1 The Basics 1 The Basics
This section of the course will acquaint you with the basics of U.S. corporate law. It will also give you an idea of what boards actually do, and introduce you to a variety of shareholder types and relationships.The basic problemThe basic corporate governance problem is how to control those who have been entrusted with the assets assembled in the corporation: managers and directors.This economic problem is called an “agency problem”: how to ensure that the “agents” (managers/directors) act in furtherance of the “principals’” (shareholders’) interests rather than the agents’ own interest? Not employing agents at all is not a solution because centralized management is essential in large organizations. Instead, the trick is to devise appropriate controls.(NB: the economic terminology of “agent” and “principal” employed in this section is related to, but much broader than, the legal terminology in the law of agency. Legally, directors and managers are agents for the corporation, not for shareholders. From an economic perspective, however, the corporation is a fiction — a convenient way of describing relationships between human beings. In this perspective, directors and managers ultimately work for shareholders and hence are shareholders’ agents in an economic, though not legal, sense.)The basic partial solutionsShareholder voting and fiduciary dutiesU.S. corporate law offers two basic solutions to the corporate agency problem: shareholder voting, and fiduciary duties enforced by shareholder lawsuits.First, shareholders vote on certain important corporate decisions. In particular, shareholders elect, and can remove, directors, who in turn appoint management. This is often referred to as “corporate democracy” but, as we will see shortly, shareholder voting differs considerably from political elections.Second, directors and managers hold their corporate powers as fiduciaries, i.e., for the sole benefit of “the corporation and its shareholders.” As fiduciaries, directors and managers owe a duty of care and a duty of loyalty to “the corporation and its shareholders.” Crucially, U.S. courts liberally grant shareholders standing to enforce these duties in court through derivative suits: “The derivative action developed in equity to enable shareholders to sue in the corporation's name where those in control of the company refused to assert a claim belonging to it. The nature of the action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.”Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984).Other shareholder rightsIn addition to voting rights and standing to sue, shareholders also have the right to access certain corporate information. This is an important ancillary right because both shareholder voting and derivative suits require information to work well. DGCL 220 allows shareholders “to inspect for any proper purpose . . . [t]he corporation’s . . . books and records.” Furthermore, publicly traded corporations must make extensive affirmative disclosures under the securities laws.Finally, shareholders can sell their stock. This is important for individual shareholders’ liquidity, i.e., shareholders’ ability to convert the value of their corporate investment into cash when necessary. However, this so-called Wall Street Walk is useless, at least by itself, as a protection against bad management. If the corporation has bad management, its value to shareholders will be less than it could be, and its stock price will be discounted to reflect this. So a shareholder can sell, but that just locks in the loss from bad management; it does not fix it. (By analogy, an arson victim’s right to sell the land with the burnt ruins hardly compensates the victim for, nor prevents, the arson.) Selling is useful only in as much as it enables a buyer to amass a large enough position from which to challenge the sitting board using the first two tools (voting and suing).Default rules vs. contractual arrangementsImportantly, U.S. corporate law generally sets only default rules. Charter provisions and other contractual or quasi-contractual arrangements can supplement or alter all or most of these rules. Indeed, “contractual” arrangements pervade corporate law, from the definition of shareholder rights and allocation of management power in the corporate charter, to bylaws on voting, to executive compensation contracts. Read: DGCL 102(b)(1), 151(a), 141(a), and 109(b).Variations on the basic problemThe board as a monitorSo far, I have framed the basic problem of corporate governance as how to control managers and the board. An important tool of corporate governance, however, is control of managers by the board. Arguably, the primary role of a board composed mostly of outside members (i.e., non-management) is to select, monitor, and thus control managers. It is now standard or even legally required for public corporations’ boards to consist mostly of independent directors, i.e., directors who do not have other relationships with the corporation, especially not a role in management. That being said, in U.S. corporations, it is still customary for CEOs and other top managers to sit on the board and even to chair it.Some countries go even further and fully separate outside directors and management. Under the so-called two-tier system, a “supervisory board” composed exclusively of outside directors is superimposed on the “management board” composed of top managers. Shareholders elect the supervisory board, which in turn appoints and monitors the management board. (In some jurisdictions the supervisory board is self-nominating or partially elected by the corporation's employees.)But while directors may indeed monitor management, this only shifts the basic problem one level up: how can we control those who have been entrusted with this monitoring role? Quis custodiet ipsos custodes?Dominant shareholdersMonitoring the monitor is a particularly acute problem with respect to large, dominant shareholders. Most public corporations around the world have a dominant shareholder. In the U.S. and in the U.K., dispersed ownership is the norm but far from universal. On the positive side, dominant shareholders help overcome shareholders' collective action problem in monitoring managers and the board. On the flip side, however, dominant shareholders may attempt to extract a disproportionate share for themselves. Delaware limits such minority abuse by imposing fiduciary duties on “controlling shareholders.” Other jurisdictions impose super-majority requirements, or outright prohibit certain transactions, etc.Protecting other constituenciesI defer until the end of the course the question of whether corporate law does or should protect constituencies other than shareholders (often called “stakeholders”), such as creditors, workers, or customers. For the time being, I just note that the question is not whether stakeholders should be protected at all, but whether they should be protected by the tools of corporate law beyond the level of protection afforded by contract (loan agreements, employment contracts, collective bargaining, etc.) and other branches of law (employment law, labor law, consumer law, etc.).EnforcementEnforcement and its problems are of paramount importance for corporate law. At the extreme, if general law enforcement were too weak, managers could, for example, simply abscond with the corporation’s money. No fiduciary duties, shareholder litigation, or shareholder voting could protect against this. Fortunately, criminal law enforcement in the U.S. is strong enough that outright fraud and theft are not the most pressing concerns and can be mostly ignored in this course.In the more subtle form of inadministrability, however, enforcement problems are key to understanding the rationale behind much of corporate law — and indeed behind much of law generally. Administrability refers to courts’ ability to administer the laws as written. The problem is that courts often lack the requisite information. For this reason, many superficially appealing rules do not work as intended. For example, it is certainly desirable that managers always do only what is best for shareholders, or at least what they think is best for shareholders, and that they do so flawlessly or at least to the best of their abilities. Formally speaking, that is indeed more or less what fiduciary duties require of managers. That does not mean, however, that it is realistic to think that courts could actually enforce such a standard. Courts may not know what action was best for shareholders, much less what the managers truly thought was best for shareholders. Nor can courts easily know whether managers gave their best. Courts will inevitably misjudge many careful, loyal actions as disloyal or careless, and vice versa — in spite of costly and lengthy investigations.Faced with such difficulties, it may be best to forego costly judicial review altogether unless a transaction raises a red flag. The reddest of red flags is when the decision would financially benefit the decision-makers or their affiliates more than (other) shareholders. That, in a nutshell, is the approach taken in Delaware and other U.S. states and epitomized by the business judgment rule. We will dive deep into the details later. For now, here is the scoop in the words of the seminal case, Aronson v. Lewis:“The business judgment rule is an acknowledgment of the managerial prerogatives of Delaware directors under Section 141(a). It is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Absent an abuse of discretion, that judgment will be respected by the courts. . . .[However, the rule’s] protections can only be claimed by disinterested directors . . . .. From the standpoint of interest, this means that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing . . . . See 8 Del.C. § 144(a)(1).[Moreover], to invoke the rule's protection directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed, they must then act with requisite care in the discharge of their duties. While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence."473 A.2d 805, 812 (Del. 1984) (footnotes and internal references omitted).More generally, many rules of corporate law are decidedly second-best. That is, they are optimal only in recognition of the difficulties of enforcing any alternative rule. Agency problems can be reduced. They can never be eliminated.
