Court of Chancery Dismisses all Claims Brought by Minority Stockholder
By Shoshannah Katz and Tom Sperber
In Francis M. Ford (VMware Inc.) v. VMware Inc. C.A. No. 11714-VCL (Del. Ch. May 2, 2017), the Delaware Court of Chancery granted defendants’ motion to dismiss the plaintiff’s complaint in full for failing to state a claim upon which relief can be granted. Francis M. Ford (“Plaintiff”) alleged breaches of fiduciary duty against VMware Inc. (“VMware”), EMC Corp. (“EMC”), Denali Holding Co. (“Denali”), Dell Inc. (“Dell”), Universal Acquisition Co. (“Universal”), and several directors of these companies. Plaintiff was a minority stockholder of VMware prior to a merger between EMC, VMware’s controlling stockholder, and Denali that closed in September 2016. The Court held that Plaintiff failed to allege that the parties to the merger breached any fiduciary duties to the VMware stockholders or that the parties otherwise bound VMware to unfair terms. The Court also found that the restructuring of VMware prior to the merger was subject to the business judgment rule, and that Plaintiff failed to sufficiently plead that Denali’s issuance of a tracking stock reflecting the performance of VMware’s stock price was a misappropriation or a wrongful dilution.
Before the merger, EMC was a publicly traded corporation with majority ownership and effectively total control of VMware, also a publicly traded corporation, pursuant to protective provisions in VMware’s governance documents associated with the shares of stock held by EMC.
After considering spinning off VMware, EMC decided instead to pursue a merger with Denali, a holding company owned by affiliates of Dell’s Michael Dell and a private equity firm. The parties discussed several strategies, most of which involved Denali’s issuing a class of stock tracking the value of VMware in order to structure a transaction requiring less cash at consummation. Ultimately, the parties agreed to conduct a reverse triangular merger with EMC emerging as a wholly owned subsidiary of Denali. In exchange for their EMC common stock, EMC stockholders received cash and shares of a newly issued derivative security from Denali (“Class V Stock”), which tracked the value of 65% of Denali’s 81% indirect interest in VMware. The only parties to this agreement were EMC and Denali. As part of the merger, EMC also agreed to forgo any actions that it could legally take to defend against the merger, including amending VMware’s bylaws or issuing additional shares of EMC or VMware.
VMware’s stock value began to fall, both immediately after the announcement of the merger, and over the next several months, during which VMware announced the termination of a plan to engage in certain transactions and announced both broad layoffs and disheartening future earning estimates. Plaintiff’s complaint alleged that the devaluation of VMware’s stock price constituted a loss caused by breaches of fiduciary duty and duty of loyalty by the defendants.
The Court of Chancery classified the Plaintiff’s allegations as advancing five theories of potential breach: (1) The failure to spin theory; (2) the known looter theory; (3) the merger agreement theory; (4) the restructuring theory; and (5) the tracking stock theory. All other objections that Plaintiff cited in its complaint were not adequately briefed and, therefore, were found by the Court of Chancery to have been waived.
Plaintiff claimed that EMC and its directors breached their duty of loyalty by failing to spin-off VMware when presented with an opportunity to do so prior to the merger. The Court of Chancery dismissed this claim citing the long-standing rule that a majority stockholder has no obligation to alienate its own shares and ruling that EMC could act in its own interest in making a decision whether and how to sell its property.
Next, Plaintiff claimed that Denali was a “known looter,” and that as such EMC breached its fiduciary duty by selling itself to Denali, and that the directors of both EMC and VMware breached their fiduciary duties for failing to defend against the sale. The Court of Chancery identified that a successful “known looter doctrine” claim would have had to allege facts supporting a reasonable inference that EMC knew Denali was a looter or was aware of circumstances that would create a reasonable inference that Denali was dishonest or untruthful, and that Denali actually looted EMC/VMware. The Court of Chancery dismissed the claim, holding that Plaintiff’s allegations did not create a reasonable inference that Denali was known to be a looter or actually looted VMware, and that as a result the directors had no obligation to defend against the sale because there was no reasonable threat of harm and the complaint failed to identify any action that the board could have taken to defend against the merger.
Plaintiff further claimed that the merger agreement “shackled” VMware to the merger terms and stripped it of its ability to defend against it, and that EMC breached its fiduciary duty by agreeing to it. The Court of Chancery found that while some merger provisions did restrict EMC’s actions as to VMware, VMware was not a party to the agreement and such provisions did not bind VMware directly, rather they bound EMC’s actions with respect to its interest in VMware, which could not be the basis for a breach of fiduciary duty. Plaintiff also claimed that the other defendants aided and abetted the binding of VMware, but as such a claim requires an underlying breach of fiduciary duty, the Court of Chancery dismissed it.
Plaintiff alleged that the restructuring of VMware between the announcement of the merger and its closing also amounted to a breach of the duty of loyalty by EMC. The Court of Chancery dismissed this claim, finding that the restructuring and subsequent loss in stock value affected all stockholders proportionally, including EMC, and thus its actions did not reflect any conflict of interest for its own disproportionate benefit. As such, the equal-treatment safe harbor applied to EMC’s actions and its decision was protected by the business judgment rule.
Lastly, Plaintiff claimed that Denali’s issuance of the Class V Stock tied to VMware’s stock price was improper in three ways: (1) That it was a tax dodge; (2) that the shares were actually VMware securities rather than Denali securities, making the financing of the merger a misappropriation of VMware funds; and (3) that the Class V Stock effectively diluted VMware’s trading shares. The Court of Chancery dismissed the first theory because Plaintiff failed sufficiently to address it in its brief. As to the misappropriation theory, the Court of Chancery clearly identified the tracking stock as a derivative equity security created and issued by Denali, not VMware. The Court also dismissed the dilution claim, determining that the tracking stock did not create traditional dilution because the relative ownership and voting power of the VMware stockholders was not reduced, nor did it constitute wrongful dilution by creating an attractive substitute for VMware stock, thus reducing its market share. The Court of Chancery held that the duty of loyalty only applies to a controlling stockholder when it exercises the power of its controlling position over the company, and as the issuance of the tracking stock was merely Denali and EMC exercising their power over their own personal property— their shares—no breach resulted.
Thus, Plaintiff failed to adequately plead any of its claims, resulting in the Court of Chancery granting the defendants’ motion to dismiss in full.