2004 Developments in Delaware Corporate Law
Introduction
2004 presented another interesting year in Delaware Corporate Law. In this article, we have attempted to assemble and summarize the most important - as well as most interesting - decisions of 2004. The topics range from the still evolving duty of good faith (as discussed in Emerging Communications, Inc., the latest Walt Disney decision, and Integrated Health Services) to the rights of shareholders with respect to books and records (see Orloff v. Weinstein Enterprises, Inc.); from statutory interpretation (Jones Apparel Group, Inc. v. Maxwell Shoe Co.) to deal protection mechanisms (Orman v. Cullman); and from increased liability of expert directors (Emerging Communications) to the test for derivative versus direct claims (Tooley v. Donaldson, Lufkin & Jenrette, Inc.).
MBAs and CPAs Beware: Liability of the Expert Director
In re Emerging Communications, Inc. Shareholders Litigation
Emerging Communications, Inc. ("ECM") was the exclusive provider of wired telephone service in the U.S. Virgin Islands. ECM's majority stockholder was Innovative Communications Corporation, L.L.C. ("Innovative"). ECM's Chairman and CEO, Jeffrey Prosser ("Prosser") owned and controlled Innovative through his ownership of another entity. Prosser therefore had effective voting control over both ECM and Innovative.
In 1998, Prosser proposed to merge ECM into a subsidiary, but decided against it because of his belief that the lack of market interest in the stock had caused ECM stock to be undervalued. Thus, he proposed that Innovative acquire all of the ECM shares it did not already own for $9.125 per share. ECM formed a special committee (the "Committee") to represent the public shareholders, and the Committee hired its own legal and financial advisors. The Committee and its financial advisors were provided with ECM's March 1998 financial projections but, significantly, were not provided with June 1998 projections, which Prosser had caused to be prepared. Not surprisingly, the June projections predicted substantially higher growth than the March projections.
The Committee negotiated a merger price of $10.25 per share, and based on the Committee's recommendation, the full board approved the privatization of ECM, via a tender offer and subsequent merger. The merger agreement contained a "majority-of-the-minority" provision, requiring that the majority of the minority stockholders tender their shares for the merger to be consummated. A majority of the minority stockholders did in fact tender their shares, and ECM was merged into Innovative.
Plaintiffs, former shareholders of ECM, brought suit seeking appraisal of the fair value of their shares of ECM, alleging as well that the directors of ECM had breached their fiduciary duties of care and loyalty by approving the transaction. As to the appraisal portion of the action, the Court concluded that the proper valuation incorporated the June 1998 projections, and fixed the fair value of ECM at $38.05 per share.
Having determined the fair value of ECM to be significantly higher than the price paid to the minority shareholders, the Court looked at the "fair dealing" aspect of the entire fairness analysis "if only to enable the Court to determine the 'basis for the [defendants'] liability' for § 102(b)(7) exculpation purposes."[2] Both parties agreed that entire fairness was the standard of review, but they disagreed as to the appropriate allocation of the burden of proof. Defendants argued that the burden of establishing that the merger was not entirely fair shifted to the plaintiffs because the merger was approved by both an informed independent committee of disinterested directors and an informed majority of minority stockholders. The Court held, however, that neither the Committee nor the minority stockholders were "informed" because they had not been provided with the June Projections. Accordingly, the Court held that the burden of proving the entire fairness of the merger remained with the defendants. The Court further found that defendants had not met this burden because of various deficiencies in the negotiation and approval process. Specifically, the Court found that Prosser had timed the freeze-out merger to take advantage of the temporarily and artificially depressed stock price. The Court found that the Committee was not independent, because two of its three members were beholden to Prosser. As to the remaining committee member, the Court held that he had been "careless, if not reckless" in routing all of his communications with the other Committee members through Prosser's secretary.[3]
Finally, the Court addressed the issue of which of the individual defendants were personally liable for their breaches of duties. Such a determination centered on whether the defendants were guilty of breaching the duty of care, for which they would be exculpated under a 102(b)(7) provision in ECM's charter, or the duty of loyalty or good faith, for which they would not. With respect to Prosser, the Court held that he had breached his duty of loyalty, as had Innovative and another Prosser-controlled entity, ICC, which were the mechanisms through which Prosser accomplished the merger. The Court held that defendant John P. Raynor ("Raynor"), Prosser's personal attorney and business associate, had breached his duty of loyalty as well, notwithstanding that he did not directly benefit from the transaction, because he had actively assisted Prosser in carrying out the Privatization and had acted to further Prosser's interests, rather than the interests of the minority stockholders. The Court found that Raynor's "economic interests were tied solely to Prosser and he acted to further those economic interests."[4]
In the most notable portion of the opinion, the Court found that defendant Salvatore Muoio, a principal in an investment advising firm, with significant experience in finance, had breached his duty of loyalty because he voted to approve the transaction "even though he knew, or at the very least had strong reasons to believe, that the $10.25 per share merger price was unfair."[5] In support of this finding, the Court made specific mention of Muoio's financial expertise and experience, suggesting that such special knowledge might enhance the standard by which a director's performance is gauged.
