Delaware Supreme Court Revives Stockholder Claims, Finding MFW Protections Were Not In Place Prior To Economic Negotiations
04/16/2019On April 5, 2019, the Delaware Supreme Court reversed in part and affirmed in part a decision of the Delaware Court of Chancery that had dismissed a stockholder challenge to an all-stock business combination between Earthstone Energy, Inc. (“Earthstone”) and Bold Energy III LLC (“Bold”). Olenik v. Lodzinski et al., No. 392, 2018 (Del. April 5, 2019). Plaintiffs claimed that Earthstone’s directors, officers, and Earthstone’s alleged controlling stockholder, Oak Valley Resources, LLC (“Oak Valley”), breached their fiduciary duties by entering into an unfair transaction that benefited Oak Valley and EnCap Investments, L.P. (“EnCap”), a private equity firm with majority stakes in both Bold and Oak Valley, at the expense of Earthstone and its minority stockholders. As discussed in our prior post on the case, the Court of Chancery dismissed the case after concluding that the transaction was properly structured under Kahn v. M&F Worldwide, 88 A.2d 635 (Del. 2014) (“MFW”), and the business judgment rule applied. On appeal, the Delaware Supreme Court reversed, finding that Earthstone initiated economic negotiations before the requisite MFW protections were put in place. Accordingly, the Court reinstated the breach of fiduciary claim as to the terms of the transaction; the Court sustained dismissal of the disclosure-based claim.
The Court of Chancery had determined that, although Earthstone’s initial discussions with EnCap and Bold allegedly had been ongoing for months before EnCap’s special committee made a formal offer, those negotiations “never rose to the level of bargaining” and “were entirely exploratory in nature.” The trial court dismissed the complaint because it found that the opening offer contained the required MFW deal protections (i.e., approval by a special committee and a majority of the minority stockholders). The Delaware Supreme Court disagreed, concluding that the negotiations between Earthstone and Bold before the formal offer went beyond preliminary discussions and served as the framework for economic negotiations because, among other things, Earthstone presented two proposed valuations of Bold to EnCap, in which Earthstone management valued Bold at $305 million in the first and $335 million in the second. The Court found that “[b]ased on these facts, it is reasonable to infer that these valuations set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made.”
The Delaware Supreme Court explained that the Court of Chancery’s dismissal was inconsistent with the Supreme Court’s subsequent decision in Flood v. Synutra, 195 A.3d 754 (Del. 2018) (see our post). Synutra clarified that the MFW conditions must be in place “at the beginning stage of the process . . . before any negotiations commence between the Special Committee and the controller over the economic terms of the offer.” The present decision confirms that where “the plaintiff has pled facts that support a reasonable inference that the two procedural protections were not put in place early and before substantive economic negotiation took place, the plaintiff has met his pleading-stage burden” and the complaint should not be dismissed on MFW grounds.