In one of his final decisions before his retirement this July, Vice Chancellor Lamb has handed down an important ruling on continuing director poison puts, San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, Inc. (Nasdaq: AMLN), 2009 WL 1337150 (May 12, 2009). A poison put is a contractual provision, typically found in loan agreements or indentures, that triggers adverse consequences to the debtor upon a change-in-control of the debtor. In this case the question was whether the holders of the $625 million 3% convertible notes, due 2014 (the “Convertible Notes”), acting through The Bank of New York Mellon Trust Company, the indenture trustee, would have the right to redeem the Convertible Notes (which were trading at a discount) at face value upon the occurrence of a “fundamental change” in Amylin, defined to include, among other things, a change in the makeup of the board of directors of Amylin such that the “continuing directors” would not constitute a majority of the board. “Continuing directors” included those on the board on the date of issuance of the Convertible Notes — June 2007 — and any successors who are approved by the directors then in office (or their approved successors).
The plaintiff’s allegations and the Court’s treatment of the poison put in the Convertible Notes Indenture and in Amylin’s Credit Agreement with Bank of America raise troubling questions concerning the viability of continuing director poison puts.
A. The Context
This lawsuit was triggered by a proxy contest over the directors to be elected at Amylin’s 2009 annual meeting of shareholders, to be held May 27, 2009. Twelve directors are to be elected. In January 2009 two dissident shareholders — Icahn Partners LP, an 8.8% Amylin stockholder, and Eastbourne Capital Management, L.L.C., a 12.5% stockholder — each nominated a five-person short slate for election to the board. Eastbourne, having done its homework, asked the Amylin board to take action to prevent the adverse consequences that would befall Amylin if the continuing directors’ provision of the Convertible Notes’ Indenture were triggered. Eastbourne’s proposed solution was to ask Amylin to include a “significant” number of nominees from its and Icahn’s slates in management’s slate of directors to be recommended to the stockholders.
Amylin filed its 2008 10-K with the SEC on February 27, 2009. In the 10-K, Amylin highlighted the potential adverse consequences of the continuing directors’ provisions of the Convertible Notes’ Indenture and the BofA Credit Agreement if they were triggered by election of the Icahn and Eastbourne slates. (The BofA Credit Agreement is even more restrictive than the Convertible Notes’ Indenture, in that candidates elected or appointed to the board as a result of an “actual or threatened solicitation of proxies or consents for the election or removal of Amylin directors” would not qualify as continuing directors.)
Promptly after the filing of the 10-K, Eastbourne sent a letter to the Amylin board questioning the “legitimacy” of the continuing directors’ provisions of the Convertible Notes’ Indenture and the BofA Credit Agreement, “calling upon the board to use its power to remove any obstacle to the operation of the stockholder franchise,” and calling upon Amylin to “approve” the dissident slates under the Convertible Notes’ Indenture.
On March 17, 2009, Amylin announced publicly the tentative date for its 2009 annual meeting – May 27, 2009.
B. The Litigation
Plaintiff launched a frontal assault on the continuing director provisions of the Convertible Notes’ Indenture and BofA Credit Agreement. It alleged —
• breaches of the fiduciary duties of care and loyalty by the Amylin board in its 2007 adoption of the Indenture and Credit Agreement, insofar as they both contained continuing directors covenants;
• breaches of the fiduciary duties of care and loyalty by the board in failing to approve the dissident nominees in order to “sanitize” them under the continuing directors provision of the Indenture; and
• breaches of the fiduciary duties of care and loyalty in the allegedly misleading and coercive manner in which the board disclosed the risks presented by the continuing directors provisions in the Indenture and Credit Agreement in the context of the proxy contest in Amylin’s 2008 10-K.
Besides seeking declaratory relief, plaintiff sought a mandatory injunction requiring the directors to approve the Icahn and Eastbourne nominees for director.
The plaintiff filed its class action complaint on March 24, 2009. In April the plot thickened. Clearly made a bit anxious by plaintiff’s allegations, and seeing a relatively harmless settlement strategy, Amylin and its board first filed an answer on April 7, 2009, which included a cross-claim against the Indenture trustee, seeking declaratory relief that the board has the power to approve any or all stockholder nominees at any time up to their election. And, on April 13, 2009, plaintiff and Amylin announced a partial settlement. Under the terms of the settlement, plaintiff withdrew its allegations of breach of the duty of loyalty and lack of good faith by the Amylin board. That withdrawal is important for indemnity and insurance purposes, as under Delaware GCL §102(b)(7), and Amylin’s charter, the personal liability of directors cannot be eliminated for breaches of the duty of loyalty or acts or omissions not taken in good faith. Plaintiff also agreed not to seek damages against Amylin or the board, to dismiss its claim of coercive disclosure in the 2008 10-K, and to dismiss its claim against the board for breach of fiduciary duty in failing to approve the Icahn and Eastbourne nominees. In return, the board, subject to court affirmation of its power to do so, agreed to “approve” the Icahn and Eastbourne nominees solely for the purpose of the continuing directors provision of the Indenture. This is called a clever work-around.