1.1 Shareholder Voting 1.1 Shareholder Voting
Shareholders vote to elect the board and to approve fundamental changes, such as charter amendments (cf. DGCL 242(b)) or mergers (cf. DGCL 252(c)). Other matters may be submitted to a shareholder vote.“Shareholder democracy”Shareholder voting is often labeled “shareholder democracy.” It differs considerably, however, from political elections in contemporary democracies such as the U.S.First, the default rule in corporations is one vote per share (“one share one vote”), rather than one vote per shareholder (cf. DGCL 212(a)).Second, voting rights are determined on the “record date,” 10-60 days before the actual vote (DGCL 213). At least in practice, one keeps one’s voting rights even if one sells the shares in between. (Any problem with this?)Third, incumbents enjoy a large advantage. They control the voting process, and the corporation pays for their campaign.Fourth, rational apathy is more pronounced in shareholder voting than in (national) political elections. In large corporations with dispersed ownership, an individual small shareholder has practically no influence on the outcome. It is thus rational for the shareholder not to spend time and resources learning about the issues at stake (“rational apathy”). So-called institutional investors such as pension funds or mutual funds might have more influence but their decision-makers lack the incentive to use it: The decision-makers are the funds’ managers, but the benefits of higher share value accrue primarily to the funds’ beneficiaries. (You might think that a fund manager benefits indirectly by attracting more new customers if the fund generates a higher return for existing customers. This is true for some idiosyncratic funds. But many funds, particularly index fund, invest in the same assets as their competitors and are evaluated relative to one another. The only way such funds can distinguish themselves from their competitors is through lower cost. For these funds, spending resources on voting hurts their competitive position relative to passive competitors even if the voting does lead to higher asset values.)Voting rules and frequencyUnless otherwise provided in the charter or the statute, a majority of the shares entitled to vote constitutes a quorum (DGCL 216.1), and the affirmative vote of a majority of the shares present is required to pass a resolution (DGCL 216.2). The default for director elections is different (plurality voting, DGCL 216.3), but most large corporations have instituted some form of majority voting rule for director elections as well. This matters mostly when shareholders express their dissatisfaction through a “withhold campaign” against a particular director. Under the default rule, the director could be elected with a single vote (if running unopposed, as is the norm).A more radical but rare deviation from the default rule is cumulative voting. See DGCL 214 for the technical details. Roughly, cumulative voting ensures proportional representation. Cf. eBay v. Newmark later in the course.The corporation must hold a stockholder meeting at least once a year, DGCL 211(b). By default, all board seats are up for election every year. Under DGCL 141(d), however, the charter or a qualified bylaw can provide that as few as one third of the seats are contestable each year, i.e., that directors hold staggered terms of up to three years. This so-called “staggered board” probably seems like technical minutiae to you now. But it turns out to be an extremely important provision because it may critically delay anybody’s attempt to take control of the board. We will first see this in Blasius. An important complementing rule is that unlike standard boards, staggered boards are subject to removal only for cause (DGCL 141(k)(1); cf. DGCL 141(k)(2) for the case of cumulative voting).ProxiesIn principle, shareholders still vote at a physical “meeting” (but see the possibility of action by written consent, DGCL 228). But in large corporations, few shareholders attend such meetings in person, and those who do may not be the most important ones. Instead, shareholders vote by mail — sort of. U.S. corporations do not mail shareholders a proper ballot. Instead, the board solicits “proxies” on behalf of, and paid by, the corporation. Shareholders “vote” by granting or withholding proxies, and by choosing between any options that the proxy card may provide.A proxy is a power of attorney to vote a shareholder’s shares (cf. DGCL 212(b) — see sample card here (2nd last page)). The board solicits proxies on behalf of the corporation to ensure a quorum, to prevent a “coup” by a minority stockholder, and because the stock-exchange rules require it (see, e.g., NYSE Listed Company Manual 402.04). The board decides which proposals and nominees to include on the corporation’s proxy card, with the exception of SEC proxy rule 14a-8, which allows shareholders to submit certain proposals for the corporation’s proxy card (see below). The corporation pays.Occasionally, “insurgents” solicit their own proxies in opposition to the incumbent board, usually in order to elect their own candidates to the board. This is called a proxy fight. Outside the takeover context, however, proxy fights are very rare. Shareholders face a considerable collective action problem. The soliciting shareholder bears the entire cost of the solicitation, while receiving only a fraction of any benefit created.This explains why it is so important who or what gets onto the corporation’s proxy card. If it’s not on the corporation’s card, it won’t receive any votes at the meeting, even if properly moved during the meeting. As far as the board is concerned, that’s not a problem. They’ll put onto the corporation’s card whatever resolution and candidate they support. By contrast, challengers must rely on the law to get their proposals onto the corporation’s card, otherwise boards happily reject the challengers’ proposals. The “Proxy Access” section below deals with this question directly.The federal proxy rulesProxy solicitations are heavily regulated by the SEC’s proxy rules (Regulation 14A promulgated under section 14 of the Securities Exchange Act). As a result, the rules of corporate voting in the U.S. are a complicated interaction of federal proxy rules, state law, and a corporation’s bylaws and charter.The federal proxy rules are tedious. I provide a guide at simplifiedcodes.com. For a first course on corporations, you only need to know the following:1. Before any proxy solicitation commences, a proxy statement must be filed with the SEC (rule 14a-6(b)). In contested matters, a preliminary proxy statement must be filed 10 days before any solicitation commences (rule 14a-6(a)).2. The content and form of the proxy materials are heavily regulated (rules 14a-3, - 4, and - 5, and Schedule 14A). Virtually everything you see in an actual proxy statement is prescribed by the rules.3. “Proxy” and “solicitation” are defined extremely broadly (rule 14a-1(f) and (l)(1)). Accordingly, the sweep of the proxy rules is very wide. In fact, in the past, the proxy rules impeded even conversations among shareholders about their votes. Certain exceptions to the definitions (particularly rule 14a-1(l)(2)(iv)) or requirements (particularly rules 14a-2(a)(6) and 14a-2(b)(1)-(3)) are therefore extremely important — you should read them.4. Rule 14a-8 is the only federal rule requiring corporations to include shareholder proposals in the corporation’s proxy materials. Under the rule, corporations must include in their proxy certain precatory resolutions and bylaw amendments sponsored by shareholders. By contrast, the rule does not cover director nominations or anything else that would affect “the upcoming election of directors” (see official note 8 to paragraph (i) of the rule). You should read the rule — unlike the rest of the proxy rules, it’s written in plain English.5. There is a special anti-fraud provision (rule 14a-9).
1.1.1 Schnell v. Chris-Craft Industries, Inc. 1.1.1 Schnell v. Chris-Craft Industries, Inc.
Schnell is the classic Supreme Court authority emphasizing the importance of corporate voting, and announcing special judicial vigilance towards anything that interferes with this voting. Pay close attention to the legal reasoning. Is it compelling? We will come back to this often.
Andrew H. SCHNELL, Jr. and Jack Safer, Plaintiffs Below, Appellants,
v.
