• Court of Chancery holds that Corwin cleansing does not apply to claims seeking to enjoin entrenching actions subject to enhanced scrutiny review under Unocal.
• The Court found that Plaintiffs successfully pled facts warranting enhanced scrutiny under Unocal because the challenged provisions on their face permitted a reasonable inference that they were adopted to defend against a perceived threat of stockholder activism.

On May 1, 2023, the Delaware Court of Chancery in In Re Edgio, Inc. Stockholders Litigation,¹ held that the case-dispositive cleansing effect of Corwin² does not extend to claims seeking to enjoin board-entrenching actions subject to review under Unocal.³ The Court thus denied Defendants’ motion to dismiss the stockholder Plaintiffs’ complaint seeking to enjoin provisions in a stockholders’ agreement that would have the effect of protecting the incumbent directors from activist campaigns. Because Defendants did not actually argue that the challenged provisions satisfied enhanced scrutiny under Unocal, the Court denied the motion to dismiss in its entirety.

Background

Edgio, Inc., f/k/a Limelight Network, Inc. (the “Company”), is a provider of network service for digital media content and software delivery. In July 2020, the Company’s stock reached an all-time high of $8.19 per share, but afterwards declined significantly, closing at $4.33 per share on January 20, 2021.

In March 2021, market commentators and analysts began to speculate that the Company may be a target for activist investors. No activist investor emerged, but in June 2021, Edgecast, Inc. (“Edgecast”) approached the Company about a potential merger. Edgecast was the indirect subsidiary of College Parent, L.P. (“College Parent”), which is a portfolio company of a private equity fund and the parent of Yahoo, Inc.

The Company ultimately agreed to acquire Edgecast for common stock worth approximately $300 million, with the possibility for additional stock-based earnout consideration of $100 million (the “Acquisition”). As a result of the Acquisition, College Parent would hold approximately 35% of the Company’s outstanding stock.

In connection with the Acquisition, College Parent and the Company entered into a stockholders’ agreement that contained three provisions challenged by Plaintiffs in the litigation (the “Challenged Provisions”):

• A “director-voting provision” requiring College Parent to vote in favor of the board’s director nominees and against any nominees not recommended by the board.
• A “vote-neutralization provision” requiring College Parent to vote on other non-routine matters either in favor of the board’s recommendation or pro rata with all other Company stockholders.
• A “three-year transfer restriction” whereby, during the first two years, College Parent could not transfer its shares without the board’s written consent, and in the third year College Parent could not transfer its shares to a Company competitor or any one of the 50 most significant activist investors listed on the “SharkWatch 50” compiled by FactSet.

Pursuant to NASDAQ Rule 5635(d), the Company was required to obtain stockholder approval for the stock issuance to College Parent. In advance of this vote, the Company issued a proxy statement on May 4, 2022 (the “Proxy”), summarizing the Acquisition, describing the stockholders’ agreement, and explaining that the Acquisition could not be completed if the stockholders did not approve the stock issuance. The Proxy sought approval of the stock issuance but did not ask stockholders either to approve the stockholders’ agreement or to ratify any of the Challenged Provisions.

On June 9, 2022, the stockholders voted in favor of the stock issuance and the Acquisition closed the following week.

Thereafter, Plaintiffs filed a class action complaint alleging that the Company’s directors breached their fiduciary duty. In particular, Plaintiffs claimed that the Company’s directors included the Challenged Provisions in the stockholders’ agreement to interfere with the stockholder franchise or to entrench themselves. Notably, Plaintiffs acknowledged that the Acquisition itself was a boon to the Company and did not seek damages. Plaintiffs asked only that the Court of Chancery enjoin the Challenged Provisions.

Defendants moved to dismiss the complaint, arguing that Corwin cleansed the Challenged Provisions by virtue of the Company’s stockholders approving the stock issuance through a fully informed, uncoerced vote. Corwin and its progeny have held that when fully informed, uncoerced, and disinterested stockholders approve an M&A transaction not subject to entire fairness review due to the presence of a conflicted controlling stockholder, post-closing litigation seeking damages for the transaction will be dismissed under the “irrebuttable” business judgment rule.⁴ The Court denied Defendants’ motion.

