In a legal challenge to a corporate transaction, the applicable standard of review is often outcome determinative. The deferential business judgment rule applies where the board is not majority conflicted. The burden is on the challenger to show bad faith sufficient to overcome the board’s business judgment – a high standard that almost always results in dismissal of the challenge. On the other hand, the more onerous entire fairness review applies to conflicted transactions. Where entire fairness applies, the burden is on the board to prove that the price and approval process were fair. This is a fact-intensive analysis that does not lend itself to dismissal at the pleadings stage.
Delaware case law provides several tools that, when properly implemented, preserve business judgment deference for even conflicted transactions. The Delaware Court of Chancery in Salladay v. Lev recently addressed two of these tools: (i) use of a fully empowered, disinterested and informed special committee to approve the transaction and (ii) conditioning approval of the transaction on an informed, uncoerced vote of the disinterested stockholders.[1]
Salladay involved a challenge by dissenting stockholders to the 2018 acquisition of publicly-traded technology company Intersections, Inc. The stockholders adequately pled that the board was conflicted because a majority of its members received special benefits through the transaction. Nevertheless, the defendants countered that the transaction remained subject to business judgment deference because it was contingent upon approval by an independent, special committee. About a week before formation of the committee, Intersections’ CEO communicated his personal views of the acquisition price range to representatives of the purchaser. The purchaser initially offered the lowest price in the CEO’s range, and the committee was able to negotiate the price only to slightly below the mid-point of the CEO’s range.
The court recognized that “the true empowerment of a committee of independent, unconflicted directors removes the malign influence of the self-interested directors, and thus should result in business judgement review.” Importantly however, the committee is ineffective unless it is sufficiently constituted and authorized to act before any substantive economic negotiations begin. The court held that the CEO’s price disclosure to the purchaser “essentially formed a price collar that ‘set the field of play for economic negotiations to come,’” thereby rendering the committee ineffective to cleanse the conflicted transaction and preserve invocation of the business judgment rule.
The defendants further argued that approval by a majority of the disinterested stockholders cleansed the transaction. The dissenting stockholders challenged the validity of the vote because the transaction-related disclosures were incomplete or misleading. The court found two of the transaction-related disclosures to be deficient. First, the committee engaged multiple financial advisors but did not disclose why it needed to do so. The court observed that there could be innocent reasons for doing so, such as a conflict arose with the initial advisors. On the other hand, there could have been a more sinister reason, such as the committee was shopping for an advisor that would support the transaction. Second, proper analysis of the purchaser’s potential board control post-transaction required a cobbling together of disjointed information from throughout the disclosures, reference to public records outside of the disclosures, and sophisticated capital structure calculations. This was akin to a scavenger hunt for relevant information, which ran afoul of sufficient disclosure principles. “In other words, proxies should be lucid, and not a game of Clue,” according to the court.
[1] The MFW framework provides another such procedural vehicle (discussed here), but was not at issue in Salladay.
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