In re AmTrust Financial Services, Inc. Stockholder Litigation, C.A. No. 2018-0396-AGB (Feb. 26, 2020) (Bouchard, C.)

In this decision resolving motions to dismiss for failure to state a claim, the Court of Chancery declined to apply the business judgment rule to a private equity-backed controller buyout based on the cleansing mechanism described by the Delaware Supreme Court in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”).  Although the transaction was conditioned from the outset on approval by a special committee of the board and a majority of the minority stockholders, the Court found that the complaint adequately pled that the special committee was not effective because three of the four members were interested in the transaction as a result of the transaction’s effect of extinguishing valuable derivative claims that had previously been asserted against them. 

On February 28, 2018, a four-person special committee formed to negotiate a buyout transaction with the controlling stockholders of AmTrust Financial Services, Inc. (“AmTrust”), backed by private equity firm Stone Point Capital LLC (“Stone Point”), approved a deal at $13.50 per share.  The deal was negotiated from the outset by the special committee, and the transaction was conditioned ab initio on approval by a majority of the minority stockholders. 

The price obtained by the special committee drew criticism from AmTrust’s other major stockholders, one of which, Carl Icahn, filed a lawsuit and solicited proxies to challenge the transaction.  When it became apparent that a majority of the minority would not vote in favor, the stockholder meeting to vote on the transaction, which was set for June 4, 2018, was adjourned.  Shortly after the adjourned meeting, Icahn engaged in discussions with individuals in the buyer group, without participation by the special committee, and agreed to withdraw his lawsuit and support the transaction at an increased price of $14.75 per share.  A few days later, the special committee approved a transaction at that price, which then received approval by approximately 67% of the unaffiliated minority stockholders.

The four-person special committee was comprised of Donald DeCarlo, Abraham Gulkowitz, Susan Fisch, and Raul Rivera.  Prior to the buyout negotiations, two derivative lawsuits had been filed against the members of the special committee.  The first was an action initiated by one of the plaintiffs to this lawsuit, Cambridge Retirement System, in the Court of Chancery for alleged breaches of fiduciary duty and usurpation of a corporate opportunity (the “Cambridge Action”) against three of the four special committee members (DeCarlo, Fisch, and Gulkowitz), among other defendants, and the second was a consolidated derivative action in the United States District Court for the District of Delaware against all four committee members, among others, for alleged securities law violations, breach of fiduciary duty, unjust enrichment, and waste.  In response to a motion to dismiss filed by one of the defendants in the Cambridge Action, the Court of Chancery commented that the core allegations were “very troubling” and “describe a very unusual set of circumstances” concerning the approval of a conflicted transaction.

Certain stockholders of AmTrust filed lawsuits challenging the controller buyout transaction in the Court of Chancery.  Those suits were consolidated, and the operative complaint asserted four counts:  three counts for breach of fiduciary against AmTrust’s board, the members of the controlling stockholder group, and one of the individuals in the control group in his capacity as an officer of AmTrust for their respective roles in negotiating and approving the buyout; and one count against Stone Point and entities affiliated with it for aiding and abetting breach of fiduciary duty.  All of the defendants moved to dismiss for failure to state a claim.

The threshold question for the Court in resolving the motions to dismiss was whether the business judgment rule applied due to the defendants’ adherence to the MFW cleansing mechanism for conflicts in controller buyouts.  In MFW, the Delaware Supreme Court held that the business judgment rule, rather than entire fairness, is the standard of review applied to controller buyouts if the transaction is conditioned, ab initio, upon approval by both a well-functioning special committee and the fully informed unaffiliated minority stockholders.  While the transaction here had those conditions imposed ab initio, the Court found that the special committee’s approval was insufficient for application of the business judgment rule because three of its four members were interested in the transaction because it would extinguish valuable derivative claims that had previously been asserted against them.  Emphasizing that the MFW protections were designed “to ensure not only that members of a special committee” are not “beholden to a controlling stockholder” but also “have no disabling personal interest in the transaction at issue,” the Court found that, at the pleadings stage, it was reasonably conceivable that the special committee members’ exposure in the Cambridge Action was material to them personally, based on the facts that:  (1) the special committee members tacitly acknowledged the validity of the lawsuit by answering rather than moving to dismiss; (2) the Court previously described the conduct alleged as “very troubling” and “very unusual”; (3) the claims were valued by the plaintiff’s expert to be worth in excess of $300 million; and (4) the special committee’s own financial advisor estimated the “net settlement value” of the claims to be approximately $15 to $25 million. 

Accordingly, the Court sustained the claims for breach of fiduciary duty against the controlling stockholders, as well as the three interested members of the special committee and the remaining directors on the board (who were part of the control group).  The Court, however, dismissed the lawsuit as to the fourth special committee member, Rivera, who was not named as a defendant in the Cambridge Action.  Because the plaintiffs had not alleged that Rivera had a material self-interest in the buyout and failed to plead non-conclusory facts sufficient to support a finding of bad faith, the Court found that the complaint did not state a non-exculpated claim against him. 

The Court proceeded to dismiss the count for breach of fiduciary duty against one of the individuals in the control group in his capacity as an officer of AmTrust, finding that the complaint lacked sufficient allegations of misconduct as an officer to sustain a claim.  Finally, the Court dismissed the aiding and abetting claim against Stone Point and its affiliates, finding no non-conclusory allegations in the complaint sufficient to support an inference that the Stone Point defendants knew that three of the special committee members were interested, and finding that their conduct as alleged was otherwise consistent with arm’s-length negotiations.

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