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  • Delaware Chancery Court Enjoins Directors From Implementing Board Reduction Plan
     

    05/31/2016
    Vice Chancellor Laster of the Delaware Chancery Court enjoined certain directors of Cogentix Medical, Inc. from implementing a plan to reduce the size of the Company’s board to defeat a proxy fight.  Pell v. Kill, C.A. No. 12251-VCL (Del. Ch. May 19, 2016).  The opinion’s application of Delaware’s standard for reviewing director action that affects shareholder voting strongly favors protecting stockholder voting rights.

    Cogentix was formed through a merger between Vision-Sciences, Inc. (“VSI”) and Uroplasty, Inc. in March 2015.  After the merger, disputes arose between legacy management, which culminated in a threatened proxy contest by a former VSI director, Lewis Pell.  Pell argued to the Cogentix board—the majority of whom were legacy-Uroplasty directors, including CEO, President, and Chairman Robert Kill—that Kill exercised too much control.  Kill, along with two legacy-Uroplasty directors, forced a board vote to reduce the size of the board so that Pell could not gain control in the proxy fight.  Pell sued Kill and the legacy-Uroplasty directors and sought preliminary injunctive relief to halt implementation of the board reduction plan. 

    First, in assessing the probability of success on the merits, Vice Chancellor Laster applied enhanced scrutiny to the defendant directors’ decision-making because the directors’ conduct “‘affect[ed] . . . an election of directors’” and “‘touch[ed] on matters of corporate control.’”  Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 811 (Del. Ch. 2007).  Under that standard, “the defendant fiduciaries bear the burden of proving (i) that ‘their motivations were proper and not selfish,’ (ii) that they ‘did not preclude stockholders from exercising their right to vote or coerce them into voting a particular way,’ and (iii) that the directors’ actions ‘were reasonable in relation to their legitimate objective.’”  Id. at 810-11.
       
    Vice Chancellor Laster assumed that the defendant directors’ motives were proper but found that it was reasonably probable that they could not satisfy the second or third factors of the enhanced scrutiny test.  Specifically, the court found that the defendant directors approved the board reduction plan to avoid a proxy fight.  The court also rejected the directors’ attempt to justify their actions by arguing that stockholders did not know what was best for them.  According to the court, the other explanations proffered by the defendants—cost savings and greater efficiency—were insufficient to justify foreclosing a proxy contest. 

    Second, the court found that the shareholders were subject to irreparable harm as they were to be denied the right to vote.  Finally, the court ruled that the equities weighed in favor of granting the injunction because “‘the interests of corporate democracy on which [stockholders] rely have the greatest effect on the balance of the equities.’” Sherwood v. Ngon, 2011 WL 6355209, at *15 (Del. Ch. Dec. 20, 2011).
    CATEGORY: Fiduciary Duties