With respect to the other four directors, the Court held that, although their conduct was "highly troublesome," there was nothing in the record to suggest that they had breached their duties of loyalty.[6] Furthermore, quoting the much-publicized Disney decision, the Court held that these directors were also not liable for breaching the duty of good faith because there was no evidence that these directors had "consciously and intentionally disregard[ed] their responsibilities, adopting a 'we don't care about the risks' attitude concerning a material corporate decision."[7]
You Gotta Have Faith (Good Faith, that is): Disney Developments
In re Walt Disney Company Derivative Litigation
In this most recent Disney opinion, the Court of Chancery addressed defendant Michael Ovitz's motion for summary judgment in the much-publicized derivative action brought on behalf of the Walt Disney Company ("Disney" or the "Company") following Ovitz's tenure and termination as Disney's president in 1995-1996. The motion focused on plaintiffs' claims that Ovitz breached his fiduciary duties in the negotiation of his employment agreement, and a claim of waste relating to Ovitz's termination and receipt of Non-Fault Termination ("NFT") benefits. The Court granted in part and denied in part Ovitz's motion for summary judgment.
Ovitz was hired on October 1, 1995 to serve as president of Disney, following the untimely death of Frank Wells and the acrimonious exit of Jeffrey Katzenberg. As of that date, he did not have a finalized and duly executed employment agreement, although he had entered into a letter agreement on August 14, 1995. Between August 14 and October 1, there were material and substantial changes to the draft employment agreement. Following October 1, however, the only change in the draft employment agreement was to change the date on which Ovitz's options would be priced. A final agreement was signed on or about December 16, 1995, with an effective date of October 1, 1995. Plaintiffs alleged that the negotiation surrounding the employment agreement, both before and after Ovitz was officially retained, was the result of breaches of Ovitz's fiduciary duties of due care and loyalty. Specifically, Plaintiff alleged Ovitz negotiated employment terms that were favorable to him at the expense of Disney's shareholders.
The Court first concluded that Ovitz was not a fiduciary until October 1, 1995. Although plaintiffs argued that Ovitz owed fiduciary duties starting in mid-August 1995, when his official installation as President and status as a fiduciary was a foregone conclusion, the Court found that a bright-line rule, whereby directors and officers become fiduciaries only when they are officially installed, was the only way to avoid uncertainty regarding when one becomes a fiduciary. The Court held that, prior to this time, Ovitz was free to negotiate for himself the best employment terms possible.
The Court also concluded that the negotiations surrounding the employment agreement that took place after October 1, 1995 did not constitute a breach of fiduciary duty because the employment agreement did not substantially change between October 1 and December 16, when the agreement was executed. Plaintiffs argued that, even without any substantial changes, Ovitz breached his fiduciary duties by signing and accepting its benefits. The Court also rejected this argument, stating that it would make little sense to adopt a rule that allowed an officer to retain the benefits of an agreement he executed before he took office, but required an officer to demonstrate the entire fairness of the agreement if he executed it after he took office.
As to Plaintiffs' claims for waste, the Court concluded that issues of material fact remained as to whether Disney received "'any substantial consideration'" and whether there was a "'good faith judgment'" by the board "'that in the circumstances the [No-Fault Termination was] worthwhile….'"[9] The Court also concluded that issues of material fact remained regarding whether Ovitz breached his fiduciary duties in receiving a non-fault termination. Ovitz argued that as long as he held a subjective belief that Disney did not have good cause to terminate him, he was justified in receiving NFT benefits. The Court, however, ruled that Delaware law has always taken an objective approach to determining fiduciary duties. Thus, these claims were not dismissed, as the Court believed that material issues of fact remained as to the basis for Ovitz's receipt of the NFT, and the use of his position to obtain the NFT.
Official Committee of Unsecured Creditors of Integrated Health Services, Inc. v. Elkins
Plaintiff, the Official Committee of Unsecured Creditors (the "Committee" or "Plaintiff") of Integrated Health Services, Inc. ("IHS"), initiated a suit against the current and former members of the IHS Board of Directors, alleging that the directors had breached their fiduciary duties of loyalty and care in the approval of various compensation arrangements for Robert N. Elkins ("Elkins"), IHS's former chairman and CEO.
