In re Straight Path Communications Inc. Consol. S'holder Litig., C.A. No. 2017-0486-SG (Del. Ch. June 25, 2018) (Glasscock, V.C.)
In this memorandum opinion, the Court of Chancery granted in part and denied in part Defendants’ motions to dismiss. The Court found that a transfer to the controller of a company of an indemnification claim belonging to the company’s stockholders and that would inure to their benefit upon the sale of the company was a direct claim, not derivative. The controller’s purchase of the indemnification claim and certain of the company’s assets for well below their fair values were sufficiently intertwined with the sale of the company such that the complaint stated viable claims of breaches of fiduciary duties. However, Plaintiffs’ claim for declaratory judgment and a constructive trust were dismissed because those claims were moot.
Straight Path Communications Inc. (“Straight Path”) is a wireless communications holding company. On July 31, 2013, in connection with Straight Path’s spin off from IDT Corporation (“IDT”), then Straight Path’s parent, Straight Path and IDT entered into a Separation and Distribution Agreement that obligated IDT to indemnify Straight Path for certain liabilities related to the period before the spinoff (the “Indemnification Claim”). On or about September 2016, the Federal Communications Commission (“FCC”) began investigating IDT for certain misconduct related to IDT’s renewal of certain licenses in 2011 and 2012. In connection with the FCC Investigation, Straight Path entered into a Consent Decree with the FCC, causing IDT to acknowledge in its public filings that it could be the subject of an Indemnification Claim from Straight Path related to Straight Path’s liability from the Consent Decree.
After the Consent Decree, Straight Path’s only real option was to sell itself. In connection with a possible sale, Straight Path’s Special Committee decided to exclude the value of the Indemnification Claim from any potential sale of the company and preserve and pursue the Indemnification Claim for the benefit of the stockholders, including a plan to establish a litigation trust through which the Indemnification Claim could be pursued against IDT post-closing. Howard Jonas, founder and chairman of IDT and Straight Path’s controlling stockholder, did not want the Indemnification Claim to survive a sale of Straight Path because a successful pursuit of the Indemnification Claim could bankrupt IDT, in which Howard’s children held a 10% equity interest. Consequently, Howard threatened the Special Committee that he would nix the sales process if the Committee stuck to its plan of preserving the Indemnification Claim, eventually giving the Committee no option but to reach a binding agreement with IDT to settle the Indemnification Claim for $10 million and sell Straight Path’s IP Assets to IDT for $6 million.
On February 28, 2018, Verizon acquired Straight Path for $3.1 billion and Verizon and Straight Path paid the FCC $614 million in accordance with the Consent Decree. Plaintiffs, JDSI and The Arbitrage Fund, both common stockholders of Straight Path, filed a class-action complaint directly challenging the Verizon merger. Plaintiffs’ complaint contained four counts. Count I asserted a breach of fiduciary duty claim against Howard for using his position as controlling stockholder to extract unique benefits, including settling the Indemnification Claim for well below its fair value and purchasing the IP Assets for only $6 million despite a fair value of $50 million. Count II alleged a breach of fiduciary duty against Davidi Jonas, Howard’s son and Straight Path’s CEO, for tipping off his father as to the Special Committee’s plan to put the Indemnification Claim in a litigation trust. Count III alleged that IDT aided and abetted Howard and Davidi’s breaches of fiduciary duties. Finally, Count IV, brought derivatively, sought a declaratory judgment and a constructive trust, though both requests were moot given the merger had closed.
Defendants moved to dismiss. Howard argued that Plaintiffs’ claims were derivative rather than direct and that the derivative claims failed as a matter of law. Additionally, Howard argued, as did Davidi, that the complaint failed to plead a breach of fiduciary duty.
The Court found that Plaintiffs’ claims were direct, not derivative. In support, the Court stated that there was reasonable inference that Howard, through IDT, improperly diverted the merger consideration that otherwise would have gone to Straight Path’s stockholders. The Court noted that, if the Special Committee had established the litigation trust, the stockholders would have benefitted from a larger total amount of merger consideration. Instead, by forcing the Special Committee to settle the Indemnification Claim, Howard’s conduct resulted in the stockholders receiving hundreds of millions of dollars less. Furthermore, the complaint established “a causal link between the breach complained of and the ultimate unfairness of the merger.” Accordingly, the complaint stated direct claims and the Verizon merger did not extinguish Plaintiffs’ standing to bring a claim.
Having found that Plaintiffs had standing to sue, the Court next considered whether Plaintiffs stated viable claims for breaches of fiduciary duty against Howard and Davidi. The Court found that Plaintiffs stated viable claims against Howard because Howard conditioned the merger on receiving unique, non-ratable benefits at the expense of the minority stockholders and threatened to undercut the sale process if he did not get his way—conduct that warranted entire fairness review. The Court also found that, by tipping off his father about the Special Committee’s plan to preserve the Indemnification Claim post-merger, Davidi put his interest above those of Straight Path and its stockholders and, for that reason, the Plaintiffs had stated a claim for breach of fiduciary duty.
The Court also found that the complaint adequately alleged unfair price. Howard, through IDT, forced the Special Committee to settle the Indemnification Claim for only $10 million, despite a fair value of hundreds of millions of dollars. Additionally, Straight Path sold its IP Assets to IDT for $6 million, even though the IP Assets were valued at about $50 million. Howard’s disloyal actions were intertwined with the Verizon merger and helped render the merger consideration unfair.
Finally, Plaintiffs’ aiding and abetting claim against IDT survived because the complaint adequately alleged breaches of fiduciary duties against Howard and Davidi.