In Chester County Employees’ Retirement Fund v. KCG Holdings, Inc. et al, C.A. No. 2017-0421-KSJM (Del. Ch. June 21, 2019), the Delaware Court of Chancery denied the defendants’ motion to dismiss claims of breach of fiduciary duty, aiding and abetting, and civil conspiracy brought against the largest stockholder of KCG Holdings, Inc. (“KCG”), its directors, and its long time financial advisor for failure to maximize value for KCG stockholders when negotiating the merger transaction due to certain actions taken by influencers during the sale process. The Court held that the plaintiff stockholders adequately pled their claims against the defendants to avoid dismissal of claims.Read More
In Glidepath Ltd. v. Beumer Corp., C.A. No. 12220-VCL (Del. Ch. February 21, 2019), the Delaware Court of Chancery held that the buyer of a company did not breach transaction documents or violate the implied covenant of good faith and fair dealing in maximizing the long-term value of the company at the expense of short-term profits that would have resulted in greater contingent consideration being paid to the seller plaintiffs (the “Sellers”).Read More
by David L. Forney and Tom Sperber
In Klein v. H.I.G. Capital, L.L.C., et. al, C.A. No. 2017-0862-AGB, the Delaware Chancery Court issued a Memorandum Opinion granting in part and denying in part a motion to dismiss under Court of Chancery Rule 23.1 for failing to make a demand and under Court of Chancery Rule 12(b)(6) for failing to state a claim of relief. Melvyn Klein (“Plaintiff”), a stockholder of Surgery Partners, Inc. (“SP”), brought direct and derivative claims against one of SP’s directors Michael Doyle (“Doyle”), SP’s controlling stockholder H.I.G. Capital, L.L.C. (“HIG”), and Bain Capital Private Equity, LP (“Bain”) (collectively, “Defendants”), alleging breaches of fiduciary duty against Defendants stemming from three interdependent transactions that were allegedly conflicted and unfair. The Court found that demand was futile because the Plaintiff sufficiently alleged that the board was interested, and found that Plaintiff stated claims for breach of fiduciary and aiding and abetting breach of fiduciary duty by HIG and Bain, respectively, because Defendants failed to show that the conflicted transactions were entirely fair.
The board of directors of SP (the “Board”) approved, and SP entered into, three transactions on May 9, 2017 (the “Transactions”). The Transactions consist of: (1) SP acquiring National Surgical Healthcare for $760 million; (2) HIG selling its shares of SP to Bain at a price of $19 per share; and (3) SP issuing to Bain 310,000 shares of a new class of stock of SP at a price of $1,000 per share. These transactions were interrelated and dependent on each other; if one fell through, the others would fail as well. The Board approved the Transactions without a special committee and with no publicly disclosed abstentions. No public stockholders voted on the transactions as HIG approved each by written consent as majority stockholder. Bain and SP used the same law firm and accounting firm to represent them during negotiations. Once the Transactions were finalized, Bain was SP’s controlling stockholder.
Plaintiff filed a complaint alleging eight claims. Of those claims, four were pled directly and four were pled derivatively. Each direct claim had a corresponding derivative claim. Counts I and V asserted claims for breach of fiduciary duty against the Board of LP (all of whom were dropped from the complaint except for Doyle) for entering into the Transactions without ensuring that the share issuance to Bain was entirely fair. Counts II and VI were claims for breach of fiduciary duty against Bain and HIG for entering into a conflicted transaction in the share issuance to Bain. Counts III and VII alleged claims of breach of fiduciary duty against HIG, in the alternative, as the sole controlling stockholder for entering into the conflicted transaction. Lastly, Counts IV and VIII asserted that Bain aided and abetted breaches of fiduciary duty by HIG and Doyle.
In deciding Defendants’ motion to dismiss, the Court first turned to whether Counts I-IV were properly brought as direct claims. The Court observed that the claims brought by Plaintiff constitute “a classic form of an ‘overpayment’ claim,” which must normally be pled derivatively. Plaintiff, however, argued that his claim resembles the claim brought in Gentile v. Rosette, where the Delaware Supreme Court recognized a situation where a corporate overpayment claim implicated both direct and derivative injury. The Court, in rejecting Plaintiff’s argument, cited several subsequent Delaware cases that limited the holding in Gentile to its facts and applied it only where the challenged transaction resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder. The Court also observed that not only was Bain not yet the controlling stockholder before the share issuance, but that even if it was, its increase in voting power would not have been so great as to have triggered the Gentile rule. Furthermore, the Court pointed to the structure of the share issuance for the proposition that common stockholders’ shares will only be diluted if and when Bain converts its preferred shares into common stock. Ultimately, the Court found that Plaintiff’s claims could not be brought directly, and therefore dismissed Counts I-IV.