IHS was engaged in the business of operating a national chain of nursing homes. Following changes to the Medicare reimbursement formula effected by the Balanced Budget Act of 1997, IHS's cash flow was negatively affected and the Company eventually went into bankruptcy.
Prior to IHS's downfall, Elkins had received a five-year employment agreement from IHS providing for salary, a performance-based bonus, stock and stock options, and contributions to the IHS employee benefit and retirement plans. Over the next several years, Elkins was awarded several large bonuses, options, and various loans. IHS also made loans to other officers in Elkins's management team. In January 2000, IHS amended the employment agreements of Elkins and the officers having outstanding loans from IHS to allow for forgiveness of those loans (totaling approximately $16 million) if Elkins were to depart from IHS. When Elkins left IHS in January 2000, IHS forgave $16 million in loans to other IHS officers, as well as $ 40 million in loans to Elkins. Plaintiffs challenged each of these various compensation transactions as breaches of the directors' duties of loyalty and care. Defendants moved to dismiss on the grounds that a majority of disinterested, independent directors approved all of the compensation arrangements (thus precluding plaintiffs from succeeding on a duty of loyalty claim); and that they were insulated from liability for duty of care claims by the 102(b)(7) exculpation provision of IHS's charter and that, in either event, their conduct was not grossly negligent, the standard for a duty of care claim.
The Court first looked at the duty of loyalty issue and concluded that, because a majority of the Board members who approved the challenged transactions were disinterested and independent, it could not find that the directors, other than Elkins, breached their duty of loyalty.
As to the duty of care claim, however, the Court looked at the so-called "Disney" standard, noting that a defendant director could be liable for a breach of fiduciary duty where they "consciously and intentionally disregarded their responsibilities."[11] Noting that both this case and Disney involved Board approval of compensation packages, and the appropriateness of acting with deference to corporate officers' judgments, the Court stated, "the board must exercise its own business judgment in approving an executive compensation package."[12]
Observing that the latter standard "moves beyond gross negligence," the Court concluded that plaintiff had nevertheless met this burden for purposes of surviving a motion to dismiss by alleging: (1) that the Board had acted to approve loans in 1996 without investigation, deliberation, consultation or explanation; (2) that the Board had approved the forgiveness of amounts due under a $2.088 million loan in "blind faith,"; (3) that the Board had approved of a $4.5 million loan to Elkins without any deliberation as to the appropriateness of granting the loan; and (4) that IHS's amendment of the employment agreements of Elkins and other officers, to provide for forgiveness of Elkins's and other officers' loans upon Elkins's leaving IHS, had been done without any corporate authorization or any analysis of the amendment's effect on IHS.[13] Thus, the Court denied Defendants' motion to dismiss with respect to each of these claims. Finally, the Court concluded that plaintiff had not adequately pled its claim of corporate waste.
What the DGCL Giveth, the Charter May Taketh Away: Validity of Charter Provisions Restricting the Authority Granted to Boards of Directors by the DGCL
Jones Apparel Group, Inc. v. Maxwell Shoe Company, Inc.[14]
Jones Apparel Group is a Pennsylvania corporation engaged in the business of designing and marketing branded apparel, footwear and accessories. Maxwell Shoe Company is a Delaware corporation in the business of designing, developing, and marketing casual and dress footwear for women and children.
In November 2003, Jones approached Maxwell about the possibility of a negotiated acquisition of Maxwell. Informal negotiations ensued, but no formal offer resulted. On February 25, 2004, Jones publicly announced its proposal to acquire all of Maxwell's shares at a price of $20 per share. Maxwell's board unanimously declared that offer inadequate.
On March 23, 2004, Jones filed its Schedule TO with the SEC commencing its tender offer for Maxwell, and a preliminary consent solicitation stating that Jones was considering proposing the removal of Maxwell's yet-to-be elected management slate that was seeking election at the annual meeting on April 8, 2004.
With respect to action taken by written consent Maxwell's charter provided:
- The record date with respect to the determination of stockholders entitled to consent in writing to any action shall be the first date on which a signed written consent setting forth the action to be taken or proposed to be taken is delivered to the corporation…[15]
On March 25, 2004, Maxwell announced that its board had "'set a record date of March 25, 2004 in connection with Jones Apparel Group, Inc.'s consent solicitation…'"[16] The announcement did not mention whether Maxwell had received any written consents in connection with the Jones solicitation.
The next day, Jones served Maxwell with a books and record demand, pursuant to Section 220, seeking specifically to determine whether Maxwell had received any written consents from any stockholders as of March 25. Jones feared that Maxwell had obtained a consent simply to accelerate the setting of a record date and effectively shorten the 60-day period for consideration of Jones's solicitation materials, which under Section 228(c) would begin on the day the earliest consent was properly delivered to the corporation. Maxwell refused the demand and Jones filed a complaint under Section 220.
