The Delaware Law Series


Disclosure Regarding Director’s Conflict During Merger Negotiations

Jason M. Halper is partner, Jared Stanisci is special counsel, and Victor Bieger is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Mr. Bieger, Nathan M. Bull, and Sara Bussiere. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware courts have not been shy about warning of the dangers that can arise when merger negotiations are handed over to conflicted directors who fail to keep their boards fully informed about their divided loyalties. Over the last two years, the Delaware Supreme Court has faulted a director for lining up a buyer without disclosing that he had negotiated a lucrative equity roll-over deal on the side, and the Court of Chancery chastised a director (and his hedge fund sponsor) for engineering a quick sale of a company without disclosing to the rest of the board that he had been tipped off to the price the buyer had in mind. Directors have an “‘unremitting obligation’ to deal candidly with their fellow directors,” the Delaware courts have stressed, and that is no more true than when they are entrusted to lead merger negotiations.

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Renewed Interest in IPOs of Public Benefit Corporations

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

I can think of only one public company that is currently a Delaware Public Benefit Corporation. That’s Laureate Education, which initially filed with the SEC in 2015 and went effective in 2017. (See this PubCo post.) Now, finally, we have a second company that has filed for its IPO as a PBC—Lemonade, Inc., which declares on the cover page of its prospectus that it is incorporated in Delaware as a PBC as a demonstration of its “long-term commitment to make insurance a public good.” It’s been quite a long dry spell since the PBC legislation was signed into law in 2013. In the last few years, however, we have witnessed intensifying investor focus on sustainability as a strategy (see, for example, this PubCo post), as well as swelling numbers of companies declaring their commitments to all stakeholders, as reflected, for example, in the Business Roundtable’s adoption of a new Statement on the Purpose of a Corporation (see this PubCo post) and the World Economic Forum’s Stakeholder Principles in the COVID Era (see this PubCo post). What’s more, new legislation just passed by the House in Delaware will, if ultimately signed into law, make it easier to slip in and out of PBC status. [Update: This bill was signed into law on July 16.] Will these trends toward sustainability and stakeholder capitalism, together with the Delaware legislation, fuel a renewed interest in the PBC for public companies and expecting-to-become public companies? Will Lemonade open the floodgates?

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Did Delaware Really Kill Corporate Law? Shareholder Protection in a Post-Corwin World

Matteo Gatti is Professor of Law at Rutgers Law School. This post is based on his recent article published in the NYU Journal of Law and Business, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here) and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

Corwin v. KKR is considered one of the most important corporate law decisions of this century. Corwin shields directors from the enhanced scrutiny of Revlon in favor of the business judgment rule whenever a transaction “is approved by a fully informed, uncoerced vote of the disinterested stockholders.” Commentators see Corwin as the poster child of an increasingly more restrained approach by Delaware courts—something labeled with expressions such as “Delaware’s retreat,” “the fall of Delaware standards,” and even “the death of corporate law.”

Supporters of the decision applaud the shift from courts to markets in determining whether directors satisfactorily performed in the sale of the company. In an age of enhanced investor sophistication due to the growing size of institutional ownership, the argument goes, the judiciary has ceded the role of optimal decision maker to shareholders. However, the mainstream view among scholars is that Corwin is a setback in shareholder protection. To some, directors’ legal obligations are now limited to full disclosure. Others think that enhanced scrutiny is no longer available and the sole constraint directors face is the shareholder vote. In the views of critics of Corwin, the structure, nature, and quality of the substitute (vote vs. judicial review) are not compelling.

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A Flowchart of the Delaware Standards of Review

Matthew M. Greenberg is a partner and Taylor B. Bartholomew, and Christopher B. Chuff are associates at Troutman Pepper. This post is based on their Troutman Pepper memorandum and is part of the Delaware law series; links to other posts in the series are available here

In the context of an M&A transaction, practitioners are routinely left to navigate the various standards of review that are applied by the Delaware courts to evaluate whether a Delaware corporation’s directors have complied with their fiduciary duties. Determining which standard of review will apply to a given transaction is particularly critical—depending on the applicable standard, a Delaware court may heavily scrutinize a transaction or determine that the directors may face personal liability for their decisions in connection with the transaction. The flowchart below has been prepared to serve as a quick-reference tool for M&A practitioners when determining which standard of review might apply. While this chart has been prepared in accordance with applicable case law decided to date, it is important to bear in mind that each step set forth below necessarily involves a fact-intensive analysis and that this flowchart should not be exclusively relied upon.

The flowchart is available here.