This “approval” did not mean that Amylin would endorse Icahn’s or Eastbourne’s nominees for election: the “approval” was solely to finesse the trigger under the Indenture permitting the Convertible Noteholders to redeem their Notes at face value. Amylin continued to oppose Icahn’s and Eastbourne’s nominees, with vigor.
Plaintiff, Amylin, and BofA also agreed to remove the BofA Credit Agreement continuing director provision from the case. Under this settlement, BofA and its group of lenders agreed to waive any event of default that might be triggered by the election of Icahn’s and/or Eastbourne’s nominees to the Amylin board, in return for — what else — money: a $625,000 fee (payable in the event that the continuing directors provision of the BofA Credit Agreement would otherwise be triggered by the election of the Icahn and/or Eastbourne nominees).
The parties then tinkered with the record before Vice Chancellor Lamb even further. On May 6, 2009, two days after close of the record date for determining the stockholders entitled to vote at the meeting, Amylin notified the Court that Eastbourne had reduced the number of candidates it was nominating to the board from five to three, and Icahn from five to two. Accordingly, even if the dissidents’ nominees are elected to the board, the board will still consist of a majority of continuing directors.
The sole remaining creditor defendant, the Indenture trustee, in response to these developments, at this point pleaded with the Court to dismiss or stay the claims against it, as the issues of the validity of the continuing director provision in the Indenture were now not ripe for determination. Plaintiff and Amylin, on the other hand, asked the Court to proceed because “whether or not the stockholder-nominated directors constitute Continuing Directors may have a significant effect on next year’s annual stockholder meeting.” 2009 WL 1337150 at *6.
C. Vice Chancellor Lamb’s Ruling
The trustee’s argument for application of the continuing directors provision of the Indenture to the Amylin proxy contest was straightforward:
“[t]he Board’s determination not to recommend the election of any of the Dissident Nominees, to recommend its own competing slate, and that the election of the Dissident Nominees would not be in the best interests of the Company—determinations that have not changed as a result of the Partial Settlement—simply cannot be reconciled with the plain meaning of the term ‘approval.’ To the contrary, such determinations by the Board clearly indicate disapproval.”
2009 WL 1337150 at *7 (footnote omitted) (emphasis in original).
Amylin, on the other hand, argued that “approval” does not mean “endorsement” or “recommendation.” “By Amylin’s reading, therefore, the board may approve a slate of nominees for the purpose of the Indenture (thus sanctioning their nomination for election) without endorsing them, and may simultaneously recommend and endorse its own slate instead.” Id.
The Vice Chancellor concluded that Amylin’s reading of the Indenture was the correct one. Clearly he was motivated by the effect of the continuing director provision upon the stockholder franchise, and he uses terms that should cause all boards considering continuing director poison puts concern:
“A provision in an indenture with such an eviscerating effect on the stockholder franchise would raise grave concerns. In the first instance, those concerns would relate to the exercise of the board’s fiduciary duties in agreeing to such a provision. The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting such a provision, it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it. Additionally, the court would have to closely consider the degree to which such a provision might be unenforceable as against public policy.”
2009 WL 1337150 at *8 (footnotes omitted).
Having concluded that the Amylin board had the power under the Indenture to “approve” a dissident’s slate under the continuing director provision of the Indenture, while at the same time opposing the election of that slate, Vice Chancellor Lamb next turned to the question of whether the Amylin board had properly approved the dissidents’ slates under the Indenture. Relying upon Hills Stores Company v. Bozic, 769 A.2d 88 (Del. Ch. 2000), the Vice Chancellor applied this test:
“… the board may approve the stockholder nominees if the board determines in good faith that the election of one or more of the dissident nominees would not be materially adverse to the interests of the corporation or its stockholders.”
Id. at *8 (footnote omitted).
Here, the Vice Chancellor ran into a problem. There was no evidence before him as to how the Amylin board came to its decision to “approve” Icahn’s and Eastbourne’s nominees or, to be more precise, the evidence before the Vice Chancellor cut the other way. First, and most obviously, the public record was replete with negative comments made by Amylin about the Icahn and Eastbourne nominees, some of which are quoted by the Vice Chancellor in note 39 to his decision. But these negative comments are not dispositive, so concluded the Vice Chancellor, because he recognized that such comments could be election “puffery” in the context of a proxy contest. In other words, the other guys’ nominees could be worse, much worse than management’s nominees, but not bad. That is a fine line to walk. The second unhelpful fact before the Vice Chancellor was the circumstance of the Amylin settlement with the plaintiff, clearly giving rise to the inference that Amylin agreed to “approve” Icahn’s and Eastbourne’s nominees to settle breach of duty and loyalty claims against its board of directors.
