Frank v. Elgamal, C.A. No. 6120-VCN (Del. Ch. Mar. 30, 2012) (Noble, V.C.)
In this memorandum opinion, the Court of Chancery addressed a motion to dismiss a stockholder class action complaint challenging the merger of a wholly owned subsidiary of AH Holdings, Inc. with and into American Surgical, Inc. The plaintiff, a minority stockholder, alleged that the board of directors and a group acting as a controlling stockholder breached their fiduciary duties to the minority stockholders by agreeing to a merger that allegedly disproportionately benefitted the defendants. Plaintiff also alleged that the purchasing entities aided and abetted those breaches of fiduciary duties.
The merger of American Surgical, Inc. (“American Surgical” or “the company”) and a wholly owned subsidiary of AH Holdings, Inc. (“AH Holdings”) arose out of American Surgical’s decision in August 2009 to explore strategic alternatives for the company. Although several suitors emerged, the special committee, which was formed to negotiate any deal terms, determined that a deal with AH Holdings, Inc. presented the transaction most favorable to American Surgical’s stockholders. After months of negotiation, the parties entered into a merger agreement, whereby American Surgical would merge into a wholly owned subsidiary of AH Holdings and each stockholder would receive $2.87 per share.
In connection with the merger agreement, certain members of American Surgical’s board and certain of its employees who were also stockholders each entered into three sets of agreements with AH Holdings. Specifically, those stockholders entered into voting agreements pursuant to which they committed to support the merger and exchange agreements pursuant to which they agreed to exchange some of their American Surgical shares for AH Holdings shares. Under the third set of agreements, the Employment Agreements, the signatories agreed to become employees of AH Holdings. The plaintiff alleged the individuals who entered into these agreements, and who collectively owned 71.19% of American Surgical (the “Control Group”), exercised effective control of American Surgical and therefore owed fiduciary duties as a controlling stockholder. The Court agreed, reasoning that a controlling stockholder need not be a single person or entity and finding the members of the Control Group were “connected in a legally significant way” because they entered into substantially similar side agreements.
The plaintiff first contended the Control Group violated its fiduciary duties to the minority stockholders because the merger maximized the value of the Control Group’s shares while diminishing the value of the remaining stockholders’ shares. The Court found the situation similar to the facts in the cases In re LNR Property Corp. Stockholders Litigation and In re John Q Hammons Hotels Inc. Stockholders Litigation. In those cases, minority stockholders were cashed out in a merger while the controlling stockholder received an ownership interest in the acquiring entity. The Court explained that transactions analogous to Hammons and LNR are subject to entire fairness unless conditioned on robust procedural protections (namely, both (i) negotiation and recommendation of the transaction by a special committee of disinterested directors and (ii) approval by a fully informed “majority of the minority” stockholder vote). Because the merger contained no such protections, the Court concluded entire fairness applied. Although the defendants requested the Court shift the burden of proving entire fairness because a special committee and an independent majority of the board approved the merger, the Court concluded that burden shifting would be improper on a motion to dismiss. Accordingly, the Court denied the defendants’ motion to dismiss the breach of fiduciary duty claims against the Control Group.
Similarly, the Court found the plaintiff adequately alleged the Control Group was unjustly enriched as a result of the merger because the merger allowed the Control Group to benefit from the company’s ongoing success while the stockholders were cashed-out at an unfairly low price. The Court agreed that, for purposes of a motion to dismiss, the Complaint adequately alleged the enrichment of the Control Group was related to the impoverishment of the other stockholders. Finding that the plaintiff’s breach of fiduciary duty and unjust enrichment claims were, to some extent, duplicative, the Court nevertheless concluded that the plaintiff could pursue alternative claims for relief.
The plaintiff’s third cause of action alleged members of the Control Group and other members of the board breached their fiduciary duty to ensure that the merger was fair and to disclose all information relevant to a decision to seek appraisal. As to the Control Group, the Court reiterated entire fairness would apply and the plaintiff’s claims would survive the motion to dismiss. As to the board members who were not part of the Control Group, the Court concluded that the plaintiff had alleged facts sufficient to infer that at least one was not independent but insufficient facts to challenge the independence of the remaining two. However, the Court explained, those defendants might still have beached their duty of care. Defendants’ had conceded that dismissal of duty of care claims under a Section 102(b)(7) exculpatory charter provision would not be warranted under the circumstances if entire fairness were the applicable standard of review. Based on the foregoing, the Court denied the defendants’ motion.
The last cause of action alleged the purchasing entities aided and abetted the breaches of fiduciary duty. The Court dismissed the aiding and abetting claims, rejecting the plaintiff’s arguments that the purchasing entities knowingly participated in the breach because they were intimately involved in the negotiations and because they demanded and acquired deal protection measures.