CHRIS-CRAFT INDUSTRIES, INC., a Delaware corporation, Defendant Below, Appellee.
Supreme Court of Delaware.
November 29, 1971.
H. Albert Young and Edward B. Maxwell, 2nd, of Young, Conaway, Stargatt & Taylor, Wilmington, and Carl F. Goodman, New York City, and Jay L. Westbrook, of Surrey, Karasik & Greene, Washington, D. C., for plaintiffs below, appellants.
David F. Anderson and Charles S. Crompton, Jr., of Potter, Anderson & Corroon, Wilmington, and Arthur L. Liman and Daniel P. Levitt, of Paul, Weiss, Rifkind, Wharton & Garrison, New York City, and Washington, D. C., for defendant below, appellee.
Before WOLCOTT, Chief Justice, and CAREY and HERRMANN, Associate Justices:
[438] HERRMANN, Justice (for the majority of the Court):
This is an appeal from the denial by the Court of Chancery of the petition of dissident stockholders for injunctive relief to prevent management[*] from advancing the date of the annual stockholders' meeting from January 11, 1972, as previously set by the by-laws, to December 8, 1971.
The opinion below is reported at 285 A.2d 430. This opinion is confined to the frame of reference of the opinion below for the sake of brevity and because of the strictures of time imposed by the circumstances of the case.
It will be seen that the Chancery Court considered all of the reasons stated by management as business reasons for changing the date of the meeting; but that those reasons were rejected by the Court below in making the following findings:
"I am satisfied, however, in a situation in which present management has disingenuously resisted the production of a list of its stockholders to plaintiffs or their confederates and has otherwise turned a deaf ear to plaintiffs' demands about a change in management designed to lift defendant from its present business [439] doldrums, management has seized on a relatively new section of the Delaware Corporation Law for the purpose of cutting down on the amount of time which would otherwise have been available to plaintiffs and others for the waging of a proxy battle. Management thus enlarged the scope of its scheduled October 18 directors' meeting to include the by-law amendment in controversy after the stockholders committee had filed with the S.E.C. its intention to wage a proxy fight on October 16.
"Thus plaintiffs reasonably contend that because of the tactics employed by management (which involve the hiring of two established proxy solicitors as well as a refusal to produce a list of its stockholders, coupled with its use of an amendment to the Delaware Corporation Law to limit the time for contest), they are given little chance, because of the exigencies of time, including that required to clear material at the S.E.C., to wage a successful proxy fight between now and December 8. * * *."
In our view, those conclusions amount to a finding that management has attempted to utilize the corporate machinery and the Delaware Law for the purpose of perpetuating itself in office; and, to that end, for the purpose of obstructing the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contest against management. These are inequitable purposes, contrary to established principles of corporate democracy. The advancement by directors of the by-law date of a stockholders' meeting, for such purposes, may not be permitted to stand. Compare Condec Corporation v. Lunkenheimer Company, Del.Ch., 230 A.2d 769 (1967).
When the by-laws of a corporation designate the date of the annual meeting of stockholders, it is to be expected that those who intend to contest the reelection of incumbent management will gear their campaign to the by-law date. It is not to be expected that management will attempt to advance that date in order to obtain an inequitable advantage in the contest.
Management contends that it has complied strictly with the provisions of the new Delaware Corporation Law in changing the by-law date. The answer to that contention, of course, is that inequitable action does not become permissible simply because it is legally possible.
Management relies upon American Hardware Corp. v. Savage Arms Corp., 37 Del.Ch. 10, 135 A.2d 725, aff'd 37 Del.Ch. 59, 136 A.2d 690 (1957). That case is inapposite for two reasons: it involved an effort by stockholders, engaged in a proxy contest, to have the stockholders' meeting adjourned and the period for the proxy contest enlarged; and there was no finding there of inequitable action on the part of management. We agree with the rule of American Hardware that, in the absence of fraud or inequitable conduct, the date for a stockholders' meeting and notice thereof, duly established under the by-laws, will not be enlarged by judicial interference at the request of dissident stockholders solely because of the circumstance of a proxy contest. That, of course, is not the case before us.
We are unable to agree with the conclusion of the Chancery Court that the stockholders' application for injunctive relief here was tardy and came too late. The stockholders learned of the action of management unofficially on Wednesday, October 27, 1971; they filed this action on Monday, November 1, 1971. Until management changed the date of the meeting, the stockholders had no need of judicial assistance in that connection. There is no indication of any prior warning of management's intent to take such action; indeed, it appears that an attempt was made by management to conceal its action as long as possible. Moreover, stockholders may not be charged with the duty of anticipating inequitable action by management, and of seeking anticipatory injunctive relief to foreclose such action, simply because the [440] new Delaware Corporation Law makes such inequitable action legally possible.
Accordingly, the judgment below must be reversed and the cause remanded, with instructions to nullify the December 8 date as a meeting date for stockholders; to reinstate January 11, 1972 as the sole date of the next annual meeting of the stockholders of the corporation; and to take such other proceedings and action as may be consistent herewith regarding the stock record closing date and any other related matters.
WOLCOTT, Chief Justice (dissenting):
I do not agree with the majority of the Court in its disposition of this appeal. The plaintiff stockholders concerned in this litigation have, for a considerable period of time, sought to obtain control of the defendant corporation. These attempts took various forms.
In view of the length of time leading up to the immediate events which caused the filing of this action, I agree with the Vice Chancellor that the application for injunctive relief came too late.
I would affirm the judgment below on the basis of the Vice Chancellor's opinion.
[*] We use this word as meaning "managing directors".
1.1.2 Blasius Industries, Inc. v. Atlas Corp. 1.1.2 Blasius Industries, Inc. v. Atlas Corp.
Blasius is the classic Chancery Court decision applying, and expanding on, Schnell. What exactly does Chancellor Allen have to say about corporate voting— what is it about voting that is important? Does Allen’s discussion of voting, its importance, and its judicial treatment matter for the ultimate outcome of the case here? If not, why would he have bothered? As always, also pay attention to what is going on in the underlying business dispute: Is this a normal vote taken at a meeting? What did the board do to frustrate the vote, and why would that work? I edit this case more than usual because it involves M&A issues and terminology that we will only learn later in the course. For present purposes, it is enough to understand that Blasius attempted to get its people elected to the Atlas board, and that Atlas's management did not like this at all.
BLASIUS INDUSTRIES, INC., William B. Conner, Warren Delano, Jr., Harold H. George, Harold E. Hall, Michael A. Lubin, Arnold W. MacAlonan, Thomas J. Murnick, and William P. Shulevitz, Plaintiffs,
v.
ATLAS CORPORATION, John J. Dwyer, Edward R. Farley, Jr., Michael Bongiovanni, Richard R. Weaver, Walter G. Clinchy, Andrew Davlin, Jr., Edgar M. Masinter, John M. Devaney and Harry J. Winters, Jr., Defendants.
Court of Chancery of Delaware, New Castle County.
[652] A. Gilchrist Sparks, III, and Michael Houghton of Morris, Nichols, Arsht & Tunnell, Wilmington, and Greg A. Danilow, M. Nicole Marcey, and Meric Craig Bloch, of Weil, Gotshal & Manges, and Linda C. Goldstein of Kramer, Levin, Nessen, Kamin & Frankel, New York City, for plaintiffs.