Exercising judicial discretion, the Vice Chancellor elected to punt on the question of whether the Amylin board properly “approved” the Icahn and Eastbourne nominees under the terms of the continuing director provision of the Indenture to a later date. It helped the Vice Chancellor in making this decision that the dissidents had reduced their slate of nominees to a number less than a majority of the Amylin board. If the dissidents are elected, and Amylin chooses to do so, then it could return to the Court for sanction of the board’s due care in “approving” the dissident nominees.
D. Did the Amylin Board Breach its Duty of Due Care in Approving the Poison Put?
The one due care issue remaining in the case that the Vice Chancellor did address is one that will give boards and their advisors pause.
The standard applied by the Vice Chancellor is one of gross negligence, that is, was the Amylin board grossly negligent in approving the Indenture with its continuing director provision? Here, the record was somewhat embarrassing, in that, in its consideration of the Indenture, the committee of the board that approved the Indenture was unaware of the poison put! So too were Amylin’s CEO and CFO! Indeed, the poison put proceeded through drafts of the Indenture without comment by Amylin or its counsel. (Indeed, there is more: when counsel was asked by the board committee whether the Convertible Notes were subject to any terms which counsel saw as “unusual or not customary,” Amylin’s counsel responded that they were not.)
Nevertheless, the Vice Chancellor concluded that the Amylin board was not grossly negligent “in failing to learn of the existence of the Continuing Directors provisions…” 2009 WL 1337150 at *10. Focusing on the board, and the advice it had received from “highly-qualified counsel,” the Vice Chancellor observed that “no one suggests that the directors’ duty of care required them to review, discuss and comprehend every word of the 98-page Indenture.” Directors can breathe a sigh of relief at that observation.
But then the Vice Chancellor concludes with words of caution to boards and their advisors:
“This case does highlight the troubling reality that corporations and their counsel routinely negotiate contract terms that may, in some circumstances, impinge on the free exercise of the stockholder franchise. In the context of the negotiations of a debt instrument, this is particularly troubling, for two reasons. First, as a matter of course, there are few events which have the potential to be more catastrophic for a corporation than the triggering of an event of default under one of its debt agreements. Second, the board, when negotiating with rights that belong first and foremost to stockholders (i.e., the stockholder franchise), must be especially solicitous to its duties both to the corporation and to its stockholders. This is never more true than when negotiating with debtholders, whose interests at times may be directly adverse to those of the stockholders. Outside counsel advising a board in such circumstances should be especially mindful of the board’s continuing duties to the stockholders to protect their interests. Specifically, terms which may affect the stockholders’ range of discretion in exercising the franchise should, even if considered customary, be highlighted to the board. In this way, the board will be able to exercise its fully informed business judgment.”
Id. at *10.
E. Plaintiff Appeals
Not satisfied with the Vice Chancellor’s blessing of its strategy for finessing the continuing director provision of the Indenture, plaintiff has appealed the Vice Chancellor’s ruling deferring a decision on whether the Amylin board exercised due care in “approving” the dissidents’ shortened slate of director nominees. Plaintiff essentially doesn’t like the uncertainty created by the Vice Chancellor’s ruling. In its application for an expedited hearing before the Delaware Supreme Court, it argues that, in the absence of an expedited final resolution prior to the date of the stockholder meeting, “stockholders will be coerced from voting for the five stockholder nominees because of the cloud cast by the lower Court’s ruling.” Plaintiff’s Motion for Expedited Scheduling Regarding Dismissal of Count III, dated May 13, 2009, at 2. Justice Jacobs of the Delaware Supreme Court denied the motion for an expedited hearing on May 15.
F. Whither the Continuing Director Poison Put?
If Vice Chancellor Lamb’s decision stands, it is hard to see how continuing director poison puts will survive. If drafted more restrictively, to protect lenders, it could subject a board to claims of entrenchment and thereby implicate the duty of loyalty, stripping from the directors the “due care” waivers permitted in charter provisions such as those permitted by Delaware GCL §102(b)(7). As to existing poison puts, plaintiff’s strategy in this lawsuit provides a roadmap on how to neuter them, although the path that a board must follow is akin to Ulysses’ travels between Scylla and Charybdis: how to “approve” a dissident slate while at the same time slamming them in the heat of battle.
Breaches of continuing director provisions are not, of course, monetary defaults. They provide a signal to lenders of potential trouble. A more classic way of signaling such trouble is through the use of financial covenants, e.g., debt to equity ratios, debt service coverage, or through events of default that foreshadow trouble, such as a rating decline, or through negative covenants such as a requirement to secure the lenders’ consent for any merger, consolidation, etc. Debtors and their counsel will in all likelihood point lenders to reliance upon these types of provisions in lieu of reliance upon continuing director poison puts (assuming, of course, it is the lenders who are the parties requesting continuing director poison puts).
