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Melvyn Klein v. H.I.G. Capital, L.L.C., et al., C.A. No. 2017-0862-AGB (Del. Ch. Dec. 19, 2018) (Bouchard, C.)

December 19, 2018

In this memorandum opinion, the Court rejected a stockholder plaintiff’s assertion that admittedly derivative claims could be pursued as “dual” direct and derivative claims under the Delaware Supreme Court’s decision in Gentile v. Rosette, reasoning that the alleged economic injury to the minority stockholders did not result from “the expropriation of economic value . . . by diluting their aggregate ownership percentage” but rather from the issuance of preferred stock at a lower price than should have been paid.  The Court further held, however, that the plaintiff alleged sufficient facts to state certain derivative claims in connection with a series of related transactions involving Surgery Partners, Inc. (the “Company”), its former controlling stockholder, H.I.G. Capital, L.L.C. and its affiliates (collectively, “HIG”), and Bain Capital Private Equity LP and its affiliates (collectively, “Bain”). 

The plaintiff, a stockholder of the Company, brought direct and derivative claims for breach of fiduciary duty against HIG, certain of the Company’s directors, and Bain, as well as an aiding and abetting claim against Bain in the alternative, for their roles in three related transactions in May of 2017.  The three transactions, each of which was conditioned on the others, were:  (i) the Company’s purchase of National Surgical Healthcare from a third party for approximately $760 million, (ii) HIG’s sale of its 54% common stock stake in the Company to Bain for $19 per share in cash ($502.7 million total) and (iii) the Company’s issuance of 310,000 shares of newly created Series A preferred stock to Bain for $1,000 per share.  The plaintiff alleged that the Series A preferred stock had several attractive features, including an “extraordinarily favorable” dividend rate, significant voting rights and a convertible price that was already “near or in the money.”  The plaintiff argued that the interrelated transactions incentivized HIG “to provide Bain favorable terms on the Series A preferred in order to maximize the price at which HIG could liquidate and exit its investment in Surgery Partners.”  The plaintiff further alleged, in conjunction with the issuance of the Series A preferred stock to Bain, that:  the Company and Bain used the same legal and accounting advisors during their negotiations; the Company failed to utilize a special committee; the Company did not receive a fairness opinion from its financial advisor regarding the proposed consideration for the issuance of the Series A preferred stock; and the financial advisor was conflicted due to the additional consideration it would receive from providing financing in connection with the National Surgical Healthcare transaction.

The Court first rejected the plaintiff’s attempt to invoke the “transactional paradigm” in Gentile v. Rosette, 906 A.2d 91, 99 (Del. 2006) by pleading “dual” direct and derivative claims for breach of fiduciary duty in connection with the Company’s alleged overpayment in its issuance of the Series A preferred stock to Bain.  The Court noted that the Delaware Supreme Court had narrowed the scope of Gentile in El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248 (Del. 2016) to only those cases in which (i) there is a controlling stockholder or control group; and (ii) the challenged transaction results “in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.”  The Court held that, even if the Court treated Bain as a controlling stockholder, the minority stockholders would still not suffer the type of economic injury contemplated by the Court’s decision in Gentile because the common stockholders would retain the same “aggregate percentage” ownership of the Company’s common stock.  The Court therefore dismissed the direct claims as “classic” overpayment claims that were “plainly derivative in nature.” 

The Court then considered the plaintiff’s assertion that a pre-suit demand on the Company’s board should be excused as futile.  Because the plaintiff conceded the independence of two directors and the defendants had not contested the lack of independence of three of the directors, the Court focused its analysis on one of the two remaining directors, the Company’s former chief executive officer.  The Court held that the plaintiff had pled facts that raised a doubt as to that director’s independence, relying largely on consulting fees that the director allegedly continued to receive from the Company after it was controlled by Bain, which exceeded both his prior salary as CEO and the independence threshold established by the NASDAQ rules.  The Court therefore concluded that the majority of the board was not independent and disinterested under Aronson v. Lewis, thus excusing the plaintiff’s failure to make a demand on the Company’s board.

The Court next analyzed the derivative claims.  First, the Court rejected the plaintiff’s “novel” theory that Bain could be a part of the controlling stockholder group, when it did not own any stock of the Company until the completion of the three transactions.  The Court stated that Bain, at most, had “potential to exercise control,” which was not enough under Delaware law to trigger a fiduciary duty, and dismissed the derivative breach of fiduciary duty claim against Bain.

Second, the Court found that the plaintiff had successfully invoked the entire fairness standard of review with respect to its claim against HIG, as the Company’s controlling stockholder, by alleging that HIG received a non-ratable benefit and was conflicted with respect to the challenged transactions.  Because the complaint raised litigable issues concerning the fairness of the preferred stock issuance, the Court declined to dismiss that claim. 

Third, the Court held that the plaintiff stated a claim that Bain aided and abetted HIG’s alleged breach of fiduciary duty, finding that the facts pled in the complaint raised “a reasonable inference that Bain may have knowingly exploited HIG’s conflict to its advantage.

Finally, the Court dismissed the breach of fiduciary duty claim against the Company’s former CEO, who was not alleged to have acted in bad faith or have a personal interest in the challenged transaction.

The full opinion is available here