Chancery Decision Expands the Court’s Approaches on Director Independence

The Goldstein v. Denner (May 26, 2022) litigation arose out of the $11.6 billion cash acquisition of Bioverative, Inc. (which had recently been spun off from Biogen, Inc.) by Sanofi, S.A. The Delaware Court of Chancery held, at the pleading stage of litigation, that certain directors and officers of Bioverative may have breached their fiduciary duties in connection with the sale process. The plaintiff claimed that the defendant directors and officers sold the company (in a single-bidder process) too quickly after the spinoff; at a price far below the company’s stand-alone value (as indicated by the company’s projections prepared in the ordinary course of business); at a time when the universe of potential buyers was limited (due to tax-related restrictions following the Spinoff not expiring for another few months); and with materially inaccurate and misleading disclosure to the stockholders.

The sale process was led by an outside director, “D,” an activist investor, who allegedly was acting in accordance with his “usual playbook” of pressuring a public company into putting him on the board, then recruiting his “supporters” onto the board, and then forcing a near-term sale of the company. In this case, allegedly, he had “supercharged” the process by having the hedge fund he controlled (the “Fund”) buy a significant stake in the company after Sanofi first approached him about its in interest in acquiring the company, and then waiting until the expiration period for disgorgement of short-swing profits under Section 16(b) of the Exchange Act to inform the board of Sanofi’s interest and initiate the sale process.

In an opinion that clarifies, and arguably expands, the court’s current approaches on important topics, Vice Chancellor Laster found, at the pleading stage of litigation, that it was “reasonably conceivable” (the standard for survival of claims at the pleading stage) that all of the defendant directors and officers committed unexculpated breaches of their fiduciary duties in connection with the sale process. The court reserved judgment for a future decision on the claim that D’s Fund aided and abetted D’s alleged fiduciary breach.

Key Points

• The court suggested that “short-term investors”—at least when acting in accordance with a short-term “playbook”—may have an inherent disabling conflict of interest in a sale process. The court stated that investors with a “short-term investment strategy” have a divergent interest from the other stockholders based on which they may well favor a near-term sale when the best interests of the other stockholders would be served by remaining independent. The court amplified its recent erosion of the Synthes doctrine, stating flatly that an investor’s desire for liquidity may create a disabling conflict even if the investor does not have an “exigent need” for liquidity but simply wants “to redeploy capital” to a “different investment option.”
• The court suggested that directors appointed by activist funds—or by other “repeat players”—may inherently be non-independent. The court held that two of Bioverative’s four outside directors may not have been independent based on the likelihood of their gratitude to D for their Bioverative board seats and the likelihood that they expected that he would provide them with “future benefits” in the form of other board seats, as he was a “repeat player” in locating directors for his Fund’s portfolio companies.
• The court clarified that a director may have a disabling conflict based on a significant change-in-control entitlement even if the entitlement arises pursuant to a pre-existing agreement. Vice Chancellor Laster characterized previous Court of Chancery decisions as going “a step too far” in purportedly establishing a “rule of law” that change-in-control benefits cannot create a conflict of interest when they are paid out pursuant to a pre-existing agreement and are not triggered by the specific bidder or transaction. The Vice Chancellor stated that, even under such a scenario, whether a conflict exists depends on the facts and circumstances. He found that the $72.3 million severance payable to Bioverative’s CEO-director (“C”) was sufficiently material that it was reasonable to infer that C may have supported the near-term sale to Sanofi based on his self-interest in receiving the severance.
• The court refused to credit the company’s portrayal of certain material sale process events in the company’s disclosure to stockholders because the board minutes were silent with respect to those events. The court found it reasonably conceivable that “updates” to the board from D and another director regarding their conversations with Sanofi during the sale process, which were described in the company’s Schedule 14-D “Background of the Transaction,” had never happened given that they were not reflected in board minutes (or other books and records produced in response to the plaintiff’s Section 220 demand). Based on this (and other alleged disclosure flaws), the court ruled that Corwin (which would have “cleansed” any sale process fiduciary breaches) did not apply and that the applicable standard of review was enhanced scrutiny under Revlon.
• We note the importance of the overall factual context. Importantly, the court’s conclusions were reached in the context of a factual situation that included, allegedly, inopportune timing for the sale of the company; illicit stock purchases by D’s Fund (with the Fund standing to gain a profit of $35 million on those shares at the $90 per share price of Sanofi’s initial indication of interest); communications between D and Sanofi that were not disclosed to the board; a sale price that was significantly below the value indicated by the company’s projections prepared in the ordinary course; major revision to the projections to support the price, although there had been no changes in the company’s business; the lead director-negotiator acting consistently with a “usual playbook” of pressuring companies into near-term sales after obtaining board membership and recruiting “supporters” onto the board; and numerous alleged inaccuracies in the disclosure to stockholders. Presumably, the court’s approaches may have been different had the overall context not been apparently egregious (particularly as the court in some instances characterized its findings as “close calls” or emphasized that they were based on the plaintiff’s allegations “taken together”).

