Corwin’s Nuance

Meredith E. KotlerRoger A. Cooper, and Mark E. McDonald are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Ms. Kotler, Mr. Cooper, Mr. McDonald, and April Collaku, and is part of the Delaware law series; links to other posts in the series are available here.

In In re Xura, Inc. Stockholder Litigation, [1] decided earlier this week, the Delaware Court of Chancery denied the target CEO’s motion to dismiss claims that he breached his fiduciary duties by “steer[ing]” the company into an allegedly unfair acquisition by a private equity firm that promised to retain him post-acquisition, while knowing that his job was in jeopardy if the target remained independent. This case is yet another example of why disclosures are so important in the post-Corwin [2] era: Vice Chancellor Slights rejected the CEO’s argument that the claims against him were extinguished by the stockholder vote approving the transaction, finding that a number of material omissions precluded a finding that the stockholders’ vote was fully informed. The vote was thus ineffective to invoke the business judgment rule at the pleading stage.

On the other hand, the court dismissed the plaintiff’s aiding and abetting claim against the private-equity acquiror even though the complaint alleged that the acquiror knew that (1) the CEO of the target favored it over other potential bidders, (2) the target CEO was excluding the target’s financial advisor from discussions relating to the acquisition, and (3) the target was omitting material information from its proxy. In each case, the court explained that there were no facts alleged suggesting that the acquiror both knew that the target CEO was engaging in a breach of fiduciary duty and that the acquiror was participating in that breach. These rulings demonstrate the high hurdle for aiding and abetting claims to survive dismissal at the pleading stage, even in cases in which Corwin cleansing is denied. Despite the favorable ruling on the aiding and abetting claim, the case serves as a reminder to acquirors of their own interest in promoting adequate processes and disclosures on behalf of the target.

Background

Xura, Inc. (“Xura”) was a publicly-traded company that designed and developed communication software solutions. The complaint alleged the following, based on discovery that had been produced to the plaintiff, and at the pleading stage the court was required to accept all well-pleaded facts as true and to draw all inferences from them in favor of the plaintiff: On a number of occasions, Xura’s CEO discussed a potential acquisition of Xura with executives of Siris Capital Group, LLC (“Siris”), a private equity firm. Xura’s board eventually decided to consider an offer from Siris, creating a strategic committee to review, evaluate and negotiate the terms of the proposed transaction, and retaining a financial advisor. However, the strategic committee “never met with Siris, never took any formal action and never kept minutes nor any written record of its activities.” In fact, one of the members of the committee was unaware of its existence until he learned of it in his deposition. In addition, the Xura board’s financial advisor was often excluded from the process by Siris and Xura’s CEO, and the negotiations with Siris were conducted in large part by the CEO alone. For example, Xura’s CEO conducted meetings with Siris and suggested a deal price without informing the board and, at one point in the process, continued discussions with Siris despite the Xura board’s determination to go “radio silent.”

As is commonly done by prospective private equity acquirors, Siris suggested in each of its bid letters that it would retain Xura’s management (including its CEO) post-acquisition by stating that it was “excited about the opportunity of working with [Xura] and its leadership team.” In the meantime, Xura’s chairman privately told the CEO that he could lose his job should the deal fall through.

Following Xura’s disclosure to the market that it was considering an offer to sell the company for $25 per share, another private equity firm expressed interest in submitting an alternative bid. But when this private equity firm learned that Siris was the other bidder (in circumstances the court found suspicious), it decided instead to join Siris as a co-investor. Similarly, an institutional stockholder with a sizeable minority stake in Xura negotiated a “side deal” to join Siris on the buy-side.

Ultimately, the acquisition was approved by a majority of the Xura stockholders on August 16, 2016 and closed three days later. Although Xura’s CEO quickly sought to negotiate a lucrative contract with his new employer, he was terminated soon after the closing.

The Decision

After plaintiff filed its complaint post-closing (seeking damages, including rescission and disgorgement), both Xura’s CEO and Siris (the only named defendants) moved to dismiss the complaint on several grounds. First, both defendants argued that all claims in the case were extinguished by the uncoerced and fully informed stockholder vote under Corwin. [3] Vice Chancellor Slights rejected that argument, finding that “at the pleading stage,” plaintiff had adequately alleged seven material omissions (any one of which, the court suggested, would have resulted in denial of Corwin cleansing). Specifically, Xura stockholders were not informed of the following alleged facts:

  1. Xura’s CEO and Siris regularly communicated regarding the acquisition in private without the knowledge or approval of the board or its financial advisor;
  2. Xura’s CEO and Siris negotiated price terms directly without board approval, and Xura’s CEO even advised Siris what offer Xura’s board would accept;
  3. Siris made clear its intention to work with target management (including the CEO) after consummation of the transaction in all of its offer letters to Xura;
  4. The strategic committee did not do the work attributed to it in the proxy statement;
  5. Another private equity firm initially expressed interest in providing a superior bid but “somehow” learned that Siris was bidding for Xura, after which this other private equity firm joined Siris as a co-investor in the deal;
  6. Siris offered an institutional investor with a stake in Xura a “side deal” to co-invest its equity with Siris on the buy-side; and
  7. Xura’s CEO received word from Xura’s chairman during negotiations with Siris that his position at Xura was in jeopardy if Xura was not sold.

