In re Trados S'holder Litig., Consol. C.A. No. 1512-VCL (Del. Ch. Aug. 16, 2013) (Laster, V.C.)
A former common stockholder filed a purported class action for breach of fiduciary duty arising out of the transaction, alleging that the former Trados directors breached their duty of loyalty by favoring the interests of the preferred stockholders at the expense of the common stockholders. Specifically, the plaintiff alleged that the three directors designated by the venture capital firms were incapable of exercising disinterested and independent business judgment. The plaintiff also alleged that the two management directors received material personal benefits from the MIP as a result of the merger, and were therefore incapable of exercising disinterested and independent business judgment. The plaintiff also challenged the independence of one of the two independent directors, who had relationships and business dealings with the venture capital firms.
Following trial, the Court agreed with the plaintiff that a disinterested and independent majority of the seven-member board did not approve the transaction. The Court concluded that the two management directors received material personal benefits from the merger, including $2.34 million and $1 million, respectively, from the MIP, as well as well-paid employment with SDL following the merger. The Court also found that the three venture capital-affiliated directors were not disinterested and independent, but rather were focused on their firms’ desire to exit their investments in Trados. The Court further found that one of the two independent directors was not disinterested and independent because of, among other things, his relationships and business dealings with the venture capital firms, which resulted in a sense of “owingness” that compromised his independence.
The Court also agreed with the plaintiff that the Company’s board did not deal in a procedurally fair manner with the common stockholders. The Court explained: “The VC directors did not make this decision after evaluating Trados from the perspective of the common stockholders, but rather as holders of preferred stock with contractual cash flow rights that diverged materially from those of the common stock[.]” “There was never any effort to explore prices above $60 million or to consider whether alternatives to the Merger might generate value for the common.”
The Court also found that the VC directors adopted the MIP to incent management to favor a quick exit, and that the MIP “took value away from the common” in that, “without the MIP, the preferred stockholders would have received $57.9 million and the common stockholders $2.1 million.” “As a result, the common stockholders contributed 100% of their ex-MIP proceeds while the preferred stockholders only contributed 10% ($5.7 million / $57.9 million).” Consequently, “the MIP skewed the negotiation and structure of the Merger in a manner adverse to the common stockholders.” The MIP cutback feature also “eliminated any financial incentive for senior management to push for a price at which the common stock would receive value or to favor remaining independent with the prospect of a higher valued sale at a later date.”
The Court likewise held that the board did not approve the merger in a procedurally fair manner, because the Company directors “did not understand that their job was to maximize the value of the corporation for the benefit of the common stockholders, and they refused to recognize the conflicts [of interest] they faced.” Indeed, “the directors could not recall any specific discussion of the common stock, and they could not comprehend the possibility that the economic interests of the preferred stockholders might diverge from those of the common.” The Court also noted that “[t]he failure to condition the deal on a vote of the disinterested common stockholders . . . deprives the defendants of otherwise helpful evidence of fairness.”
Despite concluding that the merger was not approved by a disinterested and independent majority of board, and that the board engaged in an unfair process, the Court held that the defendants did not breach their fiduciary duties because the Company’s common stock had no economic value. The Court found credible the testimony of the defense expert, who, using a DCF analysis and plaintiff-friendly assumptions, valued the Company at $51.9 million, which was less than the deal price. The threat of bankruptcy, the viability of its business plan, and the size of its market were all concerns for the Company. Accordingly, the Court concluded “that Trados would not be able to grow at a rate that would yield value for the common. Trados likely could self-fund, avoid bankruptcy, and continue operating, but it did not have a realistic chance of generating sufficient return to escape the gravitational pull of the large liquidation preference and cumulative dividend” held by the preferred stockholders. Thus, it was entirely fair for the common stockholders to receive nothing in return for their shares, which were appraised at zero by the Court.