In three relatively low profile decisions issued by the Delaware Court of Chancery in February 2013, the court reached seemingly atypical results given the issued involved and the procedural postures of the respective cases. The first decision was on February 6 in In re Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS (TRANSCRIPT). There, Chancellor Strine denied from the bench a motion to dismiss a claim alleging that the defendant directors had breached their duty of loyalty by failing to monitor the company’s officers. This result is noteworthy in that such so-called Caremark claims have been characterized by the court as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”[i] Also noteworthy are the court’s decisions denying motions to expedite in Corwin v. MAP Pharmaceuticals, Inc., C.A. No. 8267-CS (Feb. 20, 2013) (ORDER) and In re BioClinica, Inc. Shareholder Litigation, C.A. No. 8272-VCG (Feb. 25, 2013). Both of these cases concerned challenges to pending M&A transactions and, in particular, allegations of insufficient disclosure of the targets’ financial information. The fact that the motions were denied is unusual because motions to expedite entail perhaps possibly the lowest burden on plaintiffs, requiring a showing that the claim is merely “colorable.”[ii]
Despite the uncommon dispositions of these three motions, the courts’ reasoning in all three instances relied nevertheless on well-settled doctrine. In that regard, these three cases are the proverbial exceptions that prove the rule or, more precisely, serve to reinforce the overarching principle that, under Delaware’s corporation law, context always matters.
Puda Coal is a Delaware corporation, but its key operating subsidiary and assets were based in China. Furthermore, that operating subsidiary initially accessed the U.S. capital markets via a reverse triangular merger with an extant public company. Although the Delaware parent corporation’s board contained three independent directors, two of those directors were based in the U.S. with limited ability to oversee the company’s assets, officers, or operations. Indeed, according to the allegations in the complaint, the independent directors failed to realize for approximately 18 months that the company’s chairman and CEO along with another inside director had looted the company by selling the operating subsidiary—i.e., essentially all of the Delaware corporation’s assets—even though the transfer was reported in official Chinese government documents. In the interim, moreover, the independent directors continued to authorize public filings attesting to the company’s ownership of assets that, in fact, had been sold.
According to Chancellor Strine, “the magnitude of what happened, the length of time that it went undiscovered, [and] the repetitive filing of statements saying that the company owned assets they didn’t” gave rise to a reasonable inference at the motion to dismiss stage of the litigation that the directors failed to exercise meaningful oversight, thus precluding dismissal of the plaintiffs’ Caremark claim.[iii] The court emphasized that fulfilling one’s duties as a director—and especially for independent directors whose primary “ability [is] to monitor the people who are managing the company” because independent directors necessarily are less likely to have relevant industry expertise[iv]—requires understanding the specific company and its actual operations. Here, for example, overseeing operations and assets based in China would have required retaining financial and legal experts “fit to the task of maintain system of controls,” probably some proficiency with “the language skills to navigate the environment in which the company is operating,” and perhaps even “hav[ing] your physical body in China an awful lot.”[v] The court added that the independent directors’ failure to do so was particularly “troubling” given Delaware’s concern with the “integrity” of its corporation law when foreign company’s make “use of a Delaware [shell] entity” solely to access the U.S. capital markets.[vi]
At the same time, the court observed that “proportionality comes into play in assessing . . . the reasonableness of peoples’ efforts at compliance because you can’t watch everybody everywhere.”[vii] That is, there is no requirement that directors of a multinational corporation visit every jurisdiction where corporate assets are located, for example, or that directors be in a position to monitor compliance risk exposing the company to small penalties relative to total assets. “Because the entire asset base of the company was sold out from under the independent directors nearly two years before they discovered it,” however, the factual circumstances of this case were “distinct from your typical Caremark case.”[viii]
In addition to the alleged failure to monitor, the court suggested that “the behavior of these directors once they recognized what the insiders had done” also could constitute a breach of duty.[ix] Upon learning of the fraudulent transfer but being “stonewalled” in their attempts to conduct an investigation, the directors ultimately resigned, thus “leav[ing] the company under the sole dominion of a person they believe[d] ha[d] pervasively breached his fiduciary duty of loyalty.”[x] The court said, “there are some circumstances in which running away . . . involves a breach of duty.”[xi] Although the facts of this case are extreme, the implication of the court’s statement are important in that, depending on the circumstances, directors may be duty-bound to attempt to rectify corporate misfeasance that occurred during their tenure.
MAP Pharmaceuticals and BioClinica
Both of these cases concerned challenges to pending M&A transactions, with a particular emphasis by the plaintiffs on the alleged insufficiency of the disclosures disseminated to stockholders. When a transaction is scheduled to close sooner than the Court of Chancery’s ordinary rules for scheduling, propounding discovery, and briefing a preliminary injunction motion otherwise would permit, the plaintiff must move to expedite the proceedings. As noted above, while the standard on a motion to expedite is relatively low and Delaware courts “traditionally ha[ve] acted with a certain solicitude for plaintiffs” challenging a fast-moving deal by “erring on the side of more hearings rather than fewer,” the plaintiff still must “justify imposing on the defendants and the public the extra (and sometimes substantial) costs” of an expedited schedule.[xii] Moreover, the Court of Chancery is well aware of the rising rates of M&A litigation apparently filed for little more than settlement value.[xiii] Undoubtedly, this backdrop framed the courts’ decisions in MAP Pharmaceuticals and BioClinica.
