Reinstating A Post-Closing Merger Challenge, Delaware Supreme Court Holds Views Expressed By Directors In Connection With A Transaction Vote Are Not Per Se Immaterial
02/27/2018On February 20, 2018, the Delaware Supreme Court, in an opinion by Chief Justice Leo E. Strine, Jr., reversed the dismissal of a suit brought by former stockholders of Diamond Resorts International (“Diamond”) challenging the company’s two-step cash-out merger. Appel v. Berkman, No. 316, 2017 (Del. Feb. 20, 2018). As discussed in our prior post on this case, the Delaware Court of Chancery dismissed plaintiffs’ breach of fiduciary duty claims because the disinterested stockholders of Diamond, who were “fully informed,” overwhelmingly accepted the tender offer. In reaching that decision, the Court of Chancery found it immaterial that the proxy did not disclose that Diamond’s chairman—who abstained from the board vote on the deal—had expressed disappointment with the price and indicated that “it was not the right time to sell.” Reversing and remanding, the Delaware Supreme Court held that when a board discloses its reasons for recommending a transaction, “the contrary view of an individual board member may be material.” In this case, the Delaware Supreme Court concluded, the chairman’s expressed views regarding the wisdom of the sale were material and the omission rendered the proxy misleadingly incomplete.
On June 26, 2016, at the conclusion of a public sales process, Diamond’s board voted in favor of the company’s sale for cash in a two-step merger involving a tender followed by a back-end merger under Delaware General Corporation Law Section 251(h). However, Diamond’s founder and chairman abstained from the vote and said he was abstaining because mismanagement of Diamond had negatively affected the sale price and it was therefore not the right time to sell the company. The merger proxy, which discussed at length the reasons for the merger, disclosed that all the directors voted in favor “with the exception of the Company’s chairman, who abstained.” The proxy did not provide a reason for the abstention. More than 80% of the outstanding shares were tendered and the merger closed on September 2, 2016. Thereafter, plaintiffs asserted claims for breaches of fiduciary duty against Diamond’s directors, alleging that the transaction was encumbered with conflicts and that the disclosures were materially false and misleading. The Court of Chancery dismissed the claims pursuant to Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), because of the shareholder tender. The Court of Chancery explained that “the significant weight of twenty-five years of Delaware authority” did not require disclosure of “the grounds of [an individual director’s] judgment for or against a proposed shareholder action.”
Reversing and remanding, the Delaware Supreme Court rejected the argument that the reasons for a dissenting or abstaining board member’s vote can never be material. Here, according to the Court, in the “high-stakes context” of “a sale for cash,” the fact that the chairman and founder— “a ‘key board member’ if ever there were one”—thought it was the wrong time to sell was material. As the Court explained, the disclosure of the chairman’s objections would have alerted stockholders to the possibility that a fair price might not have been obtainable at the time of the transaction. Therefore, the omission precluded the invocation of the business judgment rule at the pleading stage and necessitated a reversal of the dismissal. Significantly, however, the Delaware Supreme Court made it clear that it was not adopting a per se approach and that its decision “in no way implies that the reason for a particular director’s dissent or abstention will always be material.” Instead, the Court explained, a proper assessment of materiality involves a “contextual approach” entailing examination of the fact in question, which may include the fact that a director shared with the board particular reasons for his position on an important transaction.