Chancery Court Dismisses Derivative Claim Over Board’s Defensive Measures Against a Takeover as Stockholder Failed to Plead Specific Facts
By Rem Kinne and Peter Soskin
In Ryan v. Armstrong, et al., C.A. No. 12717-VCG (Del. Ch. May 15, 2017), the Delaware Chancery Court dismissed the derivative action brought by a Plaintiff-shareholder (“Plaintiff”) against specified members of the board of directors (“Defendants”) of nominal defendant The Williams Companies (“Williams”). Plaintiff brought his claim against the Defendants without first demanding that the board pursue an action following Williams’ decision to allegedly undertake defensive measures against a takeover. The court granted Defendants’ motion to dismiss holding that Plaintiff failed to plead facts demonstrating that an exception to the demand requirement of Court of Chancery Rule 23.1 applied.
Plaintiff alleged that Defendants caused Williams to enter into an agreement to purchase the remaining minority ownership interest in Williams Partners, L.P. (“WPZ”) of which Williams owned the majority as a defensive mechanism to prevent Williams from being acquired by Energy Transfer Equity, L.P. (“ETE”), in order to entrench Defendants in their positions as members of Williams’ board of directors. In 2014, before Williams agreed to acquire WPZ, ETE informally expressed an interest in acquiring Williams. Williams’ board member and CEO, Alan Armstrong (“Armstrong”), viewed an acquisition by ETE as “undesirable” but agreed to take any offer to Williams’ board.
In May, 2015 Williams entered into a contract to acquire the minority interest and remaining shares of WPZ. A week later, ETE offered to acquire Williams on the condition that Williams cancel the WPZ acquisition. Williams then agreed to be acquired by ETE. As a result, Williams incurred $428 million in losses from its payment to WPZ of a termination fee and a penalty to cancel a force-the-vote provision under the WPZ acquisition agreement. Ultimately, however, ETE failed to complete its acquisition of Williams.
The court noted that Plaintiff’s complaint generally alleges that the Defendants voted in favor of the WPZ merger, and initially against the ETE merger because as a result of their positions as directors they receive benefits such as compensation and bonuses. The court emphasized the closest thing to a particularized allegation against the board members other than Armstrong was “the conclusion that they voted in favor of the WPZ Acquisition” because they knew they would lose their board seats if ETE acquired Williams. The allegations with respect to Armstrong are somewhat more specific. They describe his position and history on the Williams board, and the amount he stood to lose if he were to be removed from the Williams Board.
While the Defendants moved to dismiss pursuant to Court of Chancery Rules 15(aaa), 12(b)(6), and 23.1, the court dismissed the Plaintiff’s complaint pursuant to Rule 23.1. The court noted that a plaintiff-shareholder’s complaint must be dismissed where the plaintiff-shareholder fails to demand board action unless the complaint alleges particularized facts showing the futility of such a demand. In order to excuse demand, the complaint must plead specific facts “sufficient to create reasonable doubt that a majority of directors were incapable of exercising business judgment.” The court held that Plaintiff did not plead particularized facts on a director-by-director basis that a majority of the board was interested in the transaction, and he could not rely on the inference of entrenchment under Unocal alone to satisfy Rule 23.1.
First, the court explained it would not address the applicability of Unocal scrutiny in a damages case, such as this one where the board has already acted and injunctive relief is not available, unless the Plaintiff establishes that he was excused from demanding board action. Under Rule 23.1, demand is excused where the complaint demonstrates that a demand is futile, and futility is demonstrated when the complaint’s facts, and its reasonable inferences “create reasonable doubt that a majority of the directors could exercise business judgment with respect to the demand,” and those facts must create such doubt with respect to each of the individual Defendants.
Second, the court analyzed the Plaintiff’s complaint under Aaronson v. Lewis, which requires a Plaintiff who has made no demand to show there is reasonable doubt that a majority of directors are capable of using business judgment in response to such a demand. Under Aronson, the court must conclude either (1) the particularized pleading creates a reasonable doubt that the directors were not interested or independent in making the decision; or if it does not, (2) that the pleading creates reasonable doubt that the decision was otherwise not the product of business judgment.
Analyzing the complaint under Aronson’s first prong, the court described Plaintiff’s complaint as lacking specific pleadings that show a breach of loyalty because they were not specific to any director, and failed to even imply Armstrong controlled any specific director, or that the merger with ETE would have caused a member of the board to lose directorship fees “material” to that director. The court further noted that because the Defendants were protected by an exculpatory charter provision, they were not precluded from considering a demand fairly unless particularized pleading enabled the court to conclude that it was substantially likely that their conduct fell outside the exemption. The court concluded that Plaintiff failed to meet the first prong of Aaronson because the Plaintiff did not allege particularized allegations that the majority of the board faced a disabling interest with respect to a demand.
The court ruled that Plaintiff failed to meet Aronson’s second prong which excuses demand where the facts alleged demonstrate a “transaction so egregious on its face that the board cannot meet the test of business judgment.” The Plaintiff’s conclusory allegation that the directors’ actions were “taken for entrenchment purposes,” excusing demand failed to plead “particularized facts sufficient to create reasonable doubt that the board’s sole or primary motivation was entrenchment or otherwise demonstrate a substantial threat of liability.” Accordingly, the Plaintiff failed to allege facts sufficient to permit an inference that the majority of the Defendants acted with bad faith.
Finally, the court addressed Plaintiff’s argument that demand should be excused under the “safety valve” of Aronson’s second prong because the WPZ acquisition could only be explained by bad faith. The court noted that while it is “reasonably conceivable” that the WPZ acquisition was a defensive mechanism to the ETE takeover, Plaintiff’s allegations are insufficient to support an inference that bad faith is the only explanation for the board members’ decision.
Ryan v. Armstrong, et al., C.A. No. 12717-VCG (Del. Ch. May 15, 2017)