I reviewed Vice Chancellor Noble’s decision in Ryan v. Lyondell Chemical Company, 2008 WL 2923427 (July 29, 2008) in my blog post of September 11. I noted that the most surprising aspect of the Vice Chancellor’s opinion is that he devoted only three pages of his 73-page opinion to disposing of the director defendants’ argument that, even if they breached their Revlon duties in agreeing to the merger with Basell AF, Lyondell’s certificate of incorporation and Delaware’s General Corporation Law § 102(b)(7) precluded an award of damages. I observed that the Vice Chancellor devoted “almost no effort to explicating Stone v. Ritter’s use of the word ‘conscious’ before ‘disregard for their responsibilities …’ as applied to the conduct of the Lyondell director defendants.
The director defendants apparently thought likewise, and requested that the Vice Chancellor certify an interlocutory appeal to the Delaware Supreme Court. Vice Chancellor Noble denied the request by his 26-page letter opinion dated August 29, 2008.
The Vice Chancellor begins with, and repeats throughout his letter opinion, his exasperation at the paucity of the record the director defendants elected to present to him in making his summary judgment decision:
“Defendants made a tactical choice to seek summary judgment very early in this case, and, consequently, they acted upon a record developed in connection with related preliminary injunction litigation in Texas.”
Letter Opinion note 2.
“Once again, the Court emphasizes that this is summary judgment and the record, as it presently stands, is nothing more than the record prepared for the preliminary junction hearing in Texas. …
In short, the predicament in which the [defendant] directors presently find themselves is entirely of their own making and the result of their impatience with the litigation process.”
Letter Opinion note 38.
Obviously aware of the hullabaloo his opinion has created, and the fact that the court may not have expounded “in sufficient detail upon its reasons for denying the directors the protection of Lyondell’s exculpatory charter provision …” Letter Opinion at 6, the Vice Chancellor takes the occasion of this request to explain, in much further detail, why he is not prepared, on the record before him, to exonerate the director defendants based upon Lyondell’s exculpatory charter provision:
“A fair reading of the Opinion [the Vice Chancellor’s opinion of July 29, 2008], however, plainly reveals that the Court’s concern about the application of a Section 102(b)(7) defense on this rudimentary summary judgment record is whether by taking no discernible action to prepare for a possible sale of the Company in light of the 13D filing, and then, later, by doing nothing (or virtually nothing) actively to confirm that Basell’s offer really was the ‘best’ deal reasonably available, the Defendants may have exhibited a ‘conscious disregard’ for their known fiduciary obligations in a sale scenario. Thus, the Court did not apply an inappropriate concept or definition of ‘bad faith’ in this context under the controlling Delaware Supreme Court precedents, and it did not ‘resolve’ a substantial issue or ‘determine’ a legal right. It simply denied a motion for summary judgment on a sparse preliminary injunction record where the facts, unfortunately, suggest an inference of conscious inaction in the face of a known duty to act.”
Letter Opinion at 6-7 (footnote omitted).
Vice Chancellor Noble then proceeds with an extended discussion of the relevant authorities, including Stone v. Ritter, 911 A.2d 362 (Del. 2006) and In re Walt Disney Company Derivative Litigation, 906 A.2d 27 (Del. 2006).
So, Ryan, as plaintiff, must have an opportunity to explore, in further detail, the defendant directors’ conduct, particularly after Basell’s filing of a Schedule 13D, through their approval of the Basell proposal, to flesh out the record to enable Vice Chancellor Noble to conclude whether this is simply a duty of due care case or rises to a lack of good faith case.
One has the distinct impression in reading the Vice Chancellor’s decision and this letter opinion that it would not take a great deal to tip him over into the due care realm in this case. Competent defense counsel should be able to establish such a record. Accordingly, it would take a determined plaintiff’s counsel to take this case to trial. I would therefore not be surprised to see a settlement in this case before the end of the year.
Monday, September 15, 2008
CSX v. TCI; Second Circuit Seats Insurgents
The Second Circuit issued a summary order today affirming Judge Kaplan's refusal to enjoin the voting of the CSX shares acquired by TCI during the period of time it was not in compliance with the reporting requirements of Exchange Act Section 13(d). So that means four of the five insurgents, including TCI managing director Chistopher Hohn, will be seated on the CSX board (subject, I believe, to an ongoing challenge by CSX to certain proxies).
As I commented in my post of July 17, 2008:
"Judge Kaplan rejected all of CSX's claims that the 13D and proxy statement [filed by TCI and 3G] contained misstatements and omissions. So unless the Second Circuit panel gets inflamed by the defendants' allegedly 'egregious' conduct, I would think CSX has an uphill battle in convincing the Second Circuit to issue an injunction disenfranchising TCI/3G and 'kicking' the insurgents' nominees off the CSX board."
The brief order concludes with a statement that the panel is deciding the injunction issue alone for now, with an "opinion of the court [to] follow."
Apparently the panel deciding the case is composed of Judges Newman, Winter, and Calabresi. If that is true, then TCI/3G was fortunate in that draw, since the members (certainly Winter and Calabresi) have the background and knowledge in securities regulation and law and economics to plunge into this case without fear of the complexities of swaps.
I look forward to reading the panel's opinion. (For my previous commentary on this case, see my posts of August 23, 13, 1; July 30, 26, 17; and June 24 and 23.)
As I commented in my post of July 17, 2008:
"Judge Kaplan rejected all of CSX's claims that the 13D and proxy statement [filed by TCI and 3G] contained misstatements and omissions. So unless the Second Circuit panel gets inflamed by the defendants' allegedly 'egregious' conduct, I would think CSX has an uphill battle in convincing the Second Circuit to issue an injunction disenfranchising TCI/3G and 'kicking' the insurgents' nominees off the CSX board."
The brief order concludes with a statement that the panel is deciding the injunction issue alone for now, with an "opinion of the court [to] follow."
Apparently the panel deciding the case is composed of Judges Newman, Winter, and Calabresi. If that is true, then TCI/3G was fortunate in that draw, since the members (certainly Winter and Calabresi) have the background and knowledge in securities regulation and law and economics to plunge into this case without fear of the complexities of swaps.
I look forward to reading the panel's opinion. (For my previous commentary on this case, see my posts of August 23, 13, 1; July 30, 26, 17; and June 24 and 23.)
Saturday, September 13, 2008
Hexion v. Huntsman; Has the Issue of the Combined Firm's Solvency Been Removed from the Case?
Huntsman disclosed yesterday, September 12th, that it had received word the night before that its valuation firm, American Appraisal, which Huntsman describes as a "leading valuation firm," is prepared to issue a written opinion that a combined Hexion/Huntsman would be solvent. Huntsman's counsel retained American Appraisal as a consultant on July 14, 2008 (that arguably maintains their advice prior to their designation as an expert as confidential attorney work product); Huntsman requested a solvency opinion of the firm on September 5.
Hexion appears to have been a bit flummoxed by the announcement, issuing a short press release later yesterday stating: "From the public filing made by Huntsman this morning, it is clear Huntsman does not have a solvency certificate. We note the peculiar timing of the announcement in view of Huntsman's request for an expedited trial and the fact that the firm they reference was retained two months ago."
It's hard to see how this development doesn't take the solvency issue out of the case, at least for now. I closed my post of August 4 noting that Vice Chancellor Lamb could very well conclude that the solvency question is not ripe unless and until Credit Suisse and Deutsche Bank refuse to fund on the grounds of the parties' failure to delivery satisfactory certification of the combined firm's solvency. This recent development should only confirm that the issue is not ripe for decision.
That leaves the MAC issue as the central issue in the case, which, given the Chancery Court's natural reluctance to invite challenges over MAC issues, put additional pressure on Hexion to clearly make out its case.
For my previous commentary on this case, see my posts of September 5, August 4, and June 28.
Hexion appears to have been a bit flummoxed by the announcement, issuing a short press release later yesterday stating: "From the public filing made by Huntsman this morning, it is clear Huntsman does not have a solvency certificate. We note the peculiar timing of the announcement in view of Huntsman's request for an expedited trial and the fact that the firm they reference was retained two months ago."
It's hard to see how this development doesn't take the solvency issue out of the case, at least for now. I closed my post of August 4 noting that Vice Chancellor Lamb could very well conclude that the solvency question is not ripe unless and until Credit Suisse and Deutsche Bank refuse to fund on the grounds of the parties' failure to delivery satisfactory certification of the combined firm's solvency. This recent development should only confirm that the issue is not ripe for decision.
That leaves the MAC issue as the central issue in the case, which, given the Chancery Court's natural reluctance to invite challenges over MAC issues, put additional pressure on Hexion to clearly make out its case.
For my previous commentary on this case, see my posts of September 5, August 4, and June 28.
Friday, September 12, 2008
In re Lear Corporation Shareholders Litigation: Is Vice Chancellor Strine Critical of Ryan v. Lyondell Chemical Company?
In yesterday’s post I reviewed Vice Chancellor Noble’s decision in Ryan v. Lyondell Chemical Company, 2008 WL 2923427 (July 29, 2008) and compared it to Chancellor Chandler’s decision in McPadden v. Sidhu, 2008 WL 4017052 (August 29, 2008), noting the criticism that Vice Chancellor Noble’s decision has received by the corporate bar, as reported in The Daily Deal of September 5, 2008. The author of The Daily Deal article reads Chancellor Chandler’s decision in McPadden as critical of Ryan and he includes in that criticism his fellow member of the bench Vice Chancellor Strine in his opinion in the Lear case. I address Vice Chancellor Strine’s opinion in this post.
Fundamentally, Lear and Ryan are different cases. Vice Chancellor Noble found in Ryan that the board of directors of Lyondell Chemical Company failed in performing their Revlon duties in not adequately verifying that the $48 per share price negotiated by Lyondell’s CEO with Basell AF was the best price reasonably available for Lyondell. In Lear Vice Chancellor Strine has no qualms about the process followed by the board of directors of Lear Corporation in agreeing to a merger with affiliates of Carl Icahn, who was Lear’s largest stockholder. The question in Lear was whether the board’s subsequent agreement to pay a termination fee to Icahn, of $25 million, in the event of a naked no vote by the stockholders on the proposed merger in return for an increase in the merger price of $36 to $37.25 per share, represented a breach of the board’s fiduciary duties. Again relying upon the process followed by the board, Vice Chancellor Strine emphatically concluded that it was not.
