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 Ravenswood Investment Company v. Winmill & Co. (C.A. No. 3730-VCS and 7048-VCS (Del Ch. March 21, 2018)), plaintiff Ravenswood Investment Company (“Ravenswood”), a stockholder of Winmill & Co. (the “Company”), brought a derivative suit against the directors of the Company, Bassett, Thomas and Mark Winmill (“Defendants”) alleging that Defendants breached their fiduciary duties in two respects. First, they granted overly generous stock options to themselves (as Company officers). Second, they caused the Company to forgo audits of the Company’s financials and to stop disseminating information to the Company’s stockholders in retaliation for Ravenswood’s assertion of inspection rights. Following a trial, the Delaware Chancery Court entered judgment for Ravenswood as to the first theory and for Defendants as to the second. After finding that there was insufficient evidence to support cancellation, rescission, rescissory damages or some other form of damages, the Court awarded nominal damages to the Company of $1 per Defendant.
In Ravenswood, the Company provided investment management services and its shares were traded on NASDAQ until it was delisted in 2004, and then over-the-counter on the Pink Sheets. During all relevant time periods, Defendants comprised the entirety of the board of directors of the Company. They were also founders, stockholders, and officers of the Company. When the Company’s 1995 stock option plan expired in 2005, Defendants, in their capacity as directors, adopted a new performance equity plan (the “PEP”). Each Defendant, in his capacity as an officer of the Company, received options to purchase 100,000 shares of stock at $2.948 per share under the PEP. At the time, approximately 1.5 million shares were outstanding and the Company’s stock traded at $2.68 per share. The Defendants chose not to hire a compensation consultant, instead relying on their own ad-hoc analysis of comparable companies, many of which were much larger than the Company.
Approximately 18 months later, each of the Defendants exercised options to purchase 66,666 shares. Each Defendant paid $1,532.39 in cash and gave a $195,000 promissory note to the Company for the remainder of the purchase price. Following the exercise, each of the Defendants paid interest on the notes, but a little over a year later, in April 2008, in their capacity as board members, they forgave Thomas’ note entirely and forgave Mark’s note in three tranches over three years. Although Bassett’s note was not forgiven, later he became unable to pay the note when due and entered into a replacement note with a longer maturity. Years later, following his death, his estate finally paid off the note.
In addition, following the Company’s delisting, it continued to prepare audited financial statements until 2011, when, for cost reasons, the Defendants decided not to engage in further audits and ceased distributing financial information to stockholders.
Plaintiffs brought suit on a number of theories, which by the time of the trial, had been reduced to two theories for violation of the Defendants’ fiduciary duty of loyalty: first, that the stock options were improperly authorized and granted, and second, that the Defendants’ decision to cease distributing financial information was an improper decision in retaliation against Plaintiff, who had previously brought an action against Defendants.
After a two-day trial, the Court entered judgment for the Plaintiff on the first theory and for Defendants on the second. As to the first claim, the Court first held that the entire fairness standard applied to the PEP adoption and stock option grants as “[d]irectors who stand on both sides of a transaction have the burden of establishing its entire fairness.” The Court explained that entire fairness requires a showing that directors acted with utmost good faith and the most scrupulous inherent fairness of the bargain. This requires a showing of both fair dealing and fair price.
In analyzing fair dealing, the Court described the Defendants’ process as “neither well-documented nor well-substantiated” and in fact stated that “the term ‘process’ does not really fit here; the evidence reveals that there really was no process.” There were no contemporaneous records and no indication that the board sought the advice of any outside advisor or consulted any literature or other sources. Defendants’ only decision-making tool appeared to be comparing the PEP and proposed options to compensation plans of alleged peer companies, but the Court described this tool as “severely flawed” due to labelling companies as peers in a way that was “simply not credible” because nearly all of them were much larger than the Company. Thus the Court concluded that the stock option grants were not the result of fair dealing.
The Court next analyzed the fairness of the pricing of the options. The Court held that the initial price was fair, but the Company’s actions in forgiving notes resulted in a total payment for the options that was not fair. The Court explained that these decisions may have made perfect sense if this family business were really a family business where the Defendants were the only stakeholders, but in a public company setting these decisions resulted in an unfair price and thus a breach of the Defendants’ fiduciary duties.
