In Charles Almond, et al. v. Glenhill Advisors LLC, et al., C.A. No. 10477-CB, Chancellor Bouchard ruled in favor of the defendants, directors of furniture company Design Within Reach Inc. (the “Company”) and Glenhill Capital Management LP (“Glenhill”), on all of the plaintiff-investors’ claims relating to the 2014 acquisition of DWR by Herman Miller, Inc. (“Herman Miller”). In doing so, Chancellor Bouchard judicially validated certain measures taken by Herman Miller to rectify an error that had diluted its ownership stake in the Company. Chancellor Bouchard also dismissed claims challenging transactions through which the Company’s board members received additional equity in the Company before the merger, holding that because these claims were derivative in nature, the plaintiffs’ standing to bring such claims were extinguished because of the merger.
In August of 2009, Glenhill invested $15 million in the Company, then in financial distress, and became its controlling stockholder, holding a 92.8% equity interest consisting of common stock and the Series A Preferred. A conversion formulation dictated how the Series A Preferred were to be converted into shares of common stock in certain specified circumstances. The Series A Preferred certificate of designation provided for adjustments to such conversion formula in the event of a reverse split of the common stock; however, this certificate did not provide for any adjustment to the conversion formula in the event of a reverse split of the Series A Preferred itself.
During the summer of 2010, “DWR common stock became like a penny stock, trading intermittently and at widely fluctuating prices.” To address this volatility and save costs, the Board of the Company decided to implement a 50-to-1 reverse stock split of both the common stock and the Series A Preferred. The Board recommended, and Glenhill as the majority stockholder approved, the reverse stock split and a series related transactions. Unknown to anyone at the time, the reverse stock splits were implemented in a defective manner that had the effect of diluting the number of shares of common stock into which the Series A preferred stock could be converted by a factor of 2500-to-1, instead of the intended result of a 50-to-1 adjustment. This defect remained unknown in 2013, when Glenhill converted its Series A Preferred into common stock, and in 2014, when Herman Miller acquired the Company for approximately $170 million via a short-form merger.
Over one year after the merger closed, the plaintiffs discovered the defect and challenged the validity of Herman Miller’s acquisition of the Company, alleging that the acquisition was never consummated due to the technical mistakes before the merger and arguing that because these mistakes, Herman Miller lacked the requisite amount of stock to have completed a short-form merger. In response, Herman Miller ratified certain defective corporate acts under Section 204 of the Delaware General Corporate Law (the “DGCL”) relating to the implementation of the reverse stock splits and the subsequent conversion of the Series A preferred stock. Herman Miller then filed a counterclaim asking the court to validate those acts under Section 205 of the DGCL.
In determining whether to validate Herman Miller’s ratification of the defective corporate acts, Chancellor Bouchard examined the following equitable considerations identified in Section 205 of the DGCL: (a) whether the defective corporate acts were originally approved or effectuated with the belief that the approval or effectuation was in compliance with the provisions of the DGCL and the governing documents of the corporation; (b) whether the corporation and board of directors treated the defective corporate acts as a valid act or transaction; (c) whether any person would be or was harmed by the ratification or validation of the defective corporate acts; (d) whether any person would be harmed by the failure to ratify or validate the defective corporate acts; and (e) any other factors or considerations the Court deemed just and equitable. Chancellor Bouchard found that all of these considerations overwhelmingly favored judicial validation of Herman’s ratification of the defective corporate acts, which Chancellor Bouchard then granted.
Chancellor Bouchard then examined the second set of claims brought by the plaintiffs, which challenged certain transactions through which the Company’s board members received additional equity in the Company before the merger. Chancellor Bouchard ultimately held that because these claims were derivative in nature, the plaintiffs’ standing to bring such claims were extinguished because of the merger.