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26th TULANE CORPORATE LAW INSTITUTE: DELAWARE DEVELOPMENTS

March 27, 2014 Justice Henry duPont Ridgely

Fredrick Alexander Paul Choi

Brad Davey Mark Gentile

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Delaware Developments: Overview of Topics

• Preferred Stock Issues• Standard of Review• Appraisal Rights• Forum Selection• Additional Developments

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Delaware Developments: Preferred Stock Issues • In In re Orchard Enterprises, Inc. S’holder Litig., the Court of Chancery

held that a proxy statement in connection with a merger was materially misleading where it misstated in two places that an amendment to the certificate of incorporation was necessary to prevent the allocation of merger consideration to the holders of preferred stock to satisfy their liquidation preference where the merger did not in fact trigger the preferred stockholders’ liquidation preference.

• Relying on Section 242 of the DGCL which requires, in connection with seeking stockholder approval of a charter amendment, that stockholders receive notice setting forth such charter amendment or a brief summary thereof, the Court stated that:– “The DGCL does not require that stockholders receive many items

of information, but those that it does require are material per se.”

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Delaware Developments: Preferred Stock Issues • In Lehman Brothers Holdings, Inc. v. Spanish Broadcasting System,

Inc., the Court of Chancery held that preferred stockholders had acquiesced to a corporation’s incurrence of additional debt that was allegedly in violation of their contractual rights where, among other things:– The preferred stockholders had knowledge of their rights under the certificate

of designation to appoint directors in the event of the nonpayment of dividends for four consecutive quarters;

– Under the preferred stockholders’ purported reading of the certificate, the holders knew or should have known that such right was triggered;

– The preferred stockholders knew that the corporation intended to enter into debt transactions, but did nothing leaving the corporation to believe that the preferred stockholders had acquiesced;

– The corporation’s belief was reasonable because, among other things, preferred stockholders had a mechanism whereby they could request a special meeting to elect the preferred directors; and

– The corporation entered into the debt transactions in reliance on the preferred stockholders’ acquiescence.

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Delaware Developments: Preferred Stock Issues

• In In re Trados Inc. S’holder Litig., the designees of four VC funds that held preferred stock representing a controlling interest in the corporation constituted four of seven board members.

• Of the $60 million of total merger consideration: $52 million went to holders of preferred stock, $8 million went to management in newly adopted incentive plan and no consideration went to holders of common stock.

• In its post-trial opinion, the Court of Chancery found that the board’s decision to approve the cash-out merger was entirely fair, notwithstanding the fact that the common stockholders received no consideration.

• Reviewing the transaction for entire fairness, the Court found that, although the process was not fair, the decision to approve the merger was entirely fair because the common stock had no economic value before the merger and its appraised value was zero.

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Delaware Developments: Preferred Stock Issues

• The Court of Chancery reasoned that the process was not fair because the directors:– Analyzed the transaction from the perspective of holders of

preferred stock;– Did not consider how to fairly allocate the funds payable

pursuant to the management incentive plan among the common and preferred stockholders;

– Did not consider how the management incentive plan skewed the negotiation and structure of the merger in a manner adverse to the common stockholders;

– Did not understand that their role was to maximize value for the common stockholders; and

– Did not consider conditioning the merger on the approval of a majority of the disinterested common stockholders.

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Delaware Developments: Standard of Review• The applicable standard of review which will be applied by

Delaware courts to in transactions in which controlling stockholders are involved is an evolving area of the law.

• The role of the controlling stockholder in the transaction and the protective devices utilized in the process, if any, may dictate the applicable standard of review.

• A nuanced factual analysis will also be employed by Delaware courts in assessing whether protective devices, such as use of a special committee or a majority-of-the-minority vote should be credited.

• Three variations – (i) controlling stockholder on other side, (ii) controlling stockholder getting different consideration and (iii) controlling stockholder receiving the same consideration.

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Delaware Developments: Standard of Review• In In re MFW S’holders Litig., the Delaware Supreme Court affirmed

the Court of Chancery’s grant of summary judgment in an action challenging a merger of M&F Worldwide with its controlling stockholder.

• The Delaware Supreme Court, stressing the “vital distinction” between cases such as Kahn v. Lynch and its progeny (in which “the controller did not give up its voting power by agreeing to a non-waivable majority-of-the-minority condition”) and the facts at issue in MFW, held that the business judgment standard of review applies to a controlling stockholder merger when it is conditioned, ab initio, on:– Negotiation and approval by an independent, fully functioning and

duly empowered special committee that fulfills its duty of care; and– The uncoerced, fully informed vote of a majority of the minority

stockholders.