Charles F. Richards, Jr., Samuel A. Nolan, and Cynthia D. Kaiser of Richards, Layton & Finger, Wilmington, and Kenneth R. Logan, Joseph F. Tringali, David A. Martland, and Brad N. Friedman of Simpson Thacher & Bartlett, New York City, for defendants.
OPINION
ALLEN, Chancellor.
Two cases pitting the directors of Atlas Corporation against that company's largest (9.1%) shareholder, Blasius Industries, have been consolidated and tried together. Together, these cases ultimately require the court to determine who is entitled to sit on Atlas' board of directors. Each, however, presents discrete and important legal issues.
The first of the cases was filed on December 30, 1987. As amended, it challenges the validity of board action taken at a telephone meeting of December 31, 1987 that added two new members to Atlas' seven member board. That action was taken as an immediate response to the delivery to Atlas by Blasius the previous day of a form of stockholder consent that, if joined in by holders of a majority of Atlas' stock, would have increased the board of Atlas from seven to fifteen members and would have elected eight new members nominated by Blasius.
As I find the facts of this first case, they present the question whether a board acts consistently with its fiduciary duty when it acts, in good faith and with appropriate care, for the primary purpose of preventing or impeding an unaffiliated majority of shareholders from expanding the board and electing a new majority. For the reasons that follow, I conclude that, even though defendants here acted on their view of the corporation's interest and not selfishly, their December 31 action constituted an offense to the relationship between corporate directors and shareholders that has traditionally been protected in courts of equity. As a consequence, I conclude that the board action taken on December 31 was invalid and must be voided. The basis for this opinion is set forth at pages 658-663 below.
The second filed action was commenced on March 9, 1988. It arises out of the consent solicitation itself (or an amended [653] version of it) and requires the court to determine the outcome of Blasius' consent solicitation, which was warmly and actively contested on both sides. The vote was, on either view of the facts and law, extremely close. For the reasons set forth at pages 663-670 below, I conclude that the judges of election properly confined their count to the written "ballots" (so to speak) before them; that on that basis, they made several errors, but that correction of those errors does not reverse the result they announced. I therefore conclude that plaintiffs' consent solicitation failed to garner the support of a majority of Atlas shares.
The facts set forth below represent findings based upon a preponderance of the admissible evidence, as I evaluate it.
I.
Blasius Acquires a 9% Stake in Atlas.
Blasius is a new stockholder of Atlas. It began to accumulate Atlas shares for the first time in July, 1987. On October 29, it filed a Schedule 13D with the Securities Exchange Commission disclosing that, with affiliates, it then owed 9.1% of Atlas' common stock. It stated in that filing that it intended to encourage management of Atlas to consider a restructuring of the Company or other transaction to enhance shareholder values. It also disclosed that Blasius was exploring the feasibility of obtaining control of Atlas, including instituting a tender offer or seeking "appropriate" representation on the Atlas board of directors.
Blasius has recently come under the control of two individuals, Michael Lubin and Warren Delano, who after experience in the commercial banking industry, had, for a short time, run a venture capital operation for a small investment banking firm. Now on their own, they apparently came to control Blasius with the assistance of Drexel Burnham's well noted junk bond mechanism. Since then, they have made several attempts to effect leveraged buyouts, but without success.
In May, 1987, with Drexel Burnham serving as underwriter, Lubin and Delano caused Blasius to raise $60 million through the sale of junk bonds. A portion of these funds were used to acquire a 9% position in Atlas. According to its public filings with the SEC, Blasius' debt service obligations arising out of the sale of the junk bonds are such that it is unable to service those obligations from its income from operations.
The prospect of Messrs. Lubin and Delano involving themselves in Atlas' affairs, was not a development welcomed by Atlas' management. Atlas had a new CEO, defendant Weaver, who had, over the course of the past year or so, overseen a business restructuring of a sort. Atlas had sold three of its five divisions. It had just announced (September 1, 1987) that it would close its once important domestic uranium operation. The goal was to focus the Company on its gold mining business. By October, 1987, the structural changes to do this had been largely accomplished. Mr. Weaver was perhaps thinking that the restructuring that had occurred should be given a chance to produce benefit before another restructuring (such as Blasius had alluded to in its Schedule 13D filing) was attempted, when he wrote in his diary on October 30, 1987:
13D by Delano & Lubin came in today. Had long conversation w/MAH & Mark Golden [of Goldman, Sachs] on issue. All agree we must dilute these people down by the acquisition of another Co. w/stock, or merger or something else.
The Blasius Proposal of A Leverage Recapitalization Or Sale.
Immediately after filing its 13D on October 29, Blasius' representatives sought a meeting with the Atlas management. Atlas dragged its feet. A meeting was arranged for December 2, 1987 following the regular meeting of the Atlas board. Attending that meeting were Messrs. Lubin and Delano for Blasius, and, for Atlas, Messrs. Weaver, Devaney (Atlas' CFO), Masinter (legal counsel and director) and Czajkowski (a representative of Atlas' investment banker, Goldman Sachs).
[654] At that meeting, Messrs. Lubin and Delano suggested that Atlas engage in a leveraged restructuring and distribute cash to shareholders. In such a transaction, which is by this date a commonplace form of transaction, a corporation typically raises cash by sale of assets and significant borrowings and makes a large one time cash distribution to shareholders. The shareholders are typically left with cash and an equity interest in a smaller, more highly leveraged enterprise. Lubin and Delano gave the outline of a leveraged recapitalization for Atlas as they saw it.
Immediately following the meeting, the Atlas representatives expressed among themselves an initial reaction that the proposal was infeasible. On December 7, Mr. Lubin sent a letter detailing the proposal. In general, it proposed the following: (1) an initial special cash dividend to Atlas' stockholders in an aggregate amount equal to (a) $35 million, (b) the aggregate proceeds to Atlas from the exercise of option warrants and stock options, and (c) the proceeds from the sale or disposal of all of Atlas' operations that are not related to its continuing minerals operations; and (2) a special non-cash dividend to Atlas' stockholders of an aggregate $125 million principal amount of 7% Secured Subordinated Gold-Indexed Debentures. The funds necessary to pay the initial cash dividend were to principally come from (i) a "gold loan" in the amount of $35,625,000, repayable over a three to five year period and secured by 75,000 ounces of gold at a price of $475 per ounce, (ii) the proceeds from the sale of the discontinued Brockton Sole and Plastics and Ready-Mix Concrete businesses, and (iii) a then expected January, 1988 sale of uranium to the Public Service Electric & Gas Company. (DX H.)
Atlas Asks Its Investment Banker to Study the Proposal.
This written proposal was distributed to the Atlas board on December 9 and Goldman Sachs was directed to review and analyze it.
The proposal met with a cool reception from management. On December 9, Mr. Weaver issued a press release expressing surprise that Blasius would suggest using debt to accomplish what he characterized as a substantial liquidation of Atlas at a time when Atlas' future prospects were promising. He noted that the Blasius proposal recommended that Atlas incur a high debt burden in order to pay a substantial one time dividend consisting of $35 million in cash and $125 million in subordinated debentures. Mr. Weaver also questioned the wisdom of incurring an enormous debt burden amidst the uncertainty in the financial markets that existed in the aftermath of the October crash.
Blasius attempted on December 14 and December 22 to arrange a further meeting with the Atlas management without success. During this period, Atlas provided Goldman Sachs with projections for the Company. Lubin was told that a further meeting would await completion of Goldman's analysis. A meeting after the first of the year was proposed.
