Directors Trigger Entire Fairness Review by Approving Merger to Extinguish Potential Liability for Derivative Claims

By  Lisa Stark and Claire White

In In Re Riverstone National, Inc. Stockholder Litigation, C.A. No. 9796-VCG (July 28, 2016), the Delaware Court of Chancery held that  a board’s approval of a merger agreement containing a release of claims against the directors and entered into while a potential derivative suit for usurpation of corporate opportunity was threatened against such directors warranted entire fairness review.

The plaintiff stockholders in this case alleged that a majority of the directors of Riverstone National Inc. (“Riverstone”) had breached a duty of loyalty to Riverstone, an apartment property management company, by investing directly in the equity ownership of two related businesses formed to acquire and manage single-family homes and residential mortgages, for which Riverstone performed management services. CAS Capital Limited (“CAS Capital”) owned in excess of 90% of the Riverstone capital stock, and two of CAS Capital’s controlling parties (the “Principals”) served as directors of Riverstone.  The plaintiffs informed the board of directors of Riverstone (the “Board”) of their claims on May 20, 2014, and on May 30, 2014, the Board approved the merger of Riverstone with a third party for all-cash consideration. The merger agreement contained a release of all claims against Riverstone, including the derivative claims.  The merger consideration was further adjusted for indebtedness, including certain contested contributions by the Principals in the amount of approximately $20 million that had been accounted for as unsecured debt due to affiliates, rather than equity contributions.

Examining the facts in the light most favorable to the plaintiff on this motion to dismiss action, the Court found that Riverstone held as an asset a chose-in-action against the directors for breach of fiduciary duty stemming from the derivative claims, which was extinguished by the merger, and that the directors received a material benefit from the relief from potential liability in connection with the merger agreement. The claim for usurpation of corporate opportunity was supported by evidence that (1) Riverstone was financially able to exploit the opportunity to invest directly in the related businesses notwithstanding Riverstone’s negative working capital, (2) the related businesses were in Riverstone’s “line of business” notwithstanding its traditional focus on apartment-dwelling property management (rather than single-family home investments), (3) Riverstone’s intent to act as property manager for the related businesses could materialize into an interest or expectancy in the opportunity as a direct ownership investment, and (4) the Riverstone directors, by taking a direct equity ownership interest in the related businesses, positioned themselves in conflict with the interests of Riverstone, its stockholders, and their fiduciary duties.

The Court acknowledged that the mere allegation of a potential derivative claim extinguished by a release of claims in connection with a merger should not necessarily trigger a heightened fairness review. Nonetheless, the Court found that the plaintiffs in this matter plead particularized facts to support an inference that a majority of the directors in recommending the merger transaction were aware of the derivative claim, and obtained a material benefit from the agreement extinguishing the claim, sufficient to trigger entire fairness review in this instance.

With respect to the contested contributions of the Principals, the Court found insufficient evidence that the improper classification of these amounts was tantamount to unfair dealing because the plaintiffs failed to allege facts to support how the contributions were related to the merger consideration or that the accounting treatment or characterization of these contributions changed in connection with the merger, or that plaintiffs suffered harm as a result of the alleged misclassification.


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