In re Merge Healthcare Inc. S’holders Litig., C.A. No. 11388-VCG (Del. Ch. Jan. 30, 2017) (Glasscock, V.C.)
In this decision, the Court of Chancery granted the defendants’ motion to dismiss a complaint alleging that directors had breached their fiduciary duties in connection with a sale process. While the sale process was found to be less than pristine, the Court concluded that the fully informed and uncoerced vote of the minority stockholders approving the transaction cleansed any fiduciary violations, giving rise to the presumption that the directors exercised proper business judgment.
The dispute arose from IBM’s acquisition of Merge Healthcare, Inc. (“Merge” or the “Company”). In response to a proposal from IBM, the Company’s board of directors (the “Board”) discussed forming a special committee, but ultimately decided not to do so. The Company’s CEO and holder of approximately 26% of the Company’s outstanding stock, Michael Ferro, had an arrangement to receive a $15 million consulting fee from Merge if he sold the Company for at least $1 billion. In an effort to raise IBM’s offer, Ferro waived his consulting fee, thereby increasing the sale price by $15 million. The holders of 77% of the stock held by the Company’s other stockholders voted in favor of the transaction.
Plaintiffs sought damages, alleging that the defendant directors had breached their fiduciary duties of care and loyalty in connection with the transaction and also that the disclosures to stockholders in connection with the merger had been inadequate. Defendants argued that their decision was protected by the business judgment rule by reason of the Delaware Supreme Court’s holding in Corwin v. KKR Financial Holdings LLC. In Corwin, the Supreme Court held that if a transaction is not subject to the entire fairness standard of review, the approval by a fully informed, uncoerced vote of the disinterested stockholders will have a cleansing effect on the transaction, such that the business judgment rule will apply. Plaintiffs argued that the doctrine in Corwin should not be applied because entire fairness should be the applicable standard of judicial review and because the disclosures to stockholders were inadequate.
Plaintiffs contended that entire fairness should apply, rendering Corwin inapplicable, because Ferro was allegedly a controlling stockholder and because a majority of the Board was allegedly conflicted because of their relationships with Ferro, who plaintiffs alleged desired to liquidate his shares.
The Court explained that the cleansing effect of Corwin may still be available in some instances in which entire fairness applies. As the Court of Chancery had explained in Larkin v. Shah, the only transactions subject to entire fairness that cannot be cleansed by approval of disinterested stockholders under Corwin are those in which a controlling stockholder sits on both sides of the transaction, or only on one side but competes with the common stockholders for consideration. The Court, therefore, assessed whether this was a situation in which a controlling stockholder appeared on both sides of the transaction or competed with other stockholders for consideration – in which case, the cleansing effect of Corwin would not be available.
For purposes of its analysis, the Court assumed (without deciding) that Ferro (a 26% stockholder) could be deemed a controlling stockholder. Ferro, however, was not on both sides of the transaction and the Court found that his interests were fully aligned with those of the other stockholders because Ferro’s benefit in the sale was proportionally equal to the other stockholders’ benefit. The Court explained that the complaint had not pled a situation in which Ferro’s interest in liquidating his position in the Company arose in the context of a “fire sale.” Nor did it adequately allege that Ferro was facing imminent financial distress; rather, the complaint pled that he had been selling his stock slowly over the prior six years. Thus, the Court found that the complaint failed to plead any diverging interest between Ferro and the other stockholders. Accordingly, the Court explained that the stockholder vote would cleanse the transaction if the stockholder vote was fully informed.
The Court then analyzed whether the plaintiffs had identified material misstatements or omissions in the proxy statement. If the proxy statement contained material disclosure deficiencies, the defendants could not invoke the cleansing effect of the disinterest stockholder approval of the transaction. Plaintiffs alleged that: 1) the proxy statement failed to disclose that Goldman Sachs treated stock-based compensation as a cash expense; 2) the proxy statement failed to describe the present value of the Company’s net operating losses; and 3) the proxy statement failed to disclose Ferro’s true reason for waiving the his $15 million consulting fee. Sufficient disclosure, the Court held, is providing a summary for the stockholders to comprehend, not recreate, a financial advisor’s analysis. The Court held that the proxy statement provided a fair summary of the work performed by the Board’s financial advisor and that the additional alleged omissions described in the plaintiffs’ complaint were immaterial. Furthermore, the Court explained that Ferro’s subjective intent when he waived his consulting fee is equally immaterial, since the facts surrounding the waiver were disclosed and disclosure of Ferro’s alleged subjective intent likely would not alter the total mix of information available to stockholders in deciding whether to approve the transaction. The Court found that the stockholders were fully informed in their approval of the transaction and therefore held that the stockholder vote had a cleansing effect and that the business judgment rule applied.