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Clean Harbors, Inc. v. Safety-Kleen, Inc., C.A. No. 6117-VCP (Dec., 9, 2011) (V.C. Parsons)

December 9, 2011

In this opinion, the Court of Chancery denied defendant‘s motion to dismiss plaintiff’s claims for breach of contract and breach of the implied covenant of good faith and fair dealing.  In so holding, the Court of Chancery reiterated that allegations of a failure to act in good faith need not meet the heightened pleading standard applicable to claims for breach of fiduciary duty in the corporate or derivative context. 

In the fall of 2010, plaintiff, Clean Harbors, Inc. (“Clean Harbors”), approached defendant, Safety-Kleen, Inc. (“Safety-Kleen”), with an offer to purchase all of Safety-Kleen’s common stock at $13 per share.  Safety-Kleen’s board of directors considered the offer, but ultimately determined that its shares were worth at least $20 per share, and discussions among the parties ceased.  Shortly thereafter, six former Safety-Kleen employees approached Clean Harbors about the possibility of acquiring their stock options to acquire, in the aggregate, 1.7 million shares of Safety-Kleen.  The majority of the options were set to expire in January 2011, and the option holders did not have sufficient funds to exercise those options.  The parties ultimately entered into an agreement, pursuant to which the option holders agreed to exercise their options and Clean Harbors would purchase the shares for $7.50 per share, which amount represented the strike price, applicable withholding tax and a small premium for each share.  Safety-Kleen was advised of the planned transaction and agreed to permit the parties to enter into the stock purchase agreement by and among Clean Harbors and the six option holders.  On the date that the transaction was consummated, Safety-Kleen exercised certain call rights on the shares, which permitted Safety-Kleen to call the shares issued as a result of exercising the options in consideration for the “Fair Market Value of such Share[s] on the date upon which the right is exercised.”  “Fair Market Value,” in turn, was defined as the fair market value of a share, as determined by a committee of the board of directors of Safety-Kleen, in its good faith discretion.  Pursuant to the terms of the option agreements, Safety-Kleen called all of the shares acquired by Clean Harbors at $7.50 per share. 

In its complaint, Clean Harbors sought a declaration that the determination made by Safety-Kleen’s board of directors that $7.50 per share constituted the “fair market value” was not made in good faith and that the shares in question had a substantially higher value.  Clean Harbors also asserted a breach of contract claim arising out of Safety-Kleen’s purported failure to make a good faith determination as to the fair market value of the shares, and also a claim that Safety-Kleen breached the implied covenant of good faith and fair dealing by calling the shares at a price that was less than fair market value.  In the Court’s view, the dispute centered on two questions: (i) whether $7.50 was less than the fair market value of the shares, and (ii) whether Safety-Kleen acted in bad faith by determining that the fair market value of the shares was $7.50 per share.  As to both questions, the Court concluded that Clean Harbors pled sufficient facts to support its arguments regarding the same, and denied Safety-Kleen’s motion to dismiss.  As a preliminary matter, the Court first noted the existence of a potential ambiguity in the relevant agreements relating to whether Safety-Kleen was required to determine the fair market value of the shares in question, which were encumbered by the call right, or whether Safety-Kleen was required to determine the value, and pay to Clean Harbors, the value associated with regular, unencumbered shares of common stock.   For purposes of the motion to dismiss only, the Court expressed its willingness to adopt Clean Harbors’ interpretation and assumed that Safety-Kleen was required to determine the fair market value of the shares without regard to the call right.  The Court also rejected Safety-Kleen’s argument that the $7.50 value represented the fair market value because it was derived from an arm’s length negotiation among third parties, finding that it was reasonable to infer from the facts that the shares were sold under compulsion, thereby potentially diminishing the true value of the shares.  Approximately 60% of the options expired in January 2011, and the option holders may have felt compelled to recoup at least some of the value of the options by selling to a third party.  Moreover, Safety-Kleen is a thinly-traded private company and the other option holders may have been concerned about the ability to find another buyer.  In addition to the foregoing, Clean Harbors pointed to Safety-Kleen’s rejection of its offer to purchase the company for $13 per share and Safety-Kleen’s response that its shares were worth at least $20 per share.   While recognizing that the $20 per share estimate included a control premium, the Vice Chancellor concluded that the size of that control premium could not be measured absent further discovery.  Thus, after drawing all reasonable inferences in favor of Clean Harbors, the Court found that it was at least conceivable that the fair market value of the shares in question was in excess of $7.50 per share. 

The Court likewise found that Clean Harbors alleged sufficient facts to support a conclusion that Safety-Kleen acted in bad faith.  Safety-Kleen argued that to survive a motion to dismiss, Clean Harbors must allege facts that could support a finding that Safety-Kleen’s conduct constituted “subjective bad faith.”  Clean Harbors, on the other hand, contended that Safety-Kleen’s reliance on cases addressing breach of fiduciary duty in the corporate context was misplaced because such claims must rebut the presumption of good faith under the business judgment rule.  Citing the Court of Chancery’s decision in Winston v. Mandor, 710 A.2d 835 (Del. Ch. 1997), Vice Chancellor Parsons concluded that Clean Harbors need only satisfy the notice pleading threshold.  In Winston, the Court of Chancery held that allegations of bad faith did not need to meet the heightened pleading standards of Rule 9(b).  Applying that pleading standard, the Court found that Clean Harbors sufficiently pled “bad faith” through its allegations that Safety-Kleen failed to act in good faith in determining the fair market value of the shares, together with an alleged improper motivation, claiming that Safety-Kleen desired to benefit the remaining shareholders (including the director and officer shareholders) at Clean Harbors’ expense.  Clean Harbors also alleged that Safety-Kleen tricked Clean Harbors into agreeing to purchase the shares by assuring Clean Harbors that it had no objection to the acquisition of the option holders’ shares, while the board of directors of Safety-Kleen had already determined to exercise the call right. 

Finally, the Court of Chancery addressed Safety-Kleen’s claims that the implied covenant of good faith and fair dealing could not be asserted because the underlying agreements contain an express provision giving Safety-Kleen the discretion to determine the shares’ fair market value.  In general, the implied covenant applies only “where a contract lacks specific language governing an issue and the obligation the court is asked to imply advances, and does not contradict, the purposes indicated in the express language of the contract.”  Alliance Data Sys. Corp. v. Blackstone Capital P’rs V L.P., 963 A.3d 746 (Del. Ch. 2009).  Because the Court could not rule out the possibility that the implied covenant might apply to other provisions governing the shares, the Court rejected this argument.  In support of this finding, the Court noted that the ambiguity as to whether Safety-Kleen was required to value the shares with or without reference to the call right could support a reasonable inference that, among other things, there was a misunderstanding among the parties as to the agreements and Safety-Kleen, having knowledge of this misunderstanding, intended to exercise its call rights but nevertheless “lulled” Clean Harbors into acquiring the shares.  In the Court’s view, such facts and inferences could support a claim for breach of the implied duty of good faith and fair dealing even if they did not support an express breach of contract claim.  Taken together with the foregoing, the Court denied Safety-Kleen’s motion to dismiss.

The full opinion is available here