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Delaware Developments: Standard of Review• Thus, under the MFW framework, in controller buyouts, the

business judgment standard of review will be applied if and only if:– the controller conditions the procession of the transaction on the

approval of both a special committee and a majority of the minority stockholders;

– the special committee is independent; – the special committee is empowered to freely select its own

advisors and to say no definitively; – the special committee meets its duty of care in negotiating a fair

price;– the vote of the minority is informed; and– there is no coercion of the minority.

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Delaware Developments: Standard of Review• Importantly, however, the Court held that if a plaintiff can plead a

reasonably conceivable set of facts showing that any or all of the conditions entitling the merger to the business judgment standard of review did not exist, the complaint would state a claim for relief that would entitle the plaintiff to proceed and conduct discovery.

• Further, “[i]f after discovery, triable issues of fact remain about whether either or both of the dual procedural protections were established, or if established were effective, the case will proceed to a trial in which the court will conduct an entire fairness review.”

• Notably, that Court stated that the complaint in MFW would have survived a motion to dismiss based on allegations attacking the fairness of the price, which called into question the adequacy of the special committee’s negotiations.

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Delaware Developments: Standard of Review• In SEPTA v. Volgenau, the Court of Chancery held that a merger

between a corporation with a controlling stockholder and a third-party private equity buyer was entitled to review under the business judgment rule due to the use of “robust procedural protections.”

• Distinguishing MFW because the controller in MFW stood on both sides of the transaction, the Court of Chancery held that the business judgment rule would nonetheless apply if the procedural protections set forth in In re John Q. Hammons Hotels Inc. S’holder Litig. were met, namely:– Transaction recommended by disinterested and independent special

committee;– Special committee had sufficient authority and opportunity to bargain on

behalf of minority (including the ability to hire independent advisors);– Transaction approved by stockholder in non-waivable majority of minority

vote; and– Vote was fully informed and non-coercive.

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Delaware Developments: Standard of Review• In In re Morton’s Restaurant Group, Inc. S’holder Litig., the Court of

Chancery granted defendant’s motion to dismiss where alleged controlling stockholder shared a control premium pro rata with minority stockholders in a third-party deal.

• The Court of Chancery stated:– “[T]he presumption is that a large blockholder, who decides to take

the same price as everyone else, believes that the sale is attractive, and thus is a strong indication of fairness and that judicial deference is due . . . there are only ‘narrow circumstances’ where a controlling stockholder's desire to sell in a transaction according equal treatment to all stockholders would create a disabling conflict of interest. Those unusual circumstances ‘involve a crisis, a fire sale’ in which . . . the controller imposes pressure on the corporation to artificially truncate the market check and forgo the additional value that could be brought about by making ‘logical buyers aware’ that the company is for sale and giving them a reasonable time and fair opportunity to consider whether to make an offer.”

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Delaware Developments: Appraisal Rights

• Appraisal rights experience in Michael Dell’s buyout of Dell, Inc.

• Appraisal rights experience in David Murdock’s acquisition of Dole Food Company, Inc.

• Trends in use of appraisal rights by stockholders

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Delaware Developments: Appraisal Rights• In Huff Fund Investment Partnership v. CKx, Inc., in connection with

an appraisal proceeding in which the Court of Chancery held that the best indicator of value of petitioner’s shares was the merger price generated by an arm’s length sales process, the respondent filed a motion seeking the Court to order the petitioner to accept an unconditional offer that represented the base case scenario, plus accrued interest, in order to stop the accrual of interest while the parties supplemented the record as to whether the merger price included synergies that should be excluded.

• Despite noting that, “compared to fault-based litigation, the opportunities for rent-seeking in appraisal actions are comparatively high” and that permitting a respondent to cut off the accrual of interest may have merit for policy reasons, the Court held permitting the respondent to do so was incompatible with the balance struck by the General Assembly in amending Section 262 and limiting the Court’s discretion in determining the proper rate at which interest would accrue.

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Delaware Developments: Appraisal Rights• In Huff Fund Investment Partnership v. CKx, Inc., in connection with

an appraisal proceeding in which the Court of Chancery held that the best indicator of value of petitioner’s shares was the merger price generated by an arm’s length sales process, the respondent filed a motion seeking the Court to order the petitioner to accept an unconditional offer that represented the base case scenario, plus accrued interest, in order to stop the accrual of interest while the parties supplemented the record as to whether the merger price included synergies that should be excluded.