Background. After pressure from activist investor Carl Icahn, Biogen spun off Bioverative as a public company (the “Spinoff”) in 2017. Three months after the Spinoff, Sanofi approached two of Bioverative’s directors, D and “P,” to express interest in acquiring Bioverative for about $90 per share. At the time, Bioverative’s stock was trading in the mid-$50’s. D and P “demurred” and did not inform the Bioverative board about the approach. D then immediately caused his Fund to buy more than a million shares of Bioverative in the market. D did not disclose the purchases to the board and the purchases violated the company’s insider trading policy. When Sanofi approached D and P over the following few months, they continued to maintain that the company was not for sale. However, when Sanofi approached them just before the six-month period after which short-swing profits from the Fund’s market purchase of shares would no longer have to be disgorged under the securities laws, D, without the board’s knowledge or authorization, invited Sanofi to bid for the company as part of a pre-emptive, single-bidder process.

Sanofi then submitted an offer to the board to acquire the company for $98.50 per share. The board requested a higher bid; Sanofi offered $101.50; the board countered at $105; and Sanofi agreed. The $105 price was almost one-third below the company’s more than $150 per share standalone value based on the company’s internal projections in its long-range plan. Company management then “slashed” the company’s projections. A fairness opinion was obtained based on the revised projections and the Bioverative board approved the transaction. In the first-step tender offer, 62.5% of the outstanding common stock was tendered. After the closing of the second-step merger, the plaintiff inspected corporate books and records under a Section 220 demand and then brought suit.

The court’s holdings. The court held, at the pleading stage, that it was reasonably conceivable that:

• The disclosure to stockholders may have been materially inaccurate or misleading—therefore, Corwin was inapplicable and enhanced scrutiny under Revlon applied;
• Because of D’s actions and his and the other directors’ conflicts—which “steered the Company toward a quick sale to Sanofi to serve [D’s] own interests…at the expense of generating greater value through a competitive bidding process or by having the Company remain independent”—the sale process “did not have achieve the best value reasonable available to the stockholders”;
• D acted in bad faith (a) by concealing information from the board about his communications with Sanofi, and, separately, (b) by supporting the sale based on his own and his Fund’s self-interest in obtaining liquidity and a profit on the shares illicitly purchased by the Fund;
• P (an outside director) acted in bad faith by concealing information about his and D’s conversations with Sanofi;
• C acted in bad faith by supporting the sale based on his self-interest in obtaining a very significant severance award;
• “G” and “AP” (outside directors) acted in bad faith by supporting the sale to strengthen their relationship with D—due to likely gratitude for their board seats and a likely expectation that D would secure future board seats for them;
• All six directors (e., including the one outside director who the court deemed to be independent and not to have supported the sale based on self-interest) acted in bad faith in issuing disclosure to the stockholders about the sale process that they likely knew was materially inaccurate or misleading; and
• The defendant officers (the CEO, CFO and CLO) breached their fiduciary duties by assisting the defendant directors in conducting a flawed sale process—including by revising company projections to support the deal price when no changes had occurred in the business, “embellishing” the board minutes to make the sale process seem less flawed than it was, and participating in the drafting of inaccurate disclosure to the shareholders.

