Delaware Court Of Chancery Dismisses Derivative Claims Challenging A Convertible Debt Issuance At The Onset Of The COVID-19 Pandemic For Failure To Plead That Demand Was Excused
On November 23, 2021, Vice Chancellor Sam Glasscock III of the Delaware Court of Chancery dismissed stockholder derivative claims for breach of fiduciary duty against the directors of Wayfair, Inc. (the “Company”). Equity-League Pension Tr. v. Great Hill Partners, C.A. No. 2020-0992-SG (Del. Ch. Nov. 23, 2021). Plaintiff challenged the sale by the Company of $535 million in convertible notes at the outset of the COVID-19 pandemic to a consortium of investors allegedly tied to four of the Company’s directors, including the two co-chairmen, one of whom was also the CEO. There was no dispute that two of the nine board members were disinterested and independent. As to three others, plaintiff alleged that their service on the audit committee presented a substantial likelihood of liability because it was charged with reviewing conflicted transactions. Highlighting that the Company’s charter exculpated directors for breaches of the duty of care, however, the Court explained that the complaint must therefore plead bad faith, which it referred to as a “rara avis.” Although the Court acknowledged that the transaction was not a “model of best practices,” it found that the complaint and the documents incorporated by reference therein did not support an inference of bad faith.
As the pandemic began to take hold, the stock price of the Company—an online retailer of home goods—fell from over $72.50 per share on February 24, 2020 to $23.52 per share on March 19, 2020. The Company determined to issue debt in the form of convertible notes and invited several investors to submit indications of interest. Allegedly the board became involved on March 31, 2020, when it established a transaction committee of two directors, one of whom was also the CTO. On April 5, 2020, the transaction committee approved the transaction with the consortium of related investors, which had featured a conversion price of $72.50 per share.
The board met to consider the transaction the same day and the audit committee unanimously passed a resolution approving the deal during a five-minute break, after which the full board voted to approve the transaction as well. By August 5, 2020, the Company’s stock price exceeded $300 per share. To support its contention that pre-suit demand under Court of Chancery Rule 23.1 was excused, plaintiff argued that the audit committee hastily approved the transaction without becoming fully informed, including with respect to whether the terms were comparable to those that could have been obtained at arm’s length.
The Court found, however, that the documents incorporated by reference into the complaint demonstrated that a summary of the process, including discussions with potential investors and a comparison of the key terms of the lead proposals, had been delivered to the board in advance of the audit committee meeting. As a result, the Court determined that the audit committee was aware of negotiations with other arm’s-length bidders and key terms of alternative proposals, as well as the interests of the co-chairmen in the investor consortium. The Court held that “[t]he allegations that these Directors should have done more falls short of ‘[k]nowing or deliberate indifference’ to the risks” and were “insufficient to support an inference … [of] bad faith.”