Chancery Court Sustains Breach of Fiduciary Duty Claims Against Nonparty to LLC Agreement

Taylor Bartholomew is an associate and Matthew Greenberg and Joanna Cline are partners at Troutman Pepper Hamilton Sanders LLP. This post is based on a recent Troutman Pepper memorandum by Mr. Bartholomew, Mr. Greenberg, Ms. Cline, and Christopher B. Chuff. This post is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In 77 Charters, Inc. v. Gould, the Delaware Court of Chancery refused to dismiss breach of fiduciary duty claims against an indirect, “remote controller” of a limited liability company in connection with a series of transactions whereby the controller purchased preferred interests in the limited liability company from a member and subsequently amended the limited liability company’s operating agreement to increase the preferred’s distribution preference to the detriment of the holder of the limited liability company’s common interests. The decision serves as a cautionary reminder to investors that their actions may not be insulated from fiduciary liability—no matter how many intermediaries are involved—unless the applicable operating agreement clearly and expressly disclaims fiduciary duties.

Background

In 2007, as part of an investment in a retail shopping center, Cookeville Retail Holdings, LLC (Cookeville Retail) was formed by its managing member, Stonemar Cookeville Partners, LLC (Stonemar Cookeville), and its preferred member, Kimco Preferred Investor LXXIII, Inc. (Kimco). Around the same time, Stonemar Cookeville was formed by its managing member, Stonemar MM Cookeville, LLC (Stonemar MM), and its nonmanaging members, one of which is 77 Charters, Inc. (plaintiff). Jonathan D. Gould (Gould) is the managing member of Stonemar MM. Under the Limited Liability Company Agreement of Cookeville Retail (the CRA), Kimco was first allocated a 9 percent distribution on its capital contributions, while the excess was distributed to Stonemar Cookeville and its members (including the plaintiff). The following chart depicts the parties’ relationships.

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Fiduciary Duty of Disclosure Does Not Apply to Individual Transactions with Equityholders

Matthew Greenberg and Joanna Cline are partners, and Taylor Bartholomew is an associate at Pepper Hamilton LLP. This post is based on a recent Pepper memorandum by Mr. Greenberg, Ms. Cline, Mr. Bartholomew, and Christopher B. Chuff. This post is part of the Delaware law series; links to other posts in the series are available here.

In Dohmen v. Goodman, the Delaware Supreme Court declined to impose an affirmative fiduciary duty of disclosure on a general partner arising out of the general partner’s solicitation of capital contributions from a limited partner where the general partner knowingly made misrepresentations in the process. The court’s decision provides a comprehensive roadmap not only for general partners in assessing the scope of their fiduciary duties when communicating with limited partners under Delaware law, but also corporate fiduciaries more generally.

Background

In 2010, Bert Dohmen formed Croesus Fund, L.P. (the Fund) as a Delaware limited partnership with the intention of starting a hedge fund. Dohmen also formed Macro Wave Management, LLC to serve as the Fund’s general partner. In 2011, Albert Goodman made an initial capital contribution in the Fund and became a limited partner. During the same year, Dohmen himself also invested in the Fund. Following Goodman’s investment, Goodman inquired several times as to whether there were other investors in the Fund. Dohmen stated that he had several friends who were liquidating assets in order to participate in the Fund, but, according to the court, no friends of Dohmen’s were actually doing so and Dohmen was aware of this. In 2011, Goodman again invested in the Fund. Dohmen represented to Goodman that his friends were interested in the Fund and were reviewing certain investment documents, which the court characterized as a knowingly false statement. In 2012, Dohmen informed Goodman for the first time that there were only two investors in the Fund. Dohmen offered to allow Goodman to withdraw his investments, but Goodman declined. By 2014, the net asset value of the Fund declined to $100,000. Goodman did not receive a return of any portion of his investment.
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Chancery Court Denies Motion to Dismiss and Application of MFW Safe Harbor

Meredith Kotler and Paul Tiger are partners and Marques Tracy is an associate at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum and is part of the Delaware law series; links to other posts in the series are available here.

In a 94-page opinion issued last Thursday, Vice Chancellor Laster denied defendants’ motion to dismiss in In re Dell Technologies Inc. Class V Stockholders Litigation, [1] finding that the complaint alleged facts that made it “reasonably conceivable” that the safe harbor established by Kahn v. M&F Worldwide Corp. (“MFW”), 88 A.3d 635 (Del. 2014), would not apply and thus that entire fairness could be the operative standard of review, rather than the more favorable business judgment standard. While the facts in Dell are unique, the opinion offers helpful guidance to boards seeking the benefit of MFW, particularly on issues relating to establishment of a special committee, its role in negotiations, potential threats or coercion, and director independence.

Background

In 2016, Dell Technologies (“Dell” or the “Company”) acquired EMC Corporation with a combination of cash and newly-issued shares of Class V stock. A critical feature of the Class V shares was the existence of a conversion right: if the Company listed its Class C shares on a national exchange, then the Company could forcibly convert the Class V shares into Class C shares pursuant to a pricing formula that the Court characterized as “superficially simple” and that commentators had suggested could be influenced to the disadvantage of the Class V stockholders by the existence of the conversion right itself.