Discussion

The court rejected the defendants’ arguments that the significant premium reflected in the deal price, and the absence of a post-signing competing bidder, supported the reasonableness of the sale process. The court noted evidence that the defendants themselves believed that the market was not yet fully valuing Bioverative (which had only recently been spun off). The company’s projections (prepared in the ordinary course of business for its long-range plan) and the company’s valuations that supported higher values for the company were based on information about the company’s products and pipelines that had not been publicly disclosed. While Sanofi had access to the long-range plan, competing bidders would not have had access to it to inform their bids. In addition, several logical potential bidders could not participate given the timing of the sale process several months before expiration of the tax-related “restricted period” following the Spinoff.

The court found it reasonably conceivable that the disclosure in the Schedule 14D-9 was false or misleading—in some cases because sale process events depicted in the disclosure were not corroborated by the board minutes. The court found that the plaintiff’s allegations, “taken together,” supported a reasonable inference that there was “a series of incomplete or inaccurate disclosures” in the Schedule 14D-9 relating to (i) D’s and P’s early discussions with Sanofi; (ii) the stock purchases made by D’s Fund; (iii) the implications for the sale process of the Tax Matters Agreement entered into in connection with the Spinoff; and (iv) the company’s projections and revisions management made to them during the sale process. With respect to (i) above, the court noted that the board minutes (and contemporaneous emails produced by the company in response to the plaintiff’s Section 220 demand) were silent with respect to “updates” that the disclosure stated that D and P provided to the board with respect to their contacts with Sanofi during the sale process. The court noted that the defendants potentially could establish at trial (and, indeed, that there already was some evidence) that these events had occurred—but that the lack of corroboration in the minutes or other books and records gave rise to a reasonable inference at the pleading stage that the events did not occur. The court noted that “[a] lack of disclosure to the Board [was] also consistent with [D]’s successful efforts to keep secret [his Fund]’s illicit purchases of Company common stock.”

The court suggested that “short-term investors,” at least when acting in accordance with a short-term “playbook,” may have an inherent disabling conflict. The court acknowledged that, ordinarily, the Fund’s significant holdings of Bioverative shares would have helped to undermine any concern that D and the Fund might had have an interest that was divergent from the other stockholders’ interest in obtaining the best price reasonably available on a sale of the company. However, the court stated, “particular types of investors [who] espouse short-term investment strategies”—especially “activist hedge funds, which are the archetypal short-term investor”—”creat[e] a divergent interest in pursuing short-term performance at the expense of long-term wealth.” While D’s association with an activist hedge fund alone was insufficient to infer that he had a disabling conflict, such a conflict was reasonably inferable based on “the playbook that [D] ha[d] followed on multiple occasions,” the court wrote. The plaintiff’s complaint detailed how D had previously targeted particular biopharma or healthcare companies; used a proxy contest or the threat of one to “force his way into the boardroom”; once on the board, had “recruit[ed] director allies in the form of [the Fund]’s insiders or supportive repeat players”; and then had pursued an outcome that facilitated the Fund’s short-term investment horizons, typically through a near-term sale of the company.” As D’s actions were consistent with the “known playbook,” the plaintiff was entitled to an inference at the pleading stage that D was “following the playbook”—that is, that he was acting in furtherance of a short-term strategy that served the best interests of his Fund rather than the best interests of the company and its stockholders.

