Delaware Court of Chancery holds that directors on a special committee are interested in a going-private merger when the merger effectively extinguishes their personal liability from viable derivative litigation

By: Scott E. Waxman and Chris Fry

In Re AmTrust Financial Services, Inc. Stockholder Litigation, No. 2018-0396AGB (Del. Ch. 2020), George Karfunkel, Leah Karfunkel, and Barry Zyskind, the controlling stockholders of AmTrust Inc. (respectively, the “Controlling Stockholders” and “AmTrust”), teamed up with private equity firm, Stone Point Capital LLC (“Stone Point”), to take AmTrust private through a squeeze-out merger (the “Merger”), which closed in November 2018. Former stockholders (the “Plaintiffs”) challenged the Merger, asserting several claims for breach of fiduciary duty and aiding and abetting against the Controlling Stockholders, Stone Point, and AmTrust’s Board of Directors (the “Board”), among other participants in the Merger (collectively, the “Defendants”). DeCarlo, Gulkowitz, Fisch, and Rivera sat on both the Board and the special committee (the “Special Committee”), which negotiated the Merger and made recommendations to the Board regarding the same. The Delaware Court of Chancery (the “Court”) upheld the claims against the Board finding that the Controlling Stockholders and members of the Special Committee, except Rivera, were, among other issues, interested in the transaction, and therefore the Merger failed to comply with the procedures outlined in controlling precedent to obtain the benefit of a business judgment review, subjecting the Merger to the entire fairness standard of review. 

Under the controlling precedent, the business judgement rule applies in controller buyouts only if each of six criteria are satisfied to ensure the independence of the special committee, both from influence by controlling stockholders and any “disabling personal interest in the transaction at issue.”  The second criteria explicitly states that the special committee must be independent.  Under Delaware law in the context of this Merger, directors are interested in a transaction if they expect to “derive any personal financial benefit… material to that director.”

Here the Board (except Rivera who was not a member at the time, the “Cambridge Defendants”) was subject to previous derivative AmTrust stockholder suits alleging usurpation of opportunity, among other claims (the “Cambridge Action”). Reviewing the facts and circumstances surrounding the Cambridge Action, the Court found that the Cambridge Defendants could not credibly challenge the viability of the Cambridge Action or its materiality to each of them personally, as the estimated settlement was between $15 million and $25 million.  The Merger effectively terminated the Cambridge Action and extinguished personal liability for the Board and three members of the Special Committee. 

Accordingly, the Court found that the Special Committee, except Rivera, had a material personal interest in the Merger. With Institutional Shareholder Services at one point criticizing the “less-than-robust sale process” surrounding the Merger, among other deficiencies, the Court allowed the claims for breach of fiduciary duty to proceed against the Cambridge Defendants on the Board.  Regarding the remaining claims, the Court dismissed the claim against Rivera, finding that the Plaintiffs did not plead sufficient facts to challenge Rivera’s independence.  The Court also dismissed the claims against Stone Point of aiding and abetting a breach of fiduciary duties.  The scienter requirement for aiding and abetting is acting “with the knowledge that the conduct advocated or assisted constitutes such a breach.” In this case, the Plaintiffs relied on conclusory statements that Stone Point must have known of the Cambridge Defendants’ conflicts of interest and failed to plead facts with sufficient particularity to support a reasonable inference that Stone Point acted with knowledge in aiding and abetting the alleged breach of fiduciary duty.


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