In this opinion, the Court of Chancery denied defendants’ motion to dismiss plaintiffs’ claim for breach of fiduciary duty in connection with the approval of the merger of Primedia, Inc. (“Primedia”) with an entity affiliated with TPG Capital, L.P. (“TPG”) on the grounds that the merger was not entirely fair in light of an alleged insider trading claim against Kohlberg Kravis Roberts & Co. L.P (“KKR”), Primedia’s former controlling stockholder, that passed to the control of the acquirer at closing. The Court otherwise granted defendants’ motion to dismiss.
Prior to the current action, plaintiffs, shareholders of Primedia, had asserted various derivative claims against KKR, which controlled approximately 58% of Primedia’s outstanding common stock and maintained a significant presence on the Primedia board prior to Primedia’s merger (the “Merger”) with an affiliate of TPG. Plaintiffs’ claims included, in relevant part, an alleged breach of the duty of loyalty against KKR based upon its alleged improper use of material nonpublic information (the “Brophy claim”). Primedia formed a Special Litigation Committee (“SLC”), which moved to dismiss plaintiffs’ claims in their entirety following the completion of its own investigation. On June 14, 2010, ruling from the bench and applying the standard set forth in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), the Vice Chancellor dismissed plaintiffs’ claims with prejudice, holding that (i) the SLC’s decision had been based upon an independently thorough investigation of the claims’ merits and a cost-benefit analysis of pursuing such claims; and (ii) the Brophy claim against KKR might otherwise survive dismissal for failure to state a claim, but that Primedia had suffered no harm and therefore disgorgement was not available.
On June 20, 2011, the Delaware Supreme Court reversed the Court of Chancery’s dismissal, making clear that full disgorgement of profits was an available remedy under Brophy. The Supreme Court held that “actual harm to the corporation is not required for a plaintiff to state a claim under Brophy.” The Supreme Court remanded the case to determine if a broader reading of Brophy would alter the balancing under the second prong of Zapata, which requires the Court to exercise its independent business judgment to determine whether the claim should be dismissed. When the Merger closed on July 13, 2011, however, plaintiffs’ standing to pursue derivative claims was eliminated and the case was dismissed. Plaintiffs filed the class action complaint at issue on December 12, 2011 (the “Complaint”). Plaintiffs alleged that the Merger was unfair because the Primedia directors failed to obtain any value for the Brophy claim. They further argued that the Merger must be reviewed for entire fairness because KKR received a special benefit in that it knew it was highly unlikely any acquirer would pursue the Brophy claim. Finally, plaintiffs challenged a provision in the merger agreement limiting the Primedia board’s ability to change its recommendation that stockholders vote in favor of the Merger. Defendants moved to dismiss the Complaint for failure to state a claim.
In its analysis, the Court of Chancery first considered whether plaintiffs had standing to sue post-merger to challenge the fairness of the Merger. To determine standing, the Court applied the three-part test originally set forth in Parnes v. Bally Entertainment Corp., 722 A.2d 1243 (Del. 1999). First, the Court found that, assuming the allegations pled to be true at this procedural stage, the Brophy claim would survive a motion to dismiss. Second, the Court determined that the value of the Brophy claim was material in the context of the merger. In light of the Supreme Court’s holding that Brophy claims allowed for the full disgorgement of profits, the potentially recoverable damages totaled roughly $190 million (before interest). In the context of a merger that gave Primedia’s stockholders total consideration of $316 million, the Court found the claim’s value to be material. This remained true, in the Court’s view, even after accounting for litigation risks that may prevent recovery on the claim. Finally, the Court considered whether the Complaint contained adequate allegations to support pleadings-stage inferences that TPG would not assert the underlying Brophy claim and did not provide value for it. Concluding that such inferences were adequately supported, the Court held that plaintiffs had satisfied Parnes’ three-part test and thus established standing to maintain a direct claim challenging the Merger based on the failure to value the Brophy claim.
After establishing standing, the Court considered whether plaintiffs’ challenge to the fairness of the Merger stated a claim. Plaintiffs alleged that by approving the Merger at the price TPG offered, without taking any action to preserve the value of the Brophy claim, Primedia’s board and KKR breached their fiduciary duties. Because it was “reasonably conceivable that KKR [the controlling stockholder] received a unique benefit in the Merger not shared with the other stockholders” – the transfer of the Brophy claim to an acquirer unlikely to pursue it – the Court applied the entire fairness standard and concluded that plaintiffs had stated a claim that the Merger was not entirely fair.
The Court rejected a defense based on Section 102(b)(7) of the Delaware General Corporation Law as a premature ground for dismissal at this stage in the proceedings. Despite what the Court described as “relatively insubstantial allegations of bad faith,” the claim was “inextricably intertwined with issues of loyalty.” The Court also rejected a defense of collateral estoppel.
Accordingly, the Court denied defendants’ motion to dismiss as to the claim for breach of fiduciary duty against KKR and the Primedia board members on the grounds that the Merger was not entirely fair.
The Court did, however, dismiss plaintiffs’ claim that a provision of the merger agreement that prevented the Primedia board from changing its recommendation in favor of the merger after KKR delivered its written consent to adopt the merger agreement on the same day on which the merger agreement was approved by the board. In this regard, the Vice Chancellor distinguished cases involving a stockholder vote at a duly called meeting, noting the requirement that the “board has an ongoing obligation to review and update its recommendation,” which is not limited to the context of a superior proposal, fell away once KKR supplied the requisite vote by written consent.
The full opinion is available here.