As discussed in prior posts on the Cleary M&A and Corporate Governance Watch blog, recent applications of the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015) have emphasized the high bar for surviving a motion to dismiss in damages actions by stockholder plaintiffs after completion of a merger transaction, as “dismissal is typically the result” where informed, disinterested stockholder approval requires application of the business judgment rule to extinguish all claims except for waste. See Singh v. Attenborough, 137 A.3d 151, 152 (Del. 2016). Two recent Chancery Court decisions have further underscored the claim-extinguishing effect of informed, disinterested stockholder approval.
In the first, City of Miami Gen. Employees v. Comstock, No. CV 9980-CB, 2016 WL 4464156 (Del. Ch. Aug. 24, 2016), Chancellor Bouchard dismissed plaintiff’s post-closing damages claim after over 97% of the target’s stockholders voted to approve the transaction. Despite “the preference under Delaware law” that disclosure allegations be litigated pre-closing, Comstock, 2016 WL 4464156 at *9, the Court considered the merits of plaintiff’s various post-closing disclosure claims, as Corwin requires an informed stockholder electorate for the vote to be given cleansing effect. The Court concluded that plaintiff’s disclosure claims were meritless, necessitating dismissal of all non-waste claims under “a straightforward application of Corwin and Attenborough” unless the transaction were subject to entire fairness review. Id. at *17. Attempting to invoke entire fairness, plaintiff pointed to (a) the target’s board members’ purported desire for board seats in the surviving entity, and (b) the alleged tainting effect of the target’s CEO’s pursuit of a post-closing position, id. at *17, but neither argument persuaded the Court, which noted the board’s majority of outside directors and the absence of any self-interested “duplicitous conduct” by the CEO. Id. at *18-21. As such, plaintiff’s breach of fiduciary duty claims were dismissed, as were its aiding and abetting claims against the target’s financial advisor, the buyer, and others.
While neither argument for entire fairness review prevailed in Comstock, the Court’s decision necessarily assumed that several different triggers for entire fairness review, including allegedly conflicted target board members, could preclude claim extinguishment. The day after Comstock was decided, however, Vice Chancellor Slights outlined a much narrower scope for entire fairness review in post-closing actions, which would require that “a controlling stockholder [have] extracted personal benefits” from the merger for entire fairness to apply following informed, disinterested stockholder approval and thus to avoid claim extinguishment. Larkin v. Shah, C.A. No. 10918-VCS, 2016 WL 4485447, at *1 (Del. Ch. Aug. 25, 2016). Larkin concerned a post-closing challenge to a two-step merger pursuant to Section 251(h) of the Delaware General Corporation Law, in which 78% of stockholders tendered their shares. Labeling the cleansing effect of informed, disinterested stockholder approval as the “irrebuttable” business judgment rule, the Court contrasted scenarios involving a conflicted board and a controlling stockholder involved in a conflicted transaction, both of which trigger entire fairness outside the merger context. Id. at *8. The Court concluded that only the latter case should require entire fairness review in post-closing actions following fully-informed stockholder approval, as only controlling stockholder cases involve “[c]oercion[,] [which] is deemed inherently present in controlling stockholder transactions . . . , but not in transactions where the concerns justifying some form of heightened scrutiny derive solely from board-level conflicts or lapses of due care.” Id. at *12 (emphasis added). Thus, in the absence of a “looming conflicted controller,” id. at *13, the business judgment rule, “irrebuttable in this context,” id. at *8, would cleanse the transaction of all claims save waste. With no “looming conflicted controller” or pled claim for waste, plaintiffs’ complaint was easily dismissed, with prejudice, as plaintiffs had no hope of alleging waste.
In the year since Corwin was decided, Delaware courts have only strengthened the deference afforded to informed, disinterested, uncoerced stockholder approval of merger transactions. As such, robust pre-closing disclosures should in most cases be sufficient to extinguish nearly all post-closing damages claims, although transactions involving (or alleged to involve) controlling stockholders will continue to receive additional scrutiny. Finally, with at least one pending appeal concerning the cleansing effect of Corwin, the Delaware Supreme Court will no doubt be providing further guidance concerning the post-closing application of the irrebuttable business judgment rule.
This post comes to us from Cleary Gottlieb Steen & Hamilton LLP. It is based on the firm’s client update, “Recent Applications of Corwin v. KKR Financial Holdings LLC Confirm High Bar to Pleading Post-Closing Damages Actions,” dated September 12, 2016, and available here.