In an April 7, 2004 letter to the Court, Maxwell stated that they had not received a written consent, but had set the March 25, 2004 record date pursuant to 8 Del. C. § 213(b), which it contended granted the board the authority to set the record date in connection with any written consent solicitation, whether or not the Maxwell charter purported to deprive the board of that authority. Section 213(b) provides:
- In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the board of directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the board of directors, and which date shall not be more than 10 days after the date upon which the resolution fixing the record date is adopted by the board of directors. If no record date has been fixed by the board of directors, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the board of directors is required by this chapter, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation…[17]
Maxwell argued that Section 213(b) gave its board the statutory power to set the record date and that either the charter provision should be read so as to permit the board to retain that power, or the provision should be declared invalid because it purported to divest the board of statutory power granted to it by Section 213(b).
Jones agreed to dismiss its 220 Complaint and the scheduled expedited proceedings on the narrow issue of whether Maxwell's board could set the record date, notwithstanding that it had not yet received a written consent.
The Court first addressed the question of whether Maxwell's board had violated the terms of the charter provision. The Court found that the language of the provision was "plainly mandatory and does not admit of any exception that would permit the record date to be set by any other method, including by decision of Maxwell's board."[18] The absence of any mention of the board's discretion to fix a record date in the provision, in the Court's view, was striking in light of the fact that Section 213(b) provided the same method for selecting a record date as a default rule when the board has failed to act.
Next, the Court considered whether the charter provision was invalid under the DGCL. Jones argued that the provision was valid under two separate provisions of the DGCL: 8 Del. C. § 102(b)(1) and 8 Del. C. § 141(a). Section 102(b)(1) provides that a certificate of incorporation may contain:
- Any provision for the management of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, or the members of a nonstick corporation; if such provisions are not contrary to the laws of this State.[19]
Section 141(a) provides:
- The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.[20]
Maxwell argued that the charter provision was contrary to law in that it conflicts with what Maxwell contended was Section 213(b)'s clear empowerment of boards to set record dates. Maxwell pointed out that the DGCL contained 48 separate provisions expressly referring to the variation of a statutory rule by charter.[21] Those statutes contain the prefatory language: "unless otherwise provided in the certificate of incorporation."[22] Section 213(b) does not contain that prefatory language, and Maxwell argued that the absence of that language was evidence that the General Assembly did not intend to permit a charter provision eliminating the board's authority to set the record date.
In rejecting that argument, the Court first noted that Delaware's corporate statute is widely regarded as the "most flexible in the nation because it leaves the parties to the corporate contract (managers and stockholders) with great leeway to structure their relations, subject to relatively loose statutory constraints and to the policing of director misconduct through equitable review."[23] "Sections 102(b)(1) and 141(a) are therefore logically read as important provisions that embody Delaware's commitment to private ordering by charter."[24] The Court then noted, "as skilled as the drafters of the DGCL are, I will not pretend that the DGCL is a model of drafting consistency and that there are no ambiguities within it."[25] The Court pointed specifically to the "recursive loop" created by Sections 109(b) and 141(a). Thus, the Court stated that in approaching decisions like this one, it was important to decide the precise question at issue without pretending to have answered other questions not before the Court.
Observing that at the text and legislative history of Section 213(b) did little to help resolve the question, the Court rejected the assertion that, unless a DGCL provision contained the magic words "'unless otherwise provided in the certificate of incorporation,'" a charter provision could not deprive the board of the authority granted.[26] The Court found this argument unconvincing, because it "leaves little room for §§ 102(b)(1) and 141(a) to operate, despite their obvious status as general provisions of broad application."[27] The Court stated that the magic words should be read as a "bylaw excluder" rather than a "charter includer."[28] Thus, the inclusion of those words in other provisions of the DGCL was meant to show that those provisions could only be amended by charter and not by bylaw. The absence of the magic words, therefore, could be read as permitting the statute to be modified by either bylaw or charter provision. The Court stated that this interpretation of the magic words gave meaning to Sections 102(b)(1) and 141(a), whereas Maxwell's interpretation did not. Thus, the Court held that the Maxwell board had violated its charter provision by setting the record date before the receipt of the first written consent, and that the record date would be established according to that provision.
Back in Black: The Rights and Duties of Controlling Stockholders
Hollinger International, Inc. v. Black
Plaintiff Hollinger International, Inc. ("International") brought suit against Lord Conrad Black, its ultimate controlling stockholder, seeking: 1) a determination that certain bylaw amendments procured by Black through written consent were illegal and inequitable; 2) a determination that a rights plan adopted by the board was valid; and 3) a preliminary injunction preventing Black from entering into a transaction with entities owned by English twin brothers, David and Frederick Barclay (the "Barclays"). In this post-trial opinion, Vice Chancellor Strine held that the bylaw amendments were proper under the Delaware General Corporation Law (the "DGCL"), but were nonetheless invalid because they were made in bad faith and for an inequitable purpose; that the rights plan was properly adopted; and that International was entitled to a preliminary injunction preventing Black from entering into the Barclays transaction.
