Directors Breach Fiduciary Duties in Coercive Self-Tender

By: Annette Becker and Serena Hamann

In Robert A. Davidow v. LRN Corporation, et al., C.A. No. 2019-0150-MTZ (Del. Ch. Feb. 25, 2020), the Delaware Court of Chancery denied a motion to dismiss breach of fiduciary duty claims brought against the founder and two directors (the “Individual Defendants”) of LRN Corporation, a corporation that advises on ethics and compliance (“LRN”) because the plaintiff (on behalf of the former stockholders who tendered shares in the tender offer) (“Plaintiff”) adequately pled facts sufficient to state a claim that the Individual Defendants breached their fiduciary duties by launching a coercive self-tender at an unfair price, providing inadequate disclosure, and authorizing the self-tender notwithstanding the Individual Directors’ interestedness.

In 2017, the Individual Defendants and LRN launched a self-tender to acquire shares of LRN’s common stock for $1.35 per share (the “Self-Tender”). The Individual Defendants and LRN sent an Offer to Purchase (“OTP”) to LRN stockholders stating that LRN had recently received one-time lump sum payments totaling over $20 million and that the Individual Defendants had decided to allocate a portion of the funds to provide stockholders with the opportunity to sell their shares. The OTP warned stockholders that if they did not tender they may need to hold the stock for a long time without receiving payments and in fact may never receive payments for their stock. The OTP stated that the offer price was based on an appraisal but provided little information regarding the appraisal and LRN’s future performance. Ultimately, stockholders tendered roughly 23% of LRN’s outstanding shares. The tender resulted in LRN’s founder and chairman Dov Seidman (“Seidman”) holding more than 50% of the voting stock of LRN. The other two Individual Defendants did not participate in the Self-Tender resulting in an increase of their equity stake in LRN.

A year later, Leeds Equity Partners (“Leeds”) acquired LRN for $255 million or $7.00 per share. Seidman, as LRN’s controlling stockholder, approved the acquisition and negotiated other personal benefits, including a spin-off of an LRN business to a company he controlled, and the right to serve as chairman and to appoint two members to LRN’s  board of directors following the acquisition. Seidman cashed out 80% of his shares for approximately $128 million. The other two Individual Defendants also cashed out their shares during the acquisition.

Plaintiff filed a class action on behalf of all stockholders who tendered in the Self-Tender. Plaintiff claimed that the 2017 Self-Tender was coercive, that material information relating to the transaction was inadequately disclosed, that the Individual Defendants breached their fiduciary duties to the LRN stockholders, and that the 2017 Self-Tender was not entirely fair.

The Court noted that self-tenders have built-in conflicts of interest requiring directors to structure the offers non-coercively and disclose all material facts. An entire fairness standard applies where the self-tender is coercive or where the company’s directors lack independence in approving the transaction.

The Court found that Plaintiff adequately alleged that the OTP omitted material information. The Court relied on Eisenberg v. Chicago Milwaukee Corporation, 537 A.2d at 1058, 1056 (Del Ch. 1987)in finding that information regarding offer purpose, price fairness, and director interestedness was material information. The Court held that directors owe a fiduciary duty to stockholders to disclose all facts material to a transaction, and that the Individual Defendants breached this duty to disclose by withholding information in all three material categories. The Plaintiff adequately alleged that the true purpose of the Self-Tender was to squeeze out LRN stockholders and buy Seidman control and to ultimately enable the Individual Defendants to cash out at a high value in the undisclosed forthcoming transaction. Additionally, the Individual Defendants provided insufficient and outdated financial information related to price fairness and did not disclose that the Individual Defendants had personal interest in the success of the Self-Tender.

The Individual Defendants claimed they had no duty to disclose a prospective sale because such information was immaterial as a matter of law. However, the Court found these arguments premature on a motion to dismiss, and found a reasonable inference that the prospective sale process was more than preliminary in nature during the Self-Tender.

The Court found the OTP disclosures, when read collectively under the circumstances, were designed to induce the stockholders to tender through inadequate information rendering the Self-Tender voluntary in appearance but coercive as a matter of substance. The Court also found the Self-Tender was structurally coercive because it was designed to make stockholders believe that they would receive little or no return on LRN stock unless they chose to tender. As the Self-Tender was coercive and the Individual Directors were interested, entire fairness review applied.

The Court found the Plaintiff adequately alleged that the Self-Tender was the product of unfair process and resulted in an unfair price. The price was inadequate because LRN had a history of arbitrary pricing, the appraisal used to generate the price was questionable and based on incomplete and outdated financials, and the Leed’s acquisition price was much higher. The Individual Defendants also failed to obtain a fairness opinion or an independent valuation. The Court concluded that the Individual Defendants’ choice to structure the 2017 Self-Tender for their benefit amounted to a non-exculpated breach of the duty of loyalty that was subject to entire fairness review and denied the Individual Defendants’ motion to dismiss.  The Court granted the motion to dismiss as to LRN as the Plaintiff did not seek relief against LRN.

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