CHANCERY COURT DISMISSES BREACH OF FIDUCIARY CLAIMS FOLLOWING THE CLOSING OF A MERGER INVOLVING INSIDER SIDE DEALS
By Joanna Diakos and Dean Brazier
In Alan Kahn v. Michael D. Stern, et al., C.A. No. 12498-VCG (Del. Ch. Aug. 28, 2017), the Delaware Chancery Court granted a motion to dismiss the stockholder plaintiff’s claims that the director defendants breached their fiduciary duties when they approved a merger that included side deals. The Court noted that the plaintiff had the burden of proving either that the board was not disinterested or that the board acted in bad faith with respect to the disclosures in the information statement released to stockholders. The Court concluded that the plaintiff failed to state a claim upon which relief could be granted.
Kreisler Manufacturing Corporation (the “Company”) is a small, thinly-traded, aerospace manufacturing company. In 2015, the Company initiated the process of finding a potential buyer and added a fifth director, Jeffery Bacher. The Court detailed the process by which Arlington Capital Partners (“Arlington”) won the bidding process, culminating in an offer for $18.75 per share, subject to adjustments, in January 2016. During the first half of 2016, as the Company and Arlington negotiated the final terms, Michael Stern and Edward Stern negotiated several side deals between themselves and the Company or Arlington. Both of the Sterns held directorships and senior executive positions at the Company. The special committee created at the outset of the bidding process, consisting of Bacher and John Poling, presented the final terms to the full board in May 2016 and unanimously recommended approval of the sale to Arlington. The defendants are the five directors that made up the full board. The final price was $18.00 per share. Together, the Sterns, Joseph Daly (who was both a director and the largest stockholder in the Company), and AB Value Partners LLC held more than 50% of the Company and they approved the sale via written consent, resulting in the minority stockholders receipt of an information statement but not an opportunity to vote in favor or against the sale.
The central concerns of the case are the side deals that the Sterns negotiated throughout the sale process. Michael Stern negotiated a post-employment agreement and an equity position in an Arlington subsidiary. Edward Stern negotiated “better benefits” than he previously had. Both Sterns negotiated a contingent bonus based on the Company’s post-sale cash balance. Here, the plaintiff made three arguments supporting the lone count for breach of fiduciary duty. First, the directors knowingly approved a merger with side deals that did not maximize stockholder value. Second, the directors knowingly allowed the Sterns to negotiate self-interested deals that translated into “adjustments” that lowered the purchase price. Third, the directors knew that the disclosures in the information statement were materially deficient.
The Court divided the plaintiff’s arguments into process and disclosure components. The Court required that the plaintiff “plead facts from which the Court could reasonably infer that a majority of the Director Defendants were interested in the transaction, or dominated or controlled by an interested party, or that the majority of the Board failed to act in good faith.” In addressing the first two arguments, the Court noted that the analysis rested on whether Daly was or was not an interested director because both sides agreed that the Sterns were interested and Bacher and Poling (the special committee members) were disinterested. In this case the plaintiff failed to show that Daly, despite being the single largest stockholder of a thinly-traded company, received any benefits not available to all other stockholders or that his personal circumstances placed a unique burden on him to sell his shares that would result in a compromise of his judgment. Absent such circumstances, the Court held that Daly was a disinterested director. Determining that a majority of the Company’s directors were not interested made the plaintiff’s remaining arguments substantially more difficult to sustain.
In addressing the third argument, the Court explained that because a majority of the board was disinterested and independent, and the Company’s charter contained an exculpatory provision, to survive a motion to dismiss the plaintiff must plead facts making it “reasonably conceivable that a majority of the board acted in bad faith” and that their decision was “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.” The plaintiff, again, relied on the existence of the side deals and allegedly insufficient disclosures in the information statement. The Court concluded that the side deals for Michael Stern were neither uncommon nor lacking a legitimate business rationale. Furthermore, the assertion of “better benefits” for Edward Stern was too vague to reasonably conclude that this side deal met the high burden for bad faith. The Court, turning to the adequacy of the information statement, noted that the information statement did in fact include the detailed disclosures of the very side deals upon which the plaintiff’s case attacks. In other words, the information statement did not hide material facts. The Court concluded that the plaintiff’s alleged “missing” disclosures were not sufficient to sustain a bad faith claim.
Notably, the Court acknowledges that it likely would have denied the motion to dismiss had the plaintiff filed this action prior to the sale’s closing, when he first sought an inspection of the deal terms. Such a pre-close action seeking injunctive relief could have been advanced based on the pleadings in the complaint. Instead, this post-close action seeking damages garnered a higher burden of proof because the focus of the claim was whether the directors were liable for damages based on a non-exculpated breach of fiduciary duty. This required the plaintiff to allege facts demonstrating that the directors acted in bad faith in making the challenged disclosures, which is a high burden to meet. Here, the plaintiff failed to meet this burden and the complaint was dismissed.
Alan Kahn v. Michael D. Stern, et al., C.A. No. 12498-VCG (Del. Ch. Aug. 28, 2017)