Plaintiff International owned and operated an assortment of newspapers and other related companies in a worldwide market. International's majority stockholder was Hollinger, Inc. ("Inc."), who owned 30.3% of the equity and 72.8% of the voting control of International. Inc., in turn is 70% owned by Ravelston, Co. ("Ravelston"), which was effectively controlled by defendant Black.
In May 2003, one of International's largest shareholders wrote to the board demanding an investigation into certain non-competition payments made to Black, F. David Radler (director, President and COO of International and Inc. and a Ravelston officer), Peter Atkinson (Executive VP and director of International and a Ravelston stockholder), and other International executives. These payments were received in connection with asset sales in 2000. The International board established a special committee to investigate the non-competition payments and soon discovered that the payments may have been made without approval of the International board or any of its independent directors, notwithstanding disclosures indicating that such approval had been obtained.
Facing trouble because of his receipt of these payments, Black entered into an agreement with International (the "Restructuring Proposal"). Pursuant to the Restructuring Proposal, Black agreed 1) to return the non-competition payments; 2) to cooperate with the SEC in investigations regarding the payments; and 3) to remain on the International board as Chairman and to devote his time and effort to the pursuit of a Strategic Process whereby International would be open to acquisition, sale of assets, or other transaction designed to benefit the interests of all of its stockholders ratably. As part of the Restructuring Proposal, Black also agreed not to cause Inc. to enter into any transactions that would negatively affect the Strategic Process.
Almost immediately after entering into the Restructuring Proposal, Black began negotiating with the Barclays for a sale of all of the outstanding stock of Inc. The Barclays were interested in purchasing one of International's assets, the Daily Telegraph, and initially approached Black to pursue such a transaction. Black had rebuffed their earlier expressions of interest, but once the Restructuring Proposal was in place, he invited negotiations. In the course of those negotiations, Black provided the Barclays with confidential information about International that was only available to Black because of his involvement in the Strategic Process.
When the International board caught wind of Black's activities, they undertook steps to implement a shareholder rights plan ("poison pill") to prevent a sale of control of International. The plan would be triggered by the sale of Inc. to a third party. Before the pill could be put in place, Black caused Inc. to execute written consents to amend International's bylaws and essentially strip the International board of authority to implement a pill and otherwise require 80% or unanimous consent of the board to engage in any business transaction or sale of assets.
The board, believing these bylaw amendments to be invalid, proceeded with implementation of the pill. Black announced the transaction with the Barclays that would give the Barclays a controlling interest in International. International then brought this suit.
The Court of Chancery first addressed the issue whether Black had violated his fiduciary duties as a controlling shareholder and director of International and whether he had violated the terms of the Restructuring Proposal. These findings were necessary, according to the Court, in order to determine whether the bylaw amendments had been equitably adopted.
The Court found that Black had violated his fiduciary duty of loyalty by: 1) denying International the right to fairly and responsibly consider the Barclay transaction itself, which was within the scope of the Strategic Process; 2) misleading the International directors about his conduct and failing to disclose his dealings with the Barclays; and 3) disclosing confidential information to the Barclays for his own benefit. The Court noted: "It is difficult to conceive of a meaningful definition of the duty of loyalty that tolerates conduct of this kind."[30]
The Court also found that Black had violated the Restructuring Proposal. Black had argued that he was fraudulently induced into entering into the Restructuring Proposal, and that even if not the case, the Barclays Transaction was not covered by the Restructuring Proposal because the Barclays transaction did not "negatively impact" the Strategic Process. The Court dismissed Black's fraudulent inducement claim at the outset, finding that Black had complete access to all of the information he alleged was kept from him, and that there was no intent or scienter on the part of International in proposing the Restructuring Proposal. In addition, the Court found that the Barclays Transaction did negatively affect the Strategic Process because, as a practical matter, it would send the message to potential International buyers that either a sale had already taken place, or that certain transactions (i.e., sale of Daily Telegraph) were off the table. Simply because the Barclays transaction did not preclude International from pursuing the Strategic Process did not mean that the process was not negatively affected.
