Chancery Court Dismisses Claims Against Defendants and Holds that the Transactional Structure in M&F Worldwide Applies to Conflicted One Sided Controller Transactions
By: Annette Becker and Joshua Haft
In In re Martha Stewart Living Omnimedia, Inc. Stockholder Litigation, Consolidated C.A. No. 11202-VC (Ch. Ct August 18, 2017) former stockholders of Martha Stewart Living Omnimedia, Inc. (“MSLO”) brought a consolidated class action suit against Martha Stewart (“Stewart”), the former controlling stockholder of MSLO, for breach of fiduciary duty and against Sequential Brands Group, Inc. (“Sequential”), the acquirer of MSLO by merger, for aiding and abetting that breach claiming that Stewart leveraged her position as a controller to obtain disparate consideration for herself as compared to the minority stockholders of MSLO in the acquisition of MSLO. Plaintiffs moved to dismiss, with the Court finding that the complaint failed to state a claim for breach of fiduciary duty against Stewart, and on that basis need not reach the question of whether the complaint adequately pleads the elements of aiding and abetting such a breach, and granted the plaintiffs’ motion to dismiss the complaint.
In In Re Martha Stewart Living Omnimedia, Inc. Stockholder Litigation, Stewart, the founder, namesake, and former controlling stockholder of MSLO, and Sequential, moved to dismiss certain claims of a class of MSLO Class A common stockholders at the time of the acquisition of MSLO (the “Plaintiffs”). The claims arose out of a transaction that closed in December 2015, by which Sequential acquired MSLO in a merger (the “Merger”). Pursuant to the Merger, the Plaintiffs could elect to receive $6.15 per share either in cash or common stock of Sequential based on a formula set forth in the merger agreement (the “Merger Agreement”).
Prior to the negotiation of the Merger and beginning in the summer of 2014, MSLO explored a potential strategic transaction with one of its peer companies referred to as Company A by the Court. MSLO’s board of directors determined at the time that it was appropriate to form a special committee of independent directors (the “Special Committee”) to evaluate the potential transaction with Company A. The Special Committee then retained its own legal advisor and financial advisor to assist with evaluating the potential transaction. Due to Stewart’s importance to MSLO, Company A was not willing to negotiate a transaction prior to determining whether it could reach an agreement in principle with Stewart regarding Stewart’s post-closing employment arrangements. Accordingly, Company A requested, and the Special Committee granted to Company A, the right to negotiate directly with Stewart regarding post-closing employment arrangements prior to negotiating the acquisition. Although Company A had reached an agreement with Stewart, the Special Committee rejected Company A’s best proposal and exclusivity with Company A expired on April 3, 2015.
In November 2014, Sequential first expressed interest in a transaction with MSLO, but the Special Committee elected not to engage Sequential at that time. After further discussions with Sequential, on April 21, 2015, Sequential submitted an initial proposal to MSLO. Initially, Sequential was willing to base Stewart’s post-closing arrangements on her existing arrangements with MSLO, so the Special Committee decided that negotiations of the sale of MSLO should precede Sequential’s negotiations with Stewart regarding her post-closing arrangements. However, after submitting a revised offer to MSLO, Sequential sought to negotiate with Stewart simultaneously with negotiation of the Merger so as to not commit substantial resources to the transaction until determining whether Sequential could reach agreement with Stewart. Accordingly, the Special Committee authorized Stewart to negotiate with Sequential simultaneously with the Special Committee’s negotiation of the Merger.
On June 2, 2015, Sequential submitted a further revised proposal with two alternatives for the Merger: (a) $6.15 per share with a no-shop provision and a termination fee of 3.75%, or (b) $6.00 per share with a go-shop period and a termination fee of 3.75%. The Special Committee directed its financial advisor to request that Sequential increase its bid to $6.65 per share, but Sequential declined. Stewart then informed the Special Committee that Stewart negotiated with Sequential to reimburse Stewart for up to $4 million in legal fees for negotiating her post-closing arrangements and Stewart was not prepared to alter that agreement.
The Special Committee ultimately agreed to accept $6.15 per share with a thirty-day post-signing go-shop period in lieu of the price increase. The Merger Agreement was entered into on June 22, 2015 and included a non-waivable condition that the Merger be approved by a vote of at least the majority of the voting power of MSLO’s outstanding Class A and Class B common stock and a separate vote of at least 50% of the outstanding Class A common stock not owned by Stewart and her affiliates. On the date of the Merger Agreement, Stewart entered into two agreements with Sequential: an employment agreement and a registration rights agreement and negotiated for extensions of a license agreement and IP agreement that were already in place with MSLO.
