“consistent with longstanding principles of law and capitalism”: chancery court finds that a bidder cannot be liable for directors’ breach of fiduciary duty without knowledge of the breach

By: Scott Waxman and Jeremy Crites

In Jacobs v. Meghji, et al. (C.A. No. 2019-1022-MTZ), the Delaware Court of Chancery (the “Court”) dismissed Mark Jacobs’ direct and derivative claims that Ares Management Corporation (“Ares”) aided and abetted breaches of fiduciary duty allegedly committed by directors of Infrastructure &  Energy Alternatives, Inc. (“IEA”) on the grounds that Jacobs failed to plead a necessary element of the claim. Additionally, the Court dismissed Jacobs’ claim of unjust enrichment against Ares, again finding that Jacobs failed to plead a necessary element of the claim.

Jacobs is a minority stockholder in IEA, a publicly held infrastructure construction company. IEA’s largest and controlling stockholder is Oaktree Power Opportunities Fund III Delaware, L.P. (“Oaktree”). Ares is a publicly traded asset manager that beneficially owned 6.4% of IEA’s outstanding stock. Due to a liquidity crisis in early 2019, IEA required additional capital. IEA received term sheets from Ares and Hudson Bay Capital (“Hudson Bay”), an asset management firm. Both term sheets involved Oaktree participating in the transaction. Recognizing the likely involvement of Oaktree in any final agreement, IEA created a special committee consisting of four IEA board members, to ensure that “the negotiations with Hudson Bay and Ares [would be] truly conducted on an arm’s-length basis.”

While both proposals would have involved a $50 million investment, Ares’ proposal gave Oaktree a significant windfall compared to Hudson Bay’s. IEA’s directors had retained Guggenheim Partners, LLC (“Guggenheim”), to initially negotiate with potential parties to the deal. On May 13, Guggenheim advised the special committee that the terms of Ares’ offer were better than the terms of Hudson Bay’s. The next day, the special committee approved the Ares deal. The final agreement involved the early conversion of IEA’s Series A Preferred Stock, the issuance of Series B Preferred Stock from IEA, and the issuance of warrants, in addition to a cash payout from Ares and Oaktree. A majority of voting shares had to approve the transaction, and they did so on August 14. Stockholders had no knowledge of Hudson Bay’s offer, which Jacobs’ alleged was less expensive and involved less dilution for IEA stockholders.

Jacobs brought direct and derivative breach of fiduciary duty claims against IEA’s directors for choosing the “grossly unfair” Ares proposal over the “superior proposal” from Hudson Bay, for creating the special committee only after Oaktree’s involvement was known, and for allowing “interested directors to taint negotiations.” Additionally, Jacobs brought direct and derivative claims against Ares, arguing that Ares aided and abetted the directors’ alleged breach of fiduciary duty, and that Ares received unjust enrichment.  Ares brought a motion to dismiss the claims against it under Court of Chancery Rule 12(b)(6) “for failure to state a claim upon which relief can be granted.”

In ruling on the motion to dismiss, the Court had to determine whether Jacobs had pled all elements of his claims. First, the Court addressed the aiding and abetting claim, which required that Jacobs plead “(i) the existence of a fiduciary relationship, (ii) a breach of the fiduciary’s duty, (iii) knowing participation in the breach by the defendants, and (iv) damages proximately caused by the breach.” Noting the high burden that a plaintiff faces when bringing an aiding and abetting claim against a transactional counterparty, the Court stated that an offeror may use arms-length negotiations to achieve the lowest price when it does not knowingly participate in the target board’s breach of fiduciary duty. The Court assumed for the sake of its analysis, that IEA’s directors did breach their fiduciary duty, and focused on whether Jacobs’ successfully pled that Ares knowingly participated in that breach.

First, the Court found that Jacobs did not allege that Ares had actual knowledge of any of the alleged shortcomings in the directors’ negotiations and decision-making process. Next, the Court examined whether Jacobs pled that Ares had constructive knowledge of the alleged fiduciary breaches. Jacobs argued that Ares should have known that the process favored Oaktree, considering the links between Ares and Oaktree. The Court rejected each alleged link between Ares and Oaktree. First, the Court rejected the argument that the special committee’s selection of Ian Schapiro, an Oaktree employee, to negotiate with Ares showed constructive knowledge, finding that the complaint did not allege that Ares used the choice of Schapiro “to create or exploit conflict of interest in the board.” Second, the Court rejected the argument that Ares’ participation alongside Oaktree demonstrated wrongdoing, finding that participating alongside a known controller in a transaction is not enough, in itself, to give rise to liability. Third, the Court rejected the argument that the deal’s structure showed Ares’ knowing participation in the fiduciary breach, stating that Ares combining its equity with Oaktree, taken alone, did not support the claim that Ares knew of Oaktree’s alleged wrongdoing. Lastly, the Court rejected the argument that Ares knew that the deal was “unfairly structured for Oaktree’s benefit,” finding that, unless Ares was aware of the directors’ or Oaktree’s alleged breaches, it was under no obligation to negotiate a deal that was more favorable to IEA. The Court concluded that “Ares exercised its right to secure for itself a ‘sweet’ deal,” and, because Jacobs failed to plead that Ares knowingly participated in the directors’ alleged breach of fiduciary duty, the aiding and abetting claims should be dismissed for failure to plead a necessary element.

Lastly, the Court dismissed Jacobs’ unjust enrichment claim against Ares, because Jacobs failed to plead “the absence of justification,” which is a necessary element of unjust enrichment. The Court noted that aiding and abetting breach of fiduciary duty claims and unjust enrichment claims often overlap, with the failure of one suggesting the failure of the other. Merely benefitting from another’s wrongdoing is not enough. The Court said, “[w]here the defendant participated at arm’s-length in a negotiated transaction, and the plaintiff has not alleged that the defendant was knowingly complicit in any breach of fiduciary duty, the plaintiff has also failed to allege the defendant was not justified in the enrichment it obtained via that transaction.” All claims relating to Ares were dismissed with prejudice.

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