Black also argued that the Barclays transaction was "necessary" and thus excepted from the terms of the Restructuring Proposal (which allowed Inc. to enter into transactions necessary to save itself from insolvency). Black argued that Inc. was near insolvency, and his business partner, Peter White, testified to as much at trial. Vice Chancellor Strine not only found that White's testimony lacked credibility, he refused to find that the transaction was "necessary" within the terms of the Restructuring Proposal. In so holding, the Court placed significant emphasis on the fact that Black had repeatedly asserted, when the Restructuring Proposal was entered into, that Inc. was only having "minor liquidity issues."[31]
Having found that Black had breached his fiduciary duties and the Restructuring Proposal, the Court next addressed whether the bylaw amendments were properly adopted. International argued first that the bylaw amendments violated the DGCL because they attempted to strip the directors of International of powers given to them by § 141. The Court found this argument unpersuasive, finding that the DGCL allows bylaws to restrict the powers and management of the board of directors and its committees, which is exactly what the bylaws in this case sought to do.
Nonetheless, the Court held that the bylaws were invalid because they were adopted in bad faith and for an inequitable purpose: "inequitable action does not become permissible simply because it is legally possible."[32] The inequitable purpose was to allow Black to effect the Barclays transaction, which was in violation of both his fiduciary duties and his contractual duties under the Restructuring Proposal.
Next the Court considered whether the poison pill adopted by the International board was proper. Defendants initially argued that the DGCL does not allow a pill to be adopted that is triggered by an upstream sale of control. The Court found this argument unavailing, holding "the mere fact that a rights plan inhibits the ability of an intermediate holding company to sell itself does not make that rights plan statutorily impossible, or even inequitable in all circumstances."
The defendants also argued that the International board violated their duties under Unocal Corp. v. Mesa Petroleum Co.[33] in adopting the pill. The court also dismissed this argument, finding that the board members faced a threat of control in the form of the consummation of the Barclays transaction, which would thwart the Strategic Process. In addition, the Court held that the pill was a proportionate response because "there are circumstances when a subsidiary has a legitimate right to contest a parent's sale of its control position" and that such circumstances were present in this case.[34]
The Court held that a preliminary injunction preventing Inc. from consummating the Barclays transaction was in order.
Lock-Ups get a Suspended Sentence: Deal Protection Measures post-Omnicare
Orman v. Cullman
This case involved a merger transaction between Swedish Match AB and General Cigar Holdings, Inc. Members of the Cullman family were the controlling shareholders of General Cigar. Swedish Match paid a significant premium above the market price for the public shares in General Cigar but did not purchase control of General Cigar as it wanted the Cullmans to continue managing the Company after the merger.
Plaintiff Joseph Orman sued the General Cigar board of directors for breach of their fiduciary duties in negotiating the merger terms. The defendants moved for summary judgment, contending that a fully informed vote of a majority of the public shareholders in favor of the merger operated to extinguish plaintiff's claim. The issue before the Court, therefore, was whether the General Cigar public shareholders were impermissibly coerced to vote for the merger because of a lock-up provision required by Swedish Match as part of the transaction.
In April 1999, Swedish Match purchased a part of General Cigar's business. Later that year, Swedish Match contacted the Company to discuss "'acquiring a significant stake'" in General Cigar's business.[36] In November 1999, the Company's board authorized management to pursue discussions with Swedish Match. General Cigar's board created a special committee to advise and make recommendations to the full board concerning any transaction with Swedish Match. The special committee was charged with advising the board regarding any transaction with Swedish Match, but was not authorized to solicit offers by third parties. The negotiations with Swedish Match were conducted primarily by Peter J. Solomon Company Limited, an investment company owned by a member of the Company's board. The special committee also retained independent legal and financial advisors.
During the negotiations, Swedish Match insisted that the Cullmans enter into a stockholders' voting agreement. Pursuant to which the Cullmans would agree not to sell their shares, and to vote their shares against any alternative acquisition proposal for one year following any termination of the merger between Swedish Match and General Cigar. Swedish Match agreed to purchase all of the publicly held stock of General Cigar and one third of the stock held by the Cullmans for $15.00 per share. Swedish Match later agreed to increase the price to $15.25 per share in exchange for a six-month extension of the period in the voting agreement. The special committee, upon the advise of its advisors, recommended the transaction to the full board, who approved it on January 19, 2000.
The voting agreement between the Cullmans and Swedish Match required that the Cullmans vote their Class B shares, constituting a majority of the voting power of the Company, in favor of the merger and against any alternative acquisition of the Company for eighteen months after termination of the merger agreement. The merger agreement was conditioned on the approval of a majority of the outstanding minority shares. In addition, it permitted General Cigar's board to entertain unsolicited acquisition proposals from potential acquirers if the board, upon recommendation by the special committee, concluded that such a proposal was bona fide and would be more favorable to the public shareholders than the proposed merger with Swedish Match. Furthermore, the agreement contained a "fiduciary out" permitting the board to withdraw its recommendation of the merger with Swedish Match if the board concluded, upon consultation with outside counsel, that its fiduciary duties so required. Because the voting agreement only bound the Cullmans as shareholders, that agreement did not impact the Cullmans ability as directors to recommend against the merger in order to comply with their fiduciary duties. The shareholder meeting was held on May 8, 2000 and the minority shareholders overwhelmingly approved the merger.