Tuesday, May 19, 2009
Wednesday, May 13, 2009
FLI Deep Marine LLC v. McKim; the Futility of Claiming Demand Futility After a Demand Has Been Made
Much of the law can be a trap for the unwary. This is particularly true with procedure. Even experienced counsel can blow it. Such appears to have been the case with plaintiffs’ counsel in this derivative action. By his letter opinion of April 21, 2009 (2009 WL 1204363) Vice Chancellor Noble dismisses this derivative action for plaintiffs’ failure to allow the board of directors of Deep Marine Holdings, Inc. (“DMT”) adequate time to respond to plaintiffs’ litigation demand.
A. Plan Ahead
Plaintiffs complained that DMT had been looted for personal gain for some four years by its controlling shareholders, acting through their controlled directors, also named as defendants in the lawsuit. But plaintiffs filed their action after plaintiffs’ counsel had demanded of the board that it take remedial action and appoint a special litigation committee to investigate the alleged breaches of duty. In response to the demand, the board established a special litigation committee, comprised of two of the defendant directors.
Notwithstanding the making of their demand, in their post-demand lawsuit, plaintiffs alleged that demand on the board was futile and should be excused, notwithstanding that they had already made one!
B. The Law Is the Law
Chancery Rule 23.1 requires that a shareholder seeking to assert a claim on behalf of a Delaware corporation to first make demand on the directors to obtain the action desired, or “state with particularity the reasons for the shareholder’s failure to make such effort.” Letter Opinion at 6-7.
The action of a board in responding to a demand is generally subject to review under the “deferential” business judgment rule, “which presumes that a board is independent, and acts reasonably and in good faith.” Letter Opinion at 7. Where a derivative plaintiff seeks to avoid demand and proceed directly with litigation on behalf of the corporation, then the inquiry focuses on “director independence” and “disinterestedness,” which plaintiff can rebut by alleging particularized facts challenging the independence of the directors and creating “a reasonable doubt that the challenged conduct was a valid exercise of business judgment.” Id.
However, where a shareholder chooses to make a demand upon a board, then the shareholder “concedes the independence of a majority of the board.” Id. at 8. In such circumstances, the Chancery Court “only examines the good faith and reasonableness of the board’s investigation.” Because plaintiffs in this action made a pre-suit demand upon DMT’s board of directors, “they have conclusively conceded the independence of the Board, and are precluded from now arguing that demand should be excused because the directors are conflicted.” Id. at 8. The Vice Chancellor reaches this conclusion notwithstanding plaintiffs’ pleas that, given the makeup of the special committee appointed to respond to their demand, the exercise would be a “mockery,” “contrived,” and a “farce.” While, based upon the allegations of the complaint, plaintiffs might well be correct, too bad: the Court “cannot diverge from settled law.” Id. at 9.
In words that undoubtedly cause plaintiffs’ counsel considerable heartburn, the Vice Chancellor observes that, yes, their demand may very well have been a misstep:
“In light of these facts [plaintiffs’ allegations of the lack of independence of the board], the Plaintiffs’ decision to make a demand upon the Board appears inprovident. The Plaintiffs ask the Court to undo the consequences of their demand; this Court will not part ways with established Delaware law to grant the Plaintiffs relief from a strategic decision they now regret.”
Id. at 10.
C. Spiegel v. Buntrock
This has happened before. It seems to be a habit of derivative plaintiffs. In a similar vein, the Delaware Supreme Court, in Spiegel v. Buntrock, 571 A.2d 767 (1990), likewise concluded that, when a shareholder makes a pre-suit demand, the shareholder “tacitly concedes the independence of a majority of the board to respond.” 571 A.2d at 777. The facts of Spiegel were even more dramatic: Spiegel first filed his derivative action. When respondents protested that he had not made a pre-suit demand, Spiegel dutifully responded by filing a demand! Gotcha! Once such demand is made, then the business judgment rule applies to the board’s response to the demand, and the issues on review of any board decision “are solely the good faith and reasonableness of the committee’s investigation.” 571 A.2d at 778, citing Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (1981). The focus is on process, not the ultimate decision, since that decision is not subject to judicial review. Id.
So it’s back to the drawing boards for plaintiffs in this case. If defendant DMT’s advisors have any brains, the special committee will follow accepted practice, appoint one or more disinterested directors, advised by special counsel, and reach the inevitable decision not to litigate. Only if DMT is foolish enough to leave the decision on how to respond to the demand in the hands of directors who are alleged, through particularized pleading, to have engaged in misconduct, would plaintiffs have a shot at claiming the board’s response was not one made in “good faith.”
A. Plan Ahead
Plaintiffs complained that DMT had been looted for personal gain for some four years by its controlling shareholders, acting through their controlled directors, also named as defendants in the lawsuit. But plaintiffs filed their action after plaintiffs’ counsel had demanded of the board that it take remedial action and appoint a special litigation committee to investigate the alleged breaches of duty. In response to the demand, the board established a special litigation committee, comprised of two of the defendant directors.
Notwithstanding the making of their demand, in their post-demand lawsuit, plaintiffs alleged that demand on the board was futile and should be excused, notwithstanding that they had already made one!
