Limelight Network Inc., a telecommunications company (Limelight or the Company) saw its stock price drop from a high of US$8.19 in July 2020 to US$4.33 by January 2021, leading to market speculation the Company could be a target for activist investors. Instead, Limelight agreed to combine with Edgecast, Inc., a business unit under Yahoo that offered cloud solutions.

Limelight conducted due diligence, and the parties agreed on an all stock deal worth approximately US$300 million, with the possibility of additional stock-based earnout consideration of US$100 million (the Acquisition).  The Acquisition resulted in Limelight changing its name to Edgio, Inc., with Yahoo’s parent company, College Parent, L.P., (College Parent) to receive 35% of the shares and three seats on Edgio’s nine member board.

As part of the Acquisition, College Parent entered into a stockholders agreement with the Company that included three provisions that were contested in the litigation (the Challenged Provisions). These included:

• College Parent must vote in favor of the Board’s recommendations with respect to director nominations and against any nominee not recommended by the Board (the Director Voting Provision).

• For other non-routine matters submitted for stockholder vote, College Parent must either vote in favor of the Board’s recommendation or pro rata with all other Company stockholders (the Vote Neutralization Provision).

• College Parent is restricted for two years from transferring its shares without the Board’s consent, and is prohibited its transferring it shares for an additional twelve months to a list of fifty activist investors named by the Board. (the Transfer Restrictions).

A fully informed, uncoerced majority Limelight stockholders voted in favor of the stock issuance, and the Acquisition closed on June 15, 2022.

On July 18, 2022, a group of stockholders, although not challenging the benefits of the business combination itself, asserted a direct claim for breach of fiduciary duty against the Edgio and its directors. The stockholders asserted that the inclusion of the Challenged Provisions was a breach of the directors’ fiduciary duties, an attempt to create a “35% voting bloc contractually committed to protecting the Board” and meant “to deter and defeat any activist threats to the incumbent directors.” The stockholders asked the court to enjoin the enforcement of the Challenged Provisions, but did not seek monetary damages.

Defendants moved for dismissal under the framework of Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015), arguing that, the Board’s decisions regarding the Challenged Provisions were protected by the business judgment rule because the Acquisition had been approved by a fully informed, uncoerced vote of disinterested stockholders. Further, defendants argued the enhanced scrutiny standard that applies to director decisions with identifiable conflicts of interest, established in Unocal v. Mesa Corporation, 493 A.2d 946 (Del. 1985), did not apply in the absence of any investor threat and corresponding director defensive action.

In a lengthy and detailed opinion, Vice Chancellor Morgan T. Zurn disagreed with the defendants and denied the motion to dismiss, concluding that Corwin stops “short of cleansing claims seeking to enjoin defensive measures.” Rather, the Court reasoned that Corwin’s business judgment rule protections did not apply to claims to enjoin defensive measures. Instead, Unocal’s enhanced scrutiny standard applied to the directors’ actions in this case, because Corwin’s rationale of allowing “stockholders to make free and informed choices based on the economic merits of a transaction” did not apply to defensive measures that would apply for years into the future.

The court noted that Delaware law “has consistently recognized that the harm caused by entrenching measures is irreparable and evades economic valuation.” Plaintiffs pleaded that the company experienced a significant drop in its stock price and “up until six months before the challenged provisions were agreed upon,” analysts had speculated that the company “may be an activist threat.” Given such allegations, along with the defensive nature of the Challenged Provisions (in particular the Transfer Restrictions), it was “reasonable to infer that the Board negotiated for and obtained the Challenged Provision to defend against a threat of activism.” In the face of this “naked entrenchment vehicle,” the court held that a stockholder vote would not provide Corwin’s business judgment rule protections. Because Unocal’s enhanced scrutiny applied, and defendants did not argue they had met this burden, the Court denied their motion to dismiss.