In re Cornerstone Therapeutics Inc. S'holder Litig., Consol. C.A. No. 8922-VCG (Del. Ch. Sept. 10, 2014) (Glasscock, V.C.)
In this opinion on a motion to dismiss, the Court of Chancery held that, in a controller transaction governed by entire fairness review, a plaintiff need not specifically plead non-exculpated breaches of duty as to disinterested director defendants in order to withstand a motion to dismiss. Instead, the Court held, whether director defendants breached a non-exculpated duty was an issue to be addressed only if, after a trial on a fully developed record, the transaction at issue was found to be not entirely fair.
Cornerstone Therapeutics, Inc. (“Cornerstone”) was a publicly-traded Delaware pharmaceutical company. Prior to the February 3, 2014 merger at issue in this litigation, the company’s Board of Directors consisted of nine directors. Chiesi Farmaceutici S.p.A. (“Chiesi”), a privately-held Italian drug manufacturing company, owned 65.4% of Cornerstone’s common stock at the time of the merger.
On February 18, 2013, Chiesi offered to acquire all of the outstanding shares of Cornerstone common stock not owned by Chiesi at a price range of $6.40 to $6.70 per share. The proposal represented an approximately 20% to 25% premium over the company’s closing price of $5.35. Chiesi’s offer was not conditioned on the approval of a majority of the minority stockholders. In response to Chiesi’s offer, Cornerstone’s board formed a special committee comprised of five disinterested directors. The special committee retained Lazard as its financial advisor.
After reviewing the company’s most recent management forecasts and Lazard’s financial analysis of the company, the special committee concluded that a valuation range of $11.00 to $12.00 per share was fair for the minority stockholders. Accordingly, the special committee rejected Chiesi’s proposal and informed Chiesi that it would entertain a deal price of $12.00 per share. Chiesi countered by stating that it would offer no more than $8.25 per share and also reminded the special committee that, as Cornerstone’s majority stockholder, Chiesi could remove and replace all of the non-Chiesi directors and the company’s senior management team. The special committee again rejected Chiesi’s $8.25 offer and countered with a proposal of $11.00 per share. Plaintiffs alleged that Chiesi’s CEO called the special committee chairman several days later to express his disappointment and frustration and threatened to terminate negotiations.
Shortly thereafter, Cornerstone released its financial results for the first quarter of 2013, which fell below company projections. Lazard correspondingly revised its financial analysis. Plaintiffs alleged that, as a result of this downward adjustment and the special committee’s fear that Chiesi would terminate discussions, the special committee made a counterproposal of $10.25 per share. Chiesi rejected the offer. Weeks later, Cornerstone learned that a competitor was seeking regulatory approval for a drug that would directly compete with one of Cornerstone’s products. Because, according to Plaintiffs, the enforceability of Cornerstone’s patent for the drug was the subject of some doubt, the special committee approached Chiesi with a revised offer of $9.75 per share and, after negotiations, reached an agreement in principle to a price of $9.50 per share. Lazard advised that this price was fair to the company’s stockholders.
The special committee recommended the transaction to the board and, with several directors recused, the board approved it. The merger agreement was thereafter approved by more than 80% of the company’s minority stockholders.
In their amended complaint in this action, Plaintiffs asserted, among other claims, a breach of fiduciary duty claim against the special committee, the company’s CEO, and one other unaffiliated director (the “Director Defendants”), all of whom were disinterested directors for purposes of the transaction at issue in this case. The Director Defendants moved to dismiss this count, asserting that Plaintiffs failed to plead specific non-exculpated breaches of duty as to each disinterested Director Defendant and, thus, failed to satisfy the applicable pleading standard.
The Court recognized that, because the case involved the acquisition of a company by a controlling stockholder, the prevailing standard of review—applied ab initio—was entire fairness. To withstand a motion to dismiss in such a case, a plaintiff must merely plead facts raising an inference that the defendant stockholder is a controller and that the transaction was not entirely fair to the minority. However, the Court noted, the motion to dismiss before the Court involved only disinterested directors who served on a special committee. Accordingly, the Court confronted the question whether specific facts raising an inference of a non-exculpated breach must be pled as to each disinterested director or whether a plaintiff could overcome a motion to dismiss by simply pleading that a disinterested director facilitated a controller transaction that was not entirely fair.
Although it recognized the analytical difficulties raised by applying the pleading standard for interested fiduciaries in an entire fairness case to disinterested directors, the Court nonetheless held that controlling precedent required it to deny the motion to dismiss. Quoting Emerald Partners v. Berlin (Emerald Partners II), 787 A.2d 85 (Del. 2001), in which the Delaware Supreme Court held that a controller transaction of the type at issue in this case is subject to the entire fairness standard of review “ab initio,” the Court stated that, in an entire fairness case, “a determination that the director defendants are exculpated from paying monetary damages can be made only after the basis for their liability has been decided,” or, in other words, upon a fully developed factual record and a determination of entire fairness.
Based on that precedent, the Court of Chancery determined that Plaintiffs satisfied their pleading standard in that they alleged that a controlling stockholder stood on both sides of the transaction, that the transaction was not entirely fair to the minority, and that the Director Defendants negotiated or facilitated the allegedly unfair transaction. The Court therefore denied the Director Defendants’ motion to dismiss. The Court stated that, if, after trial, the transaction was found to be not entirely fair, the Court would then address the issue of whether the Director Defendants breached a non-exculpated duty.