In a lengthy opinion following trial, Delaware Court of Chancery Vice Chancellor J. Travis Laster found the decision by the directors of a venture capital-backed company to approve a $60 million merger was fair, even though process was unfair and common shareholders received nothing in the merger. The court found that the company's stock had no value before the merger and thus the common shareholders got "the substantial equivalent in value of what they had before" — nothing.
Several years before the merger, venture capital firms had invested in the company, receiving preferred stock and several seats on the board of directors. When the increase in the company's revenue was not sufficient for the venture capital firms, they sought an exit. The board adopted a Management Incentive Plan (MIP) that provided for the payment of compensation to the management upon a sale of the company, even if the common shareholders received nothing. In the merger, the preferred shareholders received the bulk of the consideration and management got $7.8 million under the MIP.
After the merger, a shareholder filed an appraisal action that was later consolidated with a class action alleging breach of fiduciary duty of loyalty against the company's directors. The motion to dismiss was initially denied and a bench trial followed. Vice Chancellor Laster, applying the entire fairness standard of review, had no trouble in concluding that the directors had followed a process that was not fair to the common shareholders. However, that did not result in a finding of breach of fiduciary duty because while the process was unfair, the price was fair.
Some points to consider from this opinion are:
When a board is controlled by preferred shareholders, a conflict can arise between preferred shareholders and common shareholders. In such situations, the most rigorous review standard, the "entire fairness" standard, applies.
A conflicted board should consider using procedural protections for the common shareholders, such as a special committee of directors that is independent from the preferred shareholders or a fairness opinion from a bank engaged by the special committee.
A company is not required to continue operations to try and maximize value for the common shareholders.
Even if the process is unfair, directors can escape liability if they ensure that the price given — even if nothing at all — is fair (and can be supported as such in hindsight). Of course, directors are well-advised to attempt to satisfy both the fair process and the fair price prongs.
To view a copy of the opinion for In re Trados Inc. S'holder Litig., Del. Ch., Consol. C.A. No. 1512-VCL (Aug. 16, 2013), go to: http://courts.delaware.gov/opinions/download.aspx?ID=193520