In late 2017, the Delaware Court of Chancery issued an important decision rejecting a post-closing challenge to the sale of a venture capital-backed public company. The decision, van der Fluit v. Yates,1 by Vice Chancellor Montgomery-Reeves, provides helpful guidance for VC-backed companies going forward and addresses other noteworthy issues relevant to the current deal litigation landscape.
In recent years, the Delaware courts have issued a number of opinions that provide an important legal backdrop for this case. First, several recent decisions have held that when a controlling stockholder, or controlling stockholder group, receives a special "non-ratable" benefit in a transaction that is not shared with the other stockholders, such transaction may be subject to the stringent "entire fairness" standard of review unless the transaction is properly conditioned upon: (1) approval by a fully empowered committee of disinterested directors; and (2) a fully informed, uncoerced disinterested stockholder vote.2 Second, a number of recent cases have also considered what it means to be a "controlling stockholder"—including as to stock ownership amounts, other indicia of control, and under what circumstances a group of stockholders may be considered to be sufficiently acting together to possess control.3 A third hot topic in Delaware courts in recent years has been the so-called "Corwin" line of cases, providing that where there is not a controlling stockholder that receives a non-ratable benefit, a fully informed, uncoerced vote of disinterested stockholders can "cleanse" a transaction from fiduciary duty challenges.4 Fourth, the Delaware courts have issued several recent decisions indicating that courts should not easily disturb decisions of well-motivated, appropriately informed boards under the heightened "Revlon" standard of review that applies in changes of control.5 The new decision by the Court of Chancery addresses these various issues in turn.
The case arises out of Oracle's 2016 acquisition of Opower, at a price that represented about a 30 percent premium to Opower's trading price but that was less than half of the company's IPO price two years earlier. At the time of the deal, roughly 70 percent of Opower's outstanding stock was still owned by the company's two founders and venture capital funds that had invested in the company prior to its IPO. At the time of the merger, no single Opower stockholder held more than 22.4 percent of the outstanding shares. All stockholders received the same per-share cash price in the deal, although the two founders also received post-acquisition employment and had unvested options that converted into options of Oracle.
The plaintiff filed suit two months after the merger closed. The complaint alleged that a control group existed, either between the two founders or between the founders and venture funds combined. The plaintiff further alleged that the purported control group received special benefits in the sale, including post-acquisition employment agreements and conversion of unvested options (for the founders) and liquidity for stock acquired at lower pre-IPO prices (in the case of the funds). The plaintiff argued that based upon this alleged differential consideration, the "entire fairness" standard should apply. Alternatively, the plaintiff argued that even if the entire fairness standard did not apply, there was not a cleansing fully informed stockholder vote under the Corwin line of cases and that the target board failed to satisfy the Revlon case law.
The court addressed each claim, first holding that there was not a control group in this case. Importantly, the court held that there were no "voting, decision-making, or other agreements that bear on the transaction challenged in the instant case"—beyond simply a "concurrence of self-interest among certain stockholders." The court reasoned that there had merely been a basic Investor Rights Agreement among the stockholders pertaining to informational and registration rights, as well as customary tender and support agreements signed in connection with the deal. As for the alleged control that the founders together possessed, the court noted that the plaintiff failed to offer any facts alleging "meaningful connections" or "managerial control" between the founders—specifically, there were no allegations of a "personal relationship" between the founders or a manner of voting or operating "in unison." Although there are other Delaware decisions addressing when a control group exists, this decision is a very important addition to the case law for companies with a similar stockholder base.
From there, having found that the entire fairness standard did not apply, the court addressed the plaintiff's Revlon claims attacking the deal. The court held that there was, in fact, a disclosure violation that prevented the stockholder vote from having a cleansing effect—specifically, that the proxy statement should have disclosed, but failed to disclose, whether or not the two founders who received post-transaction employment and an opportunity to convert unvested Opower options into Oracle options led negotiations with Oracle. Nonetheless, the court still dismissed the plaintiff's Revlon claims that the target board breached its duty of loyalty, which centered on the board allegedly favoring Oracle, conducting a two-week market check, and failing to use an independent committee of the board. The court noted, among other things, that: (1) a majority of the board was composed of independent and disinterested directors; (2) plaintiff had not made specific allegations about how the market check was deficient; (3) the board had obtained a fairness opinion from an outside financial advisor; (4) the market check involved 14 strategic buyers, several of whom entered into confidentiality agreements and exchanged information with the target company; and (5) the board discussed transaction possibilities at several meetings.
In the end, the decision offers several important pieces of guidance for companies. First, the decision is helpful for venture-backed companies and similarly situated companies assessing or litigating whether a control group exists. As detailed above, that issue has various ripple-through effects in transaction planning and litigation. The case also serves as a useful reminder that disclosures to stockholders should be carefully prepared in a transaction, but also that Delaware courts will not readily disrupt or question a sale process if it is designed by properly motivated, appropriately informed boards.