By Scott E. Waxman and Uri S. Segelman
In In re Cyan, Inc. Stockholders Litigation, C.A. No. 11027-CB (May 11, 2017), the Delaware Court of Chancery dismissed Cyan, Inc. stockholders’ complaint alleging breach of duty by Cyan’s board in merging with Ciena Corp., holding that the plaintiffs had failed to plead sufficient facts to support a reasonable inference that a majority of Cyan’s board was interested in the transaction or acted in bad faith so as to sustain a non-exculpated claim for breach of fiduciary duty. In so doing, the court further denied plaintiffs’ claim for equitable relief of quasi-appraisal, holding that since such relief is typically awarded to redress disclosure deficiencies that are the product of a fiduciary breach, and given that plaintiffs failed to identify any material misrepresentation or omission from Cyan, or to allege any other viable claim for a fiduciary breach, there was no basis to impose a quasi-appraisal remedy.
Cyan is a carrier-grade networking solutions provider, and defendants are the seven members of its board of directors. In April 2014, a securities class action was filed against the seven board members, along with the underwriters, in connection with Cyan’s May 2013 IPO. Shortly after, in a need for additional capital and advised by underwriters Morgan Stanley and Jefferies LLC, Cyan issued a convertible debt offering. Two management directors, one investment firm controlled by another director, as well as Jefferies ultimately invested several million dollars altogether in the offering. The nature of the convertible notes was such that if the notes were converted in connection with a merger, the note holder would receive the same consideration that a holder of the number of shares of Cyan common stock into which such notes were convertible immediately before the merger would have been entitled to receive in the merger. Additionally, the agreement governing the convertible notes contained a “make-whole” provision, whereby if a “fundamental change” occurred, note holders could require a purchaser to repurchase the convertible notes at 100% of the principal plus interest.
After the debt offering and for the next several quarters, Cyan performed well and reported increasing revenues. The board attributed this to a significant purchase order from its largest customer, Windstream Corp. In early 2015, merger negotiations began between Cyan and Ciena, a communications networking solutions provider. Counsel for Ciena wished to ensure that any merger would terminate any note holder’s security interest in Cyan’s assets as well as the negative covenants in the convertible notes. Counsel determined that such termination could be triggered in a transaction in which consideration paid for Cyan common stock was a mix of both stock and cash. This would qualify as a “fundamental change.” Jefferies and certain members of the board held convertible notes, which may have been interpreted as a possible conflict of interest. After the issuance of a fairness opinion from Houlihan Capital LLC, the board unanimously approved the merger. A consolidated class action followed, and on June 30th, Cyan issued a proxy statement recommending the stockholders vote in favor of the merger.
Plaintiffs’ complaint asserted two claims: 1) the seven members breached their fiduciary duties in approving the merger, and 2) the defendants withheld material information that prevented the stockholders from determining “whether to pursue their statutory appraisal right,” and asked the Court for quasi-appraisal as a remedy. Defendants filed a motion to dismiss under Court of Chancery Rule 12(b)(6).
The Court began by noting that the business judgment rule governs review of this board decision. Moreover, Cyan’s certificate of incorporation contained an exculpatory provision permitted under 8 Del. C. § 102(b)(7). Accordingly, to survive the motion to dismiss, plaintiffs were required to state a claim that a majority of defendants acted in bad faith or otherwise breached their duty of loyalty.
Plaintiffs first alleged three conflicts that made the board interested in this merger: I) the members wanted to secure a buyer with “deep pockets” to indemnify them against costs associated with the securities litigation; II) the holdings of two members were large, rendering their interests unaligned with the rest of the stockholders; and III) three members were motivated to ensure a transaction occurred where they could either receive the make-whole payment from the convertible notes, or keep the convertible notes outstanding, but tied to a more financially secure company.
The Court responded to the first conflict by listing several factors discrediting the notion of a disabling conflict of interest in order to secure “deep pockets,” such as preexistent obligations by Cyan to indemnify the board members, the presence of D&O insurance, the presence of other “deep pocket” named defendants in the securities litigation, and the availability of sufficient cash for Cyan to cover potential expenses. It then addressed the second conflict by invoking In re Synthes, Inc. Shareholder Litigation, where the Court stated that “[G]enerally speaking, a fiduciary’s financial interest in a transaction as a stockholder…does not establish a disabling conflict of interest when the transaction treats all stockholders equally…,” and noting that there were neither differing considerations nor exigent circumstances that would implicate the board’s actions. Thirdly, the Court clarified that the three individuals were motivated primarily to maximize the exchange ratio in Cyan’s favor. Moreover, the Court noted that this allegation only concerned three of the seven members of Cyan’s board and thus did not show that a majority of Cyan’s board faced disabling conflicts of interest in approving the merger.
After dismissing the claim of bad faith, the Court cited defendant’s independent ground for dismissal, namely, that when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies. While plaintiffs did not allege coercion, they did allege that the board did not disclose material information, specifically information about Jefferies potential conflict of interest, the importance of and possible overreliance on Windstream as a client, and other financial information. The Court wholly rejected those claims, pointing to numerous statements in the proxy statement, as well as other SEC filings, that addressed the material information plaintiffs claimed were not disclosed. The Court further concluded that the specific items plaintiffs claimed were omitted did not alter the total mix of information available to the stockholders. It thus concluded that each allegation fell short of identifying a material misrepresentation or omission and that the stockholder vote approving the merger was fully informed.
Lastly, to the second count claim for quasi-appraisal, the Court referred to precedent to the effect that quasi-appraisal is simply shorthand for damages, typically available after a fiduciary breach. Given that the cause of action underlying the remedy sought is an alleged breach, which plaintiffs failed to plead, the claim for relief was denied.