That the Lear board appropriately complied with its Revlon duties was made clear by the Vice Chancellor in his earlier decision largely rejecting plaintiffs’ request for a preliminary injunction, In re Lear Corp. Shareholder Litigation, 926 A.2d 94 (Del. Ch. 2007). Vice Chancellor Strine makes clear his satisfaction with the process followed by the Lear board in the very first paragraph of this recent decision on the validity of the termination fee:
“In this case, stockholder plaintiffs seek to hold the board of Lear Corporation (“Lear” or “the company”) responsible in damages for agreeing to pay a bidder a termination fee payable upon a no vote on a merger in exchange for that bidder increasing its bid from the original merger agreement by $1.25 per share (“the Merger”). The bidder did not face competition from a rival bidder; in fact, Lear had been fully shopped, and no topping bid had emerged. Rather, in a frothy M & A market, stockholders perceived that the original merger price of $36 per share was inadequate and that the original bidder could do better. Facing likely defeat on the $36 merger at the polls, the Lear board bargained to get another $1.25 per share. In exchange, the bidder demanded $25 million in compensation contingent solely upon a no vote, in contrast to the original termination fee, the bulk of which was payable only if Lear consummated an alternative transaction within twelve months. The $25 million represented only 0.9% of the total deal value.”
2008 WL 4053221 at *1.
As Vice Chancellor Noble confronted in Ryan, on this motion to dismiss the question before Vice Chancellor Strine was whether plaintiffs had adequately pled demand futility, which, given that plaintiffs did not challenge the independence of the Lear board, meant that they had to establish that the board’s decision to pay Icahn the termination fee of $25 million was not the product “of a valid exercise of business judgment.” Id. at *6 (footnote omitted). Because Lear, like Lyondell, had a director exculpatory provision in its certificate of incorporation, as authorized by Delaware’s GCL § 102(b)(7), to survive the motion to dismiss plaintiffs had to plead facts “suggesting that the Lear directors breached their duty of loyalty by somehow acting in bad faith for reasons inimical to the best interests of the Lear stockholders.” Id. at *7.
Vice Chancellor Strine had no difficulty concluding that plaintiffs had not remotely met their burden:
“For starters, the complaint does not come close to alleging that the board failed to employ a rational process in considering whether to approve the Revised Merger Agreement.”
Id. at *7.
After detailing the process followed by the Lear board and the steps it had taken, the Vice Chancellor concludes:
“Put bluntly, the complaint would not state a claim for lack of due care even if simple negligence were the applicable standard.”
Id.
The case could have ended right there, but Vice Chancellor Strine being Vice Chancellor Strine, he continues, at length, addressing plaintiffs’ claim of bad faith by the Lear board. Plaintiffs argued that the Lear board agreed to the payment of a $25 million termination fee to Icahn knowing that the increase in the share price of $36 to $37.25 would not “cut it with the stockholders,” meaning that they would reject the merger in all events, thereby establishing that the agreement to pay the termination fee constituted corporate waste and therefore bad faith by the Lear board.
Vice Chancellor Strine scoffed at this notion, in typically colorful language:
“Directors are not thermometers, existing to register the ever-changing sentiments of stockholders. Directors are expected to use their own business judgment to advance the interests of the corporation and its stockholders. During their term of office, directors may take good faith actions that they believe will benefit stockholders, even if they realize that the stockholders do not agree with them. In the merger context, directors are free to adopt a merger agreement and seek stockholder approval if they believe that the stockholders will benefit upon adoption, even if they recognize that securing approval will be a formidable challenge.”
Id. at *12 (footnote omitted).
So far no hint of any disapproval by the Vice Chancellor of his colleague’s opinion in Ryan. But, in the course of his opinion, the Vice Chancellor takes an aside that can be read as critical of Vice Chancellor Noble’s decision in Ryan:
“To this point, the plaintiffs’ use of this body of law [Caremark, Disney, re director monitoring] also makes clear the policy danger raised by transporting a doctrine rooted in the monitoring context and importing it into a context where a discrete transaction was approved by the board. When a discrete transaction is under consideration, a board will always face the question of how much process should be devoted to that transaction given its overall importance in light of the myriad of other decisions the board must make. Seizing specific opportunities is an important business skill, and that involves some measure of risk. Boards may have to choose between acting rapidly to seize a valuable opportunity without the luxury of months, or even weeks, of deliberation – such as a large premium offer – or losing it altogether. Likewise, a managerial commitment to timely decision making is likely to have systemic benefits but occasionally result in certain decisions being made that, with more time, might have come out differently. Courts should therefore be extremely chary about labeling what they perceive as deficiencies in the deliberations of an independent board majority over a discrete transaction as not merely negligence or even gross negligence, but as involving bad faith. In the transactional context, a very extreme set of facts would seem to be required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties. Where, as here, the board employed a special committee that met frequently, hired reputable advisors, and met frequently itself, a Caremark-based liability theory is untenable.”
Id. at *11 (footnotes omitted).
Note again, however, that Vice Chancellor Strine is careful to qualify his observations by noting that the board followed Revlon processes in considering the Icahn merger. Thus, as he might say, his comments have no applicability to the Ryan context.
One final point: as noted by Vice Chancellor Strine, Lear is currently trading at $13 per share ($14.55 per share as of September 12, 2008), so the stockholders’ rejection of Icahn’s $37.25 proposal was a boo-boo, which simply adds an emphatic point to Vice Chancellor Strine’s decision.
Fundamentally, Lear and Ryan are different cases. Vice Chancellor Noble found in Ryan that the board of directors of Lyondell Chemical Company failed in performing their Revlon duties in not adequately verifying that the $48 per share price negotiated by Lyondell’s CEO with Basell AF was the best price reasonably available for Lyondell. In Lear Vice Chancellor Strine has no qualms about the process followed by the board of directors of Lear Corporation in agreeing to a merger with affiliates of Carl Icahn, who was Lear’s largest stockholder. The question in Lear was whether the board’s subsequent agreement to pay a termination fee to Icahn, of $25 million, in the event of a naked no vote by the stockholders on the proposed merger in return for an increase in the merger price of $36 to $37.25 per share, represented a breach of the board’s fiduciary duties. Again relying upon the process followed by the board, Vice Chancellor Strine emphatically concluded that it was not.
That the Lear board appropriately complied with its Revlon duties was made clear by the Vice Chancellor in his earlier decision largely rejecting plaintiffs’ request for a preliminary injunction, In re Lear Corp. Shareholder Litigation, 926 A.2d 94 (Del. Ch. 2007). Vice Chancellor Strine makes clear his satisfaction with the process followed by the Lear board in the very first paragraph of this recent decision on the validity of the termination fee:
“In this case, stockholder plaintiffs seek to hold the board of Lear Corporation (“Lear” or “the company”) responsible in damages for agreeing to pay a bidder a termination fee payable upon a no vote on a merger in exchange for that bidder increasing its bid from the original merger agreement by $1.25 per share (“the Merger”). The bidder did not face competition from a rival bidder; in fact, Lear had been fully shopped, and no topping bid had emerged. Rather, in a frothy M & A market, stockholders perceived that the original merger price of $36 per share was inadequate and that the original bidder could do better. Facing likely defeat on the $36 merger at the polls, the Lear board bargained to get another $1.25 per share. In exchange, the bidder demanded $25 million in compensation contingent solely upon a no vote, in contrast to the original termination fee, the bulk of which was payable only if Lear consummated an alternative transaction within twelve months. The $25 million represented only 0.9% of the total deal value.”
2008 WL 4053221 at *1.
As Vice Chancellor Noble confronted in Ryan, on this motion to dismiss the question before Vice Chancellor Strine was whether plaintiffs had adequately pled demand futility, which, given that plaintiffs did not challenge the independence of the Lear board, meant that they had to establish that the board’s decision to pay Icahn the termination fee of $25 million was not the product “of a valid exercise of business judgment.” Id. at *6 (footnote omitted). Because Lear, like Lyondell, had a director exculpatory provision in its certificate of incorporation, as authorized by Delaware’s GCL § 102(b)(7), to survive the motion to dismiss plaintiffs had to plead facts “suggesting that the Lear directors breached their duty of loyalty by somehow acting in bad faith for reasons inimical to the best interests of the Lear stockholders.” Id. at *7.
Vice Chancellor Strine had no difficulty concluding that plaintiffs had not remotely met their burden:
“For starters, the complaint does not come close to alleging that the board failed to employ a rational process in considering whether to approve the Revised Merger Agreement.”
Id. at *7.
After detailing the process followed by the Lear board and the steps it had taken, the Vice Chancellor concludes:
“Put bluntly, the complaint would not state a claim for lack of due care even if simple negligence were the applicable standard.”
Id.
The case could have ended right there, but Vice Chancellor Strine being Vice Chancellor Strine, he continues, at length, addressing plaintiffs’ claim of bad faith by the Lear board. Plaintiffs argued that the Lear board agreed to the payment of a $25 million termination fee to Icahn knowing that the increase in the share price of $36 to $37.25 would not “cut it with the stockholders,” meaning that they would reject the merger in all events, thereby establishing that the agreement to pay the termination fee constituted corporate waste and therefore bad faith by the Lear board.
Vice Chancellor Strine scoffed at this notion, in typically colorful language:
“Directors are not thermometers, existing to register the ever-changing sentiments of stockholders. Directors are expected to use their own business judgment to advance the interests of the corporation and its stockholders. During their term of office, directors may take good faith actions that they believe will benefit stockholders, even if they realize that the stockholders do not agree with them. In the merger context, directors are free to adopt a merger agreement and seek stockholder approval if they believe that the stockholders will benefit upon adoption, even if they recognize that securing approval will be a formidable challenge.”