The Court next turned to the question of whether Plaintiff was excused from making demand on the Board on the basis of demand futility. In assessing Plaintiff’s futility allegation, the Court applied the test articulated in Aronson v. Lewis, under which a Plaintiff must “provide particularized factual allegations that raise a reasonable doubt that (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” Of the Board’s seven members, Plaintiff conceded that two were disinterested, while Defendants conceded that three were interested. The Court, therefore, was tasked with determining whether either of the two remaining directors, Doyle and Brent Turner, were conflicted. The Court found that the complaint raised a reasonable doubt as to whether Doyle could make decisions regarding the Transactions independently by alleging that SP engaged him in a consulting agreement that paid him more per month than he made as SP’s CEO. On that basis, the Court found that Plaintiff had properly alleged that making demand on the board was futile.
Once the Court determined that demand was excused, it addressed the merits of Plaintiff’s remaining claims (V-VIII). First, the Court turned to Count VI, which argued in the alternative that Bain and HIG had breached fiduciary duties by acting as a “control group.” The Court dispatched Plaintiff’s argument quickly by pointing out that there was never any allegation that Bain owned any stock, let alone a controlling percentage of stock, prior to the Transactions. Ultimately, the Court dismissed Count VI for failing to state a claim.
The Court then examined Count VII, in which Plaintiff alleged that HIG breached its fiduciary duty by issuing the new shares to Bain. The Court determined that entire fairness was the proper standard of review, observing that that standard is triggered when a controlling stockholder effectuates a conflicted transaction. The Court determined that HIG was conflicted in entering into the issuance of new shares to Bain because that transaction was a condition precedent to HIG’s sale of its own shares to Bain. Entire fairness is an onerous standard for a defendant to overcome, requiring the controlling stockholder to “show, conclusively, that the challenged transaction was entirely fair based solely on the allegations of the complaint and the documents integral to it.” Because Defendants failed to show entire fairness, the Court denied Defendants’ motion to dismiss Count VII.
Count VIII alleged that Bain aided and abetted HIG’s breach of fiduciary duty. The Court found that Plaintiff’s allegations that Bain was aware of its shared legal representation with HIG, as well as the interrelated nature of the three transactions, and the lack of a stockholder vote, inferred Bain’s “knowing participation” in HIG’s breach. The Court, therefore, denied Defendants’ motion to dismiss as to Count VIII.
Lastly, due to the inclusion of an exculpatory provision in SP’s certificate of incorporation, the Court dismissed Plaintiff’s Count V for failing to allege that Doyle acted in bad faith or had personal interest in the transactions.
In Jack L. Marchand II v. John W. Barnhill, Jr., et al, the Delaware Chancery Court dismissed Plaintiff’s complaint under Court of Chancery Rule 23.1, finding that Plaintiff failed to plead particularized facts that an appeal for board action on the complaint would have been futile or that a majority of the company’s board lacked the independence needed to respond.
In Mudrick Capital Management, L.P. v. Globalstar, Inc., C.A. No. 218-0351-TMR (Del. Ch. July 30, 2018), plaintiff Mudrick Capital Management L.P. (“Mudrick Capital”), a minority stockholder of defendant Globalstar, Inc. (the “Company”), brought a demand under Section 220 of the Delaware General Corporate Law (“Section 220”) to inspect certain communications and documents relating to the Company’s proposed merger with Thermo Acquisitions, Inc. (“Thermo”). The Delaware Court of Chancery granted Mudrick Capital’s demand for certain emails, communications and valuation materials relating to the merger, and denied Mudrick Capital’s demand for certain internal draft materials.
In Feldman v. Soon-Shiong, et al. (C.A No. 2017-0487-AGB), the Delaware Court of Chancery denied in part and granted in part a motion to dismiss claims involving, among other things, breach of contract and breach of the fiduciary duty of loyalty, following a defendant’s withdrawal of $47 million from a company bank account.
