DELAWARE HOLDS THAT A SPECIAL COMMITTEE FORMED AB INITIO WILL CLEANSE A CONFLICTED TRANSACTION IN THE CONTEXT OF A MAJORITY-CONFLICTED BOARD AND UNDERSCORES THE IMPORTANCE OF DISCLOSURES REGARDING FINANCIAL ADVISORS
By Scott E. Waxman and Sara M. Kirkpatrick
In Salladay v. Lev, C.A. No. 2019-0048-SG (Del. Ch. Feb. 27, 2020), the Delaware Court of Chancery held that former stockholders of Intersections, Inc. (“Intersections”) adequately pled facts that supported a pleading stage inference that WC SACD’s take-private merger of Intersections (the “Merger”) was subject to entire fairness review, because half of Intersections’ board stood on both sides of the transaction, and that it was reasonably conceivable that the merger was not entirely fair.
Intersections is a software company that provides credit management and identity theft protection services to subscribers. In early 2018, Intersections, which was experiencing financial difficulties, began looking for possible sources of funding. Several parties expressed interest, so Intersections formed a special committee (the “Committee”) and hired Houlihan Lokey to advise the Committee. A few term sheets were exchanged with third parties, but Intersections was unable to finalize a deal and disbanded the Committee. In mid-September of 2018, a representative of iSubscribed Investor Group (“iSubscribed”) contacted two Intersections directors (one of whom was its then current CEO and another of whom was a managing director of Intersections’ largest stockholder) to express iSubscribed’s interest in Intersections. The parties quickly executed a non-disclosure agreement and formed WC SACD as a joint venture for the purpose of an acquisition.
In late September 2018, Intersections’ CEO “effectively” told WC SACD that Intersections’ board would be receptive to an offer of $3.50 to $4.00 per share. The Committee was reconstituted in early October 2018, which is around the same time Intersections’ board decided it would only approve a transaction supported by the Committee. WC SACD’s first offer came in less shortly thereafter at $3.50 per share. While the Committee did hire legal counsel and agree to condition the Merger on a majority-of-the-minority vote, the price term of the Merger was already in place by the time it hired a “nationally recognized investment firm”, who terminated the engagement just a few days after its retention. The Committee quickly retained North Point Advisors, giving it just eight days to review the Merger and provide a fairness opinion. By the end of October 2018, the Committee recommended approval of the Merger at a price of $3.68 per share, with terms that allowed two directors and Intersections’ largest stockholder to roll over a large portion of their holdings, and gave WC SACD the right to designate a majority of the members of Intersections’ board in the event the transaction was terminated. Although the proxy seeking approval of the Merger disclosed WC SACD’s contractual change in control right, it did not disclose that under NASDAQ rules, WC SACD could only appoint a majority of the members of the board if it held a majority of Intersections’ stock.
In this action, plaintiffs alleged that the Merger was a conflicted transaction because half of the board stood on both sides of the transaction, making it subject to entire fairness review because, (i) the Committee entered negotiations after substantive economic terms had been discussed, and (ii) disclosures regarding the Merger were inadequate to invoke business judgement review. The defendant directors argued that they had effectively cleansed the Merger by utilizing a special committee and a majority-of-the-minority vote.
First, the Court held that a properly constituted special committee that is formed prior to substantive economic discussions can cleanse a transaction in the context of a majority-conflicted board and subject such transaction to business judgement review. Against this backdrop, the Court found that, according to the complaint, when Intersections’ CEO told WC SACD that the company would be receptive to an acquisition offer of $3.50 to $4.00 per share, it effectively set a price collar that set the field of play for the economic negotiations to come. The alleged existence of a price collar was supported by the fact that the WC SACD’s original offer came in at the low end of this price range and WC SACD’s second and final offer was right below the mid-point of this range.
Next, the Court found that the majority-of-the-minority stockholder vote did not cleanse the transaction because the disclosures were materially incomplete or misleading. According to the complaint, the disclosures incorrectly suggested to the stockholders that if they did not approve the transaction, control of the board would transfer to WC SACD, which was unlikely because under NASDAQ rules, WC SACD would only be able to appoint a majority of the board if it held a majority of Intersections’ outstanding stock. Further, the disclosures made it difficult for stockholders to calculate the company’s current stock ownership. Finally, the Court held that the disclosures failed to explain why Intersections switched financial advisors twice, which, the Court considered an important fact “in the context of a near-completed deal and a tight schedule”.