In re Sanchez Energy Deriv. Litig., C.A. No. 9132-VCG (Del. Ch. Nov. 25, 2014) (Glasscock, V.C.)
In this memorandum opinion, the Court of Chancery held that plaintiff stockholders failed to plead particularized facts sufficient to demonstrate demand futility and dismissed the plaintiffs’ fiduciary duty, aiding and abetting, and unjust enrichment claims for failure to comply with Court of Chancery Rule 23.1. In so holding, the Court noted several times that the plaintiffs could have benefitted from a demand under 8 Del. C. § 220 and discussed defining features of a controlling minority stockholder.
Sanchez Energy Corporation (“Sanchez Energy”) is a publicly traded Delaware corporation focused on oil and natural gas resources along the U.S. Gulf Coast. Sanchez Energy was founded by certain members of the Sanchez family, two of whom—A.R. Sanchez Jr., a 16% stockholder, and A.R. Sanchez III, a 5.5% stockholder—have since served on its board of directors. Apart from directors, officers, and management services obtained from a Sanchez-controlled entity, Sanchez Energy has no employees and no directly managed operations.
This dispute arose from an August 2013 transaction (the “Transaction”) in which Sanchez Energy paid approximately $77 million in cash and stock to Sanchez Resources, LLC, another Sanchez-controlled entity (“Sanchez Resources”), and Altpoint Capital Partners LLC (“Altpoint”) to purchase interests in a Sanchez Resources’ marine shale oil extraction project in Mississippi. The Transaction was meant to buy out Altpoint’s equity interest in the project and to fund additional development. Three independent directors, acting as Sanchez Energy’s audit committee (the “Audit Committee”)—a committee created to evaluate and approve interested-party transactions with Sanchez family members—considered and approved the Transaction, with the advice of an independent financial advisor. The plaintiffs brought the derivative action against the five members of the board of directors of Sanchez Energy (the three Audit Committee members, Sanchez Jr., and Sanchez III) for breaches of fiduciary duty; against Sanchez III in his capacity as President and CEO of Sanchez Energy for breach of fiduciary duty; against Sanchez Resources, its principal, Eduardo Sanchez, and Altpoint for breaches of fiduciary duty; and against Sanchez Jr. and Sanchez III for unjust enrichment.
The Court determined that the plaintiffs failed to establish demand futility under either the first or second prong of Aronson v. Lewis. With respect to the first prong, the Court found that plaintiffs failed to plead allegations sufficient to raise a reasonable doubt that the directors comprising the Audit Committee were disinterested and independent. The plaintiffs conceded that all three members of the Audit Committee were financially disinterested in the Transaction and that one Audit Committee member was also independent, so the Court’s analysis focused on the independence of the two remaining Audit Committee members. The Court rejected plaintiffs’ allegations challenging the independence of the other two members. For instance, the Court found one director’s long-standing personal relationship with Sanchez Jr. insufficient to impugn his independence because the complaint lacked any description of the substance of that personal relationship. The Court similarly rejected allegations regarding the director’s status as an executive in the subsidiary company of an entity that counted Sanchez Jr. as one of its nine directors, as plaintiffs failed to explain how Sanchez Jr. could exert power as one of nine directors to remove an executive in a subsidiary corporation. Regarding the third member of the Audit Committee, the Court found that the plaintiffs failed to adequately plead that he lacked independence because they did not attempt to explain how alleged business relationships between the director and Sanchez Jr. could have impacted his evaluation of the Transaction.
With respect to the second Aronson prong, the Court found that the plaintiffs failed to plead allegations sufficient to allege that the Transaction was not the product of a valid exercise of business judgment for two reasons. First, the Court rejected the plaintiffs’ contention that the Transaction should be evaluated under the entire fairness standard because Sanchez Jr. and Sanchez III should be treated as controlling stockholders. Citing Chancellor Bouchard’s recent decision in In re KKR Financial Holdings LLC Shareholders Litigation and Vice Chancellor Parsons’s recent decision in In re Crimson Exploration Inc. Stockholders Litigation, the Court reasoned that actual board control in the transaction at issue is the defining and necessary feature of a non-majority controlling stockholder and that in this case the plaintiffs failed to explain how Sanchez Jr. and Sanchez III controlled the process relating to the Transaction. Second, the Court rejected the contention that the Transaction was so facially unfair that it could not possibly have been the product of a valid business judgment. The mere fact, for instance, that Sanchez Energy was paying roughly $2,500 per acre for land that Sanchez Resources paid only $184 per acre for several years prior was not sufficient for plaintiffs’ to win the “steep uphill battle” of alleging the lack of any valid business purpose under the second prong of Aronson.
In dismissing plaintiffs’ claims, the Court noted that a demand for information under 8 Del. C. § 220—which plaintiffs failed to make—may have uncovered documents relating to the negotiation process undertaken by the Audit Committee, and that such information could have enabled the plaintiffs to better plead particularized facts to support a claim for demand futility.