In re Orchard Enterprises, Inc. S'holder Litig., Consol. C.A. No. 7840-VCL (Del. Ch. Feb. 28, 2014) (Laster, V.C.)
In this opinion, the Court of Chancery, ruling on the parties’ cross motions for summary judgment and applying In re MFW Shareholders Litigation, 67 A.3d 496 (Del. Ch. 2013), granted in part the plaintiffs’ motion for summary judgment and held that the entire fairness standard of review applied to a challenged going-private squeeze-out merger. The Court of Chancery also addressed disclosure issues, burden shifting under the entire fairness standard, application of the entire fairness standard, and remedies available to the plaintiffs.
The underlying dispute arose out of a 2010 merger in which Dimensional Associates, LLC (“Dimensional”), the controlling stockholder of The Orchard Enterprises, Inc. (“Orchard”), squeezed out the minority stockholders of Orchard (the “Merger”). In October 2009, Dimensional delivered to Orchard a formal proposal for the Merger. In evaluating Dimensional’s proposal, a key issue was the valuation of Orchard’s Series A convertible preferred stock (the “Series A Stock”), of which Dimensional and its affiliates held 99%. On an as-converted basis, the Series A Stock had a value of approximately $7 million. Based on its liquidation preference (the “Liquidation Preference”), the Series A Stock had a value of approximately $25 million. Under the terms of the Series A Stock certificate, the Merger would not trigger payment of the Liquidation Preference, though other transactions with third parties in which the proceeds would be distributed to Orchard’s stockholders could trigger payment of the Liquidation Preference.
In December 2009, a special committee of the board (the “Special Committee”) concluded that they would recommend the Merger as long as (1) the price for Orchard’s common stock was at least in a range of $2.05 to $2.15 per share, and the financial advisor opined that such a price was fair, (2) the merger was conditioned on the affirmative vote of a majority of the minority stockholders, and (3) the merger agreement provided for a go-shop period. Dimensional countered by offering $2.00 per share with a go-shop period, but resisted the majority-of-the-minority vote condition. As negotiations continued, Dimensional offered a price of $2.10 per share with a go-shop period, but still without the majority-of-the-minority vote condition. In January 2010, the Special Committee and Dimensional agreed on a price of $2.05 per share, a go-shop period, and a majority-of-the-minority vote condition.
On July 29, 2010, a majority-of-the-minority stockholders approved the Merger and the Merger closed. After the Merger closed, certain stockholders pursued an appraisal action in the Court of Chancery (the “Appraisal Action”). In a 2012 ruling in the Appraisal Action, the Court of Chancery determined that the fair value of Orchard’s common stock at the time of the Merger was $4.67 per share.
Two months after the fair value ruling in the Appraisal Action, and more than two years after the Merger closed, the plaintiffs filed a breach of fiduciary duty action in the Court of Chancery.
First, the Court of Chancery addressed the plaintiffs’ contention that disclosures in the proxy statement were materially false or misleading. In doing so, the Court of Chancery first focused on an erroneous disclosure in the notice of meeting, which incorrectly stated that an amendment to Orchard’s certificate of incorporation was necessary to prevent the Merger consideration from first being allocated to satisfy the Liquidation Preference. The Court of Chancery noted that items of information that are required by the Delaware General Corporation Law (“DGCL”) to be provided to stockholders are material per se and that, under Section 242(b)(1) of the DGCL, a brief summary of the changes to be effected by a proposed amendment to the certificate of incorporation must be included in the notice of meeting. Therefore, the Court of Chancery held that the erroneous disclosure in the notice of meeting was material as a matter of law and granted summary judgment to the plaintiffs on this issue.
Second, the Court of Chancery addressed the appropriate standard of review for trial and which party should bear the burden of persuasion. Applying In re MFW, the Court of Chancery held that, because Dimensional did not agree up front that it would not proceed with the Merger without both (1) the affirmative recommendation of a sufficiently authorized board committee composed of independent and disinterested directors, and (2) the affirmative vote of a majority of the shares owned by stockholders that were unaffiliated with Dimensional, entire fairness would be the operative standard of review. Further, the Court of Chancery rejected the defendants’ contention that they were entitled to a pre-trial determination shifting to the plaintiffs the burden of persuasion to prove unfairness of the Merger. The Court of Chancery held that the majority-of-the-minority vote to which Dimensional eventually agreed was insufficient to shift the burden to the plaintiffs because, in light of the erroneous material disclosure in the notice of meeting, Dimensional could not establish, as a matter of law, that the majority-of-the-minority vote was fully informed.