Plaintiff alleged that the Cullmans breached their fiduciary duties by entering into the voting agreement and cited the Supreme Court's opinion in Paramount Communications, Inc. v. QVC Network[37] and Omnicare, Inc. v. NCS Healthcare.[38] In those decisions, the Court noted that a contract purporting to limit the exercise of fiduciary duties was invalid and unenforceable. The Court found that the voting agreement in this case was meaningfully distinct from the agreements in both Paramount and Omnicare, because nothing in this voting agreement prevented the Cullmans from exercising their duties as officers and directors. The voting agreement merely bound the Cullmans as shareholders. The Cullmans could have voted, as directors, to withdraw their recommendation that the public shareholders approve the merger.
Next, the Court discussed the decision in Omnicare as it related to the plaintiff's contention that the deal protection mechanisms "coerced" the shareholder vote.[39] Affirming that deal protection devices, even when implemented in connection with a proposed merger that does not result in a change of control, require enhanced scrutiny under Unocal. Under the first stage of Unocal, the Court concluded that the Board had reasonable grounds for believing that a danger to corporate policy and effectiveness existed: namely, the risk of losing the Swedish Match transaction and being left with no comparable alternative. Under the second stage of Unocal, the Court concluded that the deal protection measures at issue were not coercive. The Court stated that:
- [N]othing in this record suggests that the lock-up had the effect of causing General Cigar's stockholders to vote in favor of the proposed transaction for some reason other than the merits of that transaction. Furthermore, unlike the situation in Omnicare, the deal protection mechanisms at issue in this case were not tantamount to "a fait accompli."[40]
The public shareholders were free to reject the proposed deal, even though, permissibly, their vote may have been influenced by the existence of the deal protection measures. The Court also noted that the General Cigar public shareholders were not encouraged to vote in favor of the Swedish Match transaction for reasons unrelated to the transactions merits.
In concluding that the Omnicare decision did not apply to this case, the Court noted that the General Cigar board retained a fiduciary out, and a majority of the nonaffiliated public shareholders could have rejected the deal on its merits. Unlike Omnicare, nothing in the merger or stockholder agreements made it "mathematically certain" that the transaction would be approved.[41] Although it was true that the Cullman vote against any future, hypothetical deal was "locked-up" for 18 months, the Court found that this 18 month delay was not a meaningful "cost" that could be said realistically to "coerce" the shareholders.[42] Expounding on this point, the Court stated:
- The Cullman lock-up hardly seems unreasonable, given the absence of other deal protection devices in this particular transaction and given the buyer's understandable concern about transaction costs and market uncertainties. Unless being in a voting minority automatically means that the shareholder is coerced (because the minority shareholder's investment views or hopes have been precluded by a majority), plaintiff's concept of coercion is far more expansive than Omnicare or any other decisional authority brought to my attention.[43]
Thus, the Court granted defendants motion for summary judgment and dismissed the fiduciary duty claims against them.
The New (and Improved?) Section 220: Stockholder Access to Subsidiary's Books and Records
A new statutory provision was added to Section 220 by Section 21 of 74 Del. Laws, c. 84, which became effective September 23, 2003. The new language gives stockholders of Delaware corporations the right to inspect the books and records of a "subsidiary" of the corporation. "Subsidiary" is defined as "any entity directly or indirectly owned, in whole or in part, by the corporation of which the stockholder is a stockholder and over the affairs of which the corporation directly or indirectly exercises control…."[44]
Orloff v. Weinstein Enterprises, Inc.
In this case, the first to address the new provisions under Section 220, defendant Weinstein Enterprises, Inc. sought an order staying the effect of a final order pending appeal of the Court's previous decision in a books and records action brought by plaintiff, a shareholder of the defendant corporation. Plaintiff sought books and records of J.W. Mays, Inc., a New York corporation that was found to be a subsidiary of Weinstein. The Court ordered the inspection under the newly added language of Section 220. Weinstein, which owned approximately 45% of J.W. Mays, sought a stay of the final order pending appeal, arguing that it did not exercise control over the subsidiary within the meaning of the statute because it did not have "absolute control."[46] To prove its point, Weinstein pointed to the fact that Mays board of directors "balked at turning over its books and records to Orloff…."[47]
Plaintiff argued that the statute could not be limited to wholly owned subsidiaries, and that the mere fact that the Mays board of directors resisted turning over its files did not affirmatively establish Weinstein's lack of control over it.
