In a January 3, 2013 decision, the Delaware Court of Chancery declined to dismiss a shareholder class action lawsuit that claimed the Board of Novell Inc. breached its fiduciary duty in allowing a $2.2 billion sale of Novell to software company Attachmate Corporation in 2011, and a $450 million sale of a patent portfolio to a Microsoft Corporation consortium. In re Novell, Inc. S’holder Litig., C.A. No. 6032-VCN, 2012 WL 6761917 (Del. Ch. Jan. 3, 2013).
After the transactions closed, Plaintiffs sought damages for alleged breaches of fiduciary duties by the Board of Directors of Novell. Plaintiffs claimed that the Novell Board (i) failed to meet its duty to maximize shareholder value with respect to both Attachmate’s acquisition and the Patent Sale because of “an improper and opaque” sales process; (ii) failed to disclose all material facts and issued a misleading proxy; (iii) allowed Attachmate to taint the process; and (iv) allowed Elliott Associates, L.P., a private investment fund holding a minority position in Novell, to obtain additional consideration not available to other shareholders. Plaintiffs asserted that Attachmate and Elliott aided and abetted the Novell Board’s violations of its fiduciary duties. Id. at *6.
The key issue in this case was the disparate treatment afforded to the successful bidder. Plaintiffs alleged that in October 2010, a competing bidder (“Party C”) submitted a bid to acquire all of Novell for $5.75 per share, as compared with Attachmate's offer at that time of $5.25 per share. Plaintiffs claimed that the Board made no effort to negotiate with Party C following receipt of Party C's October proposal, and further claimed that Party C was not informed of Microsoft's October 29 proposal to acquire Novell’s Patent Portfolio for $450 million. Plaintiffs argued and the Court found it credible at the pleading stage that Party C could have increased its offer of $5.75 per share had it known that it would be receiving $450 million in cash upon acquiring Novell. Id. at *8.
On a motion to dismiss in Delaware, the courts consider whether a plaintiffs’ complaint states a “reasonably conceivable” claim. The Court here concluded that only one claim was properly stated – that the Novell Board knowingly favored Attachmate over the competing bidder, to the possible detriment of shareholders.
An independent and disinterested board is not absolutely required to treat all bidders equally, and the Board could have dealt with bidders differently if the shareholders’ interests justified such a course. However, because this motion was being decided at the pleading stage, the Court found the Complaint “states a reasonably conceivable claim that the Novell Defendants treated a serious bidder in a materially different way and that approach might have deprived shareholders of the best offer reasonably attainable,” and therefore amounted to a breach of fiduciary duty. Id. at *9.
The Bad Faith Standard
Defendants, of course, denied that any breach of fiduciary duty had occurred. The Novell Board argued that even if it breached any fiduciary duty, at most, the breach was of the duty of care. They further argued that Novell’s Certificate of Incorporation contained a provision under section 102(b)(7) of the Delaware General Corporation Law exculpating the directors of monetary liability for breach of the duty of care. Plaintiffs responded that the Novell Board acted in bad faith, and such conduct deprived them of the benefit of the section 102(b)(7) charter provision. In the face of the permitted exculpatory provisions of Novell’s charter, the Court found that, to survive defendants' motion to dismiss, the Complaint must adequately plead a claim that the Novell directors breached their duty of loyalty or acted in bad faith. Id. at *7.
Citing well-established Delaware law, the Court held that a complaint challenging a sales process must plead that a board breached the duty of loyalty by alleging non-conclusory facts suggesting that a majority of the board lacked independence, or was interested in the sales process, or acted in bad faith in conducting the sales process. “A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders.” Id. at *7 (citing, inter alia, Rales v. Blasband, 643 A.2d 927, 936 (Del. 1993)). A director lacks independence if, for example, her judgment is controlled by another director or is driven by extraneous considerations. Id. (citing Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984)). A director acts in bad faith when he or she “intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his [or her] duties.” Id. (citing Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 243 (Del. 2009) (emphasis added)).
Here, Plaintiffs did not argue that a majority of the Board was interested or lacked independence. Accordingly, in order to survive the motion to dismiss, the complaint had to allege that the Board acted in bad faith.
Simple allegations that the Board should have done more under the circumstances are not enough to raise a bad faith claim. Id. (citing Wayne Co. Employees’ Ret. Sys. v. Conti, 2009 WL 2219260, at *14 (Del. Ch. July 24, 2009), aff’d, 996 A.2d 795 (Del. 2010)). “Bad faith is also not shown by disagreement with the Board's decisions during an auction process. ‘There is a vast difference between an inadequate or flawed effort to carry out fiduciary duties and a conscious disregard for those duties.’” 2012 WL 6761917, at *8 (citing, inter alia, Lyondell, 970 A.2d at 243) (emphasis added)). Further, “a plaintiff has the burden to overcome the presumption that a fiduciary acts in good faith.” Id. at *10.
