing between an allegedly underpriced deal and being stuck with now-deregistered, illiquid stock.

The question remains whether Williams provides the full legal test for determining whether a deal protection measure impermissibly coerces a stockholder vote or whether enhanced scrutiny under Unocal applies in those circumstances. The Delaware Supreme Court’s pre-Corwin decision in In re Santa Fe Pacific Corp. Shareholder Litigation, 669 A.2d 59 (Del. 1995), which applied Unocal review to evaluate deal protection defensive measures despite a cleansing stockholder vote, might be read to suggest that enhanced scrutiny is necessary. See J. Travis Laster, “The Effect of Stockholder Approval on Enhanced Judicial Scrutiny,” 40 Wm. Mitchell L. Rev. 1443, 1471–77 (2014) (discussing, pre-Corwin, how Santa Fe can be read to hold that stockholder approval does not lower the standard of review to business judgment for defensive measures subject to enhanced scrutiny, unless the stockholders had a specific, unbundled vote on the defensive measures). Saba arguably does not resolve this issue because it did not involve alleged impermissibly coercive deal protection measures.

While Paramount did involve alleged impermissibly coercive deal protection measures, the Court of Chancery declined to resolve the apparent tension between Corwin and Santa Fe because the challenged measures satisfied Unocal review even if such review applied under Santa Fe. Paramount, 2017 WL 1372659, at *6.  Accordingly, whether a Corwin qualifying vote cleanses a deal protection measure, obviating the need to evaluate the measure under Unocal enhanced scrutiny remains an open issue.

Conclusion
The curbing of disclosure-only settlements under the Court of Chancery’s highly publicized Trulia decision may cause stockholder plaintiffs to pursue more post-closing damages claims. With statutorily required stockholder approval effectively eliminating such claims under Corwin, target boards of directors should make every effort to ensure that the disinterested stockholders are fully informed (i.e., possess all material information, even if this requires supplemental disclosures) and uncoerced (i.e., free from improper influence) when they are asked to vote on or approve a merger.