The Court denied the Plaintiff’s second theory, explaining that Delaware law presumes that the directors of a Delaware corporation make business decisions on an informed basis and in the honest belief that their decision is in the corporation’s best interests. To overcome that presumption, plaintiffs must show that directors “appeared on both sides of the transaction or derived a personal benefit from a transaction in the sense of self-dealing.” The Court held that since Plaintiff had presented no evidence that the Directors ceased distributing financial information due to an improper motive rather than their claimed rationale of lowering costs and reducing the risk of disclosure-related litigation, Defendants were entitled to the protection of the business judgment rule and did not breach their fiduciary duty with respect to the second theory.
Finally, the Court discussed potential remedies. Plaintiff sough compensatory damages, but the Court held that it failed to present any evidence upon which the Court could award compensatory damages to the Company. Plaintiff also sought cancellation of the shares or rescission, but the Court explained that cancellation and rescission would not be appropriate without returning the parties to the status quo ante, which would require returning to Defendants what money they had paid for the shares. Since the Company lacked the funds to do so, these remedies were not appropriate. Finally, the Court held that Plaintiff had also failed to present evidence on which the Court could award rescissory damages. Thus, with no other measure of damages available, the Court awarded nominal damages to the Company in the amount of $1 per Defendant.
In In Re Tesla Motors, Inc. Stockholder Litigation, the Delaware Chancery Court denied Defendants’ motion to dismiss an action brought by plaintiffs (Tesla stockholders) against nominal Defendant Tesla Motors in connection with Tesla’s acquisition of SolarCity Corporation. Plaintiffs alleged that Tesla’s board of directors breached their fiduciary duties by approving the acquisition of SolarCity, which benefitted SolarCity stakeholders but negatively affected Tesla stockholders. SolarCity is a public Delaware corporation founded by Elon Musk and his cousins, Peter and Lyndon Rive. Musk and his cousins sit on the SolarCity Board. Lyndon was SolarCity’s CEO and Peter was its CTO.
In Cumming v. Edens, et al., C.A. No. 13007-VCS (Del. Ch. Feb. 20, 2018), the Court of Chancery denied a motion to dismiss a derivative suit for breach of fiduciary duties brought by a stockholder of New Senior Investment Group, Inc. (“New Senior”) against New Senior’s board of directors (the “Board”) and related parties in connection with New Senior’s $640 million acquisition of Holiday Acquisition Holdings LLC (“Holiday”). The Court made clear that compliance with Section 144 does not necessarily provide a safe harbor against claims for breach of fiduciary duty and invoke business judgment review of an interested transaction. Because the complaint alleged with specificity “that the Board acted out of self-interest or with allegiance to interest other than the stockholders,” the court applied the entire fairness standard of review and concluded that the transaction was not fair to New Senior stockholders. Read More
In Lavin v. West Corporation, C.A. No. 2017-0547-JRS (Del. Ch. December 29, 2017), the Court of Chancery held that stockholder plaintiff Mark Lavin (“Lavin”) had adequately demonstrated a credible basis from which the Court could infer that wrongdoing had occurred regarding the merger of West Corporation (the “Company”) and Apollo Global Management (“Apollo”) in support of Lavin’s Section 220 demand for inspection, and that a Corwin defense (that the transaction at issue was approved by a majority of disinterested and informed stockholders) is not a bar to an otherwise properly supported Section 220 demand for inspection.
In Ryan v. Armstrong, et al., C.A. No. 12717-VCG (Del. Ch. May 15, 2017), the Delaware Chancery Court dismissed the derivative action brought by a Plaintiff-shareholder (“Plaintiff”) against specified members of the board of directors (“Defendants”) of nominal defendant The Williams Companies (“Williams”). Plaintiff brought his claim against the Defendants without first demanding that the board pursue an action following Williams’ decision to allegedly undertake defensive measures against a takeover. The court granted Defendants’ motion to dismiss holding that Plaintiff failed to plead facts demonstrating that an exception to the demand requirement of Court of Chancery Rule 23.1 applied.
In Brinckerhoff v. Enbridge Energy Co., Inc., et al., C.A. No. 11314-VCS (April 29, 2016), the Delaware Court of Chancery reiterated its adherence to the principle stated in the Delaware Revised Uniform Limited Partnership Act (“DRULPA”) of giving “maximum effect to the principle of freedom of contract and to the enforceability of partnership agreements” as well as to the ability under DRULPA of parties to a limited partnership agreement to define their respective standards of care and scope of duties and liabilities, including to eliminate default fiduciary duties, and dismissed the plaintiff’s claims.
