(Article from Securities Law Alert, April 2017)
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In Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015),[1] the Delaware Supreme Court held that the business judgment rule applies to transactions approved by “a fully informed, uncoerced vote of the disinterested stockholders.” On March 31, 2017, the Delaware Chancery Court declined to apply Corwin to a stockholder-approved transaction where plaintiffs alleged the vote was neither fully informed nor uncoerced. In re Saba Software Stockholder Litig., 2017 WL 1201108 (Del. Ch. 2017) (Slights, V.C.). Significantly, the court held that plaintiffs need not plead any affirmative action by a fiduciary in order to allege inequitable coercion in connection with a stockholder vote. Rather, the court found that “[i]nequitable coercion can exist . . . when the fiduciary fails to act when he knows he has a duty to act.”
Background
The company at issue allegedly “engaged in a fraudulent scheme . . . to overstate its pre-tax earnings.” When the alleged scheme came to light, the company “repeatedly promised regulators, its stockholders and the market that it would . . . restate its financial statements by a certain date.” However, “each time [the company] inexplicably failed to deliver the restatement by the promised deadline.” Ultimately, the SEC set a deadline and informed the company that its stock would be deregistered in the event of noncompliance.
Just days before the SEC’s deadline, the company executed a merger agreement. The company subsequently missed the SEC’s deadline. The SEC responded by revoking registration of the company’s stock, causing the stock price to drop substantially.
Following SEC deregistration, the company’s board presented stockholders with a choice either to vote in favor of the merger at a per-share price ”well below [the stock’s] average trading price over the past two years, or continue to hold their now-deregistered, illiquid stock.” A majority of the company’s shareholders voted to approve the merger.
A former stockholder later brought suit asserting a breach of fiduciary duty claim against the directors. Among other allegations, plaintiff contended that “the [b]oard rushed to complete the transaction . . . to enable the [b]oard and members of management to cash-in on their equity awards knowing that deregistration would ultimately render the awards practically worthless.”
Business Judgment Rule Standard of Review Is Inapplicable Because the Vote Was Not Fully Informed
The court rejected defendants’ contention that the merger had “been ‘cleansed’ by a fully informed, uncoerced stockholder vote.” The court explained that “the business judgment rule is not invoked” under Corwin “if troubling facts regarding director behavior were not disclosed that would have been material to a voting stockholder.” Id. (quoting Corwin, 125 A.3d 304).
Here, the court found there were two categories of alleged “material omissions from the [p]roxy [statement] that undermined the stockholder approval of the [m]erger”: (1) “the reasons why [the company] was unable to complete the restatement;” and (2) “the post-deregistration options available” to the company.
With respect to the first category of omissions, the court reasoned that “unless the stockholders were armed with information that would allow them to assess the likelihood that [the company] would ever complete a restatement of its financials, they would have [had] no means to evaluate the choice that they were being asked to make.”
As to the “post-deregistration options available to” the company, the court recognized that “Delaware law does not require management to discuss the panoply of possible alternatives to the course of action it is proposing. . . in a typical case. ”
However, the court found that this was “hardly a typical case.” Here, “a reasonable stockholder would have needed to understand what alternatives to the [m]erger existed” when “considering whether or not [the company] was viable as a going-concern without the [m]erger.”
Plaintiff Adequately Alleged the Vote Was Coerced
The court stated that “[i]n addition to requiring a fully informed stockholder vote as a predicate to cleansing, Corwin also directs that the court consider whether the [c]omplaint supports a reasonable inference that the stockholder vote was coerced.” The court explained that “[i]n the deal context, the vote must be structured in such a way that allows shareholders a free choice between maintaining their current status or taking advantage of the new status offered by the proposed deal.”
The court rejected defendants’ argument that “to find ‘actionable coercion’ the court must identify ‘some affirmative action by the fiduciary’” that impacted stockholders’ freedom of choice. The court held that “[i]nequitable coercion can exist as well when the fiduciary fails to act when he knows he has a duty to act and thereby coerces stockholder action.” Moreover, the court found that “whether the fiduciary’s motives were benign or unfaithful when creating the circumstances that cause coercion is not dispositive.”
In this case, the court found “the [allegedly] inequitable coercion flowed from the situation in which the [b]oard placed its stockholders as a consequence of its allegedly wrongful action and inaction.” The court held plaintiff adequately alleged the existence of “‘situationally coercive factors’ [that] may have wrongfully induced . . . stockholders to vote in favor of the [m]erger for reasons other than the economic merits of the transaction.”
[1] Please click here to read our prior discussion of the Corwin decision.