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Calesa Associates, L.P. v. American Capital, Ltd., C.A. No. 10557-VCG (Del. Ch. Feb. 29, 2016) (Glasscock, V.C.)

February 29, 2016

In this memorandum opinion, the Court of Chancery denied (with one minor exception) a Rule 12(b)(6) motion to dismiss an action brought by minority stockholders of Halt Medical, Inc. (“Halt” or the “Company”) alleging breaches of fiduciary duty by current and former directors of Halt and its alleged controller (American Capital, Ltd. and its affiliates (“ACAS”)), in connection with a transaction that diluted the plaintiffs’ interest in the Company.  The Court held that the plaintiffs raised a reasonable inference that a majority of Halt’s board of directors (the “Board”) was under the actual control and influence of ACAS with respect to the transaction, such that ACAS was a controlling stockholder thereby triggering review under the entire fairness standard.

In 2007, ACAS invested $8.9 million in Halt.  Under the terms of that initial investment, ACAS was granted two seats on Halt’s five-seat Board and the right to block any subsequent pari passu investments in Halt.  According to the complaint, the relationship between ACAS and Halt deteriorated thereafter.  Through a series of transactions between the parties, by 2013 Halt owed ACAS $50 million as evidenced by a note due at the end of that year.

Under pressure from the impending due date of the $50 million note, Halt entered into a series of agreements with ACAS (the “Transaction”) pursuant to which, among other things, (i) Halt would form a merger subsidiary and be merged into it; (ii) all issued and outstanding shares of Halt’s preferred stock and warrants to purchase the Halt’s common or preferred stock would be cancelled; (iii) Halt and its stockholders would enter into a note purchase and exchange agreement with ACAS, pursuant to which ACAS would loan the Company up to $73 million; (iv) ACAS would receive a blanket first priority security interest in the Company’s assets; and (v) a management incentive plan would be adopted, under which a percentage of a subsequent sale of Halt would be divided among certain Halt employees.

Halt’s Board sought stockholder approval of the Transaction through the solicitation of stockholder consents under Section 228 of the Delaware General Corporation Law (“DGCL”).   Halt’s stockholders received copies of the Transaction documents – several of which were drafts, incomplete or missing attachments – just one day before they were instructed to return signed copies of the documents and the stockholder consent approving the Transaction.  The plaintiffs alleged that they only signed the documents because of the threat that ACAS would demand payment in full, which Halt could not pay.

As a result of the Transaction, Halt’s minority stockholders were diluted while ACAS’s ownership interest in the Company rose from 26% to 66%.  Subsequently, minority stockholders of Halt filed suit in the Court of Chancery against ACAS and current and former Board members, alleging, among other things, breaches of fiduciary duty and violation of Section 228 of the DGCL.

Before addressing the substance of the plaintiffs’ claims, the Court noted that the plaintiffs had made no attempt to argue demand futility. Citing Gentile v. Rossette, 906 A.2d 91 (Del. 2006) and Casanaro v. Bloodhound Technologies, Inc., 65 A.3d 618 (Del. Ch. 2013), the Court explained that claims alleging dilution resulting from a breach of the duty of loyalty benefiting an insider have been recognized as both derivative and direct.  However, in those cases “the derivative claims were extinguished by merger and, absent direct actions, the breaches of loyalty alleged could never be remedied, an anathema to equity.” By contrast, the plaintiffs in Calesa remained stockholders in Halt following the Transaction, and thus could have pursued their claims derivatively.  The Court went on to explain that the plaintiffs should have been required to plead demand futility, but declined to dismiss the complaint on that basis because neither party had argued that the demand futility requirement applied.

Next, the Court considered whether ACAS was a controlling stockholder standing on both sides of the Transaction thereby rebutting the business judgment rule and triggering entire fairness review. As a minority stockholder, the Court explained, ACAS must have exercised “actual control” over a majority of Halt’s seven-member Board at the time of the Transaction.  The Court found that the plaintiffs adequately alleged that two directors who served as either an officer or director of ACAS were not independent because they were dual fiduciaries and were interested because they stood to gain a personal benefit from it that was not equally shared by the other stockholders.   Halt’s information statement disclosed that a third director (who was also affiliated with ACAS entities) had interests that were in addition to or different from those of Halt’s stockholders, which such disclosure the Court found was sufficient to infer a lack of disinterestedness.  Lastly, the Court found that the plaintiffs sufficiently alleged that the fourth director, who was Halt’s CEO, was beholden to ACAS given that “he faced a decision between supporting the Transaction, on terms highly favorable to ACAS, and rejecting the Transaction, which was tantamount . . . to voting for the collapse of the Company and losing his employment.”

Having found it reasonably conceivable that ACAS was a controlling stockholder standing on both sides of the Transaction thereby subjecting the Transaction to entire fairness review, the Court denied the motion to dismiss with respect ACAS. The Court also denied the motion as to the director defendants, holding that plaintiffs had sufficiently alleged that they were not disinterested or independent of ACAS when they approved the Transaction.

Lastly, the Court found that the plaintiffs had stated a claim that the directors violated Section 228 of the DGCL because some of the exhibits to the Transaction Documents, which were referenced as exhibits to the stockholder written consent, were incomplete or missing. The Court explained that Section 228 requires strict compliance and that “when a consent specifically refers to exhibits and incorporates their terms, the plain language of Section 228(a) requires that a stockholder have the exhibits to execute a valid consent.”

The full opinion is available here