In Sandys v. Pincus et al., C.A. No. 9512-CB (Del. Ch. Feb. 29, 2016), the Delaware Court of Chancery systematically dismissed claims brought in a stockholder derivative suit on behalf of Zynga, Inc. (“Zynga”), regarding alleged breaches of fiduciary duties in connection with Zynga’s secondary offering of its common stock, due to the plaintiff’s failure to demonstrate that the procedurally required demand upon Zynga’s board of directors to initiate such litigation would have been futile. The court applied the Rales test to assess demand futility, which required the plaintiff to prove reasonable doubt that the board at the time the litigation commenced was able to properly exercise its independent and disinterested business judgement in responding to a demand to file suit, and in doing so extended the scenarios in which to apply the Rales test.
Following the initial public offering (“IPO”) of its Class A common stock at $10 per share in December 2011, Zynga launched a secondary offering in April 2012 for $12 per share, in which various executives of Zynga and four members of Zynga’s board of directors (the “Participating Board Members”) were selling stockholders. To allow such participation in the offering by the various executives and the Participating Board Members, the underwriters agreed to the early release of certain lock-up agreements entered into by such executives and directors in conjunction with the IPO, and the audit committee of Zynga’s board of directors approved exceptions to the trading window restrictions set forth in Zynga’s 10b5-1 trading plan that otherwise would prohibit such sales by these individuals at the time of the secondary offering.
The secondary offering, including the selling stockholder participation, was approved by Zynga’s board of directors; however, of the eight members at such time, only seven were present to vote. The four Participating Board Members voted for the secondary offering, constituting the majority vote required to proceed. At the time the complaint was filed, Zynga’s board had increased to nine members, comprised of six members who served on Zynga’s board at the time of the secondary offering (of which only two were Participating Board Members) and three additional members who had since been added to Zynga’s board.
On April 4, 2014, the plaintiff, a stockholder of Zynga at all relevant times, filed suit and asserted three claims: (1) against the Participating Board Members, alleging breach of fiduciary duties by misusing Zynga’s confidential information when they sold shares in the secondary offering while in possession of materially adverse, non-public information, (2) against Zynga’s board of directors at the time of the secondary offering, alleging breach of the fiduciary duty of loyalty for approving the secondary offering and exempting the Participating Board Members from the trading window restrictions set forth in Zynga’s 10b5-1 trading plan, and (3) against Zynga’s board of directors and various Zynga executives at the time of the secondary offering alleging breach of fiduciary duties by failing to put controls in place to ensure adequate public disclosures and to avoid material omissions in its public statements.
The plaintiff brought each of the claims derivatively on behalf of Zynga, invoking Court of Chancery Rule 23.1, which requires the plaintiff of a derivative stockholder suit to make a demand upon the board of directors to initiate such litigation or demonstrate that such a demand would be futile. As the plaintiff in Sandys v. Pincus did not make a demand on Zynga’s board to initiate litigation, to over come the defendants’ motion to dismiss, the plaintiff needed to instead demonstrate such demand would be futile. To prove demand futility, Delaware courts apply one of two tests. The first, articulated in Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), requires the plaintiff to plead facts that create a reasonable doubt either that the directors are disinterested and independent, or that the challenged transaction was otherwise the product of a valid business judgment (the “Aronson test”). The Aronson test does not apply when the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit. The second test, articulated in Rales v. Blasband, 634 A.2d 927, 933-34 (Del. 1993), requires the plaintiff to create reasonable doubt that the board could have properly exercised its independent and disinterested business judgment in responding to the demand at the time the complaint was filed (the “Rales test”).
As demand futility is assessed claim by claim, the court addressed each of the three claims separately, first determining whether to apply the Aronson or Rales test. The court applied the Rales test for each claim. In doing so, the court analyzed whether the plaintiff created reasonable doubt that at least five of the nine directors of Zynga’s board at the time the complaint was filed were able to properly exercise his or her independent and disinterested business judgement in responding to a demand to file suit. According to the court, a director lacks independence when he or she is sufficiently beholden to someone interested in the litigation that he or she may be unable to consider the demand impartially. An interested director is one who receives from a corporate transaction a personal benefit not equally shared by the stockholders, such that he or she could face liability if the transaction were subjected to entire fairness scrutiny.