The court suggested that an investor’s desire for liquidity simply to redeploy capital can create a disabling conflict in a sale process. The court explicitly rejected the defendants’ “simplistic view” that, in a sale process, an investor “will always wait for a higher value later rather than taking a sure thing in the near term” unless the investor has an exigent need for liquidity that would lead it to accept a “fire sale” price for the company. “That is just not true,” the court wrote, reaffirming other recent decisions in which the court has stated that the “extreme language” in Synthes (stating that a desire for liquidity creates a disabling conflict only if there is an “exigent need”) should be read “as reflecting the court’s reaction to a particularly deficient complaint” in that case, rather than reading Synthes as establishing a “general rule.” Vice Chancellor Laster, amplifying the erosion of the Synthes doctrine, wrote:

Investors follow different strategies, have different hurdle rates, and enjoy different reinvestment options. Near-term cashflows are more beneficial than outyear cashflows, precisely because they arrive sooner. An investor with attractive reinvestment options can redeploy those cash flows into other investments. An investor’s use of leverage also affects the decision. A leveraged financial investor might well seize a near term opportunity so that the profits can be deployed into an investment with a higher return. By the same token, an activist hedge fund may favor a near-term sale, followed by the redeployment of capital into another activist campaign. Yet for the common stockholders in the firm, the sounder choice may be for the firm to remain independent.

Notwithstanding this broad language, the court roots its holding to the specific factual context of the case, emphasizing D’s conflict of interest. Immediately following the language quoted above, the Vice Chancellor wrote:

The complaint supports a reasonable inference that [D] caused [the Fund] to make a significant investment in the Company’s common stock based on inside information indicating that the Company soon could be sold. Against that backdrop, the complaint supports a reasonable inference that [D] wanted the Company to be sold and that by shepherding the Company through a quick, non-competitive sale process with Sanofi, [D] could lock-in a sure gain on his illicit stock purchases. It is reasonably conceivable that by pursuing this strategy, [D] acted disloyally because he served his personal interests rather than pursuing the best interests of the Company and its stockholders.

The court rejected precedent indicating that change-in-control benefits cannot create a disabling conflict if paid pursuant to a pre-existing agreement. Vice Chancellor Laster acknowledged that, in Morrison v. Berry and In re Novell, the Court of Chancery held that change-in-control benefits cannot create a conflict of interest as a matter of law when those benefits (i) are paid out pursuant to a pre-existing agreement and (ii) there is no allegation that those benefits were triggered by the specific bidder or specific transaction. Those decisions, however, “go a step too far by converting fact-specific holdings into a rule of law,” the Vice Chancellor stated. He observed that it is the existence of a differential interest that creates a conflict, and “[t]he fact that [an] individual receives [a] payment or other differential interest because of an existing agreement does not change the fact that the individual receives the payment or other differential interest.” The Vice Chancellor commented, further, that “[t]o assert that a transaction-related benefit cannot give rise to a divergent interest simply because an existing contract calls for the payment is particularly strange for change-in-control payments, because one of their evident purposes is to create financial incentives for executives to favor transactions that otherwise might disrupt their employment and which they therefore might resist.” While the facts in any given case may establish that a change-in-control payment “did not give rise to a conflict of interest or that the fiduciary in question did not succumb to it, …[i]t does not follow that the receipt of a pre-existing contractual benefit, solely by virtue of being a pre-existing contractual benefit, cannot create a conflict as a matter of law.” The Vice Chancellor concluded that, in this case, as between a sale process that resulted in a near-term sale to Sanofi and the decision to continue operating on a stand-alone basis, C had a conflict of interest such that it was reasonable to infer that he may have been “happy to go along” with the sale based on his self-interest in obtaining $72.3 million in severance (which, the court noted, “dwarfed” his roughly $11 million in annual compensation).

