In re Morton's Restaurant Group, Inc. S'holders Litig., C.A. No 7122-CS (Del. Ch. July 23, 2013) (Strine, C.)
In this opinion, the Court of Chancery dismissed all claims in an action arising out of the acquisition of Morton’s Restaurant Group, Inc. (“Morton’s”) by entities controlled by Landry’s, Inc., finding that plaintiffs failed to support their purported entire fairness and Revlon claims.
Morton’s owned and operated a chain of high-end steakhouses. On February 1, 2012, Morton’s was acquired by wholly-owned Landry’s subsidiaries Fertitta Morton’s Restaurants, Inc. and Fertitta Morton’s Acquisitions, Inc. (together, “Fertitta”), through a tender offer approved by Morton’s board of directors (the “Board”). Prior to its acquisition by Fertitta (the “Transaction”), 27.7% of Morton’s equity was owned by a fund established by private equity firm Castle Harlan, Inc. (“Castle Harlan”). As a result of its ownership stake, Castle Harlan had the right to appoint two of Morton’s ten directors. The remaining directors were unaffiliated with Castle Harlan, and all but one of the non-Castle Harlan directors qualified as independent under the rules of the New York Stock Exchange.
According to plaintiffs, Castle Harlan suggested that the Board initiate a sales process in January 2011. Regardless of the reason, it was undisputed that the Board initiated such a process, during which 137 prospective acquirers were contacted over a period of nine months. More than 50 of those contacted entered confidentiality agreements. Morton’s engaged in due diligence with interested parties and evaluated “several” non-binding bids. Before signing up a deal with Fertitta, Morton’s entered an exclusivity agreement with another bidder, which eventually lowered its initial indication of interest and fell out of the process. Plaintiffs conceded that no potentially interested buyers went uncontacted and that the Board did not resist working with any buyers. Morton’s entered into a merger agreement (the “Merger Agreement”) with Fertitta on December 15, 2011. Under the terms of the Merger Agreement, Fertitta would acquire Morton’s in a tender offer and back-end merger in which all Morton’s stockholders would receive $6.90 per share, representing a 33% premium over Morton’s unaffected closing market price.
Multiple stockholder actions were filed in the Delaware Court of Chancery to challenge the Transaction and were subsequently consolidated. Plaintiffs conducted limited discovery. They initiated, and later abandoned, preliminary injunction proceedings to prevent the Transaction. After the Transaction closed, plaintiffs conducted additional discovery and amended their complaint to allege that the Board breached its fiduciary duties in connection with the Transaction. Plaintiffs also alleged that that Fertitta and Morton’s two financial advisors – Jefferies & Company (“Jefferies”) and KeyBanc Capital Markets Inc. (“KeyBanc”) – aided and abetted the Board’s fiduciary breach. Plaintiffs alleged that Castle Harlan controlled the Board through its 27.7% stake, ability to appoint two directors, and history as Morton’s private equity sponsor. Plaintiffs alleged that, in its alleged capacity as controller, Castle Harlan worked in its own self-interest to sell Morton’s quickly for an inadequate price in order to achieve liquidity. According to plaintiffs, Morton’s supermajority independent Board acquiesced in Morton’s plan, thereby breaching its duty of loyalty.
Plaintiffs claimed that the Transaction should be subject to entire fairness review, based both on Castle Harlan’s alleged controller status and on allegations that Castle Harlan suffered a conflict due to its need for liquidity. The Court rejected both arguments. First, because Castle Harlan owned less than 50% of Morton’s, plaintiffs were required under Delaware law to allege well-pled facts demonstrating “actual domination and control” over the independent directors in order to establish Castle Harlan as a controller. The Court found that Castle Harlan, as a 27.7% stockholder with the ability to appoint two out of ten directors, could not be considered a controller, “especially where the Complaint does not even attempt to cast into doubt the independence of the seven disinterested directors.” Second, the Court found that even if Castle Harlan were a controlling stockholder, plaintiffs had failed to allege a genuine conflict of interest. The Court found that Castle Harlan supported a “full and unhurried market check,” which belied any suggestion that it disposed of Morton’s quickly in order to achieve liquidity. Moreover, under Delaware law, the fact that Castle Harlan, as a large stockholder, supported an arm’s length, third-party transaction in which it received consideration ratably with other stockholders created a presumptive safe harbor and “immunize[d] the transaction.”
Plaintiffs attempted to circumvent the presumption of fairness by arguing that the Transaction was the culmination of plans from the “private equity playbook,” by which a firm will take a company private and improve its operations before taking it public again and ultimately selling its entire stake. The Court described itself as “flummoxed” by this “strange” part of plaintiffs’ argument because “[i]t would be perverse . . . to penalize all stockholders” by dissuading private equity firms from arranging premium deals that ultimately benefit other stockholders and American equities markets as a whole.
The Court also rejected plaintiffs’ claim that the Board breached its duties under the Revlon doctrine to take reasonable efforts in the sale of a company to obtain the highest price reasonably available. Because Morton’s charter included an exculpatory provision as permitted by Section 102(b)(7) of the Delaware General Corporation Law, plaintiffs were required to sufficiently allege a breach of the fiduciary duty of loyalty, rather than only a breach of the duty of care, to plead a viable claim under Revlon. The Court found that the Board’s extensive sales process, coupled with a lack of meaningful challenge to the fairness opinions obtained by the Board, provided “no basis for the court to infer that there was any Revlon breach, much less a non-exculpated one.”
In addition to allegations involving only Castle Harlan and the Board, plaintiffs purported to stake claims on two alleged improprieties related to Morton’s financial advisors. First, plaintiffs pointed out that the Board permitted its first advisor – Jefferies – to provide buy-side or “staple” financing late in the sales process. Plaintiffs alleged that the Board did so in order to allow Fertitta to lower its bid. The Court found no support for such an argument. Jefferies was only allowed to provide financing after Fertitta informed the Board’s M&A committee that it had experienced difficulty obtaining financing and that it had approached Jefferies for that purpose. Importantly, the Board only permitted Jefferies to provide financing subject to several conditions. Jefferies was required to recuse itself from any further negotiations with Fertitta, to reduce its fee by $600,000, and nevertheless still to provide a fairness opinion. The $600,000 fee reduction was used by the Board to hire a second financial advisor, KeyBanc, to continue shopping Morton’s and provide a separate fairness opinion. The Court found that such a strategy, undertaken to avoid the risk of “losing a bid at a high premium to market,” did not “create an inference of bad faith.”
Plaintiffs also implicated the financial advisors by challenging certain inputs to their fairness opinions, thereby attempting to establish a loyalty breach on the part of the directors who relied on those opinions. To make such a showing, plaintiffs were required to plead “non-conclusory facts creating a reasonable inference that the board purposely relied on analyses that were inaccurate for some improper reason.” Plaintiffs failed to make such a showing because they challenged only Jefferies’ decision to apply a 2% perpetuity growth rate, which it reduced from 9.2% following discussions with Morton’s management. Both the 2% rate and the reduction were disclosed. Morton’s stockholders were therefore provided with all material information to decide whether the Board justifiably relied on Jefferies’ fairness opinion, and could have sought appraisal if they thought it did not. Moreover, stockholders could look to the KeyBanc opinion, which independently applied a growth rate of less than 2%. The Court therefore dismissed all of plaintiffs’ claims with prejudice.