In a 137-page post-trial opinion, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery ruled that an activist stockholder of PLX Technology (PLX) had acted through a principal who served on the PLX board of directors to aid and abet breaches of fiduciary duties by the PLX directors.1 The litigation began in 2014 following the sale of the company. Despite the court's significant criticism of the conduct leading up to the sale, the court determined that the plaintiffs had failed to establish damages, including in light of the company's robust sale process that led to the ultimate deal price. The case offers important guidance on several issues, including the conduct of directors when navigating activism and a sale, public disclosures to stockholders, investment advisor conflicts, the handling of a target company's projections, and aiding and abetting risks for investors and other parties.
Background
In January 2013, Potomac Capital Partners (Potomac) accumulated over 5 percent of the company's stock after a prior sale of the company fell through on antitrust grounds and the company's stock price tumbled. After increasing its ownership to more than 9 percent, Potomac ran a proxy contest, advocating for an immediate sale of the company to one of the other bidders in the process. In the proxy contest, PLX's board and management publicly stated that they were open to a value-maximizing transaction, but no longer thought an immediate sale was in the company's best interests.
With Potomac's platform of having a sale of PLX, PLX stockholders elected Potomac's three nominees to PLX's board. A principal of Potomac was one of those elected and was subsequently named by the PLX board as chair of the board's special committee overseeing a possible sale. That principal went on to lead negotiations culminating in a sale of the company to a previously rejected buyer for approximately $300 million. The ensuing stockholder litigation named several defendants, including all of the members of the PLX board, the acquirer, PLX's financial advisor, and Potomac. By the time of the trial, all other defendants had either been dismissed from or settled the litigation, and Potomac was the only defendant left standing.
Opinion
The court found that the PLX directors had breached their fiduciary duties on two grounds. This finding was critical because although the directors were no longer in the litigation, the finding allowed Potomac to be potentially liable under the theory that it had aided and abetted the directors' breaches of fiduciary duty. This theory has become an increasingly common basis to pursue claims against investors, financial advisors, and other third parties in stockholder litigation.
First, the court found after trial that the directors had improperly conducted the sale process by letting the Potomac principal lead the sale process despite his divergent interests in achieving a quick sale. The court also criticized the directors for allowing the company's projections to be adjusted in a manner that supported the proposed deal price, without an adequate explanation for the adjustments. In addition, the court emphasized that the company relied on a financial advisor whose fees were contingent on a transaction and who had a "longstanding and thick relationship" with the likely buyer. Finally, it was critical to the court that Potomac's principal had received a "tip" from the acquirer five months before the ultimate sale that the acquirer wished to buy PLX for $300 million and that he did not share this information with the rest of the PLX board.
Second, the court found that PLX's disclosures were inadequate and constituted a breach of the board's fiduciary obligation to disclose all material information to stockholders in the deal context. Among other things, the court concluded that stockholders were not told of the "tip" along with other material interactions between Potomac's principal and the buyer, and that disclosures about the company's adjustments to the projections were misleading. Aside from these disclosure failures constituting a fiduciary duty breach, they also meant that the deal could not benefit from the Delaware law principle that fully informed stockholder approval can extinguish fiduciary duty claims of this kind.
The court went on to determine that Potomac had aided and abetted the directors' fiduciary duty breaches and that the behavior of its principal on the PLX board could be attributed to Potomac. The court concluded that the principal had a classic "dual fiduciary" conflict—owing fiduciary duties to the company's stockholders, but also, in this situation, seeking a short-term return for Potomac. The court observed that not all designees of an activist investor have a conflict and that there is not always a divergence of interest between a director designee and stockholders as a whole. In this case, however, the court emphasized the record before it (including public statements made during the proxy contest by both PLX and Potomac), which indicated that Potomac's interests diverged when it sought an immediate sale of the company, Potomac had a short investment horizon, and Potomac did not otherwise have a plan for the company (even though Potomac received the same consideration as other stockholders in the deal).
Despite the court's findings and criticisms about the various conduct at issue, the court declined to award damages to the plaintiffs. The court weighed expert testimony from both sides about the company's financial condition and its contemporaneous projections of its future performance at the time of the sale. The court emphasized that a "far more persuasive source of valuation evidence is the deal price that resulted from the Company's sale process" and also noted that no other offers emerged from PLX's efforts to solicit competing bids. The court determined that the sale price was essentially appropriate and that the plaintiff had failed to prove that the standalone value of PLX exceeded the deal price. As a result, PLX stockholders had not suffered economic damage from the sale—the key way in which Delaware judges measure damages in this context.
Takeaways
This decision offers several notable insights. It demonstrates the scrutiny that stockholders and courts can apply to actions taken by a multitude of parties in the context of activism and M&A events. It also highlights that where there is a perceived conflict of interest, absent a settlement, litigation can extend for years—in this case, for four years. Finally, the decision touches on several issues that are important to have in mind in the activism and M&A context, including directors' obligations to be appropriately candid with each other and stockholders, the proper conduct and importance of a sale process, the handling of projections, financial advisor conflicts, and potential exposure and conflict issues for stockholders with unique investment objectives and board designation rights.
