In a series of decisions that began with Corwin v. KKR Financial Holdings LLC, it is now clear under Delaware law that boards of directors will receive the protection of the business judgment rule “when a merger that is not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders.”[i] On March 31, 2017, in In re Saba Software, Inc. Stockholder Litigation, the Delaware Chancery Court determined, for the first time, that a transaction did not satisfy the Corwin standard.[ii] Although Saba addresses unique facts, the opinion provides useful guidance on the required level of disclosure to ensure that the “fully informed” prong under Corwin is satisfied, as well as on how Delaware courts analyze the “coerciveness” of a transaction.
Saba arose from the acquisition in 2015 of Saba Software, Inc. (“Saba”) by affiliates of Vector Capital Management, L.P. (“Vector”) in an all-cash merger (the “Merger”). Prior to the Merger, the SEC had filed a complaint accusing Saba of overstating its pretax earnings from 2008 to 2012. After the fraud was uncovered, Saba offered assurances that it would restate its earnings (the “Restatement”), but repeatedly missed deadlines to do so. In June 2013, Nasdaq delisted Saba’s common stock, which began trading over-the-counter. In September 2014, Saba and the SEC reached a settlement pursuant to which Saba was required to complete the Restatement by February 2015. Saba announced that it would complete the Restatement on time, but later concluded that it would miss the deadline. In November 2014, the Saba board of directors formed an ad hoc committee (the “Committee”) to consider strategic alternatives for the company, including a sale. In December 2014, Saba announced that it would miss the SEC’s deadline for the Restatement. In February 2015, when Saba formally missed the deadline, the SEC issued an order to deregister Saba stock, which rendered the stock illiquid.
Saba signed a merger agreement with Vector in early March 2015. In seeking stockholder approval of the Merger, Saba distributed a proxy statement to its stockholders (the “Proxy Statement”), which stated, among other things, that Saba intended to complete the Restatement by August 2015, and included valuations of the company based on this and other timelines. Because Saba’s stock was deregistered, Saba was not required to submit its Proxy Statement or financial statements to the SEC for review, which allowed it to accelerate the stockholder vote. Three weeks after the Proxy Statement was distributed, Saba’s stockholders voted to approve the Merger. Following the closing of the Merger, a former Saba stockholder filed a complaint alleging that the members of Saba’s board of directors breached their fiduciary duties, and were aided and abetted by Vector. The defendants moved to dismiss the post-closing complaint.
The Court denied the motion to dismiss in part on the grounds that the stockholder vote was neither “fully informed” nor “uncoerced” under Corwin and, as such, the Merger was subject to enhanced scrutiny under Revlon. The Court found that the Proxy Statement contained two material omissions of fact. First, the Proxy Statement failed to describe the circumstances surrounding Saba’s failure to complete the Restatement, which led to the deregistration of Saba’s stock. The Court distinguished this from a typical claim in which a proxy statement provides the facts surrounding a board’s decision without explaining its underlying rationale; in considering such claims, Delaware courts have previously held that Delaware law “does not require management to discuss the panoply of possible alternatives to the course of action it is proposing” on the premise that stockholders “entrust management with evaluating the alternatives and deciding which fundamental changes to propose.”[iii] By contrast, in omitting the reasons for Saba’s failure to complete the Restatement, the Proxy Statement did not allegedly omit a “purposeful decision of the Board” but rather a “factual development that spurred the sale process and, if not likely correctible, would materially affect the standalone value of Saba going forward.”[iv] Even though the Proxy Statement described the consequences of deregistration and provided estimates of the value of the company based on possible dates by when the Restatement would be completed, the Court determined that the company’s history of failing to meet Restatement deadlines meant that the stockholders could not meaningfully assess the credibility of those valuations.
