Davey and Belger Discuss the Delaware Court's Position on Board Deliberation Disclosures
In Appel v. Berkman, the Delaware Supreme Court held that a company’s disclosures in connection with a tender offer were misleadingly incomplete because they failed to explain the reasons that the company’s founder and chairman abstained from the board vote on whether to recommend that stockholders accept the tender offer. The decision represents the first time the Supreme Court has reversed the Court of Chancery’s dismissal based on stockholder approval of a transaction pursuant to the Supreme Court’s landmark decision in Corwin v. KKR Financial Holdings LLC. The Appel decision raises important questions regarding the required disclosure of board deliberations. It also serves as a helpful reminder that, even after Corwin and Trulia, the record of a board’s decision-making process may be available to both potential stockholder plaintiffs and the court.
The Corwin Decision
The Supreme Court in Corwin held that when equity holders — “the real parties in interest” — have a “free and informed chance to decide on the economic merits of a transaction for themselves,” there is little utility in a court second-guessing that decision. The court therefore held that “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.” As clarified in subsequent decisions, the practical result in that scenario is the dismissal of claims challenging the stockholder-approved transaction. The Court of Chancery has also held that the same cleansing effect applies where fully informed, disinterested and uncoerced stockholders accept a first step tender offer in a two-step merger under Section 251(h) of the Delaware General Corporation Law (the “DGCL”).
Appel v. Berkman in the Court of Chancery: Director Reasons for Abstaining Are Not Material
In this case, a stockholder of Diamond Resorts International (“Diamond” or the “Company”) filed a complaint challenging the Diamond board’s decision to recommend that stockholders sell their shares to Apollo Global Management in a front-end tender offer followed by a back-end merger pursuant to Section 251(h). Among other things, the complaint attacked Diamond’s failure to disclose that Stephen J. Cloobeck, Diamond’s founder, chairman and largest stockholder, abstained from the board vote on the transaction because “he was disappointed with the price and the Company’s management for not having run the business in a manner that would command a higher price, and that in his view, it was not the right time to sell the Company.” Cloobeck’s reasons for abstaining were reflected in the minutes of two meetings of the Diamond board, which the plaintiff obtained by making a demand for Diamond’s books and records under Section 220 of the DGCL.
The Court of Chancery dismissed the complaint under Corwin on the ground that stockholders’ fully informed and uncoerced acceptance of the tender offer invoked the business judgment rule. The Vice Chancellor cited five Court of Chancery decisions from 1992-2016 for the proposition that Delaware law does not require disclosure of a director’s reasons for dissenting or abstaining from a board vote. Seeing no reason to depart from “the significant weight of twenty-five years of Delaware authority on this point,” the court held that disclosure of the fact that Cloobeck abstained from the vote was sufficient and that Diamond was not required to disclose his reasons for doing so. Because the tender offer was accepted by a majority of Diamond’s disinterested stockholders, the court found the business judgment rule applicable and dismissed the complaint.
The Supreme Court: Director Reasons for Abstaining May be Material Based on the Circumstances
The Supreme Court reversed the dismissal of the complaint and in doing so rejected the bright line rule applied by the Court of Chancery. The Supreme Court noted that Diamond’s schedule 14D-9 solicitation / recommendation statement provided extensive explanation of the board’s reasons for recommending that stockholders tender their shares, but failed to disclose Cloobeck’s contrary view. In finding the latter information material, the court explained that stockholders “are entitled to give weight to their fiduciaries’ opinions about important business matters” and that “[f]ull and fair disclosure involves giving stockholders a picture that is materially accurate, and in which the imperfections and inconsistencies are not airbrushed away.”
Again eschewing a per se rule, the Supreme Court endorsed a “contextual approach” to materiality when a board decision is less than unanimous. This requires examining the facts to determine whether the information “would materially affect the mix of information, or whether the disclosure is required to make sure that other disclosures do not present a materially misleading picture.”
In making that fact-specific determination, the Supreme Court noted Cloobeck’s “unique understanding” and “in-depth knowledge” as Diamond’s founder and former CEO, and that it is “no common thing” for a chairman “to abstain from voting on the sale of the business he founded and led.” The court likewise noted Cloobeck’s decision to share his views, which contradicted the board’s recommendation, with the entire board at two meetings. In these circumstances, the Supreme Court held that the omission of Cloobeck’s reasons for abstaining rendered Diamond’s 14D-9 “misleadingly incomplete.”
The Supreme Court concluded its opinion by declining to address the defendants’ other arguments for dismissal, which were not addressed by the Court of Chancery. Most notably, the Supreme Court cited “the nature of the omission” in declining to address defendants’ argument that the complaint should be dismissed based on Diamond’s exculpatory charter provision. That statement, along with the court’s observation that “it is difficult for us to understand how the omission was inadvertent,” arguably suggest that the Supreme Court viewed the omission as potentially rising to the level of bad faith falling outside the protections of the exculpatory charter provision. Although the Supreme Court expressly did not address that question, a finding of bad faith would be particularly notable in light of the Court of Chancery’s holding that “twenty-five years of Delaware authority” supported the argument that the information need not be disclosed.
Practical Lessons for Delaware Companies and Their Counsel
The decision raises at least two important points for Delaware companies and their counsel. First, while there are arguments that the decision could largely be limited to its facts — i.e., circumstances in which a “key board member” expressly contradicts a board’s recommendation that stockholders cash out their investments — the contextual approach the Supreme Court endorsed leaves open the question of the precise circumstances in which a director’s reasons for dissenting or abstaining from a decision will be material. Importantly, the Supreme Court’s rejection of the bright line rule applied by the Court of Chancery makes clear that companies and their counsel must carefully consider whether any “imperfections and inconsistencies” in a board’s deliberations are material to stockholders in the context of a particular decision. Second, in making that determination, companies and counsel should keep in mind that the minutes and other records of the board’s deliberative process may be available to stockholder plaintiffs through a books and records demand, and that the court may rely on those materials in determining at the pleading stage whether stockholder approval was fully informed.
This article was originally published by Law360 on March 12, 2018.