Voigt v. Metcalf, et al., No. CV 2018-0828-JTL, 2020 WL 614999 (Del. Ch. Feb. 10, 2020) (Laster, V.C.)
In this memorandum opinion, the Delaware Court of Chancery denied a motion to dismiss claims of breach of fiduciary duty against certain directors and against a purported controlling stockholder in connection with a corporation’s merger with an entity also controlled by the purported controlling stockholder. In so ruling, the Court held that it was reasonably conceivable that the purported controlling stockholder did in fact control the corporation, thereby subjecting the merger to review under the entire fairness standard. The Court further held that it was premature at the pleading stage to determine whether certain directors were protected from liability because they abstained from the final vote on the merger, recognizing that a director could be held liable, despite abstention, if the director was significantly involved in the challenged transaction.
The private equity firm Clayton, Dubilier & Rice (“CD&R”) owned shares of capital stock of NCI Building Systems, Inc. (the “Company”), a manufacturer of metal products, constituting 34.8% of the voting power of the Company’s outstanding shares of capital stock. CD&R also had the right to nominate certain directors and has longstanding ties and relationships with key executives in the Company and with certain directors that currently or historically worked for or served on the boards of CD&R’s other portfolio companies.
In July 2018, the Company acquired Ply Gem Parent, LLC (“New Ply Gem”) through a direct merger of New Ply Gem within and into the Company (the “Challenged Transaction”). When negotiating the deal, CD&R insisted on terms that valued New Ply Gem at $1.236 billion. Three months prior to the Challenged Transaction, CD&R created New Ply Gem by completing a leveraged buyout of its publicly traded predecessor, Ply Gem Holdings, Inc. (“Old Ply Gem”), then combining Old Ply Gem with a portfolio company owned by Golden Gate Capital (the “Precedent Transaction”). After the Precedent Transaction, CD&R owned 70% of New Ply Gem and had the right to appoint a majority of its directors. When negotiating the Precedent Transaction, CD&R and Golden Gate valued New Ply Gem at $638 million.
In this derivative suit, Plaintiff asserted that CD&R and the board members of the Company breached their fiduciary duties in connection with the Challenged Transaction, claiming that the Challenged Transaction was not entirely fair given that the Company—purportedly controlled by CB&R—purchased New Ply Gem for approximately $600 million more than CB&R had valued New Ply Gem just three months prior. Plaintiff also contended that CD&R was unjustly enriched by the Challenged Transaction.
The defendants moved to dismiss the complaint for failing to state a claim on which relief can be granted, maintaining that the plaintiff had not pled facts sufficient to support a reasonable inference that CD&R controlled the Company. Defendants contended that, as a result, the Challenged Transaction was not subject to review under the entire fairness standard, but that the traditional business judgment rule applied or, under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2014), an irrebuttable version of the business judgment rule governed. Seven of the individual defendants argued that even if the transaction was subject to review for entire fairness, the claims against them should be dismissed because the Company’s certificate of incorporation included a provision exculpating the directors pursuant to Section 102(b)(7) of the General Corporation Law of the State of Delaware. Four of these defendants also argued that the claims against them should be dismissed because they abstained from voting on the Challenged Transaction.
As an initial matter, the Court refused to rely upon documents produced as a result of a prior books and records demand to draw inferences in the defendants’ favor, as defendants requested. The Court explained that the incorporation-by-reference doctrine does not enable it to weigh evidence on a motion to dismiss and does not change the pleading standard that governs the motion.
The Court focused predominantly on the “headline issue” of whether the plaintiff pled facts that make it reasonably conceivable that CD&R controlled the Company. If CD&R was found to be a controlling stockholder, the defendants would have to prove entire fairness; if CD&R was found not to be a controlling stockholder, then the more deferential business judgment rule or the irrebuttable version of the business judgment rule would govern.
The Court held that at the pleading stage, plaintiff pled facts sufficient to demonstrate that it is reasonably conceivable that CD&R controlled the Company, subjecting the Challenged Transaction to review under the entire fairness standard, and that the valuation gap between the Challenged Transaction and the Precedent Transaction was sufficiently large, and the temporal gap sufficiently short, to support a pleading-stage inference of unfairness. In making this determination, the Court pointed to several indicia of influence that, taken collectively, supported a pleading-stage inference of control.
First, the Court explained that the Complaint’s allegations supported an inference that CD&R maintained significant control over the composition of the board. Four of twelve board members were nominated by CD&R, and four other directors had longstanding ties with CD&R. Indeed, the company’s own disclosures recognized CD&R’s influence over certain directors. Defendants argued, without success, that the longstanding relationships between CD&R and several directors were stale and not indicative that such directors were beholden to CD&R. Second, the Court explained that the size of the equity stake CD&R held (34.8%) contributed to an inference of actual control. Third, CD&R possessed consent rights and other contractual rights that gave CD&R “power over the Company beyond what the holder of a mathematical majority of the voting power ordinarily would possess.” Fourth, CD&R had the right to proportionate representation on each committee of the Board. Finally, the Court explained that another source of influence adequately pled by plaintiff was CD&R’s relationships with key executives, including the CEO, and with key advisors, including the financial adviser involved in the Challenged Transaction.
Having found it reasonably conceivable that CD&R controlled the Company, the Court then determined that plaintiff’s allegations supported an inference that the Challenged Transaction was not the product of fair dealing or fair price under the entire fairness standard. In reviewing the fair process aspect of the entire fairness test, the Court found that the bank selected by the special committee was advising another CD&R company while working for the committee. Most strikingly, the company’s Proxy Statement failed to disclose adequately that CD&R had recently engaged in a transaction that valued New Ply Gem at an amount that was $600 million dollars less than the price of the Challenged Transaction. As it relates to fair price, the Court found that the large valuation gap between the Challenged Transaction and Precedent Transaction alone was sufficient to support a pleading stage inference of an unfair price.
The Court granted the motion to dismiss as it related to the four directors who had no “compromising relationships or sources of influences.” However, the motion to dismiss was denied as it related to the other directors who were potentially influenced and controlled by CD&R. Moreover, the Court held that these remaining directors were not protected by the exculpation provision because the plaintiff adequately pled facts that supported an inference that these directors breached the duty of loyalty and acted in bad faith.
Finally, the Court held that it was premature to determine at the pleading stage whether certain directors were protected from liability because they abstained from the final vote on the challenged transaction. The Court recognized that a director could be held liable even if the director abstained from the formal vote to approve the transaction, depending on the director’s overall involvement with the transaction.