Id. at *12 (footnote omitted).
So far no hint of any disapproval by the Vice Chancellor of his colleague’s opinion in Ryan. But, in the course of his opinion, the Vice Chancellor takes an aside that can be read as critical of Vice Chancellor Noble’s decision in Ryan:
“To this point, the plaintiffs’ use of this body of law [Caremark, Disney, re director monitoring] also makes clear the policy danger raised by transporting a doctrine rooted in the monitoring context and importing it into a context where a discrete transaction was approved by the board. When a discrete transaction is under consideration, a board will always face the question of how much process should be devoted to that transaction given its overall importance in light of the myriad of other decisions the board must make. Seizing specific opportunities is an important business skill, and that involves some measure of risk. Boards may have to choose between acting rapidly to seize a valuable opportunity without the luxury of months, or even weeks, of deliberation – such as a large premium offer – or losing it altogether. Likewise, a managerial commitment to timely decision making is likely to have systemic benefits but occasionally result in certain decisions being made that, with more time, might have come out differently. Courts should therefore be extremely chary about labeling what they perceive as deficiencies in the deliberations of an independent board majority over a discrete transaction as not merely negligence or even gross negligence, but as involving bad faith. In the transactional context, a very extreme set of facts would seem to be required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties. Where, as here, the board employed a special committee that met frequently, hired reputable advisors, and met frequently itself, a Caremark-based liability theory is untenable.”
Id. at *11 (footnotes omitted).
Note again, however, that Vice Chancellor Strine is careful to qualify his observations by noting that the board followed Revlon processes in considering the Icahn merger. Thus, as he might say, his comments have no applicability to the Ryan context.
One final point: as noted by Vice Chancellor Strine, Lear is currently trading at $13 per share ($14.55 per share as of September 12, 2008), so the stockholders’ rejection of Icahn’s $37.25 proposal was a boo-boo, which simply adds an emphatic point to Vice Chancellor Strine’s decision.
Thursday, September 11, 2008
Are the Chancery Court's Decisions in Ryan v. Lyondell Chemical Company and McPadden v. Sidhu Incompatible?
Two recent decisions in the Delaware Chancery Court address the effect of Delaware’s director exculpatory provision, Section 102(b)(7) of the Delaware General Corporation Law (“GCL”) in the context of a M&A transaction, with dramatically different results. In Ryan v. Lyondell Chemical Company, 2008 WL 2923427 (July 29, 2008) (“Ryan”) Vice Chancellor Noble concluded, in ruling on defendants’ motion for summary judgment, that Section 102(b)(7) did not shield the directors from potential liability. In McPadden v. Sidhu, 2008 WL 4017052 (August 29, 2008) ("McPadden"), Chancellor Chandler ruled, on a motion to dismiss, that Section 107(b)(7) was available to the directors of i2 Technologies, Inc. (“i2”). Both decisions are head scratchers.
A. Ryan
On the surface, the directors of Lyondell Chemical Company should have been praised, not buried. Lyondell merged with a subsidiary of Basell AF (“Basell”) in December 2007 for a cash price of $48 per share, representing a 45% premium over the “clear day” closing price of Lyondell’s outstanding shares before Basell’s interest in Lyondell became apparent with the filing of its Schedule 13D on May 11, 2007, and a 20% premium over Lyondell’s closing price the day before the merger was publicly announced. The stockholders liked the deal: 99.33% of those who voted approved the merger!
But there is more, concluded the Vice Chancellor. Critical to his analysis is his application of “enhanced judicial scrutiny” to the process followed by the board based upon the teachings of Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) and its progeny. As summarized by Vice Chancellor Noble:
“The ultimate question is whether the process implemented by the board was a reasonable effort to advance the interests of the shareholders under the circumstances. A board of directors has considerable latitude in structuring the sale process, provided that it acts with demonstrable diligence in the pursuit of the best transaction reasonably available.”
Slip Opinion at 37.
On the record before him, Vice Chancellor Noble concluded that the board of Lyondell did not meet the test, based upon these findings:
· The merger agreement with Basell was done in a hurry. The entire deal was negotiated, considered, and agreed to in less than seven days.
· The board met formally to discuss the Basell proposal for a total of no more than six or seven hours, with half, if not more, of the that time devoted to reviewing the final terms of the merger agreement and voting to approve the deal.
· Notwithstanding Basell’s filing of a Schedule 13D disclosing its unannounced acquisition of 8.3% of Lyondell’s outstanding shares in May 2007, the board decided to do nothing, awaiting further events. It did not retain an investment banker to advise it or ask management to prepare projections to evaluate the company.
· Prior to agreeing to the merger with Basell, the board made no effort to conduct a formal market check of any kind.
· There was little evidence that the board negotiated the Basell proposal or actively participated in the sale process, leaving the negotiations, such as they occurred, to the CEO, and the critical negotiations, over price, occurred prior to the board’s even being informed of the Basell proposal.
· The board did not engage in an effective and relatively unencumbered post-signing market check.
Barkan v. Amsted Industries, 567 A.2d 1279 (Del. 1999) establishes a limited exception to the active sale process generally mandated by Revlon. The Barkan exception excuses an auction or pre-signing market check where the board possesses a body of reliable evidence with which to evaluate the fairness of a transaction. Vice Chancellor Noble found evidence to suggest that the Lyondell board had such knowledge, including that the members of the board were active and sophisticated; routinely advised of the financial outlook and condition of the company; involved in the purchase of Lyondell’s interest in a joint venture with CITGO in mid-2006, and thus aware of the market for refinery assets (one of Lyondell’s main lines of business); aware of one other transaction in the specialty chemicals business (Apollo’s acquisition of Huntsman in mid-2007, after Apollo was rebuffed by Lyondell’s CEO); and the board reviewed detailed financial analyses presented on the Basell proposal from both management and Lyondell’s financial advisor, Deutsche Bank. The board was also aware, of course, that Lyondell had, in effect, been “in play” since Basell’s filing of its Schedule 13D in May 2007, and yet no party had made a serious run (other than Basell) at Lyondell. Finally, between July and November of 2007 (when the stockholder vote took place, a period of some four months), no indications of interest or topping bids were received by the company. And the board knew, of course, that Dan Smith, Lyondell’s CEO, who is knowledgeable about the company and its markets, had effectively negotiated, in face-to-face negotiations with the controlling shareholder of Basell, an increase in the deal price from $40 to $48 per share.
So why did the Vice Chancellor conclude that the Barkan exception to the board’s Revlon duties did not apply here? On the record before him, the Vice Chancellor could not conclude that the Barkan exception was available because of the factors outlined above that lead the Vice Chancellor to conclude that the board had not met its Revlon duties.
The Vice Chancellor also found the board too supine in its agreement to the deal protections demanded by Basell, including a $385 million termination fee, matching rights, and a no-shop provision (and retention of Lyondell’s poison pill, other than as to Basell). Again applying “enhanced judicial scrutiny” to the board’s agreement to the deal protection measures, the Vice Chancellor found the board’s conduct wanting:
“In other words, where there is lingering doubt as to the Board’s efforts to ensure that it had secured the ‘best’ transaction available to the Lyondell shareholders before it endorsed the transaction, the Court also should be skeptical of the wisdom of the Board’s decision to grant considerable deal protections, simply as a matter of course, that limited its ability to discharge proactively its fiduciary obligations after the fact. On summary judgment, without undisputed and sufficient evidence of either a proactive market check or that the Board, in fact, ‘knew’ that it had secured the best deal reasonably available to the stockholders, one cannot exclude the inference that the deal protections agreed to by the Board serve no purpose other than to squelch even the remotest possibility of a competing bid that might have increased the price for the stockholders.”
Slip Opinion at 50-51 (footnotes omitted).
Lyondell’s certificate of incorporation contained a GCL § 102(b)(7) exculpatory provision. That section permits a Delaware corporation to include in its charter a provision “eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director : (i) [f]or any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; . . . .”
Ryan involves a post-merger challenge, and accordingly Ryan, on behalf of the former Lyondell stockholders, was seeking money damages. Lyondell’s exculpatory provision was thus in play. Vice Chancellor Noble thus had to address whether the failure of the Lyondell board to comply with its Revlon duties was “not in good faith.”
Given that a finding that a board has failed to act in good faith “requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence),” Stone v. Ritter, 911 A.2d 362, 369 (Del. 2006) (footnote omitted), the most surprising aspect of Vice Chancellor Noble’s opinion is that he devotes only three pages of his 73-page opinion to disposing of the defendants’ argument that, even if they breached their Revlon duties, Lyondell’s certificate and GCL § 102(b)(7) precluded an award of damages. Here the Vice Chancellor relied upon the following language of the Delaware Supreme Court in Stone v. Ritter:
“Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.”
911 A.2d at 370 (footnotes omitted).
Applying this test, Vice Chancellor Noble concluded that Section 102(b)(7) did not, at this stage of the proceedings, exonerate the directors:
“The record, as it presently stands, does not, as a matter of undisputed material fact, demonstrate the Lyondell directors’ good faith discharge of their Revlon duties – a known set of ‘duties’ requiring certain conduct or impeccable knowledge of the market in the face of Basell’s offer to acquire the Company. . . . With a record that does not clearly show the Board’s good faith discharge of its Revlon duties, however, whether the members of the Board are entitled to seek shelter under the Company’s exculpatory charter provision for procedural shortcomings amounting to a violation of their known fiduciary obligations in a sale scenario presents a question of fact that cannot now be resolved on summary judgment.”
Slip Opinion at 56 (emphasis added).
What is surprising about the Vice Chancellor’s conclusion is that he devotes almost no effort to explicating Stone v. Ritter’s use of the word “conscious” before “disregard for their responsibilities . . .” as applied to Ryan. It’s almost as if, at this point in his struggle over this decision, he had little left to analyze whether additional culpability was required from the Lyondell board to find not only a breach of Revlon duties but also a conscious violation of their Revlon duties.
