(Article from Securities Law Alert, November 2015)
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On October 29, 2015, on a motion for reconsideration of In re Zale Corp. S’holdrs. Litig., 2015 WL 5853693 (Del. Ch. 2015) (Parsons, V.C.) (Zale I) in light of the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC, 2015 WL 5772262 (Del. Oct. 2, 2015) (Strine, C.J.) (Corwin), the Chancery Court dismissed claims alleging that Merrill Lynch had aided and abetted breaches of the duty of care by the directors of Zale in connection with its merger with Signet Jewelers. In re Zale Corp. S’holdrs. Litig., 2015 WL 6551418 (Del. Ch. 2015) (Parsons, Jr., V.C.) (Zale II). The Zale II court concluded that it had “misapprehended the law” and “incorrectly applied” the Revlon enhanced scrutiny standard of review in Zale I rather than the business judgment rule standard of review in considering whether plaintiffs had pled any predicate duty of care breaches by Zale’s directors.
The Zale II court further found that “under Corwin the gross negligence standard for a duty of care breach” applies and it was “not reasonably conceivable” that Zale’s directors had “breached their duty of care by acting in a grossly negligent manner as to their engagement of Merrill Lynch.”
Background
In Zale I, plaintiffs alleged, inter alia, that Zale’s directors had breached their duty of care by failing to “act in an informed manner” when they retained Merrill Lynch to act as the board’s financial advisor in connection with the company’s merger with Signet, and further alleged that Merrill Lynch had aided and abetted those breaches. Merrill Lynch had represented to Zale’s directors that it had “limited prior relationships and no conflicts with Signet,” when “[i]n fact Merrill Lynch [had] received approximately $2 million in fees from Signet from 2012 to 2013.” According to plaintiffs, prior to the board’s retention of Merrill Lynch as its financial advisor, Merrill Lynch did not inform Zale’s directors that the firm had made a presentation to Signet’s CFO regarding a possible acquisition of Zale at a price of between $17 and $21 per share and that a Merrill Lynch managing director who served on the team presenting to Signet, also served on the team that advised the Zale board during the merger with Signet. Plaintiffs alleged that the Signet presentation was not disclosed to Zale’s directors until after the merger agreement was signed.
In its October 1, 2015 decision, the Chancery Court determined that the Revlon enhanced scrutiny standard applied to plaintiffs’ claims against Zale’s directors even though the court found that a majority of Zale’s disinterested stockholders had approved the merger in a fully informed vote. The Zale I court declined to follow the Chancery Court’s approach in In re KKR Financial Holdings LLC Shareholder Litigation, 101 A.3d 980 (Del. Ch. 2014) (KKR Financial), which held that the business judgment rule governs transactions approved by a fully informed vote of a majority of disinterested stockholders. The Zale I court found that Delaware law on this issue was “unsettled.” The Zale I court explained that “[u]ntil the Delaware Supreme Court signal[ed] otherwise,” it would apply a “strict reading” of the Delaware Supreme Court’s decision in Gantler v. Stephens, 965 A.2d 695 (Del. 2009). The Zale I court interpreted Gantler as holding that “an enhanced standard of review cannot be pared down to the business judgment rule as a result of a statutorily required vote, even one rendered by a fully informed, disinterested majority of stockholders.” The Zale I court “conclude[d] that where, as here, the merger consideration paid to the target company’s shareholders [was] cash, Revlon enhanced scrutiny applie[d], even after the merger ha[d] been approved by a fully informed, disinterested majority of stockholders.”
Turning to the allegations of the complaint, the court found it “reasonably conceivable” that the Zale directors’ reliance “without question” on Merrill Lynch’s representations regarding its prior relationship with Signet “could constitute a breach of their duty of care in this Revlon context.” The Zale I court observed that in In re Rural Metro Corp., 88 A.3d 54 (Del. Ch. 2014), Vice Chancellor Laster had underscored that given the “central role played by investment banks” in the transactional process, “directors must act reasonably to identify and consider the implications of the investment banker’s . . . relationships, and potential conflicts.” The Zale I court explained that “[i]n the context of detecting a preexisting conflict when engaging a financial advisor, this oversight duty could include negotiating for representations and warranties in the engagement letter as well as asking probing questions to determine what sorts of past interactions the advisor has had with known potential buyers, such as Signet here.”