The Delivery of Blasius' Consent Statement.
On December 30, 1987, Blasius caused Cede & Co. (the registered owner of its Atlas stock) to deliver to Atlas a signed written consent (1) adopting a precatory resolution recommending that the board develop and implement a restructuring proposal, (2) amending the Atlas bylaws to, among other things, expand the size of the board from seven to fifteen members — the maximum number under Atlas' charter, and (3) electing eight named persons to fill the new directorships. Blasius also filed suit that day in this court seeking a declaration that certain bylaws adopted by the board on September 1, 1987 acted as an unlawful restraint on the shareholders' right, created by Section 228 of our corporation statute, to act through consent without undergoing a meeting.
The reaction was immediate. Mr. Weaver conferred with Mr. Masinter, the Company's outside counsel and a director, who viewed the consent as an attempt to take control of the Company. They decided to call an emergency meeting of the board, even though a regularly scheduled meeting was to occur only one week hence, on January [655] 6, 1988. The point of the emergency meeting was to act on their conclusion (or to seek to have the board act on their conclusion) "that we should add at least one and probably two directors to the board ..." (Tr. 85, Vol. II). A quorum of directors, however, could not be arranged for a telephone meeting that day. A telephone meeting was held the next day. At that meeting, the board voted to amend the bylaws to increase the size of the board from seven to nine and appointed John M. Devaney and Harry J. Winters, Jr. to fill those newly created positions. Atlas' Certificate of Incorporation creates staggered terms for directors; the terms to which Messrs. Devaney and Winters were appointed would expire in 1988 and 1990, respectively.
The Motivation of the Incumbent Board In Expanding the Board and Appointing New Members.
In increasing the size of Atlas' board by two and filling the newly created positions, the members of the board realized that they were thereby precluding the holders of a majority of the Company's shares from placing a majority of new directors on the board through Blasius' consent solicitation, should they want to do so. Indeed the evidence establishes that that was the principal motivation in so acting.
The conclusion that, in creating two new board positions on December 31 and electing Messrs. Devaney and Winters to fill those positions the board was principally motivated to prevent or delay the shareholders from possibly placing a majority of new members on the board, is critical to my analysis of the central issue posed by the first filed of the two pending cases. If the board in fact was not so motivated, but rather had taken action completely independently of the consent solicitation, which merely had an incidental impact upon the possible effectuation of any action authorized by the shareholders, it is very unlikely that such action would be subject to judicial nullification. See, e.g., Frantz Manufacturing Company v. EAC Industries, Del.Supr., 501 A.2d 401, 407 (1985); Moran v. Household International, Inc., Del.Ch., 490 A.2d 1059, 1080, aff'd, Del. Supr., 500 A.2d 1346 (1985). The board, as a general matter, is under no fiduciary obligation to suspend its active management of the firm while the consent solicitation process goes forward.
There is testimony in the record to support the proposition that, in acting on December 31, the board was principally motivated simply to implement a plan to expand the Atlas board that preexisted the September, 1987 emergence of Blasius as an active shareholder. I have no doubt that the addition of Mr. Winters, an expert in mining economics, and Mr. Devaney, a financial expert employed by the Company, strengthened the Atlas board and, should anyone ever have reason to review the wisdom of those choices, they would be found to be sensible and prudent. I cannot conclude, however, that the strengthening of the board by the addition of these men was the principal motive for the December 31 action. As I view this factual determination as critical, I will pause to dilate briefly upon the evidence that leads me to this conclusion.
The evidence indicates that CEO Weaver was acquainted with Mr. Winters prior to the time he assumed the presidency of Atlas. When, in the fall of 1986, Mr. Weaver learned of his selection as Atlas' future CEO, he informally approached Mr. Winters about serving on the board of the Company. Winters indicated a willingness to do so and sent to Mr. Weaver a copy of his curriculum vitae. Weaver, however, took no action with respect to this matter until he had some informal discussion with other board members on December 2, 1987, the date on which Mr. Lubin orally presented Blasius' restructuring proposal to management. At that time, he mentioned the possibility to other board members.
Then, on December 7, Mr. Weaver called Mr. Winters on the telephone and asked him if he would serve on the board and Mr. Winters again agreed.
On December 24, 1987, Mr. Weaver wrote to other board members, sending them Mr. Winters curriculum vitae and notifying them that Mr. Winters would be [656] proposed for board membership at the forthcoming January 6 meeting. It was also suggested that a dinner meeting be scheduled for January 5, in order to give board members who did not know Mr. Winters an opportunity to meet him prior to acting on that suggestion. The addition of Mr. Devaney to the board was not mentioned in that memo, nor, so far as the record discloses, was it discussed at the December 2 board meeting.
It is difficult to consider the timing of the activation of the interest in adding Mr. Winters to the board in December as simply coincidental with the pressure that Blasius was applying. The connection between the two events, however, becomes unmistakably clear when the later events of December 30 and 31 are focused upon. As noted above, on the 30th, Atlas received the Blasius consent which proposed to shareholders that they expand the board from seven to fifteen and add eight new members identified in the consent. It also proposed the adoption of a precatory resolution encouraging restructuring or sale of the Company. Mr. Weaver immediately met with Mr. Masinter. In addition to receiving the consent, Atlas was informed it had been sued in this court, but it did not yet know the thrust of that action. At that time, Messrs. Weaver and Masinter "discussed a lot of [reactive] strategies and Edgar [Masinter] told me we really got to put a program together to go forward with this consent.... we talked about taking no action. We talked about adding one board member. We talked about adding two board members. We talked about adding eight board members. And we did a lot of looking at other and various and sundry alternatives...." (Weaver Testimony, Tr. I, p. 130). They decided to add two board members and to hold an emergency board meeting that very day to do so. It is clear that the reason that Mr. Masinter advised taking this step immediately rather than waiting for the January 6 meeting was that he feared that the Court of Chancery might issue a temporary restraining order prohibiting the board from increasing its membership, since the consent solicitation had commenced. It is admitted that there was no fear that Blasius would be in a position to complete a public solicitation for consents prior to the January 6 board meeting.
In this setting, I conclude that, while the addition of these qualified men would, under other circumstances, be clearly appropriate as an independent step, such a step was in fact taken in order to impede or preclude a majority of the shareholders from effectively adopting the course proposed by Blasius. Indeed, while defendants never forsake the factual argument that that action was simply a continuation of business as usual, they, in effect, admit from time to time this overriding purpose. For example, everyone concedes that the directors understood on December 31 that the effect of adding two directors would be to preclude stockholders from effectively implementing the Blasius proposal. Mr. Weaver, for example, testifies as follows:
Q: Was it your view that by electing these two directors, Atlas was preventing Blasius from electing a majority of the board?
A: I think that is a component of my total overview. I think in the short term, yes, it did.
Directors Farley and Bongiovanni admit that the board acted to slow the Blasius proposal down. See Tr. T, Vol. I, at pp. 23-24 and 81.
This candor is praiseworthy, but any other statement would be frankly incredible. The timing of these events is, in my opinion, consistent only with the conclusion that Mr. Weaver and Mr. Masinter originated, and the board immediately endorsed, the notion of adding these competent, friendly individuals to the board, not because the board felt an urgent need to get them on the board immediately for reasons relating to the operations of Atlas' business, but because to do so would, for the moment, preclude a majority of shareholders from electing eight new board members selected by Blasius. As explained below, I conclude that, in so acting, the board was not selfishly motivated simply to retain power.