B. McPadden
McPadden stands in stark contrast to Ryan. Vice Chancellor Noble obviously struggled with his decision in Ryan, which is not only apparent from the text of the decision, with its extensive “on the one hand, on the other hand” analyses, but also from the length of time it was in gestation (submitted December 5, 2007, decided July 29, 2008). Chancellor Chandler had an easier time with his decision in McPadden, as is obvious both from the text and its time in gestation (submitted June 17, 2008, decided August 29, 2008). If Vice Chancellor Noble’s failure to exonerate the board of Lyondell in Ryan is surprising, then Chancellor Chandler’s exoneration of the board in McPadden is even more surprising.
This case also involves a post-merger challenge to the sale by i2, a Delaware corporation, of its wholly-owned subsidiary, Trade Services Corporation (“TSC”). TSC was sold to a management team led by a then TSC Vice President, defendant Anthony Dubreville, for $3 million. Six months after the sale, Dubreville rejected a $18.5 million offer for TSC as too low. He sold it to another company two years after he purchased it from i2 for $25 million. No surprise – this lawsuit followed.
Plaintiff brought this derivative action against the board of directors of i2 and Dubreville for breach of fiduciary duty and, against Dubreville only, for unjust enrichment. While Dubreville was not a director of i2, he was an officer of TSC.
On this motion to dismiss, the facts are taken from plaintiff’s complaint, and subject to the usual caveats. But on the facts alleged, the process followed by the board of directors of i2 to sell TSC would qualify for inclusion in a textbook on corporate governance as an example of how not to run a deal:
· In late 2004 early 2005, the board decided to sell TSC after determining it was a non-core business that should be divested.
· In July 2002, a TSC competitor (“VIS”), with whom TSC was then in litigation, expressed an interest in buying TSC and made that interest known to i2’s then directors. VIS repeated this interest several times during 2002. In January 2003, VIS advised a director of i2 and its CFO that it would be willing to pay up to $25 million for TSC.
· On February 1, 2005, by which time the board was aware that Dubreville wanted to lead a management-led buyout of TSC, the board resolved to sell TSC. The board appointed Dubreville to conduct the sales process!
· Two versions of the pitch book for TSC were prepared, one in January 2005 and a second in February 2005. The February 2005 edition used significantly reduced projections of TSC’s revenues and income. The February 2005 edition was used by Dubreville to solicit bids for TSC.
· Dubreville did not solicit interest from any of TSC’s direct competitors to purchase TSC. He did not solicit any interest from VIS, even though he and at least three of i2’s then directors knew that VIS had “indicated a strong interest in buying TSC and had offered as much as $25 million for TSC in 2003.”
· Dubreville ultimately secured three offers for TSC, one of which was rejected because it was a bundled bid seeking two of i2’s businesses (one of which was not up for sale). One bid, for $1.8 million, was from Dubreville’s former boss and his partner in a printing company. The third was from Dubreville’s group, for $3 million, consisting of $2 million in cash and $1 million in software licensing agreements.
· On April 18, 2005, the board met to consider Dubreville’s offer for TSC. i2’s investment banker, Sonenshine Partners, gave the board its preliminary valuation of TSC at from $3 million to $7 million (using February’s management projections) and $6 million to $10.8 million using the January projections. The board approved the sale of TSC to Dubreville’s group.
· The letter of intent with Dubreville was signed on April 22, 2005. No negotiations over the letter of intent were conducted between the board or its special committee and Dubreville.
· The special committee of the board, charged with reviewing the fairness of the sale of TSC to Dubreville’s group, first met with i2’s investment banker on June 21, 2005, the week before the sale was finally approved.
· On June 28, 2005 the special committee and the board met and approved the sale of TSC to Dubreville’s group.
Because this is a derivative action, Chancellor Chandler first had to resolve whether demand was excused on i2’s board of directors under Chancery Rule 23.1. Because plaintiff made no demand on i2’s board, she had to establish, by particularized pleading in her complaint, that the sale to TSC “was otherwise [than] the product of a valid business judgment.”
Not surprisingly, Chancellor Chandler concluded that this test was met and, indeed, on the facts alleged by plaintiff in her complaint, the board of i2 had been grossly negligent in the process it followed in selling TSC to Dubreville’s group. The Chancellor was most exercised, understandably, by the board’s selection of Dubreville to conduct the sale. On the facts alleged by plaintiff, the Chancellor had little hesitation in finding that the board had been grossly negligent:
“In making its decisions, the board had no shortage of information that was both material — because it affected the process and ultimate result of the sale — and reasonably available (or, even, actually known as evidenced by the discussions at the board meetings): Dubreville’s interest in leading a management buyout of TSC’s; Dubreville’s limited efforts in soliciting offers for TSC, including his failure to contact TSC competitors, including one he knew had previously expressed concrete interest in purchasing TSC; the circumstances under which the January and February projections were produced; the use of those projections in Sonenshine’s preliminary valuations of TSC; and that TSH [Dubreville’s company] was a group led by Dubreville. That the board would want to consider this information seems, to me, so obvious that it is equally obvious that the Directors Defendants’ failure to do so was grossly negligent.”
2008 WestLaw 4017052 at *8.
In light of the process followed by the i2 board, what Chancellor Chandler does next is surprising: he grants the director defendants’ motion to dismiss because of the exculpatory provision of i2’s certificate of incorporation and Section 102(b)(7) of the GCL. Relying upon the Supreme Court’s decision in Disney (In re Walt Disney Derivative Litigation, 906 A.2d 27 (Del. 2006)) and Stone v. Ritter, discussed above, Chancellor Chandler concludes that more than gross negligence is required to establish lack of good faith and that the director defendants of i2, on the facts alleged, were guilty of the former but not the latter:
“Thus, from the sphere of actions that was once classified as grossly negligent conduct that gives rise to a violation of the duty of care, the Court has carved out one specific type of conduct — the intentional dereliction of duty or the conscious disregard for one’s responsibilities — and redefined it as bad faith conduct, which results in a breach of the duty of loyalty.”
Id. at *9.
Gross negligence, concludes Chancellor Chandler, is “conduct that constitutes reckless indifference or actions that are without the bounds of reason.” The i2 directors fell within the grossly negligent boundary and not within the bad faith boundary.
I find the Chancellor’s analysis cryptic and confusing. What more could the board of i2 have done to establish a “conscious disregard of their duties”?
If, as Vice Chancellor Noble concludes, Revlon requires “enhanced scrutiny” of a board’s sale of a company, then how is it that the i2 board’s conduct, in selling TSC, did not constitute a “conscious disregard” of their responsibilities under Revlon? Perhaps Revlon does not apply to the sale of a subsidiary, as opposed to the sale of an entire company. Chancellor Chandler does not mention Revlon, so perhaps he analyzed the i2 board’s duties under the Caremark standard, applicable to normal board supervision, as opposed to the “enhanced scrutiny” required by Revlon when a board conducts a sale of a company. On the other hand, the form followed by the i2 board – special committee, retention of investment banker, preparation of pitch books – adhered to the Revlon rubric, and therefore if Chancellor Chandler concluded sub silento that this was not a Revlon case, it would have been helpful for him to have said so.
Not all was lost for plaintiff, however, as Dubreville’s status as an officer of TSC but not a director of i2 saved the day: Officers are not eligible for exculpation under Section 102(b)(7), and therefore the Chancellor denied Dubreville’s motion to dismiss both the claim of breach of fiduciary duty against him and plaintiff’s claim for unjust enrichment. Certainly on the scale of rough justice, that is a right result.
C. Vice Chancellor Noble Criticized By His Colleagues?
There have been considerable grumblings about Vice Chancellor Noble’s decision in Ryan. See the article in The Daily Deal (September 5, 2008) (page 3). The author of The Daily Deal article reads Chancellor Chandler’s decision in McPadden and Vice Chancellor Strine’s decision in Lear (In re Lear Corporation Shareholder Litigation, 2008 WL 4053221 (September 2, 2008)) as joining in the chorus of criticism. Chancellor Chandler’s decision can be read as squarely in conflict with the analysis of Vice Chancellor Noble in Ryan if the boards in both cases were subject to Revlon duties, but can be reconciled if Revlon did not apply to the sale of TSC by the i2 board of directors.
I will address Vice Chancellor Strine’s decision in Lear in a subsequent post.
A. Ryan
On the surface, the directors of Lyondell Chemical Company should have been praised, not buried. Lyondell merged with a subsidiary of Basell AF (“Basell”) in December 2007 for a cash price of $48 per share, representing a 45% premium over the “clear day” closing price of Lyondell’s outstanding shares before Basell’s interest in Lyondell became apparent with the filing of its Schedule 13D on May 11, 2007, and a 20% premium over Lyondell’s closing price the day before the merger was publicly announced. The stockholders liked the deal: 99.33% of those who voted approved the merger!
But there is more, concluded the Vice Chancellor. Critical to his analysis is his application of “enhanced judicial scrutiny” to the process followed by the board based upon the teachings of Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986) and its progeny. As summarized by Vice Chancellor Noble:
“The ultimate question is whether the process implemented by the board was a reasonable effort to advance the interests of the shareholders under the circumstances. A board of directors has considerable latitude in structuring the sale process, provided that it acts with demonstrable diligence in the pursuit of the best transaction reasonably available.”
Slip Opinion at 37.
On the record before him, Vice Chancellor Noble concluded that the board of Lyondell did not meet the test, based upon these findings:
· The merger agreement with Basell was done in a hurry. The entire deal was negotiated, considered, and agreed to in less than seven days.
· The board met formally to discuss the Basell proposal for a total of no more than six or seven hours, with half, if not more, of the that time devoted to reviewing the final terms of the merger agreement and voting to approve the deal.
· Notwithstanding Basell’s filing of a Schedule 13D disclosing its unannounced acquisition of 8.3% of Lyondell’s outstanding shares in May 2007, the board decided to do nothing, awaiting further events. It did not retain an investment banker to advise it or ask management to prepare projections to evaluate the company.