In MAP Pharmaceuticals, the court simply denied the plaintiff’s proposed order (which is submitted with the motion) without affording the plaintiffs a hearing on the merits of their claims. Instead, the court characterized as “unfocused” the plaintiffs’ “numerous requests” for additional disclosure about the transaction process and financial advisor’s analysis “without making any colorable showing that the additional details they seek would alter in any meaningful sense the mix of information now available to stockholders.”[xiv] Although the court’s order is noteworthy in its brevity, its reasoning is consistent with other recent decisions admonishing plaintiffs for not articulating the relevance of allegedly material information omitted from disclosures. As the Court of Chancery put it in In re Midas, Inc. Shareholders Litigation,
The mere fact that some issue may have proven material in a past case cannot endow that issue with talismanic properties or reduce it to a magic word forever after. That is, the materiality of any fact, projection, or figure cannot be divorced from the particular circumstances facing the defendant company and the challenged transaction. In other words, context matters.[xv]
In BioClinica, by comparison, the plaintiffs did purport to show why the missing information was relevant under the circumstances of the challenged transaction. Nevertheless, under well-settled Delaware precedents, the missing information need not be disclosed. The recommendation statement of the target company disseminated in connection with the tender offer disclosed that the target’s financial advisor opined on the fairness of the consideration after considering, among other things, the target’s unlevered free cash flow projections. Although the Schedule 14D-9 contained management-prepared cash flow projections, it did not contain the unlevered free cash flows on which the financial advisor had relied. On that basis, the plaintiffs argued that the board had omitted to disclose material financial information it had provided to the financial advisor. Parsing the Schedule 14D-9’s literal text, however, the court noted that the disclosure merely stated that “the only thing ‘provided by management’ was ‘financial information,’ not financial projections derived from that information.”[xvi] Because there was no nonconclusory allegation that management had prepared the unlevered free cash flow projections, as opposed to the financial advisor deriving unlevered free cash flows for itself, the board was under no fiduciary duty to disclose management projections that did not exist.[xvii]
Likewise, the plaintiffs argued that shareholders were entitled to know why the target had revised its 2013 capital expenditures budget during the negotiation process, and what the former figures were, because the revisions affected the market multiples analysis performed by the financial advisor. The court noted, however, that shareholders are entitled only to management’s “best estimates [of future performance] at the time” and have no duty to disclose financial information that has gone stale or on which the investment bank did not rely.[xviii] In sum, although the disposition is somewhat unusual given its procedural posture, this case exemplifies the general rule in Delaware that, absent other relevant facts, only financial information both prepared by management and relied on by a financial advisor to render its fairness opinion is material and must be disclosed.
The plaintiffs in BioClinica also challenged the merger agreement’s suite of deal protection devices—viz., a no-shop clause (containing a fiduciary out), a top-up option, matching rights, a termination fee, a poison pill, and a standstill agreement—as preclusive to other prospective bidders. All of these provisions are relatively common in M&A transactions, and the court found ample precedents sustaining their use here. The court did give some discussion to allegations that the poison pill would be triggered upon the mere announcement of a hostile tender offer, which, if true, “may have stated a colorable claim justifying expedition.”[xix] Reviewing the literal terms of the poison pill, however, the court concluded that the plaintiffs’ allegations were overstated, in that the mere announcement of a hostile tender offer would not trigger the pill. The extent to which the court evaluated the merits of the plaintiffs’ claims in this regard itself is noteworthy, given that motions to expedite were historically “little more than a quotidian ministerial exercise to secure a date for presenting arguments on a motion” and only “on occasion has [the court] strayed into a preliminary assessment of the plaintiff’s chances [of success].”[xx]
Puda Coal, MAP Pharmaceuticals, and BioClinica—all of which were decided in February 2013—exhibit the general theme that, “given the volume of stockholder actions that the Court of Chancery adjudicates, it has the ability to speak as loudly in several less-publicized cases as it can in any one highly publicized case.”[xxi] None of these decisions was particularly “high profile.” Furthermore, although their outcomes may seem unusual, the court’s analysis and reasoning in each instance was entirely consistent with precedent and fundamental doctrine. As such, they demonstrate and undergird the importance of particular facts and circumstances in determining what one’s fiduciary duties to a Delaware corporation require.
[i] In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del. Ch. 1996).
[ii] Giammargo v. Snapple Beverage Corp., 1994 WL 672698, at *2 (Del. Ch. Nov. 15, 1994).
[iii] In re Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS, at 19 (Del. Ch. Feb. 6, 2013) (TRANSCRIPT).
[iv] Id. at 21.
[v] Id. at 17-18.
[vi] Id. at 19.
[vii] Id. at 18.
[viii] Id. at 19.
[ix] Id. at 22-23.
[x] Id. at 16.
[xi] Id. at 23.
[xii] Giammargo, 1994 WL 672698, at *2 (Del. Ch. Nov. 15, 1994).
[xiv] Corwin v. MAP Pharms., Inc., C.A. No. 8267-CS, at 2 (Del. Ch. Feb. 20, 2013) (ORDER).
[xv] C.A. No. 7346-VCP, at 18 (Del. Ch. Apr. 12, 2012) (TRANSCRIPT).
[xvi] In re BioClinica, Inc. S’holder Litig., C.A. No. 8272-VCG, slip op. at 14 (Del. Ch. Feb. 25, 2013)
[xvii] Id. at 13, 15 (citing In re Netsmart Techs., Inc. S’holder’s Litig., 924 A.2d 171, 203 (Del. Ch. 2007); In re CNX Gas Corp. S’holders Litig., 4 A.3d 397, 419 (Del. Ch. 2010)).
[xviii] Id. at 16 (quoting David P. Simonetti Rollover IRA v. Margolis, 2008 WL 5048692, at *10 (Del. Ch. June 27, 2008)) (quotation marks omitted).
[xix] Id. at 8.
[xx] Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate & Commercial Practice in the Delaware Court of Chancery § 10.07[b] (2012).