Third, the Court of Chancery addressed the parties’ cross motions for summary judgment regarding the fairness of the Merger. Though acknowledging that the disclosure issue on which the plaintiffs prevailed on summary judgment served as evidence of an unfair process, the Court of Chancery reasoned that the lone disclosure might not be outcome-determinative at trial. With respect to the fair price aspect of entire fairness, the Court of Chancery found that the Court’s holding in the Appraisal Action that the fair value of Orchard common stock at the time of the Merger was $4.67 per share was evidence of financial unfairness. However, noting that a fair price may fall within a range of prices for purposes of the entire fairness standard of review, the Court of Chancery found that it was not possible, at this stage of the proceedings, to grant summary judgment on the issue of entire fairness to either the plaintiffs or the defendants.
Fourth, the Court of Chancery addressed the parties’ motions for summary judgment on remedy issues. Because the question of entire fairness was not resolved at the summary judgment stage, the Court of Chancery found it premature to determine what remedy the plaintiffs would receive if the Merger was not entirely fair. Thus, the Court of Chancery denied the plaintiffs’ motion for summary judgment seeking damages and pre-judgment interest.
The defendants contended that they were entitled to summary judgment on four remedy issues, irrespective of whether the Merger was entirely fair. The Special Committee members sought summary judgment in their favor, contending that, at most, they violated the duty of care and that, under the exculpatory clause in Orchard’s certificate of incorporation (the “Exculpatory Clause”), they were exculpated from liability for breaches of the duty of care. The Court of Chancery acknowledged that the Exculpatory Clause was a strong defense. However, the Court of Chancery held that, in cases involving a controlling stockholder with entire fairness as the standard of review, the Court of Chancery cannot summarily apply Section 102(b)(7) of the DGCL on a motion for summary judgment to dismiss facially independent and disinterested directors. In that scenario, the Court of Chancery explained, only after conducting a trial, determining whether a transaction was entirely fair, and if not, identifying the breaches of fiduciary duties can the court determine which directors are exculpated from liability. Thus, the Court of Chancery denied the Special Committee members’ motion for summary judgment on whether the Exculpatory Clause applied.
Next, the Court of Chancery addressed the defendants’ contention that quasi-appraisal was not an available remedy. After analyzing Delaware case law regarding quasi-appraisal as a measure of damages, the Court of Chancery concluded that decisions of the Delaware Supreme Court and the Court of Chancery have consistently held that quasi-appraisal damages are available when a fiduciary breaches its duty of disclosure in connection with a transaction that requires a stockholder vote. Rejecting the defendants’ narrow construction of Delaware case law regarding the availability of quasi-appraisal, the Court of Chancery denied the defendants’ motion for summary judgment on this issue and left open the possibility that the plaintiffs could obtain quasi-appraisal damages.
As their final argument to obtain summary judgment barring any damages award, the defendants argued that, under In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008), monetary damages for a breach of the duty of disclosure cannot be awarded after a merger closes. The Court of Chancery, however, disagreed with the defendants’ reading of Transkaryotic. Due to differences in the facts and issues between Transkaryotic and this case, the Court of Chancery concluded that the holding of Transkaryotic did not apply. Further, the Court of Chancery rejected the defendants’ broad reading of dicta in Transkaryotic as being inconsistent with the Delaware Supreme Court’s decision in Loudon v. Archer-Daniels-Midland Co., 700 A.2d 135 (Del. 1997). Holding that, in an appropriate case, Delaware law recognizes the possibility of a post-closing award of damages as a remedy for a breach of the duty of disclosure, the Court of Chancery denied the defendants’ motion for summary judgment on this issue.
Last, because a corporation itself does not owe fiduciary duties and cannot aid and abet violations by the fiduciaries who serve it, the Court of Chancery granted summary judgment in favor of Orchard against the plaintiffs’ claims of breach of fiduciary duty and aiding and abetting breach of fiduciary duty.