(Article from Securities Law Alert, October/November 2019)
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On November 1, 2019, the Delaware Supreme Court affirmed the dismissal of a shareholder class action alleging that a company’s controlling stockholder “orchestrated a sale of the company [to a third party] for less than fair value to address a personal need for liquidity prompted by his retirement as the company’s CEO.” English v. Narang, 2019 WL 1300855 (Del. Ch. Mar. 20, 2019) (Bouchard, C.), aff’d, 2019 WL 5681416 (Del. Nov. 1, 2019) (Vaughn, Jr., J.). The Chancery Court found plaintiffs alleged “no concrete facts from which it can reasonably be inferred that [the CEO] had an exigent or immediate need for liquidity” that created a disabling conflict of interest with respect to the transaction. Because the court found the transaction was approved by a majority of the company’s uncoerced and fully-informed stockholders, the court determined that “the [t]ransaction is governed by the business judgment rule under Corwin and its progeny” rather than the entire fairness standard of review.[1]
Plaintiffs alleged that when the CEO “decided to retire in mid-2015 at seventy-three years of age, he needed to liquidate his position as part of his estate planning and wealth management strategy because his [company stock] holdings accounted for nearly all of his net worth.” English, 2019 WL 1300855. Plaintiffs relied on N.J. Carpenters Pension Fund v. infoGROUP, 2011 WL 4825888 (Del. Ch. Sept. 30, 2011, revised Oct. 6, 2011). There, the Chancery Court found plaintiffs adequately alleged that a controlling stockholder “forced” the sale of a company “at an inopportune time and utilizing a flawed and inadequate sales process,” so that the controller “could obtain desperately needed liquidity.” infoGROUP, 2011 WL 4825888. The infoGROUP plaintiffs alleged that the controller had over $25 million in debts at the time the complaint was filed, and had not received a salary since the controller was pushed out of his role as the company’s CEO.
Defendants in English argued that the Chancery Court’s decision in In re Synthes Shareholder Litigation, 50 A.3d 1022 (Del. Ch. 2012), provided a closer analogy. There, the court declined to apply the entire fairness standard of review to a transaction that was allegedly motivated by a controlling stockholder’s need for liquidity. The Synthes court found that “a controlling stockholder’s immediate need for liquidity” might “constitute a disabling conflict of interest” only in “very narrow circumstances.” Synthes, 50 A.3d 1022. The court stated that “[t]hose circumstances would have to involve a crisis, fire sale where the controller, in order to satisfy an exigent need (such as a margin call or default in a larger investment) agreed to a sale of the corporation without any effort” to provide “logical buyers” with the opportunity to “make a bid that would reflect the genuine fair market value of the corporation.” The Synthes court dismissed the complaint because there were “no well-pled facts to suggest that [the CEO] forced a crisis sale of [the company] . . . to satisfy some urgent need for cash.”
In English, the Chancery Court found the allegations “similar to those pled in Synthes” and “dramatically different than the situation in infoGROUP.” 2019 WL 1300855. The court noted that plaintiffs had “not identified any allegations of fact . . . about [the CEO’s] estate planning or wealth management strategy to support the inference that he was seeking to liquidate his shares quickly.” Moreover, the court found the complaint “devoid of any facts suggesting” that the CEO had “debt obligations, needed to exit his position [at the company] in order to pursue a new business venture, or had admitted to others a need for liquidity.” The court also deemed it significant that the company engaged in a lengthy sales process that included outreach to “numerous potential buyers.” The court concluded that plaintiffs “failed to plead facts to support a reasonable inference that [the CEO’s] retirement . . . posed some sort of exigency or emergency where he needed liquidity fast so as to create a disabling conflict of interest with respect to the [t]ransaction.” The court therefore found that “no basis exists to subject the [b]oard’s consideration of the [t]ransaction to entire fairness review,” and dismissed the complaint based on application of the business judgment rule.
The Delaware Supreme Court affirmed the dismissal of the complaint “on the basis of and for the reasons assigned by” the Chancery Court. English, 2019 WL 5681416.
[1] In Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015), the Delaware Supreme Court held 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 rule also applies when a majority of disinterested stockholders tender their shares in the first step of a two-step merger under 8 Del. C. § 251(h). See In re Volcano Corporation Stockholder Litig., 143 A.3d 727 (Del. 2016). Please click here to read our discussion of the Delaware Supreme Court’s decision in Corwin, and here to read our discussion of the Chancery Court’s decision in Volcano.