There was no discussion at the December 31 meeting of the feasibility or wisdom of the Blasius restructuring proposal. While [657] several of the directors had an initial impression that the plan was not feasible and, if implemented, would likely result in the eventual liquidation of the Company, they had not yet focused upon and acted on that subject. Goldman Sachs had not yet made its report, which was scheduled to be given January 6.
The January 6 Rejection of the Blasius Proposal.
On January 6, the board convened for its scheduled meeting. At that time, it heard a full report from its financial advisor concerning the feasibility of the Blasius restructuring proposal. The Goldman Sachs presentation included a summary of five year cumulative cash flows measured against a base case and the Blasius proposal, an analysis of Atlas' debt repayment capacity under the Blasius proposal, and pro forma income and cash flow statements for a base case and the Blasius proposal, assuming prices of $375, $475 and $575 per ounce of gold.
After completing that presentation, Goldman Sachs concluded with its view that if Atlas implemented the Blasius restructuring proposal (i) a severe drain on operating cash flow would result, (ii) Atlas would be unable to service its long-term debt and could end up in bankruptcy, (iii) the common stock of Atlas would have little or no value, and (iv) since Atlas would be unable to generate sufficient cash to service its debt, the debentures contemplated to be issued in the proposed restructuring could have a value of only 20% to 30% of their face amount. Goldman Sachs also said that it knew of no financial restructuring that had been undertaken by a company where the company had no chance of repaying its debt, which, in its judgment, would be Atlas' situation if it implemented the Blasius restructuring proposal. Finally, Goldman Sachs noted that if Atlas made a meaningful commercial discovery of gold after implementation of the Blasius restructuring proposal, Atlas would not have the resources to develop the discovery.
The board then voted to reject the Blasius proposal. Blasius was informed of that action. The next day, Blasius caused a second, modified consent to be delivered to Atlas. A contest then ensued between the Company and Blasius for the votes of Atlas' shareholders. The facts relating to that contest, and a determination of its outcome, form the subject of the second filed lawsuit to be now decided. That matter, however, will be deferred for the moment as the facts set forth above are sufficient to frame and decide the principal remaining issue raised by the first filed action: whether the December 31 board action, in increasing the board by two and appointing members to fill those new positions, constituted, in the circumstances, an inequitable interference with the exercise of shareholder rights.
II.
Plaintiff attacks the December 31 board action as a selfishly motivated effort to protect the incumbent board from a perceived threat to its control of Atlas. Their conduct is said to constitute a violation of the principle, applied in such cases as Schnell v. Chris Craft Industries, Del. Supr., 285 A.2d 437 (1971), that directors hold legal powers subjected to a supervening duty to exercise such powers in good faith pursuit of what they reasonably believe to be in the corporation's interest. The December 31 action is also said to have been taken in a grossly negligent manner, since it was designed to preclude the recapitalization from being pursued, and the board had no basis at that time to make a prudent determination about the wisdom of that proposal, nor was there any emergency that required it to act in any respect regarding that proposal before putting itself in a position to do so advisedly.
Defendants, of course, contest every aspect of plaintiffs' claims. They claim the formidable protections of the business judgment rule. See, e.g., Aronson v. Lewis, Del.Supr., 473 A.2d 805 (1983); Grobow v. Perot, Del.Supr., 539 A.2d 180 (1988); In re J.P. Stevens & Co., Inc. Shareholders Litigation, Del.Ch., 542 A.2d 770 (1988).
They say that, in creating two new board positions and filling them on December 31, they acted without a conflicting interest [658] (since the Blasius proposal did not, in any event, challenge their places on the board), they acted with due care (since they well knew the persons they put on the board and did not thereby preclude later consideration of the recapitalization), and they acted in good faith (since they were motivated, they say, to protect the shareholders from the threat of having an impractical, indeed a dangerous, recapitalization program foisted upon them). Accordingly, defendants assert there is no basis to conclude that their December 31 action constituted any violation of the duty of the fidelity that a director owes by reason of his office to the corporation and its shareholders.
Moreover, defendants say that their action was fair, measured and appropriate, in light of the circumstances. Therefore, even should the court conclude that some level of substantive review of it is appropriate under a legal test of fairness, or under the intermediate level of review authorized by Unocal Corp. v. Mesa Petroleum Co., Del.Supr., 493 A.2d 946 (1985), defendants assert that the board's decision must be sustained as valid in both law and equity.
III.
One of the principal thrusts of plaintiffs' argument is that, in acting to appoint two additional persons of their own selection, including an officer of the Company, to the board, defendants were motivated not by any view that Atlas' interest (or those of its shareholders) required that action, but rather they were motivated improperly, by selfish concern to maintain their collective control over the Company. That is, plaintiffs say that the evidence shows there was no policy dispute or issue that really motivated this action, but that asserted policy differences were pretexts for entrenchment for selfish reasons. If this were found to be factually true, one would not need to inquire further. The action taken would constitute a breach of duty. Schnell v. Chris Craft Industries, Del.Supr., 285 A.2d 437 (1971); Guiricich v. Emtrol Corp., Del.Supr., 449 A.2d 232 (1982).
In support of this view, plaintiffs point to the early diary entry of Mr. Weaver (p. 653, supra), to the lack of any consideration at all of the Blasius recapitalization proposal at the December 31 meeting, the lack of any substantial basis for the outside directors to have had any considered view on the subject by that time — not having had any view from Goldman Sachs nor seen the financial data that it regarded as necessary to evaluate the proposal — and upon what it urges is the grievously flawed, slanted analysis that Goldman Sachs finally did present.
While I am satisfied that the evidence is powerful, indeed compelling, that the board was chiefly motivated on December 31 to forestall or preclude the possibility that a majority of shareholders might place on the Atlas board eight new members sympathetic to the Blasius proposal, it is less clear with respect to the more subtle motivational question: whether the existing members of the board did so because they held a good faith belief that such shareholder action would be self-injurious and shareholders needed to be protected from their own judgment.
On balance, I cannot conclude that the board was acting out of a self-interested motive in any important respect on December 31. I conclude rather that the board saw the "threat" of the Blasius recapitalization proposal as posing vital policy differences between itself and Blasius. It acted, I conclude, in a good faith effort to protect its incumbency, not selfishly, but in order to thwart implementation of the recapitalization that it feared, reasonably, would cause great injury to the Company.
The real question the case presents, to my mind, is whether, in these circumstances, the board, even if it is acting with subjective good faith (which will typically, if not always, be a contestable or debatable judicial conclusion), may validly act for the principal purpose of preventing the shareholders from electing a majority of new directors. The question thus posed is not one of intentional wrong (or even negligence), but one of authority as between the fiduciary and the beneficiary (not simply [659] legal authority, i.e., as between the fiduciary and the world at large).
IV.
