"After Corwin, Court of Chancery Provides Additional Guidance on Application of Business Judgment Rule to Post-Closing Damages Claims"

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

Skadden, Arps, Slate, Meagher & Flom LLP

As previously reported in Insights: The Delaware Edition, the Delaware Supreme Court’s landmark decision in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015) articulated a new defendant-friendly rule for post-closing damages actions for breaches of fiduciary duties. The Delaware Supreme Court held that where a transaction “not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders,” the deferential business judgment standard of review will apply, leaving only a claim for waste. The Corwin decision was followed shortly by an order in Singh v. Attenborough, 137 A.3d 151 (Del. 2016) (ORDER), in which the Supreme Court, applying Corwin, explained that “[w]hen the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result ... because the vestigial waste exception has long had little real-world relevance, [and] because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.”

As a practical matter, the Corwin case has created a high bar for plaintiff stockholders to pursue a post-closing damages claim. The Delaware Court of Chancery has now applied Corwin to dismiss a number of cases at the pleading stage, which are described below. In each case, the court found that (i) the stockholder vote approving the merger was fully informed, (ii) the transaction did not involve a controller, and (iii) under Corwin, plaintiffs’ claims were subject to the business judgment rule standard of review.

The Comstock Decision

City of Miami General Employees v. Comstock, C.A. No. 9980-CB, 2016 WL 4464156 (Del. Ch. Aug. 24, 2016) involved a stockholder challenge to the merger between C&J Energy Services, Inc. (C&J) and a subsidiary of Nabors Industries Ltd. (Narbors). In November 2014, Vice Chancellor John W. Noble issued a preliminary injunction enjoining the merger until after C&J complied with a court-mandated, 30-day go-shop provision. In December 2014, the Supreme Court reversed that order. Subsequently, in March 2015, the transaction closed after receiving approval of approximately 97.6 percent of the shares of C&J stock that voted on the transaction. After closing, the plaintiff amended its complaint seeking post-closing damages for alleged breaches of fiduciary duties by C&J’s board and its officers arising from any allegedly conflicted sales process. For the first time, the plaintiff also alleged disclosure claims.

Although the court noted that “plaintiff did not heed the preference under Delaware law for disclosure claims to be litigated before a stockholder vote so that if a disclosure violation exists, it can be remedied by curing the informational deficiencies, thus providing stockholders with the opportunity to make a fully informed decision,” the court still considered the disclosure claims as part of its Corwin analysis. Specifically, the court stated that it was required to address the plaintiff’s disclosure claims to determine the appropriate standard of review under Corwin. Ultimately, the court rejected the plaintiff’s disclosure claims that, in essence, were the same “tell me more” type disclosures that the Delaware courts have consistently held are inadequate to state a colorable disclosure claim. In doing so, the court reiterated that “Delaware law does not require disclosure of a play-by-play of negotiations leading to a transaction or of potential offers that a board has determined were not worth pursuing” and that “quibbles with a financial advisor’s work simply cannot be the basis of a disclosure claim.”

With respect to the fiduciary duty claims, the plaintiff argued that entire fairness applied because: “(1) a majority of the C&J board was interested in the Nabors transaction because of their desire to obtain board seats in the surviving entity, and (2) that Comstock [the CEO and chairman of C&J,] tainted the process by which the board considered the transaction.” The court rejected both arguments, holding that (i) “enticement of a future seat on the board of the company surviving a merger is not sufficient to disqualify that director from making a disinterested decision on the basis of financial interest,” (ii) “Comstock’s large [10 percent] equity position helped to align his interest with stockholders ... and there was no temptation for Comstock to tip the scales in favor of a transaction that would give him control of the combined entity,” and (iii) in any event, the plaintiff failed to adequately allege the “type of duplicitous conduct” that Delaware courts have condemned. Because the plaintiff was unable to plead facts sufficient to invoke entire fairness review, the court held that the presumption of the business judgment rule applied under Corwin and dismissed the action. The court also dismissed claims against certain officers and aiding-and-abetting claims against the buyer and C&J’s financial advisor.

