Delaware Court Of Chancery Holds That A Special Committee Must Be Constituted Ab Initio In Order To Cleanse A Transaction Involving A Conflicted Board Majority
On February 27, 2020, Vice Chancellor Sam Glasscock III denied a motion to dismiss breach of fiduciary duty claims brought by a former stockholder of Intersections, Inc. (the “Company”), challenging the take-private acquisition of the Company. Salladay v. Lev, C.A. No. 2019-0048-SG (Del. Ch. Feb. 27, 2020). The complaint alleged that the Company was sold at an unfairly depressed price and that insiders influenced the transaction to divert consideration to themselves. Moreover, plaintiff asserted that the transaction was subject to entire fairness review because at least half the directors were conflicted by virtue of having rolled over substantial portions of their equity into the merger. Although defendants did not contest that a majority of the board was conflicted, they argued that the claims should be dismissed under the business judgment rule because the deal was negotiated and approved by a special committee of unconflicted directors. The Court, however, held that “to effectively cleanse a transaction . . . the special committee must be constituted ab initio . . . prior to substantive economic negotiations.” The Court denied the motion to dismiss because it found that the complaint adequately pleaded the existence of substantive economic negotiations before the special committee was empowered.
Specifically, the complaint alleged that a representative of the acquiring joint venture met with the Company’s CEO and board chairman (one of the allegedly conflicted directors) before the special committee was constituted. At that meeting, the CEO allegedly told the joint venture representative that the board would be receptive to an acquisition offer of $3.50 to $4.00 per share. After the special committee was established, the joint venture conveyed its initial offer of $3.50 per share, which was increased to $3.68 after negotiations. The special committee recommended approval of the deal at the increased price. The Court noted that the initial offer was “at the precise bottom of the range” suggested by the CEO and found that the special committee was empowered “after the point at which it could act to replicate an arms-length transaction.”
The Court also declined to find the transaction entitled to deferential review under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), which applies when a transaction is approved by a fully-informed uncoerced vote of the disinterested stockholders, because the complaint sufficiently alleged that the proxy was materially misleading. The Court highlighted two alleged omissions. First, the proxy disclosed that, under a note purchase agreement entered into with the acquiring joint venture in parallel to the merger agreement, the joint venture had a contractual right to appoint a majority of the board if the merger agreement were terminated, subject to a NASDAQ listing rule that generally precluded disproportionate voting power. But it did not clearly disclose that the ownership stake of the joint venture was only 33.5%. The Court explained that the proxy suggested that the joint venture had a contractual right to control the board if the vote were unfavorable and left it to the stockholders to discern the application of the NASDAQ listing rule and “track down stock ownership numbers in the exhibits to complete the analysis.” Second, the proxy did not disclose why a financial advisor that was hired to evaluate the proposed transaction—after the price term was in place—terminated its engagement a few days later (and was, therefore, replaced by another advisor that provided a fairness opinion). The Court found “it reasonably conceivable that such disclosures, not made here, [were] material.”