In a sale of a company, a fiduciary's conduct rises to the level of bad faith “if the fiduciary acted with a purpose other than advancing shareholder interests (i.e., the best interests of the corporation), intentionally violated relevant positive law, intentionally failed to respond to a known duty or exhibited a conscious disregard of a known duty.” Id. at *9 (citing Stone v. Ritter, 911 A.2d 362, 369 (Del. 2006)).
If the complaint challenges a fiduciary's duty to act, the effort required to satisfy that duty is minimal. In that context, said the court, the question is whether the fiduciary “utterly failed to attempt to obtain the best sale price.” Id. (citing Lyondell, 970 A.2d at 244)).
Plaintiffs can overcome the presumption of good faith by demonstrating “that the fiduciary's actions were ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’” Id. at *10 (citing, inter alia, In re Alloy S’holder Litig., 2011 WL 4863716, at *12 (Del. Ch. Oct. 13, 2011)).
In the Novell case, the Court concluded as follows:
This formulation of the bad faith standard best captures the focus of the Plaintiffs' challenge. Why the Novell [Directors] did not tell Party C about the proceeds of the Patent Sale has no apparent answer in the record before the Court. That conduct, coupled with the fact that Novell kept Attachmate fully informed, is enough for pleading stage purposes to support an inference that the Board's actions were in bad faith. As indicated, there may be a plausible explanation for their conduct, but the Court does not have access to those facts. Because it is reasonably conceivable that the Plaintiffs may be able to demonstrate that the Novell [Directors’] conduct was in bad faith, the exculpation of the Section 102(b)(7) charter provision is not available. Accordingly, this claim may not be dismissed at this time.
Id. at *10 (citations omitted).
Of the nine-member Novell Board, Plaintiffs only made allegations regarding the conduct of two: Greenfield (who served until 2007 as operating partner of Francisco Partners, a principal stockholder of Attachmate) and Hovsepian (Novell’s President and CEO). The Court found the Amended Complaint did not allege that either Hovsepian or Greenfield dominated or controlled the remaining disinterested and independent directors. “Merely asserting that each wished to promote his own interests is not a sufficient pleading of domination or control under Delaware law.” Id. at *11 (citing In re Nymex S’holder Litig., 2009 WL 32006051, at *6 (Del. Ch. Sept. 30, 2009)).
However, Plaintiffs alleged that Greenfield secretly funneled information to Francisco Partners and Attachmate, and that Greenfield kept Francisco Partners abreast of critical and confidential Board deliberations. The Board was fully aware of, and authorized, Greenfield's communications with Attachmate. Id. at *11.
The Court was troubled by these allegations. The Court recognized that a board may properly designate a director or member of management to contact, or negotiate with, a potential merger partner. That, however, “does not necessarily validate preferential treatment in the form of delivery of confidential information.” Id. at *11 (citations omitted). Thus, though the Court suggested that “perhaps there is no breach of fiduciary duty here,” it is still “reasonably conceivable” based on the pleadings.” Id. And because these specific allegations could not be readily separated from other claims of favorable treatment of Attachmate, the Court denied the motion to dismiss as to this claim. Id.
Court Rejects Other Claims, Including Plaintiffs’ Challenges To Deal Protection Measures
The Court rejected all other of Plaintiffs’ claims, including claims of inadequate proxy disclosure and Plaintiffs’ challenge to certain deal protection devices.
Plaintiffs claimed that Hovsepian had a number of improper or personal reasons to orchestrate a complete sale of Novell, instead of pursuing other Novell strategic alternatives (such as only executing the Patent Sale, or a standalone plan). The Complaint asserted that Hovsepian was conflicted because he was at risk of being ousted if there was a potential change in management, and that Hovsepian stood to gain, and did ultimately receive, a lump-sum cash severance payment of almost $9 million when he was not retained by Attachmate after the Closing. Id. at *11.
The Court rejected these allegations. The Court found Plaintiffs did not allege that Hovsepian exerted any undue influence over any of the seven other independent and disinterested members of the Board in their consideration of the Attachmate bid. Further, the Court held that the possibility of receiving change-in-control benefits pursuant to pre-existing employment agreements does not create a disqualifying interest as a matter of law. Id. (citing, inter alia, In re Smurfit-Stone Container Corp. S’Holder Litig., 2011 WL 2028076, at *22 (Del. Ch. May 20, 2011)).