Second, the Court found that the Proxy Statement omitted material facts relating to the Committee’s consideration of the company’s strategic options in December 2014 once it had become clear that Saba would miss the Restatement deadline and have its stock deregistered. Noting that details concerning alternative courses of action ordinarily need not be disclosed, the Court nonetheless found that the company’s realization that it would miss the Restatement deadline “caused a fundamental change to the nature and value of the stockholder’s equity stake in Saba.” Further, this realization “dramatically affected the environment in which the Board conducted the sales process” and so necessitated disclosure to stockholders regarding whether Saba was viable as a going concern if the Merger were not approved.
In addition, the Court found that the stockholder vote was coerced, which the Court framed as “whether the stockholders have been permitted to exercise their franchise free of undue external pressure created by the fiduciary [i.e., in this case, the board of directors] that distracts them from the merits of the decision under consideration.”[v] Here, the Court found that the Proxy Statement only gave stockholders a “Hobson’s choice” between proceeding with the Merger or holding onto their stock, but without the information that would permit stockholders “to assess whether the choice of rejecting the Merger and staying the course made any sense.” As such, the stockholders had “no practical alternative” but to vote for the Merger. Notably, the Court found that coercion does not require identifying some “affirmative action” by the board of directors that would have caused the stockholders who rejected the Merger to be placed in a “worse position than they occupied before the vote”; rather, coercion can exist when a board of directors permits “situationally coercive factors” to force the stockholders to vote a particular way.
It is important to highlight that Saba reaffirmed that the Corwin standard remains alive and well and will only be overcome based on unusual facts—indeed, the holding in Saba is consistent with the Delaware Supreme Court’s original admonition in Corwin that “if troubling facts regarding director behavior were not disclosed that would have been material to a voting stockholder, then the business judgment rule is not invoked.”[vi] In this regard, the Saba Court’s examination of whether the stockholder vote was coerced is coterminous in many respects with its consideration of whether the Proxy Statement omitted material facts. The gravamen of the Court’s analysis was the absence of information in the Proxy Statement that would permit stockholders to assess whether the Restatement would be completed and, as such, whether the company’s stock could begin to trade freely again. In other words, stockholders were “coerced” not because of their “Hobson’s choice” to either accept cash or retain their illiquid stock, but rather because the Proxy Statement omitted certain material facts necessary for the stockholders to reach any credible conclusions regarding the value of their stock.[vii]
[ii] In re Saba Software, Inc. S’holder Litig., C.A. No. 10697-VCS, 2017 WL 1201108 (Del. Ch. Mar. 31, 2017).
[iii] In re 3Com S’holders Litig., C.A. No. 5067-CC, 2009 WL 5173804, at *6 (Del. Ch. Dec. 18, 2009) (internal quotation marks and citations omitted).
[iv] Saba Software, 2017 WL 1201108, at *12.
[v] Id. at *16.
[vi] Corwin, 125 A.3d at 312.
[vii] As the Corwin standard requires that stockholders voting to approve a transaction must be both “fully informed” and “uncoerced,” it is unclear why the Saba Court reached the coercion issue after finding that the stockholder vote was not fully informed. Future Delaware courts may need to assess whether the “coercion” inquiry is derivative of or independent from the “fully informed” analysis in transactions in which the Corwin standard is applied. Cf. Solomon v. Armstrong, 747 A.2d 1098, 1131 (Del. Ch. 1999) (“All disclosure of material information may cause shareholders to vote in a particular way, and so is, in some general sense, ‘coercive.’ Considering the legal imperative that all shareholders be armed with all material information, it cannot be that the mere potential to influence a shareholder’s vote renders disclosed information actionable.”), aff’d, 746 A.3d 277 (Del. 2000).
This post comes to us from Gibson, Dunn & Crutcher LLP. It is based on the firm’s memorandum, “M&A Report–Delaware Chancery Court Finds Stockholder Vote To Be Coerced and Not Fully Informed in In re Saba Software, Inc. Stockholder Litigation,” dated April 12, 2017, and available here.