In re MeadWestvaco S'holders Litig., C.A. No. 10617-CB (Del. Ch. Aug. 17, 2017) (Bouchard, C.)
In this memorandum opinion, the Court of Chancery dismissed a stockholder class action suit challenging the $9 billion stock-for-stock merger involving MeadWestvaco Corporation because the complaint failed to adequately plead bad faith by the directors during the deal process. Because eight of the nine MeadWestvaco directors were unquestionably independent and disinterested, the plaintiffs’ breach of fiduciary duty claims rested solely on the allegation that the directors entered into the merger in bad faith in order to thwart a threatened proxy contest by an activist investor and, by so doing, left behind $3 billion in value. The Court rejected this argument as conclusory and not credible in the context of the transaction, which impliedly valued MeadWestvaco at $9 billion, and which was overwhelmingly approved by stockholders following intense on-again, off-again negotiations and a five-month post-signing period during which no superior bidder emerged despite the market’s awareness that the company was for sale.
MeadWestvaco, a publicly traded Delaware corporation, and Rock-Tenn Company, a Georgia company, were considered equals in the packaging business. After a Wall Street analyst note proposed a merger between the two companies, Starboard Value LP, a well-known activist investment firm, began purchasing MeadWestvaco stock until its ownership stake eventually reached 6.1%, making it one of MeadWestvaco’s largest stockholders. One month later, MeadWestvaco’s and Rock-Tenn’s respective CEOs began discussing a possible business combination.
Thereafter, Starboard sent a letter to the MeadWestvaco board stating that the company was not reaching its full potential, and demanding an overhaul through cost-cutting measures, the sale of MeadWestvaco’s specialty chemical business, and/or an outright sale or merger. Starboard put the market on notice of its intentions by filing the letter publicly. Over the next six months, merger negotiations between MeadWestvaco and Rock-Tenn continued, but were terminated twice by MeadWestvaco because it refused to accept a stock-for-stock exchange ratio below the then-market price of its stock.
After meeting with MeadWestvaco’s board regarding enhancing the company’s value, Starboard signaled a potential proxy fight. One month later, MeadWestvaco and Rock-Tenn re-engaged in merger negotiations. Several weeks later, MeadWestvaco’s board approved a stock-for-stock merger of the two companies. The stockholders approved the merger with 83% of the outstanding shares voting, of which 98% voted in favor of the transaction. The merger closed on July 1, 2015.
After the transaction was announced, class action suits were filed and later consolidated. The parties agreed to expedited discovery in advance of a preliminary injunction hearing, but after several days, the plaintiffs abandoned their preliminary injunction motion and their disclosure claims. All that remained were breach of fiduciary duty claims against the MeadWestvaco directors and an aiding and abetting claim against Rock-Tenn. The defendants moved to dismiss.
The parties agreed that the claims were not subject to entire fairness review or enhanced scrutiny because the transaction was a stock-for-stock merger of two publicly traded companies without any controllers. Because MeadWestvaco’s charter contained a Section 102(b)(7) exculpatory provision and because it was undisputed that eight of the nine directors were disinterested and independent, the plaintiffs could only defeat the motion to dismiss if the complaint adequately alleged a claim for breach of the duty of loyalty premised on bad faith conduct by a majority of the board – a claim which is very difficult to prove under Delaware law.
The plaintiffs’ core argument was that the directors knew that certain key assets of the company were undervalued by the market to the tune of $3 billion and that the directors deprived MeadWestvaco’s stockholders of this value by “flying blind” and doing “virtually nothing” to meet their fiduciary duties. The Court determined that the allegations in the complaint fell “far short” of pleading the “extreme set of facts” necessary to substantiate a bad faith claim. Far from “flying blind,” the complaint itself showed that the directors were actively engaged in the sale process – for example, upon learning of the possibility of a combination with Rock-Tenn, the directors asked probing questions relating to the possibility of a merger; the board met at least six times, obtained numerous valuations of the company, and was advised by prominent legal and financial firms (Wachtell Lipton, Merrill Lynch, and Goldman Sachs) throughout the process; and the board terminated negotiations twice after the directors felt that Rock-Tenn was undervaluing MeadWestvaco.
The Court also determined that the complaint did not support a reasonable inference that the ultimate decision to approve a strategic merger valuing the company at $9 billion was itself an act of bad faith. In support of this conclusion, the Court noted that the exchange ratio in the merger represented a 9.1% premium to the stockholders; the MeadWestvaco stockholders obtained 50.1% of the combined entity even though MeadWestvaco contributed less than half of the combined company’s revenue, net income, and EBITDA; prominent financial advisors rendered favorable fairness opinions; despite reasonable deal protection devices, no superior bidder emerged during the five-month post-signing period; and two major independent proxy advisory firms recommended that stockholders vote to approve the merger, which the stockholders did overwhelmingly.
The Court also dismissed the aiding and abetting claim against Rock-Tenn based on the absence of a predicate breach and lack of any allegations suggesting knowing participation. Because the Court disposed of the complaint on the grounds that it failed to state a claim, it did not reach the defendants’ alternative argument that the board’s decision to approve the merger was cleansed under Corwin v. KKR Financial Holdings, LLC by virtue of the stockholders’ overwhelming approval of the merger.