In Morris vs. Spectra Energy Partners (DE) GP, LP, the Court of Chancery of the State of Delaware found that a limited partner adequately pled that the general partner of a master limited partnership breached its contractual duty to act in good faith in connection with a conflicted transaction between the master limited partnership and the indirect parent of the general partner. The Court also dismissed claims for breach of the implied contractual covenant of good faith and fair dealing and tortious interference with a partnership agreement.
Delaware Court Of Chancery Ruling Provides a Cautionary Tale for Investment Fund Directors Seeking to Monetize Their Investment
In The Frederick Hsu Living Trust v. ODN Holding Corp., et al., one of the founders of ODN Holding Corporation (the “Company”) filed suit against the controlling stockholder, the board and certain officers of the Company for cash redemptions of preferred stock allegedly made in violation of statutory and common law instead of using the Company’s cash to maximize the value of the Company for the long term benefit of all stockholders. The Delaware Court of Chancery granted defendants’ motions to dismiss claims of waste and unlawful redemption. However, the Court of Chancery denied defendants’ motions to dismiss claims of breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, and unjust enrichment finding that the allegations of the Plaintiff supported a reasonable inference that the entire fairness standard would apply and that individual defendants may have acted in bad faith.
In Rodgers v. Cypress Semiconductor Corporation, C.A. No. 2017-0070-AGB (Del. Ch. April 17, 2017), the Court of Chancery held that shareholder plaintiff T.J. Rodgers (“Rodgers”) had established several proper purposes for his demand to inspect certain books and records of Cypress Semiconductor Corporation (the “Company”), along with a credible basis to infer wrongdoing by at least one of the Company’s directors. The Court granted Rodgers’ Section 220 action and directed the parties to meet and submit an order for production of all responsive documents.
In Employees Retirement System of the City of St. Louis v. TC Pipelines GP, Inc., et al, (C.A. No. 11603-VCG), Vice Chancellor Glasscock granted the defendant’s motion to dismiss claims relating to the purchase of pipeline assets from the general partner’s parent. The Court of Chancery held that the transaction was “fair and reasonable” to the master limited partnership because it was approved by a special committee and that the general partner did not breach the implied covenant of good faith and fair dealing. In this case, the Court of Chancery reaffirmed parties’ abilities to contract freely when forming alternative entities such as a master limited partnership and confirmed that judicial review of such contractual terms is very limited.
The Delaware Supreme Court affirmed RBC Capital Markets, LLC’s (“RBC”) liability for aiding and abetting a board’s fiduciary breaches based on RBC’s undisclosed conflicts of interest and its deliberately misleading the board during the company’s sales process. The Court also upheld the Chancery Court’s finding that RBC bore 83% responsibility for the shareholders’ damages, resulting in a $75 million award against RBC, plus pre- and post-judgment interest.
In RBC Capital Markets, LLC, the Delaware Supreme Court affirmed the Chancery Court’s holding that RBC was liable for aiding and abetting breaches of fiduciary duty by the board of Rural/Metro Corporation (“Rural”) in connection with the sale of Rural to private equity firm Warburg Pincus LLC (“Warburg”). The Rural board’s underlying breaches of fiduciary duties were its failure to be actively and reasonably informed when overseeing the sales process and to be adequately informed about Rural’s value, and also its breach of the duty of disclosure for including RBC’s flawed valuation analysis as well as false and misleading information about RBC’s conflicts of interest in the company’s proxy statement. RBC, in turn, knowingly induced the breaches by exploiting its own conflicted interests to the detriment of Rural and by creating an “information vacuum” for the Rural board in order to push the sale forward.
In Partners Healthcare Solutions Holdings, L.P. and GTCR Fund IX/A, L.P. v. Universal American Corp., Partners Healthcare Solutions Holdings, L.P. (“Partners”) sued Universal American Corporation (“UAM”), seeking damages and specific performance following a dispute as to Partners’ appointment of a director to UAM’s board. During the litigation, the parties reached a settlement as to the specific performance aspect of the litigation, leaving only the issues of damages. UAM filed a motion for summary judgment, which Vice Chancellor Glasscock granted.
In March 2012, Partners entered into a merger agreement with UAM, pursuant to which UAM purchased a Partners subsidiary, and Partners became one of UAM’s largest stockholders. Partners was also given a seat for its designee on UAM’s board pursuant to a letter agreement (“Board Seat Agreement”). That agreement provided that the designee must be independent under stock exchange rules, and granted Partners the right to name a replacement in the event that the initial designee resigned. Partners named David Katz, a former board member of Partners, to the UAM board.