SEPTA v. Volgenau, C.A. No. 6354-VCN (Del. Ch. Aug. 5, 2013) (Noble, V.C.)

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In this opinion, the Court of Chancery granted defendants' motion for summary judgment as to all counts of a stockholder class action complaint, which alleged breaches of fiduciary duty by corporate directors and a controlling stockholder arising from the buy-out of SRA International, Inc. (“SRA” or the “Company”) by Providence Equity Partners LLC and its related entities (collectively, “Providence”).  The Court applied the business judgment rule, rather than entire fairness, even though the controlling stockholder rolled over a substantial portion of his equity, given that the merger was approved by both a special committee and minority stockholders.

Ernst Volgenau founded SRA in 1978, took the Company public in 2002, and was its Chairman of the Board and controlling stockholder until July 20, 2011, when the merger transaction with Providence closed.  SRA had two classes of common stock:  Class A and Class B.  Through his ownership of Class B stock (which entitled him to 10 votes per share), Volgenau was able to control the Company.  Under the terms of SRA’s charter, holders of Class A and Class B common stock were required to be treated equally in the event of a merger.

In 2010, SRA began considering possible strategic alternatives, including a sale.  Volgenau became interested in the prospect of a financial acquirer engaging in a leveraged buy-out (“LBO”) of the Company, a transaction that would, in theory, provide stockholders a substantial premium and, perhaps more so than an acquisition by a strategic buyer, allow Volgenau a better opportunity to preserve the Company’s values and culture.  However, Volgenau knew that, once he and the Board made the decision to sell SRA, the eventual acquirer might very well be a strategic buyer.

In the spring of 2010, Providence contacted Volgenau to raise the possibility of a transaction.  Providence’s CEO and other employees met with Volgenau and SRA senior management to discuss a possible LBO transaction, and SRA shared proprietary information with Providence pursuant to a confidentiality agreement.  At the same time, SRA’s Board formed a “study team” to assess strategic alternatives for the Company.  The study team retained CitiGroup to advise it; CitiGroup opined that a significant acquisition by SRA would best maximize the Company’s long-term value.  Consistent with that advice, SRA made a serious attempt to acquire another company, even though that acquisition would either postpone or preclude any deal with Providence.  SRA ultimately lost out in the bidding to Veritas Capital (“Veritas”).  Following the Company’s failed bid, Volgenau and the Board refocused on a possible transaction with Providence, forming a special committee comprised of five Board members, with Michael Klein serving as Chair.  The special committee retained Houlihan Lokey (“Houlihan”) as financial advisor and Kirkland & Ellis (“Kirkland”) as legal counsel.

On November 22, 2010, Houlihan and Klein met with representatives of Providence.  During the meeting, Klein, on behalf of the special committee, informed Providence that SRA had decided not to undertake a formal sale process and that Providence’s initial $28 per share expression of interest was insufficient to start formal discussions.  Klein also rejected Providence’s request for exclusivity, but permitted Providence to conduct further due diligence.

On December 1, 2010, Serco, a strategic competitor of SRA, proposed a transaction at a price range of $29-$31 per share.  Klein advised Providence of Serco’s superior offer, intending to elicit a higher offer from Providence.  However, on December 29, 2010, Providence submitted a bid of $27.25 per share.  The special committee viewed this preliminary expression of interest as insufficient to start negotiations with Providence and determined that it was appropriate to explore additional third-party interest.

In early January 2011, the special committee decided to solicit five financial buyers, including Veritas, as well as continue discussions with Serco.  A sixth financial sponsor was added to the mix shortly thereafter.  Although generally aware that, in theory, strategic buyers potentially could pay more for SRA, the special committee declined initially to solicit other strategic buyers in order to safeguard confidential and proprietary information and avoid leaks into the marketplace.  Nevertheless, by mid-January, the markets began to speculate that SRA was for sale.  As a result of the publicity, Serco withdrew its preliminary offer and terminated discussions.  However, new expressions of interest were made by other potential buyers, and the special committee opened up the bidding process to other strategic sponsors to extract maximum value for SRA.  Accordingly, Houlihan contacted three other strategic bidders, and a fourth contacted Houlihan to express interest.  The special committee permitted Volgenau to meet with strategic acquirers to discuss his “humanistic concerns,” while the committee exclusively addressed the deal terms.  Of these 11 potential buyers, only Providence and Veritas made a formal offer, and these two firms engaged in a multi-round bidding contest. 

