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Delaware Chancery Applies Entire Fairness Standard, Denies Dismissal of Shareholder Suit Based on Claims that Directors Usurped Corporate Opportunity and Approved Merger to Avoid Liability
08/08/2016On July 28, 2016, Vice Chancellor Sam Glasscock III of the Delaware Chancery Court largely denied motions to dismiss a breach of fiduciary suit brought by former minority stockholders of Riverstone National, Inc. (“Riverstone”) against CAS Capital Ltd. (“CAS”), the majority stockholder of Riverstone, the Riverstone board (“Director Defendants”), and, nominally, Riverstone. In re Riverstone Nat’l, Inc. Stockholder Litig., Consol. C.A. No. 9796-VCG (Del. Ch. July 28, 2016). The Court applied the entire fairness standard to the merger because plaintiffs alleged that the Director Defendants usurped corporate opportunities and then caused Riverstone to enter into a merger with Greystar Real Estate Partners (“Greystar”) to extinguish said claims (the “Usurpation Claims”). Applying Delaware’s “reasonably conceivable” pleading standard, the Court held that plaintiffs adequately pleaded a claim for breach of loyalty in connection with the approval of the merger.
The Usurpation Claims arose from Riverstone’s expansion into residential property management through Invitation Homes, which acquires, renovates, and leases single-family homes. Invitation Homes became integral to Riverstone’s business as Riverstone developed a separate division dedicated solely to managing the single-family properties in Invitation Homes’ portfolio. While certain of Riverstone’s directors and officers acquired ownership interests in Invitation Homes, plaintiffs alleged that Riverstone could have done so but did not because the Director Defendants usurped the opportunity. Plaintiffs alleged that the board knew that their investments in Invitation Homes presented a conflict. On May 20, 2014, plaintiffs informed Riverstone of the Usurpation Claims and demanded they be allowed to inspect Riverstone’s books and records. Riverstone refused. On May 30, 2014, Riverstone executed the merger agreement with Greystar, which released the Usurpation Claims, with the consent of CAS (as majority shareholder).
The Court first addressed the issue of standing, holding that even though the merger extinguished the Usurpation Claims, plaintiffs had standing to pursue the breach claims because plaintiffs asserted that they received inadequate value for the merger and, therefore, the claims were direct. The Court explained that, under these circumstances, In re Primedia, Inc. Shareholders Litigation, 67 A.3d 455 (Del. Ch. 2013) (holding that even though plaintiffs’ standing to bring derivative claims was extinguished by a merger, plaintiffs could assert direct claims challenging the entire fairness of merger because the board failed to obtain adequate value for the loss of the derivative claims), was inapposite because the claims at issue in Riverstone concerned the Director Defendants’ allegedly unfair conduct in approving the merger, an obviously direct claim.
The Court next turned to whether the complaint rebutted the business judgment presumption. Although the Court acknowledged that accepting plaintiffs’ theory—that directors are interested actors when a merger extinguishes derivative claims—could lead to a proliferation of strike suits, under the circumstances alleged, the Court found the theory sustainable based on a four-factor analysis: (i) whether the Usurpation Claims (if asserted) would have met Delaware’s low-bar standard of “reasonable conceivability,” (ii) whether a majority of the Director Defendants knew about the Usurpation Claims when recommending the merger, (iii) whether the Director Defendants’ potential liability for the Usurpation Claims would have been material to the Director Defendants, and (iv) whether the merger actually extinguished the Usurpation Claims.
After concluding that the answer to each factor was yes, the Court found the business judgment presumption was rebutted and that the merger was subject to an entire fairness review. The Court determined that the plaintiffs’ assertion that the Usurpation Claims were worth approximately $4.5 million, and that the shareholders received no consideration in exchange for giving up those claims under the terms of the merger agreement (which valued Riverstone at $94 million) was “reasonably conceivable” such that the claims survived dismissal, even though the Court questioned whether materiality would ultimately be provable.
Notably, the Court declined to address as untimely the argument advanced solely on reply by two of the five Director Defendants, who were not alleged to have usurped any corporate opportunity, that Riverstone’s exculpation clause mandated dismissal. Finally, the Court dismissed Riverstone as a defendant because “fiduciary duties are owed by the directors and officers of a corporation and not by the corporation itself.”
