Delaware Chancery Court Dismisses Post-Closing Fiduciary Duty Claims, Finding The Complaint Failed To Plead Bad Faith

by Shearman & Sterling LLP
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On August 17, 2017, Chancellor Andre G. Bouchard of the Delaware Court of Chancery dismissed a shareholder suit asserting breach of fiduciary duty claims against the directors of MeadWestvaco Corporation (“MW”) in connection with MW’s strategic stock-for-stock merger with Rock-Tenn Company (“RockTenn”).  In re MeadWestvaco S’holders Litig., Consol. C.A. No. 10617-CB (Del. Ch. Aug. 17, 2017).  Plaintiffs’ central contention was that MW’s directors had entered into the merger in bad faith in reaction to a threatened proxy contest by an activist investor, leaving behind $3 billion of additional value.  The Court ruled that plaintiffs’ own pleadings suggested the board had been “actively engaged” in the merger process, and that plaintiffs’ contention that the board acted in bad faith was “simply not credible.”

Before their merger, MW and RockTenn were both publicly traded packaging companies.  Their negotiations regarding a potential merger began in April 2014 and continued sporadically over the following nine months, with MW twice breaking off discussions.  During this period, Starboard Value LP (“Starboard”), an activist investment firm, began purchasing MW stock.  In December 2014, Starboard signaled its intention to engage in a proxy fight.  By January 2015, however, MW and RockTenn had resumed negotiations, and on January 16, 2015, their CEOs had agreed to proceed with a stock-for-stock merger whereby each share of MW stock would be converted into 0.78 shares of the combined entity.  The “indicated price” derived from this exchange ratio represented a 9.1% premium over MW’s stock price before the merger announcement and implied a value for the company of approximately $9 billion. 

On January 25, 2015, MW’s board unanimously approved the plan of merger.  The merger agreement included a “fiduciary-out in case of a superior offer” and a break-up fee of $230 million (amounting to less than 3% of the $9 billion value attributed to MW).  On June 24, 2015, MW’s stockholders approved the merger, with 83% of outstanding shares voting, of which 98% were voted in favor of the transaction.  The merger closed in July 2015.  Although more than five months elapsed between signing and closing, no topping bids emerged.  

On July 21, 2016, the plaintiff shareholders asserted a claim for breach of fiduciary duty against the members of MW’s board.  Plaintiffs alleged that Starboard’s presence was the “impetus” for the board’s decision to engage in negotiations with RockTenn that led to the merger, and that MW’s directors—“flying blind” and doing “virtually nothing” to meet their fiduciary duties—approved the transaction despite knowing that certain of the company’s assets were “undervalued by the market,” thereby depriving MW’s shareholders of “at least $3 billion of additional value.”

Dismissing the complaint, the Court explained that because there had been no controlling shareholder and the consideration consisted entirely of stock in the combined company, “the decision to approve the merger presumptively is governed by the business judgment rule.”  Moreover, the Court noted that (i) the certificate of incorporation contained a Section 102(b)(7) provision exculpating the directors from personal liability for any breach of the fiduciary duty of care, and (ii) plaintiffs did not allege the presence of any disabling conflicts of interest.  Therefore, according to the Court, “plaintiffs’ case . . . rest[ed] entirely on the board’s alleged failure to discharge its duties in good faith.” 

As Chancellor Bouchard explained, a plaintiff alleging bad faith “must show either [1] an extreme set of facts to establish that disinterested directors were intentionally disregarding their duties or [2] that the decision under attack is so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”  The Court concluded that several aspects of the merger process—including the board’s active involvement at meetings and receipt of “numerous valuations”—collectively precluded a finding that the complaint stated a viable claim for bad faith.  It further explained that the parties’ “negotiation history,” in which MW twice terminated negotiations and refused offers it considered inadequate, “negate[d] the notion that the directors sanctioned a flawed process in deliberate disregard of their fiduciary obligations.”  Regarding Starboard, the Court emphasized that plaintiffs had not argued that the activist investor’s presence created a disabling conflict or that the looming proxy fight prevented MW’s directors from appropriately conducting their duties.  Without more, the Court explained, an activist’s potential opposition to the board’s reelection could not support a reasonable inference “that otherwise independent, disinterested directors  . . . would act disloyally or in bad faith.”

The Court also rejected plaintiffs’ contention that the ultimate decision to approve the merger at an implied value of approximately $9 billion was inherently an act of bad faith, highlighting (i) the premium received by MW’s stockholders; (ii) the fairness opinions of the three “nationally recognized” financial advisors; (iii) the absence of a superior offer notwithstanding the allegedly substantial value left on the table; and (iv) the recommendation of two “major independent proxy advisory firms” in favor of the merger and “overwhelming” approval by the shareholders.  

Notably, because the Court found that the complaint failed to state a claim for bad faith, the Court did not reach the issue of “whether the board’s decision to approve the merger was cleansed” under Corwin v. KKR Fin. Holdings, LLC, 125 A.3d 304 (Del. 2015), “by virtue of the stockholders’ overwhelming approval of the merger.”  

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