• Despite noting that, “compared to fault-based litigation, the opportunities for rent-seeking in appraisal actions are comparatively high” and that permitting a respondent to cut off the accrual of interest may have merit for policy reasons, the Court held permitting the respondent to do so was incompatible with the balance struck by the General Assembly in amending Section 262 and limiting the Court’s discretion in determining the proper rate at which interest would accrue.

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Delaware Developments: Appraisal Rights• In In re Orchard Enterprises, Inc. S’holder Litig., the Court of Chancery

held that quasi-appraisal was not a remedy limited to a short-form merger and that if the defendants failed to prove that the merger was entirely fair, then quasi-appraisal damages would be one form of possible remedy. The Court explained:– “[Q]uasi-appraisal damages are one possible remedy for breaches of the

duty of disclosure, and the availability of the quasi-appraisal damages measure is not limited to short-form mergers. But more importantly . . . the quasi-appraisal damages measure is simply a remedy, and it can be awarded for other breaches of fiduciary duty as well.”

• As to the issue of which defendants would be liable for the payment of such damages, the Court noted would be a “separate inquiry” in which “affirmative defenses like exculpation under Section 102(b)(7) and reliance on experts under Section 141(e) potentially apply.”

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Delaware Developments: Forum Selection• Many Delaware corporations have adopted charter and bylaw

provisions designating Delaware as the exclusive forum for stockholder litigation over derivative claims, breach of fiduciary duty claims, and other internal affairs matters.

• In Boilermakers Local 154 Retirement Fund v. Chevron Corp., stockholders challenged the facial validity of the forum selection bylaws adopted by Chevron and Fedex.

• The Court of Chancery held that the forum selection bylaws were valid under Section 109(b) of the DGCL because:– the bylaws “only regulated suits brought by stockholders as

stockholders in cases governed by the internal affairs doctrine . . . the bylaws plainly relate to the ‘business of the corporation,’ the ‘conduct of [its] affairs,’ and regulate the ‘rights or powers of [its] stockholders.’”

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Delaware Developments: Forum Selection• Treatment of forum selection clauses in non-Delaware

courts:– Miller v. Beam Inc.: Circuit Court for Cook County Illinois

enforces Beam’s board adopted forum selection bylaw (2014)– In re Metro PCS Communications: Court of Appeals for Fifth

District of Texas enforces Metro PCS’s bylaw provision (2013)– In re Facebook, Inc.: U.S. District Court SDNY declines to

enforce forum selection charter provision on technical grounds (2013)

– Galaviz v. Berg: U.S. Federal District Court for N.D. California declines to enforce Oracle’s board adopted forum selection bylaw (2011)

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Delaware Developments: Additional Developments• In Kalisman v. Friedman, a director designee sued the corporation

and his fellow directors for allegedly freezing him out of deliberations regarding a recapitalization plan that he, and the stockholder that designated him, opposed.

• Rejecting defendants’ argument that the director was frozen out because he would have shared information provided to the board with the stockholder that designated him, the Court of Chancery noted:– “When a director serves as the designee of a stockholder on the

board, and when it is understood that the director acts as the stockholder’s representative, then the stockholder is generally entitled to the same information as the director.”

• Importantly, however, the Court of Chancery noted that the director remains liable for any misuse of the shared information.

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Delaware Developments: Additional Developments• In In re Primedia, Inc. S’holders Litig., the Court of Chancery held

that plaintiffs, whose standing to pursue derivative insider trading claims had been extinguished by a merger, had standing to challenge directly the entire fairness of the merger based on a claim that the target board of directors failed to obtain sufficient value in the merger for the pending derivative claims.

• The Court determined that the plaintiffs established standing to sue by showing that:– The allegations stated a claim, – The value of the claim was material in the context of the merger since full

disgorgement of profits for a fiduciary’s insider trading was a potential remedy, and

– The acquiror was interested in the value of the business, rather than in asserting the derivative claim, and did not provide value for the claim in the merger price.

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Delaware Developments: Additional Developments

• In Activision Blizzard, Inc. v. Hayes, the Delaware Supreme Court reversed the Delaware Court of Chancery’s injunction of Vivendi’s sale of its controlling stake in Activision pursuant to a stock purchase agreement.

• The Delaware Supreme Court held that a provision in Activision’s charter that required the approval of a majority of the stockholders not affiliated with Vivendi with respect to any “business combination” or “similar transaction” did not apply to the stock sale because the term “business combination” was unambiguous and the stock sale did not “involve any combination or intermingling of Vivendi’s and Activision’s businesses.”