B. The Law Is the Law
Chancery Rule 23.1 requires that a shareholder seeking to assert a claim on behalf of a Delaware corporation to first make demand on the directors to obtain the action desired, or “state with particularity the reasons for the shareholder’s failure to make such effort.” Letter Opinion at 6-7.
The action of a board in responding to a demand is generally subject to review under the “deferential” business judgment rule, “which presumes that a board is independent, and acts reasonably and in good faith.” Letter Opinion at 7. Where a derivative plaintiff seeks to avoid demand and proceed directly with litigation on behalf of the corporation, then the inquiry focuses on “director independence” and “disinterestedness,” which plaintiff can rebut by alleging particularized facts challenging the independence of the directors and creating “a reasonable doubt that the challenged conduct was a valid exercise of business judgment.” Id.
However, where a shareholder chooses to make a demand upon a board, then the shareholder “concedes the independence of a majority of the board.” Id. at 8. In such circumstances, the Chancery Court “only examines the good faith and reasonableness of the board’s investigation.” Because plaintiffs in this action made a pre-suit demand upon DMT’s board of directors, “they have conclusively conceded the independence of the Board, and are precluded from now arguing that demand should be excused because the directors are conflicted.” Id. at 8. The Vice Chancellor reaches this conclusion notwithstanding plaintiffs’ pleas that, given the makeup of the special committee appointed to respond to their demand, the exercise would be a “mockery,” “contrived,” and a “farce.” While, based upon the allegations of the complaint, plaintiffs might well be correct, too bad: the Court “cannot diverge from settled law.” Id. at 9.
In words that undoubtedly cause plaintiffs’ counsel considerable heartburn, the Vice Chancellor observes that, yes, their demand may very well have been a misstep:
“In light of these facts [plaintiffs’ allegations of the lack of independence of the board], the Plaintiffs’ decision to make a demand upon the Board appears inprovident. The Plaintiffs ask the Court to undo the consequences of their demand; this Court will not part ways with established Delaware law to grant the Plaintiffs relief from a strategic decision they now regret.”
Id. at 10.
C. Spiegel v. Buntrock
This has happened before. It seems to be a habit of derivative plaintiffs. In a similar vein, the Delaware Supreme Court, in Spiegel v. Buntrock, 571 A.2d 767 (1990), likewise concluded that, when a shareholder makes a pre-suit demand, the shareholder “tacitly concedes the independence of a majority of the board to respond.” 571 A.2d at 777. The facts of Spiegel were even more dramatic: Spiegel first filed his derivative action. When respondents protested that he had not made a pre-suit demand, Spiegel dutifully responded by filing a demand! Gotcha! Once such demand is made, then the business judgment rule applies to the board’s response to the demand, and the issues on review of any board decision “are solely the good faith and reasonableness of the committee’s investigation.” 571 A.2d at 778, citing Zapata Corp. v. Maldonado, 430 A.2d 779, 787 (1981). The focus is on process, not the ultimate decision, since that decision is not subject to judicial review. Id.
So it’s back to the drawing boards for plaintiffs in this case. If defendant DMT’s advisors have any brains, the special committee will follow accepted practice, appoint one or more disinterested directors, advised by special counsel, and reach the inevitable decision not to litigate. Only if DMT is foolish enough to leave the decision on how to respond to the demand in the hands of directors who are alleged, through particularized pleading, to have engaged in misconduct, would plaintiffs have a shot at claiming the board’s response was not one made in “good faith.”
Saturday, May 9, 2009
Nemec v. Shrader; Redemption of Shares Just Prior to a Transaction
Timing can be everything. Long-time “partners” Joseph Nemec and Gerd Wittkemper of Booz Allen Hamilton Inc. (“Booz Allen”) retired on March 31, 2006 after illustrious careers with the firm. After their retirement, Booz Allen entered into negotiations with The Carlyle Group (“Carlyle”) to sell its government consulting business for over $2 billion. Notwithstanding assurances by Booz Allen’s chairman and CEO to both Nemec and Wittkemper that Booz Allen would not exercise its discretionary option to repurchase their shares prior to consummation of the Carlyle transaction, Booz Allen in fact did so a month before Booz Allen entered into a deal with Carlyle. The early redemption cost Nemec and Wittkemper over $60 million.
Too bad, concluded Chancellor Chandler on this motion of defendants to dismiss (reported at 2009 WL 12043465 (April 30, 2009)). The discretionary redemption did not constitute a breach of the directors’ fiduciary duties to Nemec and Wittkemper, did not breach the implied covenant of good faith and fair dealing between plaintiffs and Booz Allen, and did not constitute unjust enrichment of Booz Allen. It’s a harsh result, which may feed the Chancery Court’s reputation as plaintiff-unfriendly, but undoubtedly the correct decision.
A. The Background
Nemec spent 36 years with Booz Allen. At the time of his retirement on March 31, 2006, he ranked third in seniority among all Booz Allen “partners.” (Although a Delaware corporation, the firm, originally founded as a partnership in 1914, retained the “attitude and culture” of a partnership.) He sat on Booz Allen’s board of directors where, among other things, he served on the audit committee. Wittkemper retired on the same date, March 31, 2006, after some 20 years as a partner of the firm, building the firm’s German business and helping it to expand throughout Europe.
