PLX, Burden of Proof for Damages, and the Internal Logic of Delaware Law

In his recent PLX decision, Delaware’s Vice-Chancellor (VC) Travis Laster refused to award monetary recovery on the grounds that plaintiffs did not carry their burden of proof on damages. [1] In this short comment, I argue that the burden of proof should not have been on the plaintiffs: once VC Laster found a breach of fiduciary duty, the internal logic of Delaware law demands that burden of proof shift to the defendants.

In PLX, VC Laster held activist hedge fund Potomac Capital Partners II, L.P. liable for aiding and abetting the breach by its principal, Eric Singer, of his fiduciary duty to Potomac’s portfolio company, PLX Technology Inc. Singer had joined PLX’s board on Potomac’s slate and oversaw its sale to Avago as chair of its “Strategic Alternatives Special Committee.” VC Laster took issue with various aspects of Singer’s behavior, above all that Singer withheld from his fellow PLX board members information about Avago’s intentions that he received from PLX’s investment banker after joining the PLX board, but long before start of the sale process with Avago. [2] Reasonable people may disagree as to whether this sale process was truly “flawed from a fiduciary standpoint,” as VC Laster found the plaintiffs to have proven. [3] I take no position on this question. The point I want to make concerns what follows a finding of a fiduciary breach: who should bear the burden of proof on damages? My argument is that in the rare case where a plaintiff can prove a violation of fiduciary duty, the internal logic of Delaware law demands that the burden on damages shift to the defendant.

One of the central premises of Delaware corporate law is the recognition that business decisions are inherently difficult to evaluate. For this reason, Delaware courts explicitly, famously, and rightly refuse to second guess the business decisions of corporate boards in normal circumstances. [4] While Delaware courts have not shied away from expressing their doubts about the wisdom of many corporate decisions, they have wisely stopped short of imposing their own views of what would have been correct behavior in all but a few extreme cases. [5]

In particular, Delaware courts have been reluctant to second-guess the deal price negotiated in M&A transactions. While recognizing the “omnipresent specter” [6] of conflicts of interests when directors’ and managers’ positions are on the line, the Delaware courts also understood that there is no real alternative to letting boards and management negotiate the best deal they can reach. “Enhanced scrutiny” of merger-related actions under Unocal and Revlon is scrutiny of process only. Even in appraisal proceedings, where DGCL 262(h) explicitly directs Delaware courts to “determine the fair value of the shares … tak[ing] into account all relevant factors,” the Delaware Supreme Court recently held that the deal price resulting from “a robust sale process” deserves “heavy, if not dispositive, weight.” [7] As justification, the Court explicitly invoked “the hazards that always come when a law-trained judge is forced to make a point estimate of fair value based on widely divergent partisan expert testimony.” [8]

This is all well taken. But if it is so hard to evaluate business deals, then putting the burden of proof for damages on the plaintiff virtually guarantees that defendants will not have to pay damages even in the rare instance where a court thought the evidence sufficiently clear to find a violation of a fiduciary duty. For example, VC Laster rejected plaintiffs’ damages evidence in PLX as “not sufficiently persuasive” or “not sufficiently convincing.” [9] This isn’t surprising given the difficulty of saying anything convincing on corporate valuation (within a very wide band). But it means that even clear violations of duty will not be penalized and deterred, at least not financially. This undesirable outcome could easily be avoided by shifting the burden of proof.

There is an obvious doctrinal precedent in Delaware law for shifting the burden of proof on the suspect party: the entire fairness standard of review for conflicted transactions. If the transaction is tainted by a conflict of interest, the burden is on the conflicted fiduciary to prove that the transaction was entirely fair. In particular, the conflicted fiduciary has to prove not only “fair dealing” but also “fair price”—a natural requirement in the corporate setting where it is hard to impossible to figure out how exactly an unconflicted fiduciary might have acted differently, and how this would have affected price. This does not put the fiduciary in an impossible position because the conflicted fiduciary can take procedural steps to shift the burden of proof or escape entire fairness entirely. But if those steps were faulty, the burden remains on the conflicted fiduciary. [10]

In his discussion of damages, VC Laster drew parallels to appraisal, not entire fairness. [11] But there is a crucial difference between appraisal and fiduciary duty actions: the statutory appraisal remedy is available in all mergers, whereas a fiduciary duty action only lies if the court affirmatively finds a breach of fiduciary duty. The plaintiff’s desired remedy (a valuation above deal price) is the same, but the epistemic situation is fundamentally different. In appraisal, epistemic difficulties argue for accepting the deal price: deal price is the best evidence of value we have. In a fiduciary duty action, the opposite is the case. We already know the process was flawed, so the deal price is inevitably not a good gauge of what would have happened without the flaw.

VC Laster’s main argument to brush aside concerns about the deal process is the post-signing market check, which did not result in a higher offer. [12] This argument seems dubious. Taken to its logical conclusion, it would mean that the pre-signing process is irrelevant: all a company would need to do to get the best price is to announce some deal—any deal!—and then run a post-signing process. Neither Delaware law nor M&A practice views it that way. Perhaps there really wasn’t a better deal to be had, and the deal that was signed was better than remaining an independent company. But the enormous difficulties of figuring this out, which are so well recognized by Delaware judges, should be the defendant’s problem, i.e., the defendant should bear the burden of proof.