The Plaintiffs alleged that Stewart leveraged her position as controller to secure greater consideration for herself than was paid to the other stockholders, thereby breaching her fiduciary duty. In a motion to dismiss the complaint under Court of Chancery Rule 12(b)(6), Stewart denied that she was paid disparate consideration but argued that even if the complaint pled that she engaged in a conflicted transaction, the Court should review the allegations under the business judgment rule standard rather than the more onerous entire fairness standard, since the transaction was structured in the manner set forth in Kahn v. M&F Worldwide Corp., including dual procedural protective measures—the creation of an independent special committee and the adoption of a majority of the minority approval condition in the merger transaction.
The Court reviewed Stewart’s and Sequential’s motions to dismiss the Plaintiffs’ claims under Court of Chancery Rule 12(b)(6) on grounds of failure to state a claim upon which relief may be granted. In evaluating a motion to dismiss, the Court must accept all well-pled factual allegations as true and draw all reasonable inferences in favor of the non-movant. Dismissal is only appropriate if the Plaintiffs would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof. To make this determination, the Court’s key overarching inquiry was the appropriate standard of review to apply to Stewart’s actions, whether entire fairness or business judgment.
The Court first analyzed whether Stewart engaged in a conflicted transaction. Under Delaware law, entire fairness would be the appropriate standard of review if Stewart engaged in a conflicted transaction, such that she extracted different consideration or derived some unique benefit from the Merger not shared with the common shareholders. The Plaintiffs argued that Stewart’s employment agreement and intellectual property-related agreements constituted different consideration at the expense of a lower price per share for the Plaintiffs. However, the Court found that the offer price per share declined from $6.20 to $5.75 before Stewart began negotiating the “side deal,” and after completing the deal with Stewart, Sequential raised its offer by $0.40 per share up to $6.15. The Plaintiffs actually benefited from Stewart’s side deal and could not claim causally related damages.
Even if the Plaintiffs had not benefited, Stewart had a pre-existing side deal with MSLO before the Merger, and the new side deal with Sequential offered Stewart substantially the same consideration. The Court noted it was entirely appropriate for Sequential to secure the commitment of Stewart, the face of the Martha Stewart brand, via additional consideration, which facilitated the Merger and enabled the Plaintiffs to realize premium value for their shares. The Court found that the Plaintiffs failed to plead facts supporting a reasonable inference that Stewart secured consideration that otherwise would have been paid to the Plaintiffs and that they suffered direct monetary harm as a result.
The Court next analyzed whether the dual procedural protections employed in the Merger and described above lowered the standard of review from entire fairness to the business judgment rule, as argued by Stewart. The Court explained that, in Kahn v. M&F Worldwide Corp., the Court laid out the measures necessary to prompt application of the business judgment rule at the pleadings stage for a controlling stockholder’s buyout of its subsidiary in a negotiated merger, which are the creation of an independent special committee and the adoption of a majority of the minority approval condition in the merger transaction.
The Court then found that strict compliance with the transactional roadmap of M&F Worldwide results in the Court applying business judgment rule deference at the pleadings stage to conflicted one-side controller transactions with allegations of disparate consideration. Under the facts of this case, the Court found that the Merger’s dual procedural protection measures as deployed—the creation of a properly-empowered independent special committee and the adoption of a non-waivable, fully-informed and uncoerced vote of a majority of the minority stockholders—followed the M&F Worldwide roadmap with precision and were in place at the critical moment when Stewart, the controlling stockholder, began to negotiate for different consideration than the Plaintiffs. The Court held that business judgment review was appropriate.
The Court also found that the Plaintiffs failed to adequately plead that the members of the special committee lacked independence, that the special committee was not effective, or that the majority of the minority vote was not effective.
Ultimately, because the Court found that the Plaintiffs failed to plead facts supporting a reasonable inference that Stewart breached her fiduciary duty, and on that basis the Court did not need to reach the question of whether the complaint adequately pled the elements of aiding and abetting against Sequential.
In re Martha Stewart Living Omnimedia Inc. Stockholder Litigation opinion 170818