On March 18, 2011, Providence submitted an offer of $30 per share.  Two days later, Veritas offered the same amount, but conditioned it on Volgenau rolling over $150 million of his ownership stake, a condition to which Volgenau agreed.  On March 30, 2011, Veritas increased its offer to $30.50.  Later that evening, Providence made two new alternative proposals, increasing its bid to $31 per share or higher.  Under one alternative, Providence offered $30.50 plus a contingent amount equal to the proceeds from the sale of two SRA subsidiaries.  Under the second scenario, Providence offered $31 per share if Volgenau agreed, as part of his $150 million rollover commitment, to provide a $30 million non-recourse loan to Providence, which would be repaid only if the Company realized sufficient proceeds from the sale of the two subsidiaries.  The special committee determined that the second scenario would not result in Volgenau receiving any additional economic benefit; in fact, the second proposal was, according to Volgenau, “a rotten deal” offering “no upside and all downside[.]”  Nevertheless, for the good of the minority stockholders, Volgenau agreed.

Shortly after Providence’s latest proposals were discussed by the special committee, Veritas increased its bid to $31.25 per share and requested exclusivity.  The special committee agreed to negotiate exclusively with Veritas until the following afternoon, but discussions stalled.  Providence then raised its bid to $31.25 per share.  With both bidders deadlocked, the special committee requested that each submit its best and final offer.  Veritas withdrew its offer, leaving only Providence, which declined to make a higher offer.  On March 31, 2011, the special committee unanimously recommended that the Board accept Providence’s offer.  Houlihan opined that the $31.25 per share offer was fair.  Kirkland summarized the terms of the proposed transaction, which included a 30-day go-shop provision, a $28.2 million breakup fee during the go-shop, a $47 million termination fee after the go-shop, and a reverse breakup fee of $112.9 million.  The merger also was subject to a majority of the minority vote that was not waivable by the special committee.  Except for Volgenau, who abstained, the Board voted unanimously to approve the merger and to recommend it to the stockholders.

During the go-shop period, Houlihan solicited 50 potential bidders, including 29 strategic buyers and 21 financial sponsors.  No bidders emerged.  On July 15, 2011, SRA’s minority stockholders approved the merger with 81.3% of the total outstanding minority shares (99.7% of the total minority voting shares) voting in favor of the merger.  The merger, valued at $1.88 billion, closed on July 20, 2011.  SRA stockholders received $31.25 in cash, which represented a 52.8% premium over SRA’s unaffected stock price.

Following the announcement of the merger, Southeastern Pennsylvania Transportation Authority (“SEPTA”), a stockholder of SRA, filed a complaint on April 7, 2011, which it subsequently amended.  In its operative complaint, SEPTA asserted the following claims:  (1) breach of fiduciary duty against the Board for approving the merger pursuant to an inadequate process and for an unfair price; (2) breach of fiduciary duty against Volgenau and Stanton Sloane, the former CEO of the Company, for engaging in self-dealing; (3) breach of fiduciary duty against the Board for approving the merger in violation of SRA’s charter, which requires equal treatment of Class A and B stock; and (4) against Providence, aiding and abetting the Board’s breaches of fiduciary duties.

On defendants’ motion for summary judgment, the Court found that there was no genuine issue of material fact and that defendants were entitled to judgment as a matter of law as to all of SEPTA’s claims.

The Court first held that, under In re John Q. Hammons Hotels Inc. Shareholder Litigation, 2009 WL 3165613, at *12 (Del. Ch. Oct. 2, 2009) (setting forth the procedural protections necessary for a third-party transaction involving a controlling stockholder to qualify for review under the business judgment rule), the business judgment rule applied to SEPTA’s claims because of the procedural protections employed in connection with the transaction—i.e., the recommendation of a disinterested and independent special committee that had sufficient authority and opportunity to bargain on behalf of minority stockholders, and approval by fully informed and uncoerced stockholders pursuant to a non-waivable majority of the minority vote.  The Court noted with approval the recent decision in In re MFW Shareholders Litigation, 67 A.3d 496 (Del. Ch. 2013), but held that, because Volgenau did not stand on both sides of the merger, the proper analysis to determine whether the merger would be reviewed under the business judgment standard was the test set forth in Hammons.