Second, the court held that the allegations concerning the Xura CEO’s conflict, and his actions, sufficed at the pleading stage—accepting all well-pleaded facts as true, and taking all inferences from them in favor of the plaintiff—to support a viable claim that he breached his fiduciary duties. In particular, Vice Chancellor Slights observed that the well-pleaded facts supported an inference that the “looming reality” of losing his job “prompted [him] to favor Siris over other potential bidders, to feed information to Siris that would fortify its bid and then to negotiate quickly for his Transaction-related payout.” Significantly, the court also observed in a footnote that

“[i]t is remarkable to see evidence that a CEO undermined the authority and questioned the competency of his CFO in direct communications with a potential acquirer at the peak of negotiations during a sale process. Yet, that is what the pled evidence reveals here.”

Third, the Xura CEO argued that in the absence of allegations of bad faith by the other directors, the full board’s approval of the transaction served to ratify his actions. Without deciding whether board ratification could be a defense to a breach of fiduciary duty claim against the CEO, the court rejected this argument on the facts pleaded. The court found that the complaint adequately alleged that the board was unaware of material facts concerning the CEO’s conduct and thus could not ratify “what it did not know.”

Fourth, in contrast to the claim against the target CEO, Vice Chancellor Slights dismissed the plaintiff’s aiding and abetting claim against Siris, finding that the plaintiff failed to adequately allege that the acquiror knowingly participated in the breaches of fiduciary duty by Xura’s CEO. As noted above, the court reached this conclusion even though plaintiff alleged that (1) the acquiror knew the target CEO was favoring it over other potential bidders (because the complaint did not separately allege that the acquiror knew of the target CEO’s conflicted interests given his job situation); (2) the acquiror knew the target CEO was ignoring the target’s banker’s request to be included in communications with the acquiror (because the acquiror did not know that the target CEO’s refusal to include the financial advisor in such communications constituted a breach of fiduciary duty); and (3) the acquiror knew that the target was failing to disclose material information to its stockholders (because the acquiror did not facilitate those omissions).

Key Takeaways

This decision is particularly instructive for participants in public company transactions in which target management is expected to remain at the company post-acquisition. Although Xura shows that this business model creates some risk of post-closing litigation, the decision also offers several helpful lessons for acquirors as well as boards and management of public company targets:

  • Most obviously, disclosures regarding the transaction process and negotiations should be materially complete and accurate.
  • The decision on the fiduciary duty claim might have been different had the record not included explicit suggestions of post-acquisition employment for target management (notwithstanding that the private equity acquiror subsequently fired the CEO soon after the closing). However, it is quite common in private equity acquisitions for the acquiror to suggest or hint at post-closing opportunities for management in bid letters and other communications. In these cases, it is crucial that the acquiror’s offers and other communications be disclosed to the target’s stockholders.
  • Compounding that failure, the court’s decision suggests that the target CEO’s “conflict” was heightened by the board chairman having simultaneously told him that he was at risk of losing his job if the deal fell through, while he took it upon himself to unilaterally negotiate the sale to a buyer who had promised him continued employment. Again, this was not disclosed.
  • The complaint did not include a claim against the target directors; however, it appears from the allegations, which again had to be accepted as true at the pleading stage, that the board’s process was less than ideal. According to the complaint, the directors were aware of the CEO’s conflict, but do not appear to have adequately supervised the negotiations. Had the board been more directly active in the negotiations or vigorous in policing the process, the CEO’s breach may have been avoided.
  • Although Siris prevailed in getting the aiding and abetting claim dismissed, it may have avoided post-closing litigation had it sought to ensure that the Xura board and management were complying with their fiduciary duties. For instance, Siris might have sought confirmation that the CEO was keeping the board adequately informed and itself may have insisted that the board’s financial advisor remain a part of the process. Instead, the complaint alleges that Siris took the opposite tact. Siris allegedly ignored the target’s financial advisor’s request that it be included in communications and continued direct discussions with the CEO in the absence of a representative of the board. The case thus serves to remind acquirors of their own interest in adequate target processes.
  • As has become increasingly prevalent in the world of private equity transactions, the Xura CEO and senior Siris representatives regularly exchanged text messages throughout the transaction process. The case serves as yet another reminder to deal participants that, should litigation arise, their text messages are discoverable (and, if deleted, whether intentionally or not, that may lead to sanctions and/or other adverse consequences).
  • Finally, it is worth repeating that the court dismissed the aiding and abetting claim against the buyer at the pleading stage, despite finding that the acquiror was to some extent involved in the target CEO’s alleged breaches of fiduciary duty, because there were no facts alleged that the buyer knowingly participated in those breaches.

One final noteworthy aspect of the case is that the plaintiff initially sought statutory appraisal of its shares, but, after discovery, elected to file a complaint alleging the breach of fiduciary duty and aiding and abetting claims discussed above. The case thus demonstrates the possibility of breach-of-fiduciary duty litigation emerging only after closing, and utilizing discovery provided in appraisal litigation. With the Delaware Supreme Court’s DFC and Dell decisions last year, which (as discussed here and here) have made appraisal less attractive for stockholder-petitioners, time will tell whether this week’s decision in Xura will encourage more of the same.

Endnotes

1C.A. No. 12695-VCS (Del. Ch. Dec. 10, 2018).(go back)

2See Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015) (holding that business judgment protection applies to mergers that are not subject to entire fairness review and are approved by a fully informed and uncoerced vote of a majority of disinterested shareholders).(go back)

3Corwin has been held to extinguish both breach of fiduciary duty claims against directors and aiding and abetting claims, as we have discussed in a prior post.(go back)

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