The Larkin Decision

One day after Comstock was issued, Vice Chancellor Joseph R. Slights III provided additional guidance on Corwin’s application in Larkin v. Shah, C.A. No. 10918-VCS, 2016 WL 4485447 (Del. Ch. Aug. 25, 2016). Larkin involved Teva Pharmaceuticals Industries, Ltd.’s (Teva) acquisition of Auspex Pharmaceuticals, Inc. (Auspex) in a $3.5 billion all-cash deal structured as a two-step medium form merger pursuant to Section 251(h) of the DGCL. The merger closed in May 2015 after stockholders owning 78 percent of Auspex’s outstanding common stock (including 70 percent of shares not contractually bound to support the transaction) voted to approve the transaction in the first step of the two-step process. Former Auspex stockholders brought a post-closing damages action alleging that the Auspex board, several of whom were affiliated with different venture capital funds and were therefore alleged to be motivated to monetize their investments, breached their fiduciary duties by running a flawed sales process that ultimately led to an inadequate merger price.

The plaintiffs’ “showcase theory” was that entire fairness applied to the transaction because “the venture capital funds ... controlled the Auspex board and, spurred by self-interest, caused the conflicted board to approve an ill-advised transaction with Teva at the expense of Auspex’s other stockholders.” Alternatively, the plaintiffs alleged that entire fairness applied because “a majority of the Auspex board labored under actual conflicts of interest throughout the process of negotiating and approving th[e] merger.” After finding that the plaintiffs had failed to plead facts that the transaction involved a controlling stockholder, the court held that “[i]n the absence of a controlling stockholder that extracted personal benefits, the effect of disinterested stockholder approval of the merger is review under the irrebuttable business judgment rule, even if the transaction might otherwise have been subject to the entire fairness standard due to conflicts faced by individual directors.” In reaching that conclusion, the court addressed the following overarching question: “[W]hat did Corwin mean by ‘a transaction not subject to the entire fairness standard’?”

The court expressly rejected the plaintiffs’ “rigorously literal reading” of Corwin that “all transactions subject to entire fairness for any reason cannot be cleansed under Corwin” (emphasis in original). Instead, the court agreed with the defendants that “the only transactions that are subject to entire fairness that cannot be cleansed by proper stockholder approval are those involving controlling stockholders.” The court’s decision was motivated by three primary reasons: (i) a plain reading of Corwin itself, along with supporting authority and underlying context, (ii) recent guidance from the Court of Chancery including Vice Chancellor Tamika Montgomery-Reeves’ decision in In re Volcano Corp. Stockholder Litigation, 143 A.3d 727 (Del. Ch. 2016) (discussed below), and (iii) policy rationales that animate Delaware’s controlling stockholder jurisprudence, namely, that “[c]oercion is deemed inherently present in controlling stockholder transactions of both the one-sided and two-sided variety, but not in transactions where the concerns justifying some form of heightened scrutiny derive solely from board-level conflicts and lapses of due care.” The court dismissed the complaint in its entirety because the plaintiffs had not attempted to plead a waste claim.

The Volcano and OM Group Decisions

In In re Volcano Corp. Stockholder Litigation, Vice Chancellor Montgomery-Reeves rejected the plaintiffs’ post-closing damages claims arising from the transaction between Volcano Corporation and Philips Holdings USA, finding that stockholder acceptance of a tender offer has the same cleansing effect under Corwin as stockholder approval pursuant to a traditional long-form merger. The court held that because Volcano’s stockholders were fully informed as to all material facts regarding the merger, the plaintiffs were subject to an irrebuttable presumption under the business judgment rule.

In so holding, Vice Chancellor Montgomery-Reeves rejected the plaintiffs’ attempt to distinguish tender offers from stockholder votes for purposes of application of the Corwin analysis. Specifically, the vice chancellor rejected the following two arguments: (i) tender offers differ from statutorily required stockholder votes “based on ‘the lack of any explicit role in the [DGCL] for a target board of directors responding to a tender offer’” (citation omitted) (alteration in original), and (ii) “a first-step tender offer in a two-step merger is arguably more coercive than a stockholder vote in a one-step merger.” With respect to the first argument, the court explained that the target board, even in the case of two-step mergers, is obligated to adopt a resolution approving the merger agreement and declaring its advisability. Further, “in recommending that its stockholders tender their shares in connection with a [two-step] merger, the target corporation’s board has the same disclosure obligations as it would in any other communication with those stockholders.” With respect to the coercion argument, the court noted that the requirements under Section 251(h) alleviate any such coercion because the first-step tender offer must be for all of the company’s outstanding stock, the second-step merger must be effected as soon as practicable after the first-step tender offer, the same consideration must be paid in both the first- and second-steps, and appraisal rights are available in two-step mergers. Additionally, the court reiterated Corwin’s concerns about judicial second-guessing of economic decisions made by disinterested and fully informed stockholders and noted that the Corwin decision itself uses the terms “approve” and “vote” interchangeably.