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MFW Pitfalls: Bypassing the Special Committee and Pursuing Detrimental Alternatives

Christopher B. Chuff is an associate and Joanna Cline and Matthew Greenberg are partners at Pepper Hamilton LLP. This post is based on a recent Pepper memorandum by Mr. Chuff, Ms. Cline, Mr. Greenberg, and Taylor Bartholomew. This post is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

On June 11, the Delaware Court of Chancery issued important guidance [1] to boards of directors of Delaware corporations and their controlling stockholders seeking to utilize the dual protections of MFW [2]—a special committee and a majority of the minority vote—to insulate themselves from fiduciary liability in connection with various corporate transactions.

First, the court held that when a corporation’s board or the corporation’s controller bypasses the special committee and negotiates directly with the corporation’s minority stockholders, MFW cleansing and the resulting application of business judgment review will be unavailable.

Second, the court held that when a corporation and its controller empower a special committee to consider and “say no” to various transaction alternatives, but retain the authority to pursue an alternative that is detrimental to the minority, any resulting special committee and stockholder approval of the transactions submitted for their approval will be found to be tainted by coercion, such that MFW cleansing will be unobtainable.

Thus, while the court’s decision confirms that the dual protections of MFW can be effective to protect against fiduciary liability claims, boards of directors and controlling stockholders who wish to maximize the effectiveness of those protections must be sure to avoid these and other pitfalls.

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Aiding and Abetting Claims Against Board Advisors and Buyer

Paul J. Shim, Roger Cooper,and Mark McDonald are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum and is part of the Delaware law series; links to other posts in the series are available here.

In an important decision for M&A professionals and other board advisors, the Delaware Court of Chancery addressed a stockholder plaintiff’s claims that the target board’s financial advisor and law firm, as well as the private equity buyer, aided and abetted a breach of fiduciary duty by the target board in connection with a take-private merger. See Morrison v. Berry, C.A. No. 12808-VCG (Del. Ch. June 1, 2020). While the claim against the financial advisor was allowed to proceed, the claims against the law firm and buyer were dismissed. These diverging results provide early guidance as to when the Delaware courts will (and when they will not) dismiss aiding and abetting claims. In many cases, the determining factor will be whether the complaint pleads facts raising a reasonably conceivable inference that the advisor, buyer, or other third party knew the board was engaging in a breach of its fiduciary duty. This has important implications for the way board advisors and M&A buyers should approach a situation in which they become aware that the board of a target company is unaware of some material fact that could conceivably affect its ability to fulfill its fiduciary duties.

Background

This case concerns a two-step going-private transaction in which an affiliate of a private equity sponsor (“Buyer”) acquired The Fresh Market (“Fresh Market” or “the Company”), a specialty grocery chain. In July 2015, Buyer reached out to Ray Berry, chairman of Fresh Market’s board and a significant minority stockholder, indicating Buyer’s interest in taking Fresh Market private. After further communications in which Berry reached an oral agreement to roll over his equity in a transaction with Buyer, which he did not disclose to the Company’s board, the board instituted a public bidding process. During this process, Fresh Market’s financial advisor allegedly provided “inside information” about the bidding process to Buyer, which allegedly was a large client of the financial advisor. The complaint alleged that these communications may have impacted the bidding process, but were not disclosed to the Fresh Market board. Although there were multiple expressions of interest, the bidding process yielded only one definitive bid—from Buyer, on March 8, 2016, for $27.25 per share. After the board determined the same day that the offer was insufficient, Buyer submitted a revised offer of $28.50 per share on March 9. On March 11, the board accepted the offer and approved the merger. On March 25, Fresh Market publicly filed its solicitation/recommendation statement on Schedule 14D-9 (“14D-9”), which omitted certain facts about Buyer’s discussions with Berry and the Company’s financial advisor. The two-step merger closed on April 22, 2016.

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Back to Work: Protect Directors Too

William Regner and Jeffrey Rosen are partners at Debevoise & Plimpton LLP. This post is based on a Debevoise memorandum by Mr. Regner, Mr. Rosen, Sarah Jacobson and Chibundu Okwuosa. Related research from the Program on Corporate Governance includes Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

As companies refine and implement their return-to-work plans, they must wrestle with complex legal compliance risks posed by the continuing threat of the COVID-19 pandemic. In addition to complying with established laws governing worker safety, accommodation of those with disabilities, and personal privacy, companies will need to ensure that their reopening plans comply with an evolving series of federal, state, and local orders issued in response to the pandemic. While back-to-work plans are necessarily prepared by management taking into account the different needs and regulatory postures of each individual business, the board of directors has an important oversight role.

Any business whose reopening results in sick employees, customers, or suppliers, or which otherwise faces COVID-19 related legal compliance problems, risks claims that attendant corporate losses were the product of failure of oversight—in Delaware, Caremark claims. Caremark claims are named after the Delaware Court of Chancery’s 1996 decision holding that directors are protected by the business judgment rule so long as they have implemented and monitored systems reasonably designed to provide the board and management with sufficient information to facilitate educated decisions about identified legal risks. If directors completely fail to implement any reporting or information system or controls, or, having implemented such controls, fail to monitor or exercise oversight, courts may question whether directors have complied with their duty of loyalty.

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