It is established in our law that a board may take certain steps — such as the purchase by the corporation of its own stock — that have the effect of defeating a threatened change incorporate control, when those steps are taken advisedly, in good faith pursuit of a corporate interest, and are reasonable in relation to a threat to legitimate corporate interests posed by the proposed change in control. See Unocal Corp. v. Mesa Petroleum Co., Del.Supr., 493 A.2d 946 (1985); Kors v. Carey, Del. Ch., 158 A.2d 136 (1960); Cheff v. Mathes, Del.Supr., 199 A.2d 548 (1964); Kaplan v. Goldsamt, Del.Ch., 380 A.2d 556 (1977). Does this rule — that the reasonable exercise of good faith and due care generally validates, in equity, the exercise of legal authority even if the act has an entrenchment effect — apply to action designed for the primary purpose of interfering with the effectiveness of a stockholder vote? Our authorities, as well as sound principles, suggest that the central importance of the franchise to the scheme of corporate governance, requires that, in this setting, that rule not be applied and that closer scrutiny be accorded to such transaction.
1. Why the deferential business judgment rule does not apply to board acts taken for the primary purpose of interfering with a stockholder's vote, even if taken advisedly and in good faith.
A. The question of legitimacy.
The shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests. Generally, shareholders have only two protections against perceived inadequate business performance. They may sell their stock (which, if done in sufficient numbers, may so affect security prices as to create an incentive for altered managerial performance), or they may vote to replace incumbent board members.
It has, for a long time, been conventional to dismiss the stockholder vote as a vestige or ritual of little practical importance.[1] It may be that we are now witnessing the emergence of new institutional voices and arrangements that will make the stockholder vote a less predictable affair than it has been. Be that as it may, however, whether the vote is seen functionally as an unimportant formalism, or as an important tool of discipline, it is clear that it is critical to the theory that legitimates the exercise of power by some (directors and officers) over vast aggregations of property that they do not own. Thus, when viewed from a broad, institutional perspective, it can be seen that matters involving the integrity of the shareholder voting process involve consideration not present in any other context in which directors exercise delegated power.
B. Questions of this type raise issues of the allocation of authority as between the board and the shareholders.
The distinctive nature of the shareholder franchise context also appears when the matter is viewed from a less generalized, doctrinal point of view. From this point of view, as well, it appears that the ordinary considerations to which the business judgment rule originally responded are simply not present in the shareholder voting context.[2] That is, a decision by the [660] board to act for the primary purpose of preventing the effectiveness of a shareholder vote inevitably involves the question who, as between the principal and the agent, has authority with respect to a matter of internal corporate governance. That, of course, is true in a very specific way in this case which deals with the question who should constitute the board of directors of the corporation, but it will be true in every instance in which an incumbent board seeks to thwart a shareholder majority. A board's decision to act to prevent the shareholders from creating a majority of new board positions and filling them does not involve the exercise of the corporation's power over its property, or with respect to its rights or obligations; rather, it involves allocation, between shareholders as a class and the board, of effective power with respect to governance of the corporation. This need not be the case with respect to other forms of corporate action that may have an entrenchment effect — such as the stock buybacks present in Unocal, Cheff or Kors v. Carey. Action designed principally to interfere with the effectiveness of a vote inevitably involves a conflict between the board and a shareholder majority. Judicial review of such action involves a determination of the legal and equitable obligations of an agent towards his principal. This is not, in my opinion, a question that a court may leave to the agent finally to decide so long as he does so honestly and competently; that is, it may not be left to the agent's business judgment.[3]
2. What rule does apply: per se invalidity of corporate acts intended primarily to thwart effective exercise of the franchise or is there an intermediate standard?
Plaintiff argues for a rule of per se invalidity once a plaintiff has established that a board has acted for the primary purpose of thwarting the exercise of a shareholder vote. Our opinions in Canada Southern Oils, Ltd. v. Manabi Exploration Co., Del.Ch., 96 A.2d 810 (1953) and Condec Corporation v. Lunkenheimer Company, Del.Ch., 230 A.2d 769 (1967) could be read as support for such a rule of per se invalidity. Condec is informative.
There, plaintiff had recently closed a tender offer for 51% of defendants' stock. It had announced no intention to do a follow-up merger. The incumbent board had earlier refused plaintiffs' offer to merge and, in response to its tender offer, sought alternative deals. It found and negotiated a proposed sale of all of defendants' assets for stock in the buyer, to be followed up by an exchange offer to the seller's shareholders. The stock of the buyer was publicly traded in the New York Stock Exchange, so that the deal, in effect, offered cash to the target's shareholders. As a condition precedent to the sale of assets, an exchange [661] of authorized but unissued shares of the seller (constituting about 15% of the total issued and outstanding shares after issuance) was to occur. Such issuance would, of course, negate the effective veto that plaintiffs' 51% stockholding would give it over a transaction that would require shareholder approval. Plaintiff sued to invalidate the stock issuance.
The court concluded, as a factual matter, that: "... the primary purpose of the issuance of such shares was to prevent control of Lunkenheimer from passing to Condec...." 230 A.2d at 775. The court then implied that not even a good faith dispute over corporate policy could justify a board in acting for the primary purpose of reducing the voting power of a control shareholder:
Nonetheless, I am persuaded on the basis of the evidence adduced at trial that the transaction here attacked unlike the situation involving the purchase of stock with corporate funds [the court having just cited Bennett v. Propp, Del.Supr., 187 A.2d 405, 409 (1962), and Cheff v. Mathes, Del.Supr., 199 A.2d 548 (1964)] was clearly unwarranted because it unjustifiably strikes at the very heart of corporate representation by causing a stockholder with an equitable right to a majority of corporate stock to have his right to a proportionate voice and influence in corporate affairs to be diminished by the simple act of an exchange of stock which brought no money into the Lunkenheimer treasury, was not connected with a stock option plan or other proper corporate purpose, and which was obviously designed for the primary purpose of reducing Condec's stockholdings in Lunkenheimer below a majority.
Id. at 777. A per se rule that would strike down, in equity, any board action taken for the primary purpose of interfering with the effectiveness of a corporate vote would have the advantage of relative clarity and predictability.[4] It also has the advantage of most vigorously enforcing the concept of corporate democracy. The disadvantage it brings along is, of course, the disadvantage a per se rule always has: it may sweep too broadly.
In two recent cases dealing with shareholder votes, this court struck down board acts done for the primary purpose of impeding the exercise of stockholder voting power. In doing so, a per se rule was not applied. Rather, it was said that, in such a case, the board bears the heavy burden of demonstrating a compelling justification for such action.
In Aprahamian v. HBO & Company, Del.Ch., 531 A.2d 1204 (1987), the incumbent board had moved the date of the annual meeting on the eve of that meeting when it learned that a dissident stockholder group had or appeared to have in hand proxies representing a majority of the outstanding shares. The court restrained that action and compelled the meeting to occur as noticed, even though the board stated that it had good business reasons to move the meeting date forward, and that that action was recommended by a special committee. The court concluded as follows:
The corporate election process, if it is to have any validity, must be conducted with scrupulous fairness and without any advantage being conferred or denied to any candidate or slate of candidates. In the interests of corporate democracy, those in charge of the election machinery of a corporation must be held to the highest standards of providing for and conducting corporate elections. The business judgment rule therefore does not confer any presumption of propriety on the acts of directors in postponing the annual meeting. Quite to the contrary. When the election machinery appears, at least facially, to have been manipulated those in charge of the election have the burden of persuasion to justify their actions.
Aprahamian, 531 A.2d at 1206-07.