· Prior to agreeing to the merger with Basell, the board made no effort to conduct a formal market check of any kind.
· There was little evidence that the board negotiated the Basell proposal or actively participated in the sale process, leaving the negotiations, such as they occurred, to the CEO, and the critical negotiations, over price, occurred prior to the board’s even being informed of the Basell proposal.
· The board did not engage in an effective and relatively unencumbered post-signing market check.
Barkan v. Amsted Industries, 567 A.2d 1279 (Del. 1999) establishes a limited exception to the active sale process generally mandated by Revlon. The Barkan exception excuses an auction or pre-signing market check where the board possesses a body of reliable evidence with which to evaluate the fairness of a transaction. Vice Chancellor Noble found evidence to suggest that the Lyondell board had such knowledge, including that the members of the board were active and sophisticated; routinely advised of the financial outlook and condition of the company; involved in the purchase of Lyondell’s interest in a joint venture with CITGO in mid-2006, and thus aware of the market for refinery assets (one of Lyondell’s main lines of business); aware of one other transaction in the specialty chemicals business (Apollo’s acquisition of Huntsman in mid-2007, after Apollo was rebuffed by Lyondell’s CEO); and the board reviewed detailed financial analyses presented on the Basell proposal from both management and Lyondell’s financial advisor, Deutsche Bank. The board was also aware, of course, that Lyondell had, in effect, been “in play” since Basell’s filing of its Schedule 13D in May 2007, and yet no party had made a serious run (other than Basell) at Lyondell. Finally, between July and November of 2007 (when the stockholder vote took place, a period of some four months), no indications of interest or topping bids were received by the company. And the board knew, of course, that Dan Smith, Lyondell’s CEO, who is knowledgeable about the company and its markets, had effectively negotiated, in face-to-face negotiations with the controlling shareholder of Basell, an increase in the deal price from $40 to $48 per share.
So why did the Vice Chancellor conclude that the Barkan exception to the board’s Revlon duties did not apply here? On the record before him, the Vice Chancellor could not conclude that the Barkan exception was available because of the factors outlined above that lead the Vice Chancellor to conclude that the board had not met its Revlon duties.
The Vice Chancellor also found the board too supine in its agreement to the deal protections demanded by Basell, including a $385 million termination fee, matching rights, and a no-shop provision (and retention of Lyondell’s poison pill, other than as to Basell). Again applying “enhanced judicial scrutiny” to the board’s agreement to the deal protection measures, the Vice Chancellor found the board’s conduct wanting:
“In other words, where there is lingering doubt as to the Board’s efforts to ensure that it had secured the ‘best’ transaction available to the Lyondell shareholders before it endorsed the transaction, the Court also should be skeptical of the wisdom of the Board’s decision to grant considerable deal protections, simply as a matter of course, that limited its ability to discharge proactively its fiduciary obligations after the fact. On summary judgment, without undisputed and sufficient evidence of either a proactive market check or that the Board, in fact, ‘knew’ that it had secured the best deal reasonably available to the stockholders, one cannot exclude the inference that the deal protections agreed to by the Board serve no purpose other than to squelch even the remotest possibility of a competing bid that might have increased the price for the stockholders.”
Slip Opinion at 50-51 (footnotes omitted).
Lyondell’s certificate of incorporation contained a GCL § 102(b)(7) exculpatory provision. That section permits a Delaware corporation to include in its charter a provision “eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director : (i) [f]or any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; . . . .”
Ryan involves a post-merger challenge, and accordingly Ryan, on behalf of the former Lyondell stockholders, was seeking money damages. Lyondell’s exculpatory provision was thus in play. Vice Chancellor Noble thus had to address whether the failure of the Lyondell board to comply with its Revlon duties was “not in good faith.”
Given that a finding that a board has failed to act in good faith “requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence),” Stone v. Ritter, 911 A.2d 362, 369 (Del. 2006) (footnote omitted), the most surprising aspect of Vice Chancellor Noble’s opinion is that he devotes only three pages of his 73-page opinion to disposing of the defendants’ argument that, even if they breached their Revlon duties, Lyondell’s certificate and GCL § 102(b)(7) precluded an award of damages. Here the Vice Chancellor relied upon the following language of the Delaware Supreme Court in Stone v. Ritter:
“Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.”
911 A.2d at 370 (footnotes omitted).
Applying this test, Vice Chancellor Noble concluded that Section 102(b)(7) did not, at this stage of the proceedings, exonerate the directors:
“The record, as it presently stands, does not, as a matter of undisputed material fact, demonstrate the Lyondell directors’ good faith discharge of their Revlon duties – a known set of ‘duties’ requiring certain conduct or impeccable knowledge of the market in the face of Basell’s offer to acquire the Company. . . . With a record that does not clearly show the Board’s good faith discharge of its Revlon duties, however, whether the members of the Board are entitled to seek shelter under the Company’s exculpatory charter provision for procedural shortcomings amounting to a violation of their known fiduciary obligations in a sale scenario presents a question of fact that cannot now be resolved on summary judgment.”
Slip Opinion at 56 (emphasis added).
What is surprising about the Vice Chancellor’s conclusion is that he devotes almost no effort to explicating Stone v. Ritter’s use of the word “conscious” before “disregard for their responsibilities . . .” as applied to Ryan. It’s almost as if, at this point in his struggle over this decision, he had little left to analyze whether additional culpability was required from the Lyondell board to find not only a breach of Revlon duties but also a conscious violation of their Revlon duties.
B. McPadden
McPadden stands in stark contrast to Ryan. Vice Chancellor Noble obviously struggled with his decision in Ryan, which is not only apparent from the text of the decision, with its extensive “on the one hand, on the other hand” analyses, but also from the length of time it was in gestation (submitted December 5, 2007, decided July 29, 2008). Chancellor Chandler had an easier time with his decision in McPadden, as is obvious both from the text and its time in gestation (submitted June 17, 2008, decided August 29, 2008). If Vice Chancellor Noble’s failure to exonerate the board of Lyondell in Ryan is surprising, then Chancellor Chandler’s exoneration of the board in McPadden is even more surprising.
This case also involves a post-merger challenge to the sale by i2, a Delaware corporation, of its wholly-owned subsidiary, Trade Services Corporation (“TSC”). TSC was sold to a management team led by a then TSC Vice President, defendant Anthony Dubreville, for $3 million. Six months after the sale, Dubreville rejected a $18.5 million offer for TSC as too low. He sold it to another company two years after he purchased it from i2 for $25 million. No surprise – this lawsuit followed.
Plaintiff brought this derivative action against the board of directors of i2 and Dubreville for breach of fiduciary duty and, against Dubreville only, for unjust enrichment. While Dubreville was not a director of i2, he was an officer of TSC.
On this motion to dismiss, the facts are taken from plaintiff’s complaint, and subject to the usual caveats. But on the facts alleged, the process followed by the board of directors of i2 to sell TSC would qualify for inclusion in a textbook on corporate governance as an example of how not to run a deal:
· In late 2004 early 2005, the board decided to sell TSC after determining it was a non-core business that should be divested.
· In July 2002, a TSC competitor (“VIS”), with whom TSC was then in litigation, expressed an interest in buying TSC and made that interest known to i2’s then directors. VIS repeated this interest several times during 2002. In January 2003, VIS advised a director of i2 and its CFO that it would be willing to pay up to $25 million for TSC.
· On February 1, 2005, by which time the board was aware that Dubreville wanted to lead a management-led buyout of TSC, the board resolved to sell TSC. The board appointed Dubreville to conduct the sales process!
· Two versions of the pitch book for TSC were prepared, one in January 2005 and a second in February 2005. The February 2005 edition used significantly reduced projections of TSC’s revenues and income. The February 2005 edition was used by Dubreville to solicit bids for TSC.
· Dubreville did not solicit interest from any of TSC’s direct competitors to purchase TSC. He did not solicit any interest from VIS, even though he and at least three of i2’s then directors knew that VIS had “indicated a strong interest in buying TSC and had offered as much as $25 million for TSC in 2003.”
· Dubreville ultimately secured three offers for TSC, one of which was rejected because it was a bundled bid seeking two of i2’s businesses (one of which was not up for sale). One bid, for $1.8 million, was from Dubreville’s former boss and his partner in a printing company. The third was from Dubreville’s group, for $3 million, consisting of $2 million in cash and $1 million in software licensing agreements.
· On April 18, 2005, the board met to consider Dubreville’s offer for TSC. i2’s investment banker, Sonenshine Partners, gave the board its preliminary valuation of TSC at from $3 million to $7 million (using February’s management projections) and $6 million to $10.8 million using the January projections. The board approved the sale of TSC to Dubreville’s group.
· The letter of intent with Dubreville was signed on April 22, 2005. No negotiations over the letter of intent were conducted between the board or its special committee and Dubreville.
· The special committee of the board, charged with reviewing the fairness of the sale of TSC to Dubreville’s group, first met with i2’s investment banker on June 21, 2005, the week before the sale was finally approved.
· On June 28, 2005 the special committee and the board met and approved the sale of TSC to Dubreville’s group.
Because this is a derivative action, Chancellor Chandler first had to resolve whether demand was excused on i2’s board of directors under Chancery Rule 23.1. Because plaintiff made no demand on i2’s board, she had to establish, by particularized pleading in her complaint, that the sale to TSC “was otherwise [than] the product of a valid business judgment.”
Not surprisingly, Chancellor Chandler concluded that this test was met and, indeed, on the facts alleged by plaintiff in her complaint, the board of i2 had been grossly negligent in the process it followed in selling TSC to Dubreville’s group. The Chancellor was most exercised, understandably, by the board’s selection of Dubreville to conduct the sale. On the facts alleged by plaintiff, the Chancellor had little hesitation in finding that the board had been grossly negligent:
“In making its decisions, the board had no shortage of information that was both material — because it affected the process and ultimate result of the sale — and reasonably available (or, even, actually known as evidenced by the discussions at the board meetings): Dubreville’s interest in leading a management buyout of TSC’s; Dubreville’s limited efforts in soliciting offers for TSC, including his failure to contact TSC competitors, including one he knew had previously expressed concrete interest in purchasing TSC; the circumstances under which the January and February projections were produced; the use of those projections in Sonenshine’s preliminary valuations of TSC; and that TSH [Dubreville’s company] was a group led by Dubreville. That the board would want to consider this information seems, to me, so obvious that it is equally obvious that the Directors Defendants’ failure to do so was grossly negligent.”
