In this en banc decision, the Delaware Supreme Court affirmed the Court of Chancery’s certification of a class representative in a breach of fiduciary duty action, even though the class representative sold its stock in the corporation prior to the closing of the challenged merger and prior to final class certification. However, the Supreme Court further held that, under the facts and circumstances of the case, the Court of Chancery abused its discretion by not providing a discretionary opt out right from the class, certified as a non-opt out class under Court of Chancery Rules 23(b)(1) and 23(b)(2), to an objecting significant stockholder that had a clearly identified and supportable claim for monetary damages.
The appeal arose out of the certification of a class representative and the approval of a class action settlement, without an opt out right, in a breach of fiduciary duty action related to Quest Diagnostics, Inc.’s (“Quest”) acquisition of Celera Corporation (“Celera”). Quest’s acquisition of Celera was structured as a two-step transaction (the “Transaction”). The first step entailed a tender offer by Quest’s acquisition subsidiary (“Spark”) for stock of Celera and a top up option exercisable by Spark. The second step entailed a reverse triangular short form merger involving Celera and Spark.
Both before and after the announcement of the Transaction, BVF Partners L.P. (“BVF”), a significant Celera stockholder, informed Celera’s board of directors (the “Board”) that BVF disagreed with the adequacy of the Transaction price and asserted that certain of Celera’s passive drug royalties were grossly undervalued. Less than a week after the Transaction was announced, New Orleans Employees’ Retirement System (“NOERS”), also a Celera stockholder, filed a class action complaint in the Court of Chancery alleging breach of fiduciary duties in connection with the Transaction and seeking preliminary injunctive relief. Subsequently, NOERS and the defendants entered into a non-binding memorandum of understanding (the “MOU”), which provided various therapeutic benefits in connection with the Transaction, but neither increased the offer price nor otherwise addressed monetary components of the Transaction. After the parties adopted the MOU, it became known that Celera’s financial advisor erroneously interpreted a study it used to value Celera’s assets, resulting in the under-valuing of Celera’s assets, including Celera’s passive drug royalties. Several days prior to the consummation of the merger and approximately ten months before the Court of Chancery certified the class, NOERS sold its stock in Celera on the public market. By the time the merger closed, BVF was Celera’s largest stockholder.
Approximately four months after the merger closed, NOERS and the defendants entered into a proposed settlement agreement (the “Settlement Agreement”). The Settlement Agreement named NOERS as the class representative and broadly defined the class to include persons who no longer owned Celera stock on the merger date. Further, the Settlement Agreement was expressly conditioned on the class being certified with no opt out rights. BVF objected to the proposed settlement.
The Court of Chancery chastised NOERS for selling its Celera stock before the consummation of the merger and noted that such conduct called into question NOERS’s suitability to serve as class representative. Despite NOERS’s conduct, the Court of Chancery found that NOERS (barely) satisfied the requirements for an appropriate class representative. Thus, over BVF’s objection, the Court of Chancery certified NOERS as class representative and certified the class as a non-opt out class under Rules 23(b)(1) and 23(b)(2).
BVF appealed the Court of Chancery’s ruling, arguing that the Court of Chancery erred by: (1) certifying NOERS as class representative, (2) not certifying the class as an opt out class under Rule 23(b)(3) or, in the alternative, by not exercising its discretionary powers to allow BVF to opt out of the class certified under Rules 23(b)(1) and 23(b)(2), and (3) approving the settlement, because the settlement unfairly forced BVF to forego a valuable claim for scant consideration.
BVF made several arguments as to why NOERS was an inadequate class representative. Among those arguments, BVF contended that NOERS lacked standing to represent the class once NOERS sold its Celera stock. The Supreme Court, however, declined to adopt a rule of law that a stockholder representative in a breach of fiduciary duty action must own stock in the corporation continuously through the final class certification. The Supreme Court noted that the Settlement Agreement contained a broad definition of the proposed class and that, despite selling its Celera stock prior to the consummation of the merger, NOERS fit within the definition. Further, NOERS held Celera stock at the time the Board approved the merger, giving NOERS a cognizable injury in fact at the time the merger was approved. Thus, the Supreme Court concluded that NOERS had standing to represent the class.
In addition, finding insufficient evidence of such claims to render NOERS an inadequate class representative, the Supreme Court rejected BVF’s claims that NOERS was subject to unique equitable defenses, was a “frequent-filer” plaintiff with an incentive to allow settlements less favorable to the class and which maximize its lawyers’ legal fees, and abdicated control of the class to its lawyers. In particular, noting that NOERS neither voted in favor of the merger nor accepted the benefits of the transaction, the Supreme Court found that NOERS did not acquiesce in the merger by selling its stock above the buy-out price. Further, though NOERS did not have the support of Celera’s largest stockholder, BVF, the Supreme Court declined to hold that factor, on its own, as being sufficient to make NOERS an inadequate class representative. Thus, the Supreme Court held that the Court of Chancery did not abuse its discretion in certifying NOERS as the class representative.
Next, noting that Delaware courts have repeatedly held that actions challenging director conduct in carrying out corporate transactions are properly certifiable under Rules 23(b)(1) and 23(b)(2), and that the availability of potential damages alone does not automatically require certification under Rule 23(b)(3), the Supreme Court held that the Court of Chancery did not err in certifying the class under Rules 23(b)(1) and 23(b)(2). Despite reaching that conclusion, the Supreme Court agreed with BVF that, under the circumstances of the case, the Court of Chancery abused its discretion by not granting BVF a discretionary opt out right from the Rule 23(b)(2) class. Though acknowledging that Delaware law favors settlement of contested issues, the Supreme Court emphasized that the pro-settlement policy must be balanced against due process concerns, which may call for a court to grant discretionary opt out rights. Even though, as originally filed, the case presented claims for equitable relief, the Supreme Court noted that the only realistic claims being settled at this stage were for money damages. Finding that due process concerns permeated the settlement of such claims for money damages, the class representative was barely adequate, and that the objecting party was a significant stockholder prepared to independently prosecute a clearly identified and supportable claim for monetary damages, the Supreme Court held that the Court of Chancery abused its discretion by denying BVF a discretionary opt out right from the Rule 23(b)(2) class. Thus, the Supreme Court reversed the Court of Chancery’s decision on that issue.
Because it held that BVF should have been permitted to opt out of the class, the Supreme Court did not reach BVF’s argument that the Court of Chancery erred in approving the settlement.
The full opinion is available here.