Delaware Court of Chancery Rejects Business Judgment Rule Protection for Stockholder-Negotiated Redemption
By: Joanna A. Diakos Kordalis and Monica Romero
In In re Dell Tech. Inc. Class V. Stockholders Litig., Consol. C.A. No. 2018-0816-JTL (Del. Ch. Jun. 11, 2020), the Delaware Court of Chancery denied defendants’ motion to dismiss the breach of fiduciary duty claim asserted against them finding that the complaint alleged facts that made it “reasonably conceivable” that the safe harbor established by Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014), would not apply and defendants would not get the benefit of the business judgment rule.
In 2016, Dell Technologies Inc. (“Dell” or the “Company”), which is controlled by Michael Dell and Silver Lake Group LLC, acquired EMC Corporation, a data-storage firm. One of EMC’s most valuable assets was its ownership of 81.9% of the equity of VMware, Inc., a publicly traded cloud-computing and virtualization company (“VMware”). Upon acquisition, the Company converted each share of EMC common stock into the right to receive $24.05 in cash plus 0.11146 of newly-issued Class V shares. The Class V common stock was intended to track the value of the Company’s ownership interest in VMware, but in actuality it traded at roughly a 30% discount to VMware’s publicly traded shares as it was subject to a conversion right pursuant to a pricing formula.
To consolidate the value of the Company’s ownership of VMware, Dell Technologies created a special committee tasked with negotiating a redemption of the Class V shares. Dell’s Board of Directors conditioned any redemption or similar transaction on both (i) special committee approval, and (ii) approval from holders of a majority of the outstanding Class V shares. This process was designed to qualify for the safe harbor established by Kahn v. M & F Worldwide Corp. (“MFW”), 88 A.3d 635 (Del. 2014). However, the Company reserved the right to bypass the MFW process and engage in a forced conversion. Company representatives and special committee advisors stressed that a forced conversion was the least attractive option for the Class V stockholders, but the Company emphasized that it would invoke this right if a redemption agreement could not be reached.
The special committee agreed to a negotiated redemption (the “Committee-Negotiated Redemption”), but holders of Class V stock objected. Rather than negotiating further with the special committee, the Company began negotiating directly with six major shareholders of Class V stock. The Company reached an agreement with these stockholders (the “Stockholder-Negotiated Redemption”). The Stockholder-Negotiated Redemption was approved by the special committee and the remaining shareholders representing 61% of the outstanding Class V shares.
Plaintiffs, former holders of Class V stock, argued that Michael Dell, Silver Lake, and members of the Board breached their fiduciary duties when negotiating and approving the Stockholder-Negotiated Redemption. According to the plaintiffs, it was reasonably conceivable that the Stockholder-Negotiated Redemption was not entirely fair. Defendants claimed that the Stockholder-Negotiated Redemption complied with the requirements of MFW and was therefore subject to the irrebuttable version of the business judgment rule. Accordingly, defendants moved to dismiss the complaint in accordance with Court of Chancery Rule 12(b)(6).
In order to invoke MFW and receive the benefit of the irrebuttable business judgment rule, a company must irrevocably and publicly disable itself from using its power to determine or dictate the outcome of the negotiations and the shareholder vote. The Delaware Supreme Court has articulated a handful of necessary and sufficient conditions for obtaining MFW cleansing, four of which are at-issue in this case: (i) whether the transaction was conditioned on both a favorable committee recommendation and a properly constituted stockholder vote; (ii) whether the special committee and minority stockholders were coerced by the company; (iii) whether the special committee was independent; and (iv) whether the stockholder vote was fully-informed.
In Vice Chancellor Laster’s opinion, the Court considered these conditions and rejected the defendants’ pleading-stage contention that MFW necessarily applies. First, the Court found that the complaint supported a reasonable inference that the transaction was not properly conditioned on the special committee’s approval given Dell’s reservation of rights to effect a forced conversion. The Court explained that reservation of the right to exercise a Forced Conversion and direct negotiation with stockholders indicated that the Company did not fully disable itself from dictating the outcome of negotiations and that it failed to respect the distinct roles of the special committee and stockholders in transactions.
Second, the Court found that it was reasonably conceivable that by threatening a Forced Conversion, the Company created a coercive environment for both the special committee and minority stockholders.
Third, the Court found that the complaint alleged facts supporting a reasonable inference that the two special committee members were not independent. Finally, the Court found that the stockholder vote was not fully informed because the Company issued a proxy statement that did not include: (i) the prices proposed by the special committee in November 2018, (ii) misrepresented the expertise of the special committee’s financial advisors and compensation arrangement; and (iii) misrepresented a prior valuation of the Class C stock that was favorable to the Class V stockholders.
Based on this analysis, the Court concluded that MFW deference was unwarranted. Instead, the Court found that the complaint alleged facts supporting entire fairness as the operative standard of review. Accordingly, the Court denied the defendants’ motions to dismiss.