This being a matter of first impression with regard to the new language of § 220, the Court granted the stay pending appeal.
At Least One Question Finally Answered (Sort of): The Distinction Between Derivative and Direct Claims.
Tooley v. Donaldson, Lufkin & Jenrette, Inc.
In this opinion, the Supreme Court modified and established once and for all the standard for determining whether a claim is direct or derivative in nature. This distinction is important, because it is often dispositive of the claim - where a shareholder's claims are found to be derivative in nature, they are commonly dismissed for lack of standing and for failure to comply with Court of Chancery Rule 23.1
Plaintiff brought this class action alleging that the directors of Donaldson, Lufkin & Jenrette, Inc. ("DLJ") breached their fiduciary duties by agreeing to a 22-day delay in closing a proposed merger of DLJ into a subsidiary of the Credit Suisse Group. The Court of Chancery dismissed the action, finding that it was derivative in nature and that plaintiffs had lost standing when they tendered their shares. Plaintiffs appealed, arguing that their claims were direct, not derivative, because they had suffered a "special injury" by reason of the delay in receiving the merger consideration.
The Supreme Court expressly disapproved of the "special injury" test, finding it unhelpful. Instead, the Supreme Court pronounced the test for determining a direct versus derivative claim as follows:
- [A] court should look to the nature of the wrong and to whom the relief should go. The stockholder's claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.[49]
The Court went on to hold that the resolution turned on two questions: "(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?"[50]
Applying this test, the Court found that, while there was no injury to the corporation, the plaintiffs had failed to state a claim at all.
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Notes
* Michael D. Goldman is a partner and Melony R. Anderson is an associate, at Potter Anderson & Corroon LLP in Wilmington, Delaware. The views expressed herein are those of the authors and may not be representative of the views of the firm or its clients.
1 C.A. No. 16415, 2004 Del. Ch. LEXIS 70 (Del. Ch. May 3, 2004).
2 Emerging Communications, 2004 Del. Ch. LEXIS 70, at *104.
3 Id. at *131.
4 Id. at *142.
5 Id. at *143.
6 Id. at *147.
7 Id. at *153 (quoting In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 289 (Del. Ch. 2003)) (emphasis and italics in original).
8 Consol. C.A. No. 15452, 2004 Del. Ch. LEXIS 132 (Del. Ch. Sept. 10, 2004).
9 Walt Disney, 2004 Del. Ch. LEXIS 132, at *29.
10 C.A. No. 20228-NC, 2004 Del. Ch. LEXIS 122 (Del. Ch. Aug. 24, 2004).
11 Official Committee, 2004 Del. Ch. LEXIS 122, at *32 (italics in original).
12 Id. at *45 (footnote omitted).
13 Id. at *46.
14 C.A. No. 365-N, 2004 Del. Ch. LEXIS 74 (Del. Ch. May 27, 2004).
15 Jones Apparel, 2004 Del. Ch. LEXIS 74, at *6.
16 Id. at *5.
17 8 Del. C. § 213(b).
18 Jones Apparel, 2004 Del. Ch. LEXIS 74, at *12.
19 8 Del. C. § 102(b)(1).
20 8 Del. C. § 141(a) (emphasis added).
21 See, e.g., 8 Del. C. § 170(a); 8 Del. C. § 233(a).
22 Id.
23 Jones Apparel, 2004 Del. Ch. LEXIS 74, at *25.
24 Id. at *26.
25 Id. at *28.
26 Id. at *31.
27 Id. at *33.
28 Id.
29 844 A.2d 1022 (Del. Ch. 2004).
30 Hollinger, 844 A.2d at 1062.
31 Id. at 1070.
32 Id. at 1078 (citation omitted).
33 493 A.2d 946 (Del. 1985).
34 Hollinger, 844 A.2d at 1087.
35 C.A. No. 18039, 2004 Del. Ch. LEXIS 150 (Del. Ch. Oct. 20, 2004).
36 Id. at * 4.
37 637 A.2d 34 (Del. 1994).
38 818 A.2d 914 (Del. 2003).
39 Orman, 2004 Del. Ch. LEXIS 150, at *23.
40 Id. at *31.
41 Id. at *35.
42 Id. at *36.
43 Id. at *36-*37.
44 8 Del. C. § 220 (a)(3).
45 C.A. No. 186-N, 2004 Del. Ch. LEXIS 85 (Del. Ch. June 22, 2004).
46 Orloff, 2004 Del. Ch. LEXIS 85, at *3.
47 Id. at *4.
48 845 A.2d 1031 (Del. 2004).
49 Tooley, 845 A.2d at 1039.
50 Id. at 1033.