At the time of his retirement from the firm, Nemec owned 76,000 shares of Booz Allen (representing 2.6% of the issued and outstanding stock of the firm), and Wittkemper owned 28,000 shares. Under Booz Allen’s stock plan, a retiree had a “put” right, for a period of two years from the date of his retirement, to sell his shares back to the firm for book value. After expiration of the two-year put period, Booz Allen had the right to redeem part or all of a retired officer’s stock, also at book value (as of the time of redemption). Nemec and Wittkemper (in large part) retained their Booz Allen stock after retirement. In early 2007 Booz Allen commenced discussions with Carlyle over the sale of its government consulting business. Carlyle submitted a bid in November 2007 to purchase the business for $2.54 billion. The negotiations became public in January 2008; it was reported the deal was expected to close by March 31, 2008 (the end of Booz Allen’s fiscal year). If it closed by that date, Nemec and Wittkemper would participate in the benefits of the transaction, to the extent of some $700 per share.
In light of the pending transaction, Booz Allen’s board elected, in March 2008, to preserve the status quo of Booz Allen’s stock ownership, meaning it elected not to redeem any shares so as to maintain the status quo and not “disfavor any existing stockholder.” Slip Opinion at 5-6.
Nemec and Wittkemper, aware of the pending transaction, were of course anxious to participate in its fruits. Booz Allen’s chairman and CEO gave assurance to both of them that they would remain Booz Allen stockholders until the close of the transaction. The CEO stated that this was an “easy moral decision.” Slip Opinion at 6.
Moral, maybe, but on second thought, the board eschewed morality and decided to exercise the firm’s contractual rights under the stock plan and award agreements with Nemec and Wittkemper: in April 2008, before the transaction with Carlyle was formally approved, Booz Allen redeemed the plaintiffs’ shares at the pre-transaction book value — $162.46 per share.
Within weeks of the redemption of Nemec’s and Wittkemper’s shares, the firm moved to cement the transaction with Carlyle. On May 15, 2008, it entered into a merger agreement to sell its government business to Carlyle, which was announced publicly the following day. The directors of Booz Allen, who owned more than 300,000 shares, benefited by the redemption of the plaintiffs’ shares to the tune of $6 million.
B. The Fiduciary Duty Claim
Plaintiffs first claimed that the Booz Allen directors breached their duty of loyalty to plaintiffs by exercising the firm’s option to redeem plaintiffs’ shares at the pre-Carlyle value of the shares. Notwithstanding the personal benefits derived by the directors from this decision, Chancellor Chandler was unimpressed by the claim. First, the dispute fundamentally involved a contract — the award agreement setting forth the firm’s and Nemec’s and Wittkemper’s rights with respect to their stock awards under the stock plan:
“If the ‘fiduciary claims relate to obligations or they are expressly treated’ by contract then this Court will review those claims as breach of contract claims and any fiduciary claims will be dismissed.”
Slip Opinion at 8 (footnote omitted).
The Chancellor’s interpretation of the directors’ action was a matter of contract interpretation:
“Whether the Directors possessed the right to redeem plaintiffs’ shares and whether the Directors properly exercised that right is simply a matter of contract interpretation.”
Slip Opinion at 8-9.
Going beyond where he had to, the Chancellor nevertheless reached plaintiffs’ fiduciary duty claims, and rejected them. Fatal to plaintiffs’ fiduciary duty claim was their assertion that the Booz Allen board, as fiduciaries, owed “unique” duties to them. In fact, the directors’ decision to redeem plaintiffs’ shares benefitted all other shareholders, not just the directors as shareholders. Quoting from Gilbert v. El Paso, Chancellor Chandler noted that in such instances the fact that an action may adversely affect the interests of particular shareholders is of no moment:
“[D]irectors may take whatever action that, in their proper exercise of business judgment, will best serve the interests of the corporation or the entire body of shareholders. That such action may adversely affect the interests of a particular shareholder subgroup, will, in certain instances, be unavoidable. Nonetheless, no wrong doing will have occurred if the directors are able to justify the result as furthering a paramount or overriding corporate or shareholder interest.”
Slip Opinion at 9, quoting from Gilbert v. El Paso, 1998 WL 124325 at *10 (Del. Ch. 1988), aff’d, 575 A.2d 1131 (Del. 1990).