Putting the burden on the defendant will often lead to defendants paying too much relative to the true but unknowable harm. But that is possibly a feature, not a bug, and in any event it is better than the opposite, which is to deny recovery altogether. Importantly, Delaware does not provide corporate fiduciary liability for inadvertent breaches. In particular, aiding and abetting liability requires scienter. Scienter and other elements necessary for liability under Delaware law, such as bad faith, are notoriously difficult to prove. [13] But the advantage of these high thresholds is that they single out behavior that should clearly be deterred. Erring on the high side of damages achieves this important purpose. This, too, is an idea congenial to Delaware law. [14] As Chancellor Allen put it twenty-five years ago: “once a breach of duty is established, uncertainties in awarding damages are generally resolved against the wrongdoer.” [15]

Endnotes

1In re PLX Technology Inc. Stockholders Litigation, CA No. 9880-VCL, 10/16/2018. The decision is reminiscent of VC Laster’s Trados opinion applying the exacting entire fairness standard of review (In re Trados Inc. Shareholder Litigation, 73 A.3d 17 (2013)). Even though the defendant in Trados bore the burden of proof and VC Laster found that dealing was unfair, VC Laster declined to find liability because he nevertheless found the price (zero) to be fair. From a financial perspective, this argument is dubious because equity virtually always has option value, and certainly had it in Trados: there was at least a possibility that the Trados common stock would have become valuable if Trados had not been sold (yet).(go back)

2In re PLX, supra note 1, at 115: “Taken as a whole, this evidence suggests that Potomac and Singer undermined the Board’s process and led the Board into a deal that it otherwise would not have approved. Yet in spite of this evidence, I could not conclude that the Board’s decisions fell outside the range of reasonableness without one other critical fact: Krause’s secret tip to Deutsche Bank in December 2013 about Avago’s plans for PLX. In my view, by withholding this information from the rest of the Board, Singer breached his fiduciary duty and induced the other directors to breach theirs. For present purposes, by withholding this information, he fatally undermined the sale process.”(go back)

3Id. at 134, and cf. at 96 (“When a plaintiff sues a third party for aiding and abetting a breach of fiduciary duty, the plaintiffs bear the burden of proving that the directors’ conduct fell outside the range of reasonableness.”).(go back)

4See generally Holger Spamann, Monetary Liability for Breach of the Duty of Care?, 8 J. Legal Analysis 337-373 (2016).(go back)

5Cf., e.g., In re the Walt Disney Company Derivative Litigation, 906 A.2d 27, 56 (Del. 2006) (“the committee’s process … [fell] short of what best practices would have counseled,” but did not breach the duty of care).(go back)

6Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).(go back)

7Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1, 23 and 35 (Del. 2017).(go back)

8Id. at 35. The difficulties that even the best judges face in assessing financial arguments were also on display in In re PLX, supra note 1. In assessing the plaintiffs’ suggested beta of 0.985, the court argued that a (129) “beta of less than one implied that a small technology company operating in the cyclical semiconductor industry exhibited less volatility than the market as a whole,” which the court found not credible. But beta and volatility are not the same, and other semiconductor companies have equally low betas (e.g., Intel has .8, and Broadcom—the successor to PLX’s buyer Avago—has .92, according to Yahoo! Finance). The court also criticized the use of daily data for estimating beta, whereas such use is standard in finance (see. e.g., Fabian Hollstein and Marcel Prokopczuk, Estimating Beta, 51 J. Fin. & Quant. Analysis 1437 (2016)).(go back)

9In re PLX’s, supra note 1, at 124 and 130, respectively. Also cf. id. at 126 (“The evidence at trial did not give me sufficient confidence”) and 127 (“Lacking confidence in the third layer of revenue, I likewise cannot …”).(go back)

10The question of procedural insulation from review was also at issue in In re PLX. Under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), a fully informed shareholder vote would have removed the transaction from review under enhanced scrutiny. But VC Laster found that the PLX shareholder vote was not fully informed because the flaws of the sale process, particularly the principal-director’s withholding of information, had not been disclosed.(go back)

11In re PLX, supra note 1, at 122. VC Laster quoted the aforementioned recent opinions of the Delaware Supreme Court, id. at 124, 131-2.(go back)

12Id. at 134.(go back)

13Cf. RBC Capital Markets, LLC v. Jervis, 129 A.3d 816, 865-66 (2015) (“the requirement that the aider and abettor act with scienter makes an aiding and abetting claim among the most difficult to prove”).(go back)

14Cf. Guth v. Loft, 5 A.2d 503, 510 (justifying the disgorgement remedy for breach of fiduciary duty by “the purpose of removing all temptation”); In re Dole Food Co., Inc. Stockholder Litigation, CA No. 8703-VCL, 8/27/2017 (Del. Ch., per VC Laster) (where defendants’ actions “were not innocent or inadvertent, but rather intentional and in bad faith …, the stockholders are not limited to a fair price. They are entitled to a fairer price designed to eliminate the ability of the defendants to profit from their breaches of the duty of loyalty.”).(go back)

15Thorpe v. Cerbco Inc., 1993 WL 443406, at *12 (Del. Ch. Oct. 29, 1993).(go back)