City of Sarasota Firefighters’ Pension Fund v. Inovalon Holdings Inc., C.A. No. 2022-0698-KSJM (Del. Ch. June 10, 2025)

Background

           In this letter decision, Chancellor McCormick addressed defendants’ supplemental motions to dismiss, raised on remand after the Delaware Supreme Court reversed a 2023 bench ruling dismissing the complaint in its entirety under Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”).

           Minority stockholder plaintiffs brought a class action challenging the acquisition of defendant Inovalon Holdings, Inc. by a private equity consortium, asserting claims for breach of fiduciary duty against Inovalon’s board of directors and against its CEO and claims of unjust enrichment against certain rollover stockholders and one defendant who accepted a post-closing compensation package.  Plaintiff also brought a claim for breach of the implied covenant of good faith and fair dealing of Inovalon’s certificate of incorporation.  Defendants moved to dismiss, and the Court of Chancery granted the motions after concluding that the transaction complied with the requirements of MFW.^[1]  The Court did not reach Defendants’ other arguments.

          Plaintiffs appealed, contending in part that dismissal under MFW was improper because the minority stockholder vote approving the transaction was not informed as the result of material omissions in the proxy statement.^[2]  The Delaware Supreme Court agreed and reversed and remanded the case, ruling that the proxy statement failed to disclose material information about conflicts of the special committee’s advisors—information the Court deemed “uniquely important” to the minority stockholder. 

           In supplemental motions on remand, the individual director defendants, including members of the special committee, moved to dismiss the fiduciary duty claims under In re Cornerstone Therapeutics Inc. S’holder Litig., 115 A.3d 1173 (Del. 2015).  Defendants also moved to dismiss the claim for breach of the implied covenant of Inovalon’s certificate of incorporation.  The Court of Chancery denied the motions as to the fiduciary duty claims in respect of the special committee defendants and granted dismissal of the claim for breach of the implied covenant.

Analysis

           Plaintiffs argued that the special committee defendants were not entitled to dismissal under Cornerstone because the complaint had adequately pled non-exculpated claims.  Those claims focused on the directors knowingly and in bad faith failing to disclose material information in the proxy statement.  Defendants did not contest they were aware of the omitted information.  Nor was the materiality of that information at issue, having been established as a matter of law pursuant to the Supreme Court’s decision.  Therefore, the Court of Chancery’s analysis on remand turned on whether Plaintiffs had pled facts sufficient to raise an inference of bad faith.  For a bad faith claim based on disclosure deficiencies to survive a motion to dismiss, the plaintiff must plead that the defendants “intentionally withheld or failed to disclose the material information in conscious disregard of their fiduciary duties.”

            Given the “unique importance” of the omitted information to voting stockholders, the Chancellor found it reasonably conceivable that the special committee defendants had withheld certain facts to make the process “look better.”  Moreover, the Chancellor rejected the argument that any inference of bad faith was undermined by the total mix of information provided in the proxy statement.  Rather, as also noted in the Supreme Court decision, discrepancies in the information disclosed in respect of each of the advisors in the proxy statement and the more fulsome account of the advisors’ roles reflected in meeting minutes supported at least a reasonable inference that the special committee defendants intentionally withheld material information.  Thus, the complaint stated a non-exculpated claim and the Cornerstone motion to dismiss was denied.

            Defendants also moved to dismiss the breach of the implied covenant of Inovalon’s certificate of incorporation.  Inovalon’s certificate of incorporation included a provision that required the approval of the holders of Class A Common Stock and Class B Common Stock, each voting separately as a class, to authorize differential treatment between the shares of each class.  Plaintiffs contended that, although the required vote was actually obtained, the defendants violated the implied covenant because the stockholders were uninformed. 

             In support, Plaintiffs relied on Dieckman v. Regency GP LP, in which the Supreme Court reversed the Court of Chancery’s dismissal of a similar claim against a limited partnership.^[3]  There, the Supreme Court reasoned that the limited partnership agreement, which eliminated fiduciary duties but included certain contractual protections similar to MFW, contained an implied obligation not to mislead its unitholders in connection with obtaining the required approval.  The Court of Chancery rejected Plaintiff’s comparison because it ignored “the nature of the implied covenant and important distinctions between alternative entity and corporate law.”  The Chancellor noted that parties to alternative entity agreements have the freedom to eliminate or modify fiduciary obligations and that this ability “informs” the reasonable expectations of the parties when contracting.  Because those obligations cannot be modified in the corporate context, the Chancellor “did not need to speculate” about the parties’ expectations in connection with modifying the fiduciary regime.  The Chancellor dismissed the claim, as “[t]here is no space for or purpose to the implied covenant in this context.”

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