2008 WestLaw 4017052 at *8.
In light of the process followed by the i2 board, what Chancellor Chandler does next is surprising: he grants the director defendants’ motion to dismiss because of the exculpatory provision of i2’s certificate of incorporation and Section 102(b)(7) of the GCL. Relying upon the Supreme Court’s decision in Disney (In re Walt Disney Derivative Litigation, 906 A.2d 27 (Del. 2006)) and Stone v. Ritter, discussed above, Chancellor Chandler concludes that more than gross negligence is required to establish lack of good faith and that the director defendants of i2, on the facts alleged, were guilty of the former but not the latter:
“Thus, from the sphere of actions that was once classified as grossly negligent conduct that gives rise to a violation of the duty of care, the Court has carved out one specific type of conduct — the intentional dereliction of duty or the conscious disregard for one’s responsibilities — and redefined it as bad faith conduct, which results in a breach of the duty of loyalty.”
Id. at *9.
Gross negligence, concludes Chancellor Chandler, is “conduct that constitutes reckless indifference or actions that are without the bounds of reason.” The i2 directors fell within the grossly negligent boundary and not within the bad faith boundary.
I find the Chancellor’s analysis cryptic and confusing. What more could the board of i2 have done to establish a “conscious disregard of their duties”?
If, as Vice Chancellor Noble concludes, Revlon requires “enhanced scrutiny” of a board’s sale of a company, then how is it that the i2 board’s conduct, in selling TSC, did not constitute a “conscious disregard” of their responsibilities under Revlon? Perhaps Revlon does not apply to the sale of a subsidiary, as opposed to the sale of an entire company. Chancellor Chandler does not mention Revlon, so perhaps he analyzed the i2 board’s duties under the Caremark standard, applicable to normal board supervision, as opposed to the “enhanced scrutiny” required by Revlon when a board conducts a sale of a company. On the other hand, the form followed by the i2 board – special committee, retention of investment banker, preparation of pitch books – adhered to the Revlon rubric, and therefore if Chancellor Chandler concluded sub silento that this was not a Revlon case, it would have been helpful for him to have said so.
Not all was lost for plaintiff, however, as Dubreville’s status as an officer of TSC but not a director of i2 saved the day: Officers are not eligible for exculpation under Section 102(b)(7), and therefore the Chancellor denied Dubreville’s motion to dismiss both the claim of breach of fiduciary duty against him and plaintiff’s claim for unjust enrichment. Certainly on the scale of rough justice, that is a right result.
C. Vice Chancellor Noble Criticized By His Colleagues?
There have been considerable grumblings about Vice Chancellor Noble’s decision in Ryan. See the article in The Daily Deal (September 5, 2008) (page 3). The author of The Daily Deal article reads Chancellor Chandler’s decision in McPadden and Vice Chancellor Strine’s decision in Lear (In re Lear Corporation Shareholder Litigation, 2008 WL 4053221 (September 2, 2008)) as joining in the chorus of criticism. Chancellor Chandler’s decision can be read as squarely in conflict with the analysis of Vice Chancellor Noble in Ryan if the boards in both cases were subject to Revlon duties, but can be reconciled if Revlon did not apply to the sale of TSC by the i2 board of directors.
I will address Vice Chancellor Strine’s decision in Lear in a subsequent post.
Saturday, September 6, 2008
Jones v. Harris Associates, L.P.; Posner v. Easterbrook
Judges Posner and Easterbrook are two of our eminent jurists. Both are long-time members of the Seventh Circuit Court of Appeals, having been appointed by President Reagan. Both are closely associated with the Chicago School of Law and Economics, Judge Posner being one of its founders. See his textbook, Economic Analysis of the Law, now in its seventh edition. Judge Easterbrook has also made numerous contributions to the teachings of this school, see, e.g., Easterbrook and Fischel, The Economic Structure of Corporate Law (1991). Judge Posner has authored too many books to count, on virtually every subject touched by the law (and then some), his most recent being How Judges Think (2008). He was even the subject of a lengthy profile in The New Yorker (December 10, 2001) (“The Bench Burner”), and, in celebration of his 25th year on the Seventh Circuit, was the subject last year of commemorations in the Harvard Law Review (Volume 120 March 2007) (where Judge Posner attended law school and was President of the Law Review) and the University of Chicago Law Review (Volume 74, Special Issue (2007) (where Judge Posner taught and lectures). Each is a gifted opinion writer, albeit often acerbic and bordering on contemptuous of parties (often plaintiffs) whose arguments they find wanting.
It is therefore always of intense interest when they lock horns over a matter touching upon their core expertise. Such was the case most notably in Jordan v. Duff and Phelps, 815 F.2d 429 (7th Cir. 1987) (Easterbrook writing the opinion for the majority, Posner dissenting) in which the issue joined was the obligation of a closely-held corporation to disclose material information to an at-will employee when purchasing his stock on termination pursuant to a pre-set formula, Judge Easterbrook concluding the corporation had such a duty and therefore summary judgment for the corporation was improperly granted, Judge Posner concluding that summary judgment in favor of the corporation was proper. The ground still shakes from that contest. See Ramseyer “Not-So-Ordinary Judges In Ordinary Courts: Teaching Jordan v. Duff & Phelps, Inc.,” 120 Harv. L. Rev. 1199 (2007).
While the clash between Judges Posner and Easterbrook in Jones v. Harris Associates is not over a M&A transaction, because of their prominence in the field of law and economics and as jurists, I believe their clash deserves a post on this blog.
A. Panel Opinion
Echoes of their dispute in Jordan can be found in their most recent one, in Jones v. Harris Associates, L.P., 527 F.3d 627 (7th Cir. 2008), petition for rehearing and rehearing en banc denied, 2008 WL 3177282 (August 8, 2008) (Posner, with Judges Rovner, Wood, Williams, and Tinder, dissenting).
In this case, owners of shares in mutual funds brought an action against their common investment advisor (Harris Associates) under Section 36(b) of the Investment Company Act of 1940 alleging that the advisor’s compensation was excessive. The lower court granted summary judgment for the advisor, and the panel of the Seventh Circuit, in an opinion by Chief Judge Easterbrook, affirmed the judgment. In his opinion for the panel, Judge Easterbrook takes the occasion to disapprove the standard of review of advisor compensation established by the Second Circuit in its 1982 decision in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2nd Cir 1982). The Gartenberg court established, as the test for applying Section 36(b) to an advisor’s fee, the following:
“[T]he test is essentially whether the fee schedule represents a charge within the range of what would have been negotiated at arm’s-length in the light of all the surrounding circumstances.
. . .
[to] be guilty of a violation of § 36(b) . . . the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”
Gartenberg, quoted in Jones at 527 F.3d at 631.
Judge Easterbrook found Gartenberg wanting because it relied too little on markets. Investors have thousands of mutual funds to choose among, and administrative expenses (which include advisor management fees) as a percent of assets under management is a commonly used and widely distributed measure to assess mutual fund performance. High fees drive investors away. Judge Easterbrook is not shy about expressing his and the panel’s preference for the discipline of markets over that of judges or juries:
“A fiduciary duty differs from rate regulation. A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation. The trustees [of the mutual fund] (and in the end investors, who vote with their feet and dollars), rather than a judge or jury, determine how much advisory services are worth.”
527 F.3d at 632.
Betraying his background as a professor, Judge Easterbrook turns pedantic on the workings of the capital and products markets:
“Publicly traded corporations use the same basic procedures as mutual funds: a committee of independent directors sets the top managers’ compensation. No court has held that this procedure implies judicial review for ‘reasonableness’ of the resulting salary, bonus, and stock options. These are constrained by competition in several markets – firms that pay too much to managers have trouble raising money, because net profits available for distribution to investors are lower, and these firms also suffer in product markets because they must charge more and consumers turn elsewhere. Competitive processes are imperfect but remain superior to a ‘just price’ system administered by the judiciary. However weak competition may be at weeding out errors, the judicial process is worse – for judges can’t be turned out of office or have their salaries cut if they display poor business judgment.”
Id., at 632-633.
Let the market decide, concludes Judge Easterbrook:
“Mutual funds come much closer to the model of atomistic competition than do most other markets. Judges would not dream of regulating the price of automobiles, which are produced by roughly a dozen large firms; why then should 8,000 mutual funds seems ‘too few’ to put competitive pressure on advisory fees?”
Id., at 634.
B. Judge Posner’s Dissent
And so it ended, almost. Apparently the rules of the Seventh Circuit permit a single judge to call for a vote on a request for a rehearing en banc. After Judge Easterbrook’s panel voted “unanimously” to deny the plaintiffs’ petition for a rehearing by the panel, “a” judge, not identified (we can guess who) requested a vote on the request for rehearing en banc. A majority of the Circuit did not favor such a rehearing, and so the petition was denied. That led to Judge Posner’s dissent from the denial.
One would not expect judges of the stature and intellectual firepower of Judges Posner and Easterbrook to be shy or to pull punches. And they don’t. Judge Posner, in concluding his dissent, notes that the panel decision creates a “circuit split” between the Seventh and Second Circuits, “although the panel did not acknowledge this or circulate its opinion to the full court in advance of publication as is required when a panel creates a circuit split.” 2008 WL 31772, at *4. Ouch!
Judge Posner challenges the scholarship of the panel opinion in its claim that the Gartenberg approach has been found “wanting” in previous Seventh Circuit opinions. Not so, noted Judge Posner, and he cites a “slew” of positive citations to Gartenberg, and cites studies concluding that the excessive fee cases brought since Gartenberg have “resulted almost uniformly in judgments for the defendants …” Id. at *1.
