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Delaware Court Of Chancery Rejects Claims Related To The Acquisition Of An Alleged Controller’s Portfolio Company For Failure To Plead Demand Futility
01/08/2024On December 28, 2023, Vice Chancellor Morgan T. Zurn of the Delaware Court of Chancery dismissed derivative breach of fiduciary duty and other claims asserted by a plaintiff shareholder after nCino, Inc. (the “Corporation”) acquired a portfolio company (the “Target”) of the Corporation’s alleged controlling shareholder. City of Hialeah Employees’ Retirement System v. Insight Venture Partners, LLC, C.A. No. 2022-0846-MTZ (Del. Ch. Dec. 28, 2023). Plaintiff generally contended that the Corporation overpaid for the Target to the benefit of the alleged controller and the detriment of the Corporation, as reflected in the decline in the Corporation’s stock price after the deal was announced. Plaintiff sought to establish that pre-suit demand was excused because the directors faced a substantial likelihood of liability and were beholden to the alleged controller. The Court found that plaintiff did not adequately allege that the board approved the acquisition in bad faith or lacked independence from the alleged controller and, therefore, failed to plead demand futility.
The Court highlighted that the Corporation had an exculpatory provision in its charter pursuant to Delaware General Corporation Law Section 102(b)(7). Therefore, plaintiff could not show a substantial likelihood of liability in the absence of bad faith. Plaintiff focused on aspects of the approval process, including an alleged lack of price negotiations, reliance on the financial advisor’s fairness opinion, and the alleged failure to consider a valuation of the Target based on the alleged controller’s prior investment in the Target.
As to plaintiff’s price-related contention, the Court found that the complaint’s own allegations showed that the board reasonably relied on the assessment of management regarding the “floor” that the Target would accept for the deal and the fairness opinion of the financial advisor. The court also noted that the board negotiated the cash portion of the cash/stock deal down from 50% to 20%, which enabled the Corporation to avoid having to raise funds for the deal.
Regarding the analysis of the Corporation’s financial advisor, plaintiff alleged that there were several flaws, including in the financial projections the advisor used. The Court, however, concluded: “Even if [p]laintiff’s criticisms are well-founded, quibbling with or criticizing a financial analysis falls far short of showing it was so facially flawed as to rebut the presumption that the directors relied on it in good faith.”
With respect to plaintiff’s allegation that the board was “unaware” of a relevant valuation of the Target based on a prior investment, the Court explained that the allegation assumed that the Target’s valuation was the same in 2018 as in 2021 and this “assumption is unreasonable.” The Court also noted that the allegation “sounds in the duty of care” and, therefore, does not present a substantial likelihood of liability for an exculpated board.
In sum, the Court concluded that it is unreasonable to infer from the complaint that the directors acted in bad faith. The Court highlighted that the board met several times, discussed the information it received, received updates from management, spoke directly with the founder and CFO of the Target, retained reputable advisors, and walled off the alleged controller’s board appointee from the acquisition process.
The Court also rejected the complaint’s allegations that half the directors lacked independence from the alleged controller. Among other things, the Court explained that “[a]ny power [the alleged controller] had or has to appoint and elect directors does not, alone, render [the Corporation’s directors beholden to [the alleged controller].” The Court also found that the complaint did not plead with particularity that the Corporation’s CEO and founder (one of the directors) was dependent on the controller with respect to his salary. The Court noted that the complaint undermined that inference by alleging that he had made $49 million in stock sales. The Court also concluded that (i) the complaint did not adequately plead that compensation to other directors was material and (ii) service on boards of other companies in which the alleged controller held investments is insufficient to demonstrate lack of independence.
