In Gallagher Industries, LLC v. William M. Addy, et al., C.A. No. 2018-0106-SG (Del. Ch. May 29, 2020), the Delaware Court of Chancery (the “Court”) held that because Gallagher Industries, LLC (the “Plaintiff”) decided not to pursue an appraisal action following a problematic cash-out merger five years earlier, the Plaintiff’s tolling claim against William M. Addy and Joseph E. Eastin (the “Defendants”) for breach of fiduciary duty for disclosure weaknesses was barred by laches.
Plaintiff is a private equity firm. Loftus, a nonparty, is responsible for Plaintiff’s business. Defendants are William M. Addy, the founder and former chairman of ISN, and John E. Eastin, the current CEO and director of ISN. Non-party ISN provides a contractor management database that connects contractors and business owners. In 2011, ISN had one outside stockholder, Ad-Venture Capital Partners, L.P. (“Ad-Venture”). Ad-Venture owned 900 ISN shares and was looking to sell some of its shares to Polaris Venture Partners (“Polaris”).
In 2012, Plaintiff was approached by Ad-Venture’s controller, Brian Addy, about acquiring Plaintiff’s ranch properties in exchange for ISN shares. In connection with the sale, Plaintiff and Loftus obtained two valuations of ISN, one from Ad-Venture, which valued ISN at $395 million, and another from an independent company, which valued ISN at $450 million. Plaintiff did some additional due diligence before agreeing to exchange the ranch properties for 155 ISN Shares (the “Exchange Transaction”).
Less than three weeks later, ISN conducted a cash-out merger of Ad-Venture, Polaris, and Plaintiff. The purpose of the merger was to reduce the total number of stockholders so that ISN could eventually convert into an S-corporation. The merger consideration was set at $38,317 per share (the “Merger Consideration”), which valued ISN at $138 million. This valuation was determined by the Board using a 2011 valuation and making adjustments by hand on a piece of paper, which failed to account for actual revenue in 2011 and 2012, as well as projected revenue in 2013 which were substantially higher than projected in the 2011 valuation.
The stockholders were notified of the merger and their appraisal rights in connection with the merger (the “Notice”) on January 16, 2013. In addition to the Notice, ISN provided some disclosure documents, including all documents produced during Plaintiff’s due diligence and 24 pages of additional financial information (the “Supplemental Documentation”) which focused primarily on ISN’s historical financial information for 2005 through projected 2013. On January 17, 2013, Plaintiff and Loftus received the Notice, Supplemental Documentation, and a check for $5,939,135, which represented the value of Plaintiff’s 155 ISN shares at the merger price. The Notice stated that “upon cashing or negotiating the enclosed check, [Plaintiff] will be treated by [ISN] as having waived any appraisal rights to which it may otherwise be entitled.” Loftus immediately questioned the Merger Consideration and notified Plaintiff of this concern. However, Loftus presumed that the management team had better information than the Plaintiff and therefore did not contact ISN with any questions. Plaintiff did some additional diligence based upon Loftus’ concerns, but ultimately, did not seek an appraisal and cashed the merger check.
Conversely, both Ad-Venture and Polaris petitioned the Court for an appraisal of the valuation of their shares (the “Appraisal Action”). ISN maintained that it had paid fair value in the merger. During the Appraisal Action, Plaintiff and Loftus were deposed and testified regarding their respective interpretation of the Merger Consideration. The Court determined the fair value of ISN to be $357 million or $98,783 per share. ISN appealed and the Supreme Court of Delaware affirmed in October 2017. ISN paid Ad-Venture and Polaris the amount mandated by the Court in the Appraisal Action.
Plaintiff filed this claim on February 14, 2018 alleging that the Defendants breached their fiduciary duties by providing false and misleading disclosures during the course of the merger. Plaintiff claims that it could not have known that the Defendants breached their fiduciary duties until after Plaintiff heard of the Supreme Court’s decision in the Appraisal Action. Plaintiff states that the three-year statute of limitations should be tolled because of fraudulent concealment and equitable tolling. Fraudulent concealment applies when a plaintiff alleges an affirmative act of actual artifice by the defendant that either prevented the plaintiff from gaining knowledge or led the plaintiff away from the truth. Equitable tolling suspends the statute of limitations while the plaintiff reasonably relied upon the competence and good faith of a fiduciary. However, the plaintiff cannot willfully ignore red flags. The Defendants assert that the three-year statute of limitation bars the Plaintiff’s claim.
First, the Court found that the Defendants breached their fiduciary duty of care and loyalty. The Defendants had a duty to disclose all material information during the cash-out merger process and did not do so.
Next, the Court determined that, despite the Defendant’s actions, the breach of fiduciary duty was apparent to the Plaintiff when the Notice, Supplemental Documentation, and the merger check were received. The receipt of the Notice, merger check, and Supplemental Documentation on January 17, 2013 should have, and did, raise “red flags” for the Plaintiff regarding the Defendants’ disclosure violations. Such “red flags” should have alerted the Plaintiff to the possibility that the merger was unfair. The Plaintiff had an obligation to investigate any problems with the merger, and yet chose instead to cash the merger check. Further, the Court concluded that the Plaintiff had additional notice of the fiduciary duty breach because other ISN stockholders pursued appraisal claims. Therefore, the Plaintiff is barred from making a claim against the Defendants because Plaintiff could have investigated the merger and made a timely claim five years earlier.