It is most remarkable for a free market advocate such as Judge Posner to cite recent scholarship showing that “executive compensation in large publicly traded firms often is excessive because of the feeble incentives of boards of directors to police compensation,” id., at *2, most notably Lucian Bebchuk’s and Jesse Fried’s studies of executive compensation. For a judge and scholar strongly disposed to granting markets wide latitude, Judge Posner’s reliance upon the findings of this literature is striking:
“Directors are often CEOs of other companies and naturally think that CEOs should be well paid. And often they are picked by the CEO. Compensation consulting firms, which provide cover for generous compensation packages voted by boards of directors, have a conflict of interest because they are paid not only for their compensation advice but for other services to the firm – services for which they are hired by the officers whose compensation they advised on.”
Id. at *2.
Responding to the panel’s reliance upon the capital and products markets to regulate managers’ compensation, Judge Posner observes that competition in these markets “can’t be counted on to solve the problem because the same structure of incentives operates on all large corporations and similar entities, including mutual funds.” Id. Judge Posner also cites “rampant” abuses in the financial services industry, of which mutual funds are a component.
Of significance to Judge Posner is the difference in what Harris Associates charges its “captive” funds (those funds it organized and manages) and what it charges independent funds: “A particular concern in this case is the adviser’s charging its captive funds more than twice what it charges independent funds.” Id. at *3. Judge Posner is not impressed by the panel’s explanation of why this difference may be justified:
“The panel opinion throws out some suggestions on why this difference may be justified, but the suggestions are offered purely as speculation, rather than anything having an evidentiary or empirical basis.” Id., at *3. Nasty!
Concluding that the outcome of the panel decision “may” be correct, Judge Posner concludes that, because of the creation of a circuit split, the importance of the issue to the mutual fund industry, and the “one-sided character of the panel’s analysis,” the case warrants a rehearing en banc.
It’s a fair bet that much of Judge Posner’s analysis will appear in any petition for certiorari filed by the plaintiffs with the Supreme Court.
It is therefore always of intense interest when they lock horns over a matter touching upon their core expertise. Such was the case most notably in Jordan v. Duff and Phelps, 815 F.2d 429 (7th Cir. 1987) (Easterbrook writing the opinion for the majority, Posner dissenting) in which the issue joined was the obligation of a closely-held corporation to disclose material information to an at-will employee when purchasing his stock on termination pursuant to a pre-set formula, Judge Easterbrook concluding the corporation had such a duty and therefore summary judgment for the corporation was improperly granted, Judge Posner concluding that summary judgment in favor of the corporation was proper. The ground still shakes from that contest. See Ramseyer “Not-So-Ordinary Judges In Ordinary Courts: Teaching Jordan v. Duff & Phelps, Inc.,” 120 Harv. L. Rev. 1199 (2007).
While the clash between Judges Posner and Easterbrook in Jones v. Harris Associates is not over a M&A transaction, because of their prominence in the field of law and economics and as jurists, I believe their clash deserves a post on this blog.
A. Panel Opinion
Echoes of their dispute in Jordan can be found in their most recent one, in Jones v. Harris Associates, L.P., 527 F.3d 627 (7th Cir. 2008), petition for rehearing and rehearing en banc denied, 2008 WL 3177282 (August 8, 2008) (Posner, with Judges Rovner, Wood, Williams, and Tinder, dissenting).
In this case, owners of shares in mutual funds brought an action against their common investment advisor (Harris Associates) under Section 36(b) of the Investment Company Act of 1940 alleging that the advisor’s compensation was excessive. The lower court granted summary judgment for the advisor, and the panel of the Seventh Circuit, in an opinion by Chief Judge Easterbrook, affirmed the judgment. In his opinion for the panel, Judge Easterbrook takes the occasion to disapprove the standard of review of advisor compensation established by the Second Circuit in its 1982 decision in Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923 (2nd Cir 1982). The Gartenberg court established, as the test for applying Section 36(b) to an advisor’s fee, the following:
“[T]he test is essentially whether the fee schedule represents a charge within the range of what would have been negotiated at arm’s-length in the light of all the surrounding circumstances.
. . .
[to] be guilty of a violation of § 36(b) . . . the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”
Gartenberg, quoted in Jones at 527 F.3d at 631.
Judge Easterbrook found Gartenberg wanting because it relied too little on markets. Investors have thousands of mutual funds to choose among, and administrative expenses (which include advisor management fees) as a percent of assets under management is a commonly used and widely distributed measure to assess mutual fund performance. High fees drive investors away. Judge Easterbrook is not shy about expressing his and the panel’s preference for the discipline of markets over that of judges or juries:
“A fiduciary duty differs from rate regulation. A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation. The trustees [of the mutual fund] (and in the end investors, who vote with their feet and dollars), rather than a judge or jury, determine how much advisory services are worth.”
527 F.3d at 632.
Betraying his background as a professor, Judge Easterbrook turns pedantic on the workings of the capital and products markets:
“Publicly traded corporations use the same basic procedures as mutual funds: a committee of independent directors sets the top managers’ compensation. No court has held that this procedure implies judicial review for ‘reasonableness’ of the resulting salary, bonus, and stock options. These are constrained by competition in several markets – firms that pay too much to managers have trouble raising money, because net profits available for distribution to investors are lower, and these firms also suffer in product markets because they must charge more and consumers turn elsewhere. Competitive processes are imperfect but remain superior to a ‘just price’ system administered by the judiciary. However weak competition may be at weeding out errors, the judicial process is worse – for judges can’t be turned out of office or have their salaries cut if they display poor business judgment.”
Id., at 632-633.
Let the market decide, concludes Judge Easterbrook:
“Mutual funds come much closer to the model of atomistic competition than do most other markets. Judges would not dream of regulating the price of automobiles, which are produced by roughly a dozen large firms; why then should 8,000 mutual funds seems ‘too few’ to put competitive pressure on advisory fees?”
Id., at 634.
B. Judge Posner’s Dissent
And so it ended, almost. Apparently the rules of the Seventh Circuit permit a single judge to call for a vote on a request for a rehearing en banc. After Judge Easterbrook’s panel voted “unanimously” to deny the plaintiffs’ petition for a rehearing by the panel, “a” judge, not identified (we can guess who) requested a vote on the request for rehearing en banc. A majority of the Circuit did not favor such a rehearing, and so the petition was denied. That led to Judge Posner’s dissent from the denial.
One would not expect judges of the stature and intellectual firepower of Judges Posner and Easterbrook to be shy or to pull punches. And they don’t. Judge Posner, in concluding his dissent, notes that the panel decision creates a “circuit split” between the Seventh and Second Circuits, “although the panel did not acknowledge this or circulate its opinion to the full court in advance of publication as is required when a panel creates a circuit split.” 2008 WL 31772, at *4. Ouch!
Judge Posner challenges the scholarship of the panel opinion in its claim that the Gartenberg approach has been found “wanting” in previous Seventh Circuit opinions. Not so, noted Judge Posner, and he cites a “slew” of positive citations to Gartenberg, and cites studies concluding that the excessive fee cases brought since Gartenberg have “resulted almost uniformly in judgments for the defendants …” Id. at *1.
It is most remarkable for a free market advocate such as Judge Posner to cite recent scholarship showing that “executive compensation in large publicly traded firms often is excessive because of the feeble incentives of boards of directors to police compensation,” id., at *2, most notably Lucian Bebchuk’s and Jesse Fried’s studies of executive compensation. For a judge and scholar strongly disposed to granting markets wide latitude, Judge Posner’s reliance upon the findings of this literature is striking:
“Directors are often CEOs of other companies and naturally think that CEOs should be well paid. And often they are picked by the CEO. Compensation consulting firms, which provide cover for generous compensation packages voted by boards of directors, have a conflict of interest because they are paid not only for their compensation advice but for other services to the firm – services for which they are hired by the officers whose compensation they advised on.”
Id. at *2.
Responding to the panel’s reliance upon the capital and products markets to regulate managers’ compensation, Judge Posner observes that competition in these markets “can’t be counted on to solve the problem because the same structure of incentives operates on all large corporations and similar entities, including mutual funds.” Id. Judge Posner also cites “rampant” abuses in the financial services industry, of which mutual funds are a component.
Of significance to Judge Posner is the difference in what Harris Associates charges its “captive” funds (those funds it organized and manages) and what it charges independent funds: “A particular concern in this case is the adviser’s charging its captive funds more than twice what it charges independent funds.” Id. at *3. Judge Posner is not impressed by the panel’s explanation of why this difference may be justified:
“The panel opinion throws out some suggestions on why this difference may be justified, but the suggestions are offered purely as speculation, rather than anything having an evidentiary or empirical basis.” Id., at *3. Nasty!
Concluding that the outcome of the panel decision “may” be correct, Judge Posner concludes that, because of the creation of a circuit split, the importance of the issue to the mutual fund industry, and the “one-sided character of the panel’s analysis,” the case warrants a rehearing en banc.
It’s a fair bet that much of Judge Posner’s analysis will appear in any petition for certiorari filed by the plaintiffs with the Supreme Court.
Friday, September 5, 2008
Hexion v. Huntsman; Vice Chancellor Lamb's Discovery Ruling: Distinguishing Between Financial Consultants and Litigation Consultants
Merrill Lynch served as Huntsman’s financial advisor in connection with its July 2007 merger agreement with Hexion. By my posts of June 28 and August 4, I have commented on this case, in which Hexion is attempting to back out of the deal. On June 24, 2008, Hunstman also retained Merrill as its “litigation consultant” in connection with the litigation. In this discovery dispute, Hexion sought documentation evidencing Merrill’s work as financial advisor after June 18, 2008. Huntsman refused to provide it. The focus of the dispute became Chancery Rule 26(b)(4)(B) (based upon the Federal Rule of Civil Procedure of the same identification):
“A party may discover facts known or opinions held by an expert who has been retained or specially employed by another party in anticipation of litigation or preparation for trial and who is not expected to be called as a witness at trial, only as provided in Rule 35(b) [applicable to physical and mental examinations] or upon a showing of exceptional circumstances under which it is impracticable for the party seeking discovery to obtain facts or opinions on the same subject by other means.”
