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Louisiana Municipal Police Employees’ Retirement Sys. v. Fertitta, C.A. No. 4338-VCL (July 28, 2009) (V.C. Lamb)

July 28, 2009

In this case, the Court of Chancery addressed the fiduciary obligations of a board of directors and its controlling stockholder in connection with a proposed merger between the company and entities controlled by the controlling stockholder.

Landry’s Restaurants, Inc. (“Landry’s”) formed a special committee to assess an offer from Tilman J. Fertitta, Landry’s Chairman, CEO, President and 39 percent stockholder (“Fertitta”). On June 16, 2008, Landry’s entered into a $21 per share cash-out merger agreement with two entities controlled by Fertitta. The merger agreement contained a “reverse” termination and a material adverse effect clause. Fertitta personally guaranteed the payment of the $24 million reverse termination fee in the event the entity he controlled failed to close the deal. In view of his personal guarantee, Fertitta entered into a debt commitment letter (the “June Debt Commitment Letter”) with certain banks (the “Lending Banks”) that contained a similar material adverse effect clause.

After Hurricane Ike caused damage to several Landry’s restaurants, Fertitta, in a letter to the special committee, indicated that he believed the Lending Banks would refuse to finance the transaction because the hurricane damage and worsening economy amounted to a material adverse effect, and that Fertitta in turn could exercise his right to terminate. He also indicated that he believed that the Lending Banks would be willing to provide financing at a reduced price of $17 per share. At the same time, Fertitta began accumulating shares of Landry’s stock on the open market. Thereafter, Fertitta forwarded the special committee a letter from one of the Lending Banks expressing doubt that the Fertitta entities would be able to satisfy the conditions to the June Debt Commitment Letter. The special committee did not deem the bank’s letter to be a termination of the June Debt Commitment Letter, and asked Fertitta whether the entities could satisfy the conditions. In response, Fertitta stated only that he was unable to obtain financing from other banks and formally demanded that the price be revised down to $17 per share. When the special committee countered with a $19 per share price, Landry’s issued a press release that the buyout may be in jeopardy, causing a significant drop in the price of Landry’s stock.

In October, Fertitta offered $13 per share, and the parties ultimately amended the agreement by lowering the acquisition price to $13.50 per share and reducing the reverse termination fee to $15 million. In addition, Fertitta and the Lending Banks agreed not to claim a material adverse effect as a result of any known events. Notably, Fertitta negotiated with the Lending Banks to provide for alternative financing that would allow Landry’s to pay off certain senior notes in the event the merger did not close. Thereafter, Fertitta continued his open market purchases (pursuant to which he ultimately gained majority control of the company without paying a premium price), and the board of directors of Landry’s (the “Board”) did nothing to stop these purchases.

After the amendment to the merger agreement, the SEC requested that Landry’s disclose certain information in the amended debt commitment letter, and the Lending Banks refused to allow Landry’s to disclose the information. Landry’s responded by terminating the agreement, thereby waiving the $15 million reverse termination fee Fertitta would otherwise have to pay as a result of his inability to consummate the merger.

Plaintiff, a Landry’s stockholder, filed a complaint asserting class claims against Fertitta for breach of fiduciary duty and against the Fertitta entities for aiding and abetting that breach. The complaint also asserted a class claim against the directors of Landry’s for breach of fiduciary duty, and, in the alternative, a derivative claim for waste against the Board for failing to require Fertitta to pay the reverse termination fee. The defendants moved to dismiss the complaint on all counts for failure to state a claim upon which relief can be granted.

In denying defendants’ motion to dismiss, the Court pointed to three key facts, which made it “impossible” to dismiss the complaint: (1) Fertitta’s role in negotiating the refinancing commitment on behalf of Landry’s, (2) the Board’s “inexplicable impotence” in the face of Fertitta’s creeping takeover, and (3) the Board’s termination of the merger agreement allowing Fertitta to avoid paying the reverse termination fee. These facts, the Court observed, lead to inferences that Fertitta used his influence as controlling stockholder/officer to the detriment of minority stockholders, and that the Board willingly acquiesced to Fertitta as the controlling stockholder.

The Court rejected defendants’ argument that Fertitta was not a controlling stockholder (and therefore did not owe fiduciary duties with respect to the challenged actions). The Court concluded not only that Fertitta did have actual control of Landry’s, but that his negotiation of the refinancing commitment imparted fiduciary duties upon him, as he was acting either in his capacity as CEO or controlling stockholder of Landry’s. Moreover, at the time Landry’s terminated the merger agreement, Fertitta was a majority owner of Landry’s, thereby raising a presumption of control.

With respect to the claims against the Board, the Court determined that it was reasonable in the context of a motion to dismiss to infer a breach of the duty of loyalty from the Board’s failure to employ a poison pill to prevent Fertitta’s control without paying a premium. With respect to its decision to terminate the merger agreement, the Board argued that disclosure of the amended debt commitment letter would have risked the financing commitment, forcing the company into bankruptcy. The Court determined that at this stage, it was unreasonable to assume that Fertitta would have allowed the company to be forced into bankruptcy rather than pay the termination fee, and thereby raising a question as to whether the Board’s decision to terminate and excuse Fertitta’s performance constituted a rational exercise of business judgment.

Finally, the Court held that a failure to make a demand upon the Board was not fatal to the plaintiff’s derivative claim, as the complaint raised a reasonable doubt that the challenged transaction was a product of a valid exercise of business judgment.

The full opinion is available here