The Zale I court further determined that it was “reasonably conceivable” that the alleged failure by Merrill Lynch to disclose that it had previously made a presentation to Signet about a potential acquisition of Zale at a price between $17 and $21 per share had “hampered the ability of Merrill Lynch and, consequently, the Board to seek a higher price for Zale’s stockholders.”
While the Zale I court determined that Zale’s Section 102(b)(7) exculpatory provision shielded Zale’s directors from monetary liability for breaches of the duty of care, the court found that plaintiffs had adequately stated a claim against Merrill Lynch for aiding and abetting those breaches and therefore denied Merrill Lynch’s motion to dismiss plaintiffs’ claims.
Merrill Lynch Moves for Reconsideration Following the Delaware Supreme Court’s Decision in Corwin
The day after the Zale I court issued its decision, the Delaware Supreme Court affirmed the Chancery Court’s approach in KKR Financial. The Delaware Supreme Court held in Corwin that “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.” The Corwin court also clarified that Gantler did not focus on “the question of what standard of review applies if a transaction not subject to the entire fairness standard is approved by an informed, voluntary vote of disinterested stockholders.”
Merrill Lynch subsequently moved for reconsideration of the Chancery Court’s decision in Zale I. Merrill Lynch contended that the court should have applied the business judgment rule standard of review rather than the Revlon enhanced scrutiny standard when determining whether plaintiffs had adequately alleged a predicate breach of the duty of care by Zale’s directors. In a letter opinion dated October 29, 2015, the Chancery Court granted Merrill Lynch’s motion for reconsideration.
Chancery Court Finds Gross Negligence Is the Standard for Duty of Care Claims in Transactions Approved by a Fully Informed Majority of Disinterested Stockholders
On reconsideration in light of KKR II, the Chancery Court in Zale II determined that the business judgment rule was the appropriate standard of review given that a majority of Zale’s disinterested stockholders had approved the merger in a fully informed vote.
The Zale II court then considered the appropriate standard of review for rebutting the business judgment presumption and finding a breach of the duty of care in cases where, as here, “the merger has been approved by a majority of disinterested stockholders in a fully informed vote.” The Zale II court noted that in KKR Financial, Chancellor Bouchard stated that “the business judgment rule applies and insulates the transaction from all attacks other than on the grounds of waste.” However, the Zale II court found that in Corwin, the Delaware Supreme Court “suggested that ‘the gross negligence standard for director due care liability under Van Gorkom’ is the proper standard for evaluating ‘post-closing money damages claims’” (quoting Corwin, 2015 WL 5772262). The Zale II court also observed that in In re TIBCO Software, Inc. Stockholders Litigation, 2015 WL 6155894 (Del. Ch. Oct. 20, 2015) (TIBCO), a post-Corwin decision, the Chancery Court had applied a gross negligence standard in considering a motion to dismiss breach of the duty of care claims.
The Zale II court “conclud[ed] that when reviewing a board of directors’ actions during a merger process after the merger has been approved by a majority of disinterested stockholders in a fully informed vote, the standard for finding a breach of the duty of care under [the business judgment rule] is gross negligence.” The Zale II court explained that in order “[t]o support an inference of gross negligence, ‘the decision has to be so grossly off-the-mark as to amount to reckless indifference or a gross abuse of discretion’” (quoting Solash v. Telex Corp., 1988 WL 3587 (Del. Ch.1988)). The Zale II court emphasized that “gross negligence ‘requires the articulation of facts that suggest a wide disparity between the process the directors used . . . and [a process] which would have been rational’”(quoting TIBCO, 2015 WL 6155894).
Chancery Court in Zale II Dismisses Aiding and Abetting Claims Against Merrill Lynch Because There Were No Allegations That Zale’s Directors Had Been “Grossly Negligent”
Applying this standard to the allegations of the complaint, the Zale II court determined that it was “not reasonably conceivable that the Zale [d]irector [d]efendants [had] breached their duty of care by acting in a grossly negligent manner as to their engagement of Merrill Lynch.” Since the court found “no basis for a predicate fiduciary duty breach,” the court held that “the [c]omplaint also fail[ed] to allege that Merrill Lynch [had] aided and abetted such a breach.”