The court highlighted that acceleration of a director’s options or restricted stock units may create a disabling conflict—but found against the plaintiff on this point as the complaint quantified only the value received under the accelerated awards and not the value of the acceleration itself. The court rejected the plaintiff’s assertion that P was self-interested based on his receipt of $2.5 million through acceleration in the vesting of his options, and stated that Delaware courts are “rightly skeptical that director equity creates a disqualifying interest where, as here, the director received the same per-share consideration as all other stockholders.” However, the Vice Chancellor observed, “[t]hat does not mean that a disqualifying interest cannot exist” based on acceleration of options or RSUs. In this case, the Vice Chancellor found, the plaintiff did not plead facts sufficient to determine whether a disqualifying interest existed because the plaintiff had not “done the work” to quantify the amount of value conferred by the acceleration. The court explained that the value of the acceleration itself was different from (and less than, as it is only a component of) the $2.5 million aggregate value that P received from the accelerated awards.

The court’s discussion of director independence signals that directors appointed by activist funds—or by other “repeat players”—may face increased scrutiny with respect to their independence. Most notably, the court found it reasonably conceivable that certain outside directors supported the sale based on a desire to support D and strengthen their relationship with him (to be “on Team [D]”), based on their gratitude for their board seats and an expectation of future board seats or other “future benefits” from D. The court discussed recent scholarship suggesting that the court should take a more nuanced view of the personal dynamics at work when directors’ seats are secured with assistance from, and possibly for the purpose of supporting the objectives of, activist hedge funds, or controllers, venture capital firms or private equity firms, that are “repeat players.” The court noted that D and his Fund were “repeat players in the biopharma and healthcare sector”; that, for an activist fund, “the ability to secure board seats is a potent weapon”; and that, “[f]or that weapon to function, [the hedge fund] needs a pool of potential directors.” The court concluded:

It is reasonably conceivable that [D] cultivates symbiotic relationships in which he helps individuals secure lucrative directorships on the boards of the companies that [his hedge fund] targets or controls, and in return the individuals back [D]’s goals in his activist campaigns. A long-standing history of interactions would not be necessary for the carrot to have an effect. All that would be needed is a director’s desire to cultivate such a relationship. Nor would there need to be an explicit quid pro quo. The fund’s practice of rewarding directors would be a sufficient signal.

Importantly, notwithstanding the court’s broad language quoted above, the court’s holdings that two outside directors, AP and G, may have acted based on their “relationship with [D]” rather than on the best interests of the stockholders, was based not only on the relationship with D but also on the allegation that the “fast sale” to Sanofi was “at a price far below Company management’s assessment of the Company’s standalone value.” It was the combination of the relationship with the apparently low sale price that led to a reasonable inference that AP and G acted in their self-interest rather than in the interest of the stockholders. Also of note, the court characterized its holdings with respect to these directors as “close calls.”

With respect to AP, the court found that it was reasonably conceivable that “she supported a fast sale to Sanofi because she had benefitted from and wanted to keep participating in [D]’s activist campaigns.” Just weeks before joining the board, AP had received “a lucrative payout for helping [D] complete the sale of another company,” supporting an inference that she acted based on “a symbiotic relationship [with D] that she wanted to see continue.” With respect to G, the court noted that he was unemployed when D invited him to join the board, “which gave him an opportunity to restart his career”; and that, six months after G joined the board, D, after inviting Sanofi to bid for the company, secured a seat for G on the board of another company. The court noted that in a case not governed by enhanced scrutiny it would be “unlikely that a similar constellation of facts would be sufficient to overcome the presumption of good faith or to call a director’s independence into question.” For example, “the ‘reasonable doubt’ standard used in a demand futility analysis provides a higher hurdle for a plaintiff than the relatively lenient standard of review [(i.e., reasonable conceivability)] pursuant to Rule 12(b)(6),” the court wrote.

