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Delaware Chancery Court Issues Back-to-Back Decisions Regarding the Application Of Corwin Liability Shield In Post-Closing Merger Challenges
09/06/2016On August 24, 2016, Chancellor Andre G. Bouchard of the Delaware Court of Chancery dismissed a shareholder action seeking post-merger damages for breach of fiduciary duty against the directors and officers of C&J Energy Services, Inc.. City of Miami General Employees and Sanitation Employees Retirement Trust v. Jerry M. Comstock Jr., et al., C.A. No. 9980-CB (Del. Ch. August 24, 2016) (“C&J”). The Court held that allegations that the majority of the board was interested in the transaction during its consideration were insufficient to rebut the business judgment presumption that applied once a majority of shareholders voted to approve the transaction. The following day, on August 25, 2016, Vice Chancellor Joseph R. Slights III of the Delaware Court of Chancery dismissed an action brought by former shareholders of Auspex Pharmaceuticals, Inc. for breach of fiduciary duty against the company’s directors and officers, which was also based on a sale of the company that had been overwhelmingly approved by the company’s shareholders. Larkin v. Shah, C.A. No. 10918-VCS (Del. Ch. Aug. 25, 2016) (“Auspex”). Both decisions turned on the application of the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), which held that the business judgment rule applies to a court’s review of a transaction that is approved by a majority of a company’s disinterested and uncoerced stockholders upon a fully informed vote.
In C&J, plaintiff challenged the board’s approval of the company’s merger with Nabors Industries Ltd. (“Nabors”) based on alleged misrepresentations and omissions in the merger proxy and the directors’ alleged personal interests in the post-merger compensation packages and promises of continued service on the combined company’s board. Chancellor Bouchard first addressed plaintiff’s disclosure claims, explaining that in light of the shareholders’ vote to approve the transaction, analyzing the disclosures was also necessary to determine whether plaintiff’s fiduciary duty claims would be evaluated under the business judgment rule pursuant to Corwin. Chancellor Bouchard ultimately dismissed plaintiff’s disclosure claims, finding the allegations insufficiently supported and otherwise immaterial.
Turning to plaintiff’s fiduciary duty claims, Chancellor Bouchard noted that under Corwin, the business judgment rule would apply “unless plaintiff can establish a basis for applying entire fairness to the Nabors transaction.” After extensive analysis of the allegations, Chancellor Bouchard ultimately determined that a heightened “entire fairness” review was unwarranted because plaintiff’s allegations about a conflicted board neither (1) supported a finding that a majority of the board was interested in the transaction or lacked independence, or (2) adequately alleged that the C&J board was deceived by its chairman and CEO, Jerry Comstock, in relation to the transaction. Thus, despite dismissing plaintiff’s breach of fiduciary duty claims, the C&J decision implies that plaintiffs may attempt to rebut the presumption of the business judgment rule to invoke entire fairness—by demonstrating the interestedness of the board—even after a majority of the shareholders approve the transaction upon a fully informed vote.
Not so in Auspex. In Auspex, plaintiffs alleged breaches of fiduciary duty, challenging the Auspex board’s decision to sell the company to Teva Pharmaceuticals in a two-step tender offer and merger pursuant to Section 251(h) of the Delaware General Corporation Law. Specifically, plaintiffs alleged that Auspex’s CEO and certain board members, who had ties to venture capital firms that held a significant stake in Auspex, recommended that shareholders accept an early all-cash offer submitted by Teva to satisfy the venture capital firms’ alleged need for liquidity rather than negotiate a better deal for all shareholders. Plaintiffs alleged that these venture capital investors constituted a self-interested controlling shareholder block. But Vice Chancellor Slights rejected these allegations, holding that the venture capital investors’ ownership of 23.1% of Auspex’s stock was insufficient to render them a controlling stockholder block.
More fundamentally, the Court held that under Corwin, “the effect of disinterested stockholder approval of the merger [absent a controlling stockholder] is review under the irrebuttable business judgment rule, even if the transaction might otherwise have been subject to the entire fairness standard due to conflicts faced by individual directors.” Thus, in contrast with the approach in C&J, the Court found that it did not need to consider plaintiffs’ additional claims that a majority of the directors were interested in the transaction. Therefore, the Court dismissed plaintiff’s fiduciary duty claims once it determined that the merger was approved by a fully informed, disinterested, and uncoerced majority of the stockholders that tendered their shares.
