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Feldman v. Cutaia, No. 466, 2007 (Del. May 30, 2008)

May 30, 2008

The Delaware Supreme Court, relying on Tooley v. Donaldson, Lufkin & Jenrette, Inc., held that a claim challenging a board’s failure to evaluate the validity of certain options in connection with its approval of a cash-out merger, and thus the payment of a portion of merger proceeds to the holders of those options, was derivative and not direct. The Court thus affirmed the Court of Chancery’s dismissal of that claim on the basis that plaintiff, a former stockholder of the acquired company, lacked standing to pursue it. Plaintiff brought suit prior to the merger on a number of claims, challenging, inter alia, the validity of options issued to certain management defendants. During the course of litigation, the company was acquired in an all-cash, all-shares merger, with option holders receiving the per-share merger consideration, minus the exercise price, for in-the-money options, including those plaintiff had challenged. Plaintiff thereafter amended his complaint to add a direct claim against the company’s board for breach of fiduciary duty in failing to consider the validity of the challenged options prior to approving the merger agreement, and for thus allowing the wrongful diversion of a portion of the merger proceeds to those option holders. Characterizing plaintiff’s claim as a creative attempt to recast his derivative claims as direct by alleging the same fundamental harm in a slightly different way, the Court of Chancery granted dismissal on the basis that plaintiff had lost his derivative standing when, by operation of the merger, he lost his status as a stockholder. The Supreme Court affirmed, holding that (i) because damages that would flow from the board’s failure to consider the options’ validity (the purportedly direct claim) were the same as those suffered by the corporation from the allegedly improper issuance of the options (the underlying derivative claim) and (ii) because plaintiff did not attack the fairness of the merger itself, the merger price, or the process employed by the board in obtaining that price - rather, only the board’s failure to consider the challenged options and their holder's receipt of a portion of the merger consideration - plaintiff’s claim failed to allege a harm suffered by the stockholders directly, distinct from the corporation as a whole. The Court held that the claim was therefore derivative and properly dismissed.

The full opinion is available here