With respect to the first claim, the court applied the Rales test because the claim did not challenge a business decision of the board, but rather the Participating Board Members’ individual decisions to sell in the secondary offering. Applying the Rales test, the court concluded that of the members of Zynga’s board at the time the complaint was filed, only the two remaining directors that had sold shares and received a benefit, faced liability under the alleged claim. Thus, the remaining seven members were not interested directors. The court reviewed certain facts pled to ascertain whether the seven disinterested board members were beholden to the two remaining Participating Board Members, and found that facts such as friendship or co-ownership of an asset, each absent a bias nature, are insufficient to raise reasonable doubt as to independence. The court dismissed plaintiff’s first claim for failure to allege demand futility under the Rales test.
For the second claim, the court applied the Rales test because Zynga’s board composition had changed since the secondary offering, marking an expansion of the scenarios in which such test applies. In assessing whether Zynga’s board at the time the complaint was filed could impartially decide whether to pursue plaintiff’s second claim, the court stated that the mere fact that two board members are both partners in the same firm does not support the plaintiff’s theory that they would not want to initiate litigation against the other, as the plaintiff presented no evidence that they are beholden to one another or have a relationship aside from their partnership that would suggest otherwise. In addition, in response to plaintiff’s argument that non-selling directors of Zynga’s board at the time of the secondary offering are interested directors because of the litigation risk they would face in an entire fairness review applicable to such claim, the court stated that a plaintiff seeking monetary damages as a result of this claim must plead non-exculpated facts against a director who is protected by Section 102(b)(7) of the Delaware General Corporation Law. Since Zynga’s charter contains such exculpatory provision, plaintiff needed to demonstrate breaches of duty of loyalty, bad faith, or a conscious disregard for directorial duties. As the plaintiff failed to demonstrate such facts and thus to cast the required reasonable doubt, the court dismissed the claim.
Lastly, the court applied the Rales test to plaintiff’s third claim because the claim did not address a business decision of the board, but rather a violation of the board’s oversight duties. The court held that in the context of an alleged oversight violation, there is no transaction in which the directors may be interested. For directors to have a disabling interest, they must face a meaningful litigation risk with a substantial likelihood of personal liability for the violations. Due to the exculpatory provision in Zynga’s charter, its directors would not face likelihood of personal liability unless plaintiff pled exculpated facts. As no such exculpated facts were pled, the court dismissed this claim for failure to allege demand futility under the Rales test.
In sum, the court dismissed each of plaintiff’s claims due to plaintiff’s failure to demonstrate that a demand upon Zynga’s board to initiate litigation would have been futile, applying the Rales test for demand futility. Under the Rales test, plaintiff failed to prove reasonable doubt that Zynga’s board was able to properly exercise its independent and disinterested business judgement in responding to plaintiff’s demand to file suit.
In In re Molycorp, Inc. Shareholder Derivative Litigation, the Delaware Court of Chancery dismissed claims brought against director representatives of private equity investors for breach of fiduciary duties, aiding and abetting, and unjust enrichment for failure to state a claim. The Court held that the private equity investors along with certain directors exercised their contractual rights to sell their stock in Molycorp Inc. a publicly traded corporation (“Molycorp”) in a secondary offering and the directors were under no obligation to delay such a demand registration during a time in which Molycorp was experiencing a cash shortfall.
Molycorp was engaged in the production and sale of rare earth oxides. Before Molycorp’s July 2010 IPO, three initial private equity investors (PEIs) negotiated a Registration Rights Agreement. The agreement secured the PEIs right to demand that Molycorp register their shares in a secondary offering. The results of the July 2010 IPO did not yield the funds expected, and a secondary offering of Molycorp shares in February 2011 left the company still short on cash. A potential loan from the Department of Energy fell through, and potential financing arrangements with two other companies looked increasingly unlikely. In May 2011, the PEIs exercised their demand registration rights, and the offering was held in June 2011. Due to a recent spike in the price of rare earth oxides, the PEIs (and several directors appointed by the PEIs) sold their shares in the resulting June offering at an inflated value. In September 2011, the rare earth oxide bubble burst. Subsequent efforts by Molycorp to make up for its cash shortfall by issuing convertible notes left it with inadequate funds to implement its planned production increase. As a result Molycorp missed out on potential profits from the rare earth element bubble.