Most recently, Vice Chancellor Slights applied Corwin in In re OM Group, Inc. Stockholders Litigation, C.A. No. 11216-VCS, 2016 WL 5929951 (Del. Ch. Oct. 12, 2016). The OM Group litigation arose from a merger between OM Group, Inc. (OM) and Apollo Global Management, LLC (Apollo). The plaintiffs brought a post-closing rescissionary damages action for alleged breaches of fiduciary duties by OM’s board of directors and an aiding-and-abetting claim against OM’s merger partner, Apollo. The aiding-and-abetting claims were voluntarily dismissed. The plaintiffs argued that the stockholder vote should be disregarded because it was “the product of OM’s incomplete and misleading public disclosures ... regarding a director conflict, the extent to which the OM Board appreciated and managed the banker conflicts and material details of an indication of interest received by the OM Board during the post-signing go-shop.”

Applying Corwin, Vice Chancellor Slights dismissed the complaint “because a majority of fully informed, uncoerced, disinterested stockholders voted to approve the merger and [p]laintiffs [did] not allege that the transaction amounted to waste.” In so holding, the court noted that the complaint alleged “no facts from which one could infer that a majority of the OM Board was interested in the transaction or that the OM Board labored under the influence of a controller.” Further, upon analyzing the plaintiffs’ disclosure claims, the court found that there was “no material omission and no materially misleading partial disclosure” regarding indications of interest from an alternate bidder; there were “no facts from which [the court could] reasonably infer that the omitted facts relating to [an OM director’s] connection to Apollo reflect an actual conflict or are otherwise material”; and that “[t]he OM stockholders were fully apprised of [OM’s financial advisor’s] past work with Apollo and of the contingent nature of its engagement by the OM Board.”1

Key Takeaways

The Court of Chancery’s recent string of decisions applying Corwin have some important takeaways for practitioners and parties to deal litigation.

  • Delaware courts will continue to defer to the decisions of independent and disinterested target company boards, and of disinterested, noncoerced and fully informed stockholders, to approve transactions. In fact, as of the date of this article, all the cases where the Court of Chancery applied the Corwin analysis have resulted in dismissals.
  • The law underlying Corwin continues to develop. For example, one interesting issue emerging from these recent decisions is the perception that the Court of Chancery appeared to take a broader view of Corwin in Larkin than in other cases, such as Comstock.  In Larkin, Vice Chancellor Slights interpreted Corwin to hold that “[i]n the absence of a controlling stockholder that extracted personal benefits, the effect of disinterested stockholder approval of the merger is review under the irrebuttable business judgment rule, even if the transaction might otherwise have been subject to the entire fairness standard due to conflicts faced by individual directors” (emphasis added). In reaching that conclusion, the court read Corwin to hold that “the only transactions that are subject to entire fairness that cannot be cleansed by proper stockholder approval are those involving a controlling stockholder.” The Larkin court’s formulation of Corwin seems to place a higher barrier to plaintiffs in post-closing merger litigation than in other recent cases such as Comstock. Because the case law is still evolving, it remains worthwhile to monitor closely how the Court of Chancery applies Corwin to noncontroller transactions going forward.
  • While Comstock suggests that disclosure claims may be considered post-closing as part of the Corwin analysis, other recent decisions from the Court of Chancery (see Nguyen v. Barrett, C.A. No. 11511-VCG, 2016 WL 5404095 (Del. Ch. Sept. 28, 2016) and In re Columbia Pipeline Group Stockholder Litigation, C.A. No. 12152-VCL (Del. Ch. May 25, 2016) (TRANSCRIPT)) strongly indicate that disclosure claims should be brought before the stockholder vote when the purported harm of an uninformed vote may still be remedied. Accordingly, stockholder plaintiffs may not be able to seek tactical gain by deferring disclosure claims until after stockholders vote and the disclosures can no longer be supplemented.

__________________ 

1 In one recent decision, In re Comverge Shareholders Litigation, C.A. No. 7368-VMCR (Del. Ch. Oct. 31, 2016), Vice Chancellor Montgomery-Reeves stopped short of entering summary judgment for the defendants under Corwin because the court found that some of the plaintiffs’ disclosure claims presented a mix of factual issues and questions of law that required further development before they may be decided as a matter of law. It bears mentioning, however, that the court had denied a motion to dismiss on the plaintiffs’ claims almost a year before the Supreme Court issued its decision in Corwin.

Download PDF

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.