Delaware Court Of Chancery Applies Zapata To Assess New Board Committee’s Motion To Dismiss Claims Being Pursued By A Previously Established Special Committee
On December 14, 2020, Chancellor Andre G. Bouchard denied a motion to dismiss a lawsuit by a special committee of the board of The We Company (the “Company”) against the Company’s new controlling stockholder and its affiliates (collectively, the “New Controller”). In Re WeWork Litigation, C.A. No. 2020-0258-AGB (Del. Ch. Dec. 14, 2020). After the New Controller acquired control in a multi-step transaction, the Company’s board established a new committee, which determined that the special committee lacked authority to continue the suit and directed management to move to dismiss. The Court noted that this presented an issue of first impression. The Court determined to engage in an analysis akin to that developed for assessing special committee motions to dismiss derivative claims under Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981). Zapata entails a two-part assessment (i) testing the independence, good faith and reasonableness of the investigation, and (ii) applying the court’s own independent business judgment as to whether the motion should be granted. The Court denied the motion because it found (i) the new committee did not establish the reasonableness of its investigation and conclusions, and (ii) the special committee was authorized to pursue the litigation and it would be “fundamentally unfair” to dismiss the claims.
The special committee had been established to evaluate strategic alternatives and negotiate a potential transaction. It negotiated an agreement with the New Controller, which was to provide $1.5 billion in equity financing and up to $5 billion in debt financing. The New Controller was also required to purchase up to $3 billion of the Company’s stock in a tender offer. Although the New Controller complied with its other obligations under the agreement, it terminated the tender offer, asserting that certain closing conditions had not been satisfied. The special committee filed suit on behalf of the Company against the New Controller, asserting breach of contract claims. The board thereafter established a new committee consisting of two temporary directors to determine whether the special committee had the authority to commence or should have the authority to continue the litigation. After an investigation, the new committee issued a report finding that the special committee did not have the authority to file this lawsuit and directed management to move to dismiss.
The Court framed the issue as follows: “Should a temporary committee of a board of directors created in response to the filing of a lawsuit against the corporation’s new controlling stockholders … be permitted to terminate the lawsuit, which an earlier committee of the board filed on behalf of the corporation with the support of the Company’s management and its outside counsel to enforce the corporation’s contractual rights against them?” The Court viewed this as similar to a Zapata scenario because they both involve a “fully-authorized board committee to determine whether viable claims of the corporation should be dismissed.”
Under the first prong of Zapata, the Court found there were “significant shortcomings and errors in the New Committee’s report.” The Court held that the “plain language” of the board’s resolutions establishing the special committee and the agreement with the New Controller made it clear that the special committee had the authority to file the litigation. For example, the special committee was “authorized to exercise all rights and powers of the Board to the fullest extent permitted by the Delaware General Corporation Law in connection with a Potential Transaction.” This interpretation was also supported by extrinsic evidence, including statements by the Company’s transaction counsel that drafted the resolutions. Yet, the Court found that the new committee apparently did not consider such extrinsic evidence even though it found the resolutions ambiguous.
While it was not necessary to apply the second prong of Zapata, given that the first was not satisfied by the new committee, the Court did so because of the “unique circumstances of this case.” In this regard, the Court found that, “[a]s an overarching matter,” the special committee was authorized to file and pursue the action and it would be “fundamentally unfair” to dismiss the case and “constrain the ability” of tendering stockholders to obtain relief. The Court noted that it was “appropriate and necessary” in this case not involving a derivative claim to consider the interests of the minority stockholders who tendered shares in the tender offer and stood to receive the monetary recovery. The Court also explained that “one of the animating principles of Zapata” is to enable corporations to “rid themselves of meritless or harmful litigation and strike suits” brought derivatively by a stockholder. The Court found that concern “not relevant here” where the breach of contract claim was “clearly viable” rather than “frivolous.”