C. Good Faith and Fair Dealing Claim
The strongest of plaintiffs’ claims was that by redeeming their shares Booz Allen violated the implied covenant of good faith and fair dealing. Plaintiffs argued that when a contract confers discretion on a party, that party is required to make the decision reasonably and in good faith. Relying upon the principle that imposing obligations upon contracting parties through the covenant of good faith and fair dealing is “a cautious enterprise and instances [of its application] should be rare,” Slip Opinion at 11, citing Superior Vision Services, Inc. v. ReliaStar Life Ins. Co., 2006 WL 2521426 (Del. Ch. 2006), the Chancellor concluded that no violation occurred here because Booz Allen exercised rights specifically granted to it under the stock plan and award agreements with plaintiffs:
“The Stock Plan is a negotiated instrument entered into freely by both parties. The implied covenant is not implicated simply because Booz Allen, by exercising its option, received the fruits of the agreed to bargain under the stock plan. Nor is the implied covenant implicated because the exercise of the option had a negative effect on plaintiffs’ bottom line.”
Slip Opinion at 12.
D. Unjust Enrichment Claim
Chancellor Chandler tarried only a moment over this claim, noting that it applies only when it would be “unconscionable” to allow a party to retain a benefit, and the Delaware courts “have consistently refused to permit a claim for unjust enrichment when the alleged wrong arises from a relationship governed by contract.” Slip Opinion at 13.
E. What Might Have Been
One cannot read this decision without thinking of the famous case of Jordan v. Duff and Phelps, Inc., 815 F.2d 429 (7th Cir. 1987), discussed in my post of September 6, 2008. Jordan also involved an employee who terminated his employment with his employer (Jordan left to take another job). Unbeknownst to Jordan at the time he quit (he also received the book value of his shares of stock), his employer, Duff and Phelps, was in negotiations to merge. Had Jordan hung around longer, he would have received substantially more for his shares.
In this celebrated decision, in which Judges Easterbrook and Posner took opposing sides (Easterbrook for the majority, Posner in dissent), the Seventh Circuit concluded that, in such circumstances, Duff and Phelps had breached its duty of full disclosure to Jordan in connection with the redemption of his stock.
Jordan would have been in play in this case if Booz Allen had begun negotiations with Carlyle before Nemec and Wittkemper announced their decisions to retire in March 2006. But, as noted by Chancellor Chandler, the negotiations with Carlyle “began to emerge” in early 2007, too late for Nemec and Wittkemper to reach for Jordan v. Duff and Phelps. Too bad. Timing is everything.
Too bad, concluded Chancellor Chandler on this motion of defendants to dismiss (reported at 2009 WL 12043465 (April 30, 2009)). The discretionary redemption did not constitute a breach of the directors’ fiduciary duties to Nemec and Wittkemper, did not breach the implied covenant of good faith and fair dealing between plaintiffs and Booz Allen, and did not constitute unjust enrichment of Booz Allen. It’s a harsh result, which may feed the Chancery Court’s reputation as plaintiff-unfriendly, but undoubtedly the correct decision.
A. The Background
Nemec spent 36 years with Booz Allen. At the time of his retirement on March 31, 2006, he ranked third in seniority among all Booz Allen “partners.” (Although a Delaware corporation, the firm, originally founded as a partnership in 1914, retained the “attitude and culture” of a partnership.) He sat on Booz Allen’s board of directors where, among other things, he served on the audit committee. Wittkemper retired on the same date, March 31, 2006, after some 20 years as a partner of the firm, building the firm’s German business and helping it to expand throughout Europe.
At the time of his retirement from the firm, Nemec owned 76,000 shares of Booz Allen (representing 2.6% of the issued and outstanding stock of the firm), and Wittkemper owned 28,000 shares. Under Booz Allen’s stock plan, a retiree had a “put” right, for a period of two years from the date of his retirement, to sell his shares back to the firm for book value. After expiration of the two-year put period, Booz Allen had the right to redeem part or all of a retired officer’s stock, also at book value (as of the time of redemption). Nemec and Wittkemper (in large part) retained their Booz Allen stock after retirement. In early 2007 Booz Allen commenced discussions with Carlyle over the sale of its government consulting business. Carlyle submitted a bid in November 2007 to purchase the business for $2.54 billion. The negotiations became public in January 2008; it was reported the deal was expected to close by March 31, 2008 (the end of Booz Allen’s fiscal year). If it closed by that date, Nemec and Wittkemper would participate in the benefits of the transaction, to the extent of some $700 per share.
In light of the pending transaction, Booz Allen’s board elected, in March 2008, to preserve the status quo of Booz Allen’s stock ownership, meaning it elected not to redeem any shares so as to maintain the status quo and not “disfavor any existing stockholder.” Slip Opinion at 5-6.
Nemec and Wittkemper, aware of the pending transaction, were of course anxious to participate in its fruits. Booz Allen’s chairman and CEO gave assurance to both of them that they would remain Booz Allen stockholders until the close of the transaction. The CEO stated that this was an “easy moral decision.” Slip Opinion at 6.
Moral, maybe, but on second thought, the board eschewed morality and decided to exercise the firm’s contractual rights under the stock plan and award agreements with Nemec and Wittkemper: in April 2008, before the transaction with Carlyle was formally approved, Booz Allen redeemed the plaintiffs’ shares at the pre-transaction book value — $162.46 per share.
