On June 30, 2020, in an en banc opinion authored by Justice Karen L. Valihura, the Supreme Court of Delaware reversed the Delaware Court of Chancery’s dismissal of a stockholder lawsuit arising out of the merger between Towers Watson & Co. (“Towers”) and Willis Group Holdings Public Limited Company (“Willis”). City of Fort Myers Gen. Emps.’ Pension Fund v. Haley, C.A. 2018-0132-KSJM (Del. June 30, 2020). As we discussed in our prior post, plaintiffs, who had been stockholders of Towers, alleged that the CEO of Towers breached his fiduciary duty of loyalty by negotiating the merger without adequately disclosing to the rest of the Towers board a compensation proposal he had received from Willis’s second-largest stockholder, whose co-founder and Chief Investment Officer served on the Willis board. Reversing, the Delaware Supreme Court found that plaintiffs adequately pleaded facts sufficient to rebut the business judgment rule.
Specifically, plaintiffs alleged that the CEO was presented a compensation plan that would enable him to earn up to five times his pre-merger compensation and yet did not disclose the proposal to his fellow board members even as he continued to negotiate on behalf of Towers. Plaintiffs advanced the theory that he breached his fiduciary duty to Towers stockholders by agreeing to merger consideration that constituted the “minimum” necessary to secure stockholder approval for the deal in exchange for this allegedly “massive compensation package.”
Because Towers stockholders received shares in the widely-held and public post-merger company, both the Delaware Court of Chancery and, subsequently, the Supreme Court explained that plaintiffs could not state a claim unless they were able to rebut the presumption of the business judgment rule. In the absence of an allegation that the CEO controlled the board, plaintiffs were required to adequately allege that (i) he was “materially self-interested” in the transaction, (ii) failed to disclose his interest to the board, and (iii) a reasonable board member would have considered it a “significant fact in the evaluation of the proposed transaction.”
The Court of Chancery had held that the allegation of a failure to disclose the proposal was insufficient to rebut the business judgment rule because the Towers board would not have considered the proposal significant in light of other available information. For example, the board already knew that the Towers CEO would become the post-merger CEO of the combined company, which would be much larger and, therefore, entitle the CEO to increased compensation. The Court of Chancery also reasoned that the proposal was “a proposal only.”
By contrast, the Delaware Supreme Court held that plaintiffs adequately alleged that the compensation proposal “altered the nature of the potential conflict that the Towers Board knew of in a material way.” Moreover, the fact that the proposal was non-binding was “not the point,” as it “did not relieve [the CEO] of his duty to disclose to the Towers Board the deepening of the potential conflict, particularly in an atmosphere of considerable deal uncertainty.” The Court also found support for plaintiffs’ theory in allegations that another Towers director who had been on the board’s compensation committee testified in a parallel litigation that he would have wanted to know that the CEO was discussing his compensation at the post-merger company with the Willis investor. Thus, at the pleading stage, plaintiffs were “entitled to an inference that the prospect of the undisclosed enhanced compensation was a motivating factor in [the CEO’s] conduct in the renegotiations to the detriment of Towers stockholders.”
Significantly, however, the Delaware Supreme Court noted that there is “nothing inherently wrong with a Board delegating to a conflicted CEO the task of negotiating a transaction … [b]ut the conflict must be adequately disclosed to the Board, and the Board must properly oversee and manage the conflict.”
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City of Fort Myers Gen. Emps.’ Pension Fund v. Haley