In Calma v. Templeton, C.A. No. 9579-CB (Del. Ch. April 30, 2015) (Bouchard, C.), the Delaware Chancery Court held that Citrix System, Inc’s (“Citrix”) payment of compensation to non-employee directors under a shareholder-approved compensation plan must be reviewed under the entire fairness standard because the shareholders’ omnibus approval of a plan covering several different types of beneficiaries did not constitute ratification of the amount of compensation to be paid to non-employee directors.
In 2005, Citrix shareholders approved an equity compensation plan (the “Plan”) for beneficiaries such as directors, officers, employees, consultants, and advisors. The plan did not specify the amount of compensation that non-employee directors could receive, instead only providing a limit of 1 million restricted stock units (“RSUs”) for any beneficiary’s annual compensation. Based on the company’s share price at the time the suit was filed, 1 million RSUs would be worth over $55 million.
In In re Sanchez Energy, Vice Chancellor Glasscock granted a motion to dismiss in a shareholder derivative action because the plaintiffs had failed to make a demand on the Board, holding that the plaintiffs failed to meet Rule 23.1’s particularized pleading standards for demand futility. The case centered around a transaction in which Sanchez Energy Corporation (“Sanchez Energy”), a publicly held corporation, purchased property at $2500/acre from Sanchez Resources, LLC (“Sanchez Resources”), a privately held, company, which Sanchez Resources had purchased for $184/acre. Two members of the Sanchez family—A.R. Sanchez Jr. and A.R. Sanchez III—owned a combined 21.5% of the shares of Sanchez Energy and served on its board of directors, which had three other members. Those three members comprised Sanchez Energy’s audit committee, which approved the transaction.
The court rejected the plaintiff’s claim that demand would have been futile because the three members of the Audit Committee were not independent. The Vice Chancellor said the plaintiffs had failed to show the audit committee members’ social and business relationships with the Sanchezes were such that “the non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.” He also rejected Plaintiffs’ arguments that the Sanchezes should be treated as controlling shareholders because they failed to show that the Sanchezes controlled the board or the negotiation process for the transaction. Vice Chancellor Glasscock pointed to the fact that transaction was approved by the Audit Committee and that the Sanchezes owned at most a combined 21.5% stake in Sanchez Energy as evidence that the Sanchezes were not controlling shareholders. Lastly, VC Glasscock rejected the idea that because of the huge disparity between what Sanchez Resources paid to acquire the property and what Sanchez Energy paid to acquire the property from Sanchez Resources, the transaction was so facially unfair that it could not have been the product of valid business judgment, noting, among other things, that between Sanchez Resources’ initial purchase and its sale to Sanchez Energy, half of the property had been developed and found to contain proven oil reserves.
Thus, because the Complaint failed to specifically please facts excusing demand, the Court dismissed the Complaint.
In Re: Crimson Exploration Inc. Stockholder Litigation involved a consolidated class action claim made by certain minority stockholders (“Plaintiffs”) of Crimson Exploration, Inc. (“Crimson”) challenging the completed acquisition of Crimson by Contango Oil & Gas Co. (“Contango”). The transaction was structured as a stock-for-stock merger (the “Merger”), with the Crimson stockholders holding approximately 20.3 % of the combined entity following the merger and an exchange ratio representing a 7.7% premium based on the April 29, 2013 trading price of Contango common stock and Crimson common stock. Plaintiffs also alleged that the members of Crimson’s Board of Directors (the “Directors”) and various entities affiliated with the investment management firm Oaktree Capital Management, L.P. (“Oaktree”) breached their respective fiduciary duties by selling Crimson below market value for self-serving reasons. In total, Plaintiffs brought claims against Crimson, the Directors, Oaktree, Contango Acquisition, Inc. (the “Merger Sub”) and Contango (“Defendants”).
A major premise of Plaintiffs’ complaint is that Oaktree controlled Crimson and thereby had fiduciary duties to the minority stockholders of Crimson. Oaktree owned roughly 33.7% of Crimson’s pre-Merger outstanding shares and a significant portion of Crimson’s $175 million Second Lien Credit Agreement, which Contango agreed to payoff after the signing of the Merger, including a 1% prepayment fee (the “Prepayment”). Also, in connection with the Merger, Oaktree negotiated to receive a Registration Rights Agreement (the “RRA”) so that it had the option to sell its stock in the post-Merger combined entity through a private placement.