Within weeks of the redemption of Nemec’s and Wittkemper’s shares, the firm moved to cement the transaction with Carlyle. On May 15, 2008, it entered into a merger agreement to sell its government business to Carlyle, which was announced publicly the following day. The directors of Booz Allen, who owned more than 300,000 shares, benefited by the redemption of the plaintiffs’ shares to the tune of $6 million.
B. The Fiduciary Duty Claim
Plaintiffs first claimed that the Booz Allen directors breached their duty of loyalty to plaintiffs by exercising the firm’s option to redeem plaintiffs’ shares at the pre-Carlyle value of the shares. Notwithstanding the personal benefits derived by the directors from this decision, Chancellor Chandler was unimpressed by the claim. First, the dispute fundamentally involved a contract — the award agreement setting forth the firm’s and Nemec’s and Wittkemper’s rights with respect to their stock awards under the stock plan:
“If the ‘fiduciary claims relate to obligations or they are expressly treated’ by contract then this Court will review those claims as breach of contract claims and any fiduciary claims will be dismissed.”
Slip Opinion at 8 (footnote omitted).
The Chancellor’s interpretation of the directors’ action was a matter of contract interpretation:
“Whether the Directors possessed the right to redeem plaintiffs’ shares and whether the Directors properly exercised that right is simply a matter of contract interpretation.”
Slip Opinion at 8-9.
Going beyond where he had to, the Chancellor nevertheless reached plaintiffs’ fiduciary duty claims, and rejected them. Fatal to plaintiffs’ fiduciary duty claim was their assertion that the Booz Allen board, as fiduciaries, owed “unique” duties to them. In fact, the directors’ decision to redeem plaintiffs’ shares benefitted all other shareholders, not just the directors as shareholders. Quoting from Gilbert v. El Paso, Chancellor Chandler noted that in such instances the fact that an action may adversely affect the interests of particular shareholders is of no moment:
“[D]irectors may take whatever action that, in their proper exercise of business judgment, will best serve the interests of the corporation or the entire body of shareholders. That such action may adversely affect the interests of a particular shareholder subgroup, will, in certain instances, be unavoidable. Nonetheless, no wrong doing will have occurred if the directors are able to justify the result as furthering a paramount or overriding corporate or shareholder interest.”
Slip Opinion at 9, quoting from Gilbert v. El Paso, 1998 WL 124325 at *10 (Del. Ch. 1988), aff’d, 575 A.2d 1131 (Del. 1990).
C. Good Faith and Fair Dealing Claim
The strongest of plaintiffs’ claims was that by redeeming their shares Booz Allen violated the implied covenant of good faith and fair dealing. Plaintiffs argued that when a contract confers discretion on a party, that party is required to make the decision reasonably and in good faith. Relying upon the principle that imposing obligations upon contracting parties through the covenant of good faith and fair dealing is “a cautious enterprise and instances [of its application] should be rare,” Slip Opinion at 11, citing Superior Vision Services, Inc. v. ReliaStar Life Ins. Co., 2006 WL 2521426 (Del. Ch. 2006), the Chancellor concluded that no violation occurred here because Booz Allen exercised rights specifically granted to it under the stock plan and award agreements with plaintiffs:
“The Stock Plan is a negotiated instrument entered into freely by both parties. The implied covenant is not implicated simply because Booz Allen, by exercising its option, received the fruits of the agreed to bargain under the stock plan. Nor is the implied covenant implicated because the exercise of the option had a negative effect on plaintiffs’ bottom line.”
Slip Opinion at 12.
D. Unjust Enrichment Claim
Chancellor Chandler tarried only a moment over this claim, noting that it applies only when it would be “unconscionable” to allow a party to retain a benefit, and the Delaware courts “have consistently refused to permit a claim for unjust enrichment when the alleged wrong arises from a relationship governed by contract.” Slip Opinion at 13.
E. What Might Have Been
One cannot read this decision without thinking of the famous case of Jordan v. Duff and Phelps, Inc., 815 F.2d 429 (7th Cir. 1987), discussed in my post of September 6, 2008. Jordan also involved an employee who terminated his employment with his employer (Jordan left to take another job). Unbeknownst to Jordan at the time he quit (he also received the book value of his shares of stock), his employer, Duff and Phelps, was in negotiations to merge. Had Jordan hung around longer, he would have received substantially more for his shares.
In this celebrated decision, in which Judges Easterbrook and Posner took opposing sides (Easterbrook for the majority, Posner in dissent), the Seventh Circuit concluded that, in such circumstances, Duff and Phelps had breached its duty of full disclosure to Jordan in connection with the redemption of his stock.
Jordan would have been in play in this case if Booz Allen had begun negotiations with Carlyle before Nemec and Wittkemper announced their decisions to retire in March 2006. But, as noted by Chancellor Chandler, the negotiations with Carlyle “began to emerge” in early 2007, too late for Nemec and Wittkemper to reach for Jordan v. Duff and Phelps. Too bad. Timing is everything.
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