Delaware Court Of Chancery Declines To Dismiss Claims Related To Direct Offering At The Outset Of The Pandemic
On June 30, 2022, Chancellor Kathaleen St. J. McCormick of the Delaware Court of Chancery denied a motion to dismiss stockholder derivative claims for alleged breaches of fiduciary duty against the CEO/Chairman of an e-commerce car company (the “Company”). In Re Carvana Co. Stockholders Litigation, C.A. No. 2020-0415-KSJM (Del. Ct. Ch, Jun. 30, 2022). Plaintiffs alleged that the CEO/Chairman and his father controlled the Company and “orchestrated” a $600 million direct offering to selected investors in which they purchased $50 million of common stock in March 2020 when the Company’s stock price was depressed due to pandemic-related volatility. The Court held that plaintiffs adequately pleaded that pre-suit demand was excused because two of the Company’s other directors lacked independence from the CEO/Chairman. The Court further found that the transaction was subject to entire fairness—rather than deferential business judgment—review because it allegedly involved a non-ratable benefit not shared by the public stockholders and half the board lacked independence. Finally, the Court held that the CEO/Chairman’s abstention from the board’s vote approving the offering was insufficient to warrant dismissal at the pleadings stage.
Plaintiffs alleged that the direct offering was unnecessary as the Company had sufficient cash on hand and that it was conducted at a price that was below fair value. The Company’s stock price had been as high as $110 per share in February 2020 before declining to a low of less than $30 on March 20, 2020. The board approved the offering on March 27, 2020, in a range of $45-$55 per share on a day when the stock price closed at approximately $49. On March 29, 2020, the CEO/Chairman informed the board that management had decided to price the offering at $45, the lowest authorized price. By the middle of May 2020, the Company’s stock price reached $90 per share, and it exceeded $200 per share by August 2020. In the months that followed, the CEO/Chairman’s father allegedly sold shares for nearly $500 million in proceeds.
The Company had a six-member board when the complaint was filed. Defendants conceded that the CEO/Chairman was non-independent, and plaintiffs agreed that three directors were independent. The Court held that the complaint adequately pleaded that the remaining two directors lacked independence from the CEO/Chairman and his father. As to one, the Court highlighted among other allegations that the director (i) was given a job by the father after allegedly having been censured by the NYSE due to actions purportedly done on behalf of the father; (ii) rose to become CEO at the father’s company over a twelve-year period; and (iii) received a large (potentially multimillion dollar) investment from the father in a company founded by the director. As to the other, the Court noted, among other allegations, that (i) the director had been the longtime relationship banker for the CEO/Chairman’s father; (ii) the director gave the CEO/Chairman his first post-college job; (iii) the CEO/Chairman “returned the favor” when he hired the director’s son as an intern and gave him extraordinary opportunities; and (iv) the director was issued a unique grant of certain shares in the Company that became worth more than $24 million.
The Court also declined to dismiss the complaint for failure to state a claim. The Court found that plaintiffs “sufficiently alleged that [the CEO/Chairman] played a role in the negotiation, structuring, and approval of the Direct Offering such that his abstention [from the vote approving the offering] supplies no automatic victory at the pleadings stage.” For example, the complaint alleged that he led the discussions of the offering at each board meeting, reviewed the lists of selected holders to be invited to invest, and set the price of the offering within the range authorized by the board. The Court also explained that “[g]iven the fact-intensive nature of the entire fairness inquiry, dismissal is inappropriate.”