Unlike AP, G had no past history of involvement with D. However, the court applied the same analysis with respect to “a mutually beneficial relationship in which [G] supports [D]’s efforts, and D rewards [G].” D secured G’s seat on the board shortly after the Spinoff and just after Sanofi’s initial approach about a potential transaction with Sanofi. Six months later, after inviting Sanofi to made a bid, D used his position on the board of another company to secure a seat for G on that board. According to the complaint, G and D later “engineered a sale” of that company that earned G $3 million for his shares and options in that company after only two years on its board (and earned D’s Fund $364 million for its shares plus $3.7 million for D personally). Together, these facts made it reasonably conceivable that G supported the sale to Sanofi “to be supportive of [D].” The court found that it was reasonably conceivable that D, as the Chair of the Governance Committee, played a key role in the appointment of G to the Board; that the appointment “would have inspired some level of gratitude on [G]’s part since he had been out of a job since 2016”; and that G was aware of D’s “practice of looking out for his friends by helping them secure lucrative directorships.” The court found that, taken together, the allegations were “sufficient to support a rational inference that [G] acted in bad faith by supporting the Transaction out of gratitude for [D]’s help and an expectation of future rewards.”

The court found it reasonably conceivable that the officers breached their fiduciary duties. The court noted that the CEO, CFO and CLO each stood to reap very significant benefits from the transaction in the form of severance and/or acceleration of their options and restricted stock units. “Against that backdrop,” the court found that the plaintiff adequately alleged that these officers “breached their fiduciary duties by assisting the Director Defendants in achieving the quick sale to Sanofi as part of a defective sale process.” With respect to C and the CFO, the court found it was reasonable to infer that they acted disloyally when (i) failing to disclose to the board the Fund’s stock purchases (which they had reason to know may have been the result of inside information provided by D) and (ii) participating in revising the company’s projections to facilitate delivery of the fairness opinion (which involved management “systematically slashing” the projections after the board agreed to Sanofi’s $105 per share offer, although no changes had occurred in the business). With respect to the CLO, the court found it was reasonable to infer that she may have acted disloyally by “engaging in acts of creativity” when creating the record of the sale process, including by “embellishing [board minutes] to depict an idealized process rather than what actually occurred,” and by “participating in the drafting of an inaccurate Schedule 14D-9.” The court, noting inconsistencies between the board minutes and contemporaneous emails, stated that while there could be defendant-friendly explanations for them, they were sufficient at the pleading stage to state a claim.

Practice Points

• It bears continued emphasis that—particularly in light of the critical role disclosure plays in determining the standard of review at the pleading stage and the current prevalence of pre-litigation Section 220 demands— management and the board should pay special attention to board minutes, emails and other corporate books and records relating to a sale process. The benefits of more (rather than less) comprehensive board minutes should be considered—as “silence” in the minutes may lead to the court drawing negative inferences; and the court is less likely to grant access under a Section 220 demand to electronic communications of directors, officers or advisors to the extent that the board minutes and other official books and records are comprehensive. Directors should be counseled regularly and emphatically about the appropriate use and content of emails (as emails now often must be produced in response to Section 220 demands). The disclosure to stockholders should reflect the reality of what occurred (rather than an “idealized” version of events based on what should have occurred). The disclosure, minutes, contemporaneous emails, and other books and records should be consistent with one another. Indeed, in some decisions, the court has compared the disclosure line-by-line or word-for-word with board minutes and drawn negative inferences from even minor differences between the two.
• It should be kept in mind that the court may view skeptically the independence of a director who was placed on the board under the auspices of an activist investor or other investor who may be viewed as a “short-term investor” or “repeat player.” An investor who places directors on boards should weigh the benefits of “serial” appointments of the same persons to numerous board seats as compared to the litigation benefit of not creating an expectation by the director of “future benefits” from the investor in the form of additional board seats. In all cases, directors should ask questions and seek information (which may be recorded in the board minutes) that evidence that the director’s consideration is focused on the best interests of the company and its stockholders rather than the director’s self-interest or the interest of any other director or other person (including the person who helped to secure the director’s board seat).
• Again, overall context matters. The court may well decide “close calls,” or even reach in its analysis, in favor of the plaintiff where the overall factual context suggests a pattern of serious misconduct by the defendants.