Vice Chancellor Lamb granted Hexion’s motion to compel. He concluded that because Merrill was performing dual roles for Huntsman (continuing as its financial advisor and acting as a litigation consultant), and because Huntsman and Merrill had made no effort to distinguish the two roles (by, for example, setting up separate and distinct financial advisory and litigation consulting teams), Rule 26(b)(4)(B) was not available. The Vice Chancellor was also clearly influenced by the potential for abuse in using one consultant for dual purposes to cloak legitimate fact witnesses:
“The present case raises an additional ground to deny the application of that rule [Rule 26(b)(4)(B)] because the proponent (Huntsman) is trying to use the rule to shield testimony by a natural fact witness.”
August 22, 2008 Opinion at 9.
The Vice Chancellor also rejected Huntsman’s claims that Merrill’s work was protected by the work product doctrine, the attorney-client privilege, and the business strategy immunity.
The Vice Chancellor’s decision points up the risk in designating a financial advisor as a litigation consultant. To protect the advisor’s work product and opinions from discovery, the prudent course is to retain a separate consultant. If that is impracticable or inefficient, then, at a minimum, the financial advisor should set up a completely separate litigation consulting team, and a Chinese wall established between the two teams. Otherwise, all work product of the financial advisor is likely to be subject to discovery.
“A party may discover facts known or opinions held by an expert who has been retained or specially employed by another party in anticipation of litigation or preparation for trial and who is not expected to be called as a witness at trial, only as provided in Rule 35(b) [applicable to physical and mental examinations] or upon a showing of exceptional circumstances under which it is impracticable for the party seeking discovery to obtain facts or opinions on the same subject by other means.”
Vice Chancellor Lamb granted Hexion’s motion to compel. He concluded that because Merrill was performing dual roles for Huntsman (continuing as its financial advisor and acting as a litigation consultant), and because Huntsman and Merrill had made no effort to distinguish the two roles (by, for example, setting up separate and distinct financial advisory and litigation consulting teams), Rule 26(b)(4)(B) was not available. The Vice Chancellor was also clearly influenced by the potential for abuse in using one consultant for dual purposes to cloak legitimate fact witnesses:
“The present case raises an additional ground to deny the application of that rule [Rule 26(b)(4)(B)] because the proponent (Huntsman) is trying to use the rule to shield testimony by a natural fact witness.”
August 22, 2008 Opinion at 9.
The Vice Chancellor also rejected Huntsman’s claims that Merrill’s work was protected by the work product doctrine, the attorney-client privilege, and the business strategy immunity.
The Vice Chancellor’s decision points up the risk in designating a financial advisor as a litigation consultant. To protect the advisor’s work product and opinions from discovery, the prudent course is to retain a separate consultant. If that is impracticable or inefficient, then, at a minimum, the financial advisor should set up a completely separate litigation consulting team, and a Chinese wall established between the two teams. Otherwise, all work product of the financial advisor is likely to be subject to discovery.
Encite LLC v. Soni; Tortious Interference with Prospective Business Relationship - the Third Party Contract Element
Can a founder, director, and 30% stockholder of a Delaware corporation tortiously interfere with a prospective business relationship between his corporation and a third party?
Chancellor Chandler answered yes in his opinion entered August 1, 2008 in Encite LLC v. Soni, 2008 WL 2973015.
The case is about a venture investment gone bad. Echelon Ventures, L.P. and affiliates (“Echelon”) invested in Integrated Fuel Cell Technologies, Inc., a Delaware corporation (“IFCT”). Founder, former CEO, director, and 30% stockholder Stephen Marsh is the focus of this decision. IFCT failed and went into bankruptcy, and Marsh and friends formed Encite to purchase its assets. Among its other post-acquisition activities, Encite sued certain IFCT directors for breach of fiduciary duty and Echelon for aiding and abetting their breaches. Echelon filed a third-party complaint against Marsh and two former directors and stockholders of IFCT.
Echelon tried mightily to salvage its investment in IFCT, which included a proposal to acquire its assets. The board of IFCT approved Echelon’s proposal, but the approval was abandoned after a lawsuit was filed by one of Marsh’s co-defendants to scuttle it (instigated by Marsh, so Echelon alleges). The bankruptcy followed, and Marsh beat out Echelon in purchasing IFCT’s assets. Echelon, by its third-party complaint, alleges that Marsh torpedoed the Echelon proposal to purchase IFCT’s assets, intending to drive IFCT into bankruptcy and thereby acquiring its assets on the cheap.
Chancellor Chandler first had to resolve which law applied, Massachusetts’ or Delaware’s. He applied Massachusetts law but, in so doing, observed that both Massachusetts and Delaware required the same elements to be pleaded to state a claim for tortious interference with prospective business relationship. Opinion, note 11 These elements are:
· That plaintiff, here Echelon, had a business relationship for economic benefit with a third party (that is to say, not with Marsh, the cross-defendant);
· That Marsh knew of the relationship;
· That Marsh interfered with that relationship through improper motive or means; and
· That Echelon’s loss of the economic advantage was directly caused by Marsh’s conduct.
Marsh argued that he could not tortiously interfere with Echelon’s business relationship with IFCT because, as a director and a 30% stockholder of IFCT, he was, for this purpose, IFCT.
In ruling on this motion to dismiss, the Chancellor concluded that Echelon had alleged sufficient facts to establish that Marsh and IFCT were distinguishable. While Marsh’s status as the founder, a director, a significant stockholder, and former CEO of IFCT argued for a finding of indistinguishability, Chancellor Chandler found the following facts sufficient to establish, at the pleading stage, that Marsh and IFCT were distinguishable:
· Because he was considered an interested director with respect to his group’s bid to purchase the assets of IFCT, Marsh was not permitted to participate in any board evaluation of the bids submitted by interested parties, including by Echelon; and
· Marsh alone did not decide to withdraw the request for shareholder approval of Echelon’s bid — the board of directors of IFCT did.
To establish identity, the Chancellor, citing a Massachusetts employment decision, Harrison v. NetCentric Corp., 744 N.E.2d 622 (Mass. 2001), noted that the evidence would have to establish that Marsh controlled the operation of IFCT to a degree that he should be viewed as its alter ego.
It would be the rare case that would meet this standard. Accordingly, assuming the other elements for establishing tortious interference are met (and meeting the third element – interference of a relationship through improper motive or means is the challenge), executive officers or directors of a Delaware corporation are subject to claims for tortuous interference with prospective business relationships between their corporation and third parties.
Chancellor Chandler answered yes in his opinion entered August 1, 2008 in Encite LLC v. Soni, 2008 WL 2973015.
The case is about a venture investment gone bad. Echelon Ventures, L.P. and affiliates (“Echelon”) invested in Integrated Fuel Cell Technologies, Inc., a Delaware corporation (“IFCT”). Founder, former CEO, director, and 30% stockholder Stephen Marsh is the focus of this decision. IFCT failed and went into bankruptcy, and Marsh and friends formed Encite to purchase its assets. Among its other post-acquisition activities, Encite sued certain IFCT directors for breach of fiduciary duty and Echelon for aiding and abetting their breaches. Echelon filed a third-party complaint against Marsh and two former directors and stockholders of IFCT.
Echelon tried mightily to salvage its investment in IFCT, which included a proposal to acquire its assets. The board of IFCT approved Echelon’s proposal, but the approval was abandoned after a lawsuit was filed by one of Marsh’s co-defendants to scuttle it (instigated by Marsh, so Echelon alleges). The bankruptcy followed, and Marsh beat out Echelon in purchasing IFCT’s assets. Echelon, by its third-party complaint, alleges that Marsh torpedoed the Echelon proposal to purchase IFCT’s assets, intending to drive IFCT into bankruptcy and thereby acquiring its assets on the cheap.
Chancellor Chandler first had to resolve which law applied, Massachusetts’ or Delaware’s. He applied Massachusetts law but, in so doing, observed that both Massachusetts and Delaware required the same elements to be pleaded to state a claim for tortious interference with prospective business relationship. Opinion, note 11 These elements are:
· That plaintiff, here Echelon, had a business relationship for economic benefit with a third party (that is to say, not with Marsh, the cross-defendant);
· That Marsh knew of the relationship;
· That Marsh interfered with that relationship through improper motive or means; and
· That Echelon’s loss of the economic advantage was directly caused by Marsh’s conduct.
Marsh argued that he could not tortiously interfere with Echelon’s business relationship with IFCT because, as a director and a 30% stockholder of IFCT, he was, for this purpose, IFCT.
In ruling on this motion to dismiss, the Chancellor concluded that Echelon had alleged sufficient facts to establish that Marsh and IFCT were distinguishable. While Marsh’s status as the founder, a director, a significant stockholder, and former CEO of IFCT argued for a finding of indistinguishability, Chancellor Chandler found the following facts sufficient to establish, at the pleading stage, that Marsh and IFCT were distinguishable:
· Because he was considered an interested director with respect to his group’s bid to purchase the assets of IFCT, Marsh was not permitted to participate in any board evaluation of the bids submitted by interested parties, including by Echelon; and
· Marsh alone did not decide to withdraw the request for shareholder approval of Echelon’s bid — the board of directors of IFCT did.
To establish identity, the Chancellor, citing a Massachusetts employment decision, Harrison v. NetCentric Corp., 744 N.E.2d 622 (Mass. 2001), noted that the evidence would have to establish that Marsh controlled the operation of IFCT to a degree that he should be viewed as its alter ego.
It would be the rare case that would meet this standard. Accordingly, assuming the other elements for establishing tortious interference are met (and meeting the third element – interference of a relationship through improper motive or means is the challenge), executive officers or directors of a Delaware corporation are subject to claims for tortuous interference with prospective business relationships between their corporation and third parties.
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