Decision

The Court Rejected Defendants’ Argument that Corwin Cleansed the Challenged Provisions from Unocal Review

In denying Defendants’ motion to dismiss, the Court held that several aspects of Corwin preclude a stockholder vote from disposing of a subsequent claim for injunctive relief seeking to enjoin the entrenching actions:

• By focusing on post-closing damages claims for M&A transactions, the Corwin decision indicates that it was never intended to prevent a court from enjoining entrenching actions.⁵
• Corwin does not preclude the application of Unocal and Revlon to address important M&A-related issues in real time before a deal closes.⁶
• Corwin recognizes that “inequities in a transaction’s price or process are compensable by monetary damages, and therefore able to be cleansed by stockholders satisfied with the consideration they already received.”⁷ But because entrenching actions cannot readily be reduced to a monetary harm, stockholders are not able to weigh the economic consequences as a whole.⁸
• The Supreme Court’s declination in Corwin to revisit its earlier decision in In re Santa Fe Pacific Corporation Shareholder Litigation⁹ supports the conclusion that stockholder ratification is unavailable to coercive actions that stockholders do not specifically ratify.¹⁰

Accordingly, the Court concluded that Corwin’s important role of cleansing post-closing M&A damage claims does not extend to claims seeking to enjoin entrenching board actions reviewed under Unocal.¹¹

The Board Reacted to a Perceived Threat to Corporate Control, Triggering Unocal

Having determined that Corwin cleansing did not apply and the Challenged Provisions would be reviewed under Unocal, the Court held that the complaint pled sufficient facts making it reasonably conceivable the “board ‘perceive[d] a threat’ to corporate control and took defensive actions in response.”¹²

Specifically, the Court held the complaint’s allegations permitted a reasonable inference that the guaranteed support of 35% of the outstanding shares held by College Parent “tends to prevent an incumbent director from losing an election.”¹³ Likewise, the Court held that the three-year transfer restriction, including the prohibition on sales to activist investors, “closes off any easy route for an activist to target the Company.”¹⁴ Last, the Court concluded that the vote-neutralization provision “precludes outright opposition from a 35% blocholder [sic] on non-routine matters, which tends to stifle opposition to corporate policy.”¹⁵ The Court thus found, whether viewed together or separately, the Challenged Provisions have defensive effects.¹⁶

Having found the Challenged Provisions were defensive in nature, the Court concluded that the complaint sufficiently pled the board approved the provisions out of a subjective defensive motivation in response to a perceived threat. The Court noted the complaint’s factual allegations supporting a reasonable inference that the Company was a likely target for activists. The Court also concluded that the prohibition against College Parent from transferring its stock to investors likely to launch an activist campaign “bear[s] a good deal of Plaintiffs’ burden” of pleading that “the Board was concerned with the prospect of stockholder activism and negotiated with College Parent to reduce the likelihood of activist intervention.”¹⁷

Having found that the Challenged Provisions triggered review under Unocal, and that Defendants did not argue that Unocal was satisfied, the Court found Plaintiffs adequately pled their claim and allowed the case to proceed into discovery.

Key Takeaways

Edgio clarifies the Corwin landscape by holding that a claim for injunctive relief under Unocal’s enhanced scrutiny standard is not subject to the application of the irrebuttable protection of the business judgment rule under Corwin. Nonetheless, because the Court did not need to confront the issue, Edgio leaves unanswered the impact of stockholder ratification of an entrenching action specifically placed on the ballot for stockholder approval. Moreover, Edgio again demonstrates that public company directors and their counsel will need to be prepared to demonstrate to the Court under enhanced judicial scrutiny that actions taken when a company is open to attack from activists were proportionate to a reasonably perceived threat.

1. 2023 WL 3167648 (Del. Ch. May 1, 2023).
2. Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015).
3. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
4. See, e.g., 2023 WL 3167648 at *6.
5. Id. at *10-11.
6. Id.
7. Id. at *12.
8. Id.
9. 669 A.2d 59 (Del. 1995)
10. 2023 WL 3167648 at *11; see also Santa Fe, 669 A.2d at 68.
11. Defendants, for their part, relied on two pre-Corwin Delaware Supreme Court ratification cases: Stroud v. Grace, 606 A.2d 75, 82 (Del. 1992), and Williams v. Geier, 671 A.2d 1368 (Del. 1996). The Court acknowledged these precedents, but noted that the Delaware Supreme Court failed to address these precedents in Corwin. Accordingly, and notwithstanding Stroud and Williams, the Court of Chancery determined that the “omnibus absolution” of Corwin applies to actions seeking post-closing damages but not to requests to enjoin entrenching actions. See Edgio, 2023 WL 3167648, at *14 n.124 (“Under Corwin, however, the stockholder vote provides omnibus absolution, and any defensive measures and side-payments are ratified along with everything else.” (citation omitted, emphasis added)).
12. 2023 WL 3167648, at *15 (citing Stroud, 606 A.2d at 82).
13. Id. at *16.
14. Id.
15. Id.
16. Id.
17. Id. at *17.