The Court agreed with the defendants that the special committee was disinterested and independent.  In that connection, the Court determined that Volgenau did not stand on both sides of the merger due to his desire to preserve the culture and values of the Company and his rollover of equity into the merged entity.  The Court reasoned that Volgenau had no prior affiliation with Providence, and the rollover of his equity, by itself, did not mean that he stood on both sides of the transaction.  The Court also found that Klein was not self-interested in the merger despite his request to the Board that, as compensation for his committee service, the Company make a $1.3 million donation to two charities with which he was affiliated.  The Court explained that, because he requested that the monetary payment (which the Company refused to make) go to charity and not to himself, Klein did not have a material self-interest in the merger.  Relatedly, the Court concluded that neither Volgenau nor Klein dominated the special committee, observing that all of the special committee members were involved in the sale process and deliberations, and the committee, among other things, opened the bidding process up to both strategic buyers and financial sponsors (despite Volgenau’s initial desire to sell the Company to a financial sponsor to preserve the Company’s culture and values), and “bargained hard” against Providence and Veritas to obtain the best offer possible.

The Court next concluded that the merger was approved by a fully informed and uncoerced non-waivable majority of the minority vote, rejecting all of SEPTA’s purported disclosure violations.  The Court explained that disclosure regarding (1) the exploratory meetings between the Board and Providence, (2) Klein’s “wishful thinking” regarding his request for the charitable contribution, (3) Kirkland’s compensation, which was partially contingent on a deal being undertaken, (4) why Veritas withdrew from the auction process, (5) how the Board determined that the merger conformed with the equal treatment requirement in SRA’s charter, and (6) the fact that CitiGroup previously advised the study team and now was advising Providence, would not have significantly altered the total mix of information available to stockholders and, therefore, need not be made.

In light of these findings, the Court held that the business judgment standard of review was applicable to SEPTA’s claims, which the Court turned to next.

With respect to Count I, the Court rejected SEPTA’s contention that the merger price was inadequate and unfair, reasoning that the merger price (1) represented a 52.8% premium over the Company’s unaffected stock price, (2) was the highest price that any party was willing to pay after a six-month public sale process (which involved at least 10 potential buyers) and 30-day go-shop period (during which Houlihan contacted 50 potential buyers), (3) was determined to be fair by Houlihan, and (4) was approved by 81.3% of the total outstanding shares not owned or controlled by Volgenau.  The Court also rebuffed SEPTA’s argument that the Board’s process was inadequate, noting that the Board formed a special committee which retained qualified advisors to guide it, and the evidence reflected that the Board was fully informed and exercised due care in approving the merger.

With respect to Count II, the Court concluded that neither Volgenau nor Sloane engaged in self-dealing, rejecting SEPTA’s contention that Volgenau, with the aid of Sloane, secretly planned to take the Company private “at a bargain price.”  The Court determined that Volgenau, initially wary of strategic buyers, was willing to sell his shares to a strategic acquirer once he became more acquainted with them, and that there was no evidence that a strategic buyer was dissuaded from bidding because of Volgenau’s emphasis on culture and values.  The Court also found no evidence that, as SEPTA alleged, Volgenau “orchestrated a preordained deal with Providence that the Special Committee merely rubber-stamped.”  Likewise, there was no evidence that Volgenau dominated the special committee.  And, finally, the Court held that Volgenau did not receive more consideration for his shares than did the holders of Class A stock; on the contrary, Volgenau “sacrificed his economic position for the minority stockholders” by agreeing to a risky $30 million non-recourse promissory note.  Because Volgenau did not engage in self-dealing, the Court held that Sloane did not do so either.

With respect to Count IV, the Court concluded that the Board did not breach their fiduciary duty by approving a merger that violated SRA’s charter requirement that Class A and B shares receive equal consideration in a merger.  The Court explained that the clause “plainly permits differing forms of consideration,” and that Volgenau received equal or less consideration than the minority stockholders by agreeing to the risky non-recourse promissory note.

In connection with these three claims against the Board, the Court noted that, pursuant to 8 Del. C. § 102(b)(7), SRA’s charter exculpated them from money damages for a breach of the duty of care.

Lastly, the Court determined that, because the Board did not breach its fiduciary duties, Providence could not have aided or abetted such purported breaches.  Further, the Court observed that the “undisputed evidence collectively demonstrates that Providence was an arms-length bidder,” and thus, even if there were a material fact supporting a breach of fiduciary duty by the Board, there was no evidence that Providence knowingly participated in such a breach.

Accordingly, the Court granted defendants’ motion for summary judgment and entered judgment in defendants’ favor on all counts.

The full opinion is available here.