To the Court, if all Hovsepian wanted to do was to collect the change-in-control payouts in his severance agreement, he could have encouraged the acceptance of an original offer to acquire Novell. Instead, Hovsepian, along with the rest of the Board, embarked upon an eight-month sales process resulting in the sale of Novell to Attachmate. Id. As a result, there were no “reasonably conceivable” set of facts to indicate that Hovsepian’s role in the acquisition led to the breach of the Board’s fiduciary duties. Id. at *12.
The Court also rejected Plaintiffs claims against Elliott. Plaintiffs alleged that, as a minority shareholder and as the entity that put Novell in play, Elliott somehow dominated the Board's sales process throughout. According to Plaintiffs, the Board was “cowed by Elliott's threats and favored Elliott's interests as a result.” These alleged “threats” depended upon linking Elliott's status as a 7.1 percent shareholder and the risk that Elliott would initiate a proxy contest. Id. at *12.
Delaware law is clear that “[i]n the absence of majority stock ownership, a plaintiff must demonstrate that the minority shareholder held a dominant position and actually controlled the corporation's conduct. A minority shareholder's desire to sell its shares does not, on its own, evince domination and control, even if a sale does eventually occur. Control over a corporation's conduct requires control over the business and affairs of the corporation.” Id. at *12 (citations omitted).
The Court found that Plaintiffs did not sufficiently allege that Elliott controlled the business and affairs of Novell, or that Elliott had control over the Novell Board. There was no allegation of direct control, and the Court found that the claim that Elliott might have (but did not) mount a proxy contest added little, even if the Board “took Elliott's threats seriously.” Id. “The possible initiation of a proxy contest is not sufficient to establish domination and control, or to create a disqualifying interest. Moreover, the Plaintiffs do not allege that a proxy contest was under actual consideration, that other shareholders would support a proxy contest, or that one would have been successful.” Id. (citations omitted).
As to the disclosure claims, Plaintiffs asserted that the Board, in bad faith, failed to make 10 material disclosures. They claimed that Novell's public disclosures relating to both the acquisition and the Patent Sale were inadequate, and precluded a meaningful shareholder vote on either agreement. The Court noted that when seeking the affirmative vote of stockholders, the Board has a duty to disclose all material information. Id. at *13. However, since a vote on the Patent Sale was not required, the Court held that disclosure claims were irrelevant with regard to the Patent Sale. Plaintiffs then were left with their allegation that “the Novell shareholders were forced to vote on the Acquisition without all material information necessary to make a fully informed decision.” Id.
The first eight purported disclosure violations related to Elliott's role in the Board's sale process. These include requests for the full background of Elliott's involvement in the sales process, Elliott's communications with Attachmate, whether Elliott was in fact necessary for Attachmate's financing, and what Elliott would receive as a result of the acquisition. Id. The Court found no disclosure violations here: “The actions of a minority (less than ten percent) holder with no representative on the board simply do not require the disclosures that the Plaintiffs argue would have been material. Other than allowing Attachmate and Elliott to work together (and Novell shareholders were aware of this), the Board had no effective control over what Elliott did and, as set forth above, how a perceived fear of Elliott may have influenced the sales process, once initiated, is not backed by any specific factual allegations.” Id.
The other two alleged disclosure violations related to the valuation data provided by Novell. In rejecting these claims, the Court held that Delaware law “does not mandate the disclosure of every conceivable valuation datum, method, or alternative. All that is required is a ‘fair summary’ of a financial advisor's work, which was disclosed by Novell.” Id. (citing In re CheckFree Corp. S’holders Litig., 2007 WL 326188, at *2-3 (Del. Ch. Nov. 1, 2007)). Plaintiffs therefore failed to plead the materiality of any of the 10 purported disclosure violations.
Finally, the Court rejected Plaintiffs’ attempt to characterize certain deal protection measures as facts showing the Board favored Attachmate. The Court held that a no-solicitation provision, a matching rights provision, and a termination fee representing 2.7 percent of the equity value of the acquisition, were “customary and well within the range permitted under Delaware law,” and the Plaintiffs pleaded no facts suggesting these provisions were unreasonable or the product of fiduciary failure. Id.
The Court dismissed all other claims, and also found that there was no basis in the complaint to infer an aiding and abetting claim on the part of Attachmate and Elliot.
Client Alert 2013-007