In Phillips v. Insituform of North America, Inc., Del.Ch., C.A. No. 9173, Allen, [662] C. (Aug. 27, 1987), the court enjoined the voting of certain stock issued for the primary purpose of diluting the voting power of certain control shares. The facts were complex. After discussing Canada Southern and Condec in light of the more recent, important Supreme Court opinion in Unocal Corp. v. Mesa Petroleum Company, it was there concluded as follows:
One may read Canada Southern as creating a black-letter rule prohibiting the issuance of shares for the purpose of diluting a large stockholder's voting power, but one need not do so. It may, as well, be read as a case in which no compelling corporate purpose was presented that might otherwise justify such an unusual course. Such a reading is, in my opinion, somewhat more consistent with the recent Unocal case.
* * * * * *
In applying the teachings of these cases, I conclude that no justification has been shown that would arguably make the extraordinary step of issuance of stock for the admitted purpose of impeding the exercise of stockholder rights reasonable in light of the corporate benefit, if any, sought to be obtained. Thus, whether our law creates an unyielding prohibition to the issuance of stock for the primary purpose of depriving a controlling shareholder of control or whether, as Unocal suggests to my mind, such an extraordinary step might be justified in some circumstances, the issuance of the Leopold shares was, in my opinion, an unjustified and invalid corporate act.
Phillips v. Insituform of North America, Inc., supra at 23-24. Thus, in Insituform, it was unnecessary to decide whether a per se rule pertained or not.
In my view, our inability to foresee now all of the future settings in which a board might, in good faith, paternalistically seek to thwart a shareholder vote, counsels against the adoption of a per se rule invalidating, in equity, every board action taken for the sole or primary purpose of thwarting a shareholder vote, even though I recognize the transcending significance of the franchise to the claims to legitimacy of our scheme of corporate governance. It may be that some set of facts would justify such extreme action.[5] This, however, is not such a case.
3. Defendants have demonstrated no sufficient justification for the action of December 31 which was intended to prevent an unaffiliated majority of shareholders from effectively exercising their right to elect eight new directors.
The board was not faced with a coercive action taken by a powerful shareholder against the interests of a distinct shareholder constituency (such as a public minority). It was presented with a consent [663] solicitation by a 9% shareholder. Moreover, here it had time (and understood that it had time) to inform the shareholders of its views on the merits of the proposal subject to stockholder vote. The only justification that can, in such a situation, be offered for the action taken is that the board knows better than do the shareholders what is in the corporation's best interest. While that premise is no doubt true for any number of matters, it is irrelevant (except insofar as the shareholders wish to be guided by the board's recommendation) when the question is who should comprise the board of directors. The theory of our corporation law confers power upon directors as the agents of the shareholders; it does not create Platonic masters. It may be that the Blasius restructuring proposal was or is unrealistic and would lead to injury to the corporation and its shareholders if pursued. Having heard the evidence, I am inclined to think it was not a sound proposal. The board certainly viewed it that way, and that view, held in good faith, entitled the board to take certain steps to evade the risk it perceived. It could, for example, expend corporate funds to inform shareholders and seek to bring them to a similar point of view. See, e.g. Hall v. Trans-Lux Daylight Picture Screen Corporation, Del.Ch., 171 A. 226, 227 (1934); Hibbert v. Hollywood Park, Inc., Del. Supr., 457 A.2d 339 (1982). But there is a vast difference between expending corporate funds to inform the electorate and exercising power for the primary purpose of foreclosing effective shareholder action. A majority of the shareholders, who were not dominated in any respect, could view the matter differently than did the board. If they do, or did, they are entitled to employ the mechanisms provided by the corporation law and the Atlas certificate of incorporation to advance that view. They are also entitled, in my opinion, to restrain their agents, the board, from acting for the principal purpose of thwarting that action.
I therefore conclude that, even finding the action taken was taken in good faith, it constituted an unintended violation of the duty of loyalty that the board owed to the shareholders. I note parenthetically that the concept of an unintended breach of the duty of loyalty is unusual but not novel. See Lerman v. Diagnostic Data, supra; AC Acquisitions Corp. v. Anderson, Clayton & Co., Del.Ch., 519 A.2d 103 (1986). That action will, therefore, be set aside by order of this court.
V.
I turn now to a discussion of the second case which is a Section 225 case designed to determine whether the nominees of Blasius were elected to an expanded Atlas board pursuant to the consent procedure.[6]
On March 6, 1988, after several rounds of mailings by each side, Blasius presented consents to the corporation purporting to adopt its five proposals. The corporation appointed an independent fiduciary (Manufacturers Hanover Trust Company) to act as judge of the stockholder vote. It reported a final tally report on March 17 and issued a Certificate of the Stockholder Vote on March 22. That certificate stated that the vote had been exceedingly close and that, as calculated by Manufacturer's Hanover, none of Blasius' proposals had succeeded. In order to be adopted by a majority of shares entitled to vote, each proposition needed to garner 1,486,293 consents. Each was about 45,000 shares short (about 1.5% of the total outstanding stock).[7]
Blasius' Position
Blasius contends that the inspector of elections made an error in the counting of the vote that under our law should be [664] reviewed, and, when reviewed, must be corrected. When corrected, it contends the vote adopted each of its proposals. That "error" is described below. Blasius goes on to argue that while the court may and should review the testimonial (deposition) evidence that establishes this point, it may not rely upon other evidence (offered by Atlas and admitted over objection) that tends to establish that a material number of shares were counted as granting consent by record holders either without authority or in contravention of the beneficial owners' actual intention.
The single "error" that Blasius seeks to have remedied relates to the effect that the judges gave to revocations received from record holders for whom earlier dated consents had been submitted. The background must be set forth. Each side made two mailings to shareholders. Each mailing enclosed a card for voting. The Blasius (white) card provide a space to mark "consent," "consent withheld," or "abstain."[8] It provided that "[s]igned but unmarked consent cards will be deemed to give consent to the action set forth below."[9] The management (blue) card was intended as a revocation card. It also addressed each of the five propositions. While it was intended as a means to revoke consents, one could vote to give a consent by using that card as well. (It is unclear why this revocation card did not simply provide for the revocation of consents already given; perhaps SEC rules require the added confusion that providing for the giving of a consent on a revocation card entails). A "revoke" vote would, of course, have no meaning unless that shareholder had previously granted a "consent." The judges received many revoke cards that did not relate to prior consents — some shareholders used the revoke card as one might use a proxy card to express endorsement of management.
Voting, or the granting of consent to stockholder action, is, of course, the legal right of record holders of stock only. In practice, there are often as many as four (or more) levels of activity in connection with a vote or a consent solicitation. First, record holders are frequently depository companies (Depository Trust Company, for example, holding through its nominee, Cede & Co.). They hold for brokers or other institutions, who in turn hold for beneficial owners. The institutions sometimes contract with Independent Election Company of America (IECA) which distributes voting materials for brokers to their customers and which, as agent, receives back proxy cards or consent cards from beneficial owners, collects them and makes out one or more cards for each broker or bank for which it acts. IECA then physically sends voting cards to the corporation or the judges of election. The depository companies (the actual record holders) will have given blanket proxies to their customers — the institutional record holders, who will then act themselves or through IECA.
The judges of the process counted the vote according to the following procedure in calculating the consents. First, the cards of individual stockholders were treated. All of the Blasius (white) cards and the Atlas (blue) cards were put in alphabetical order. They were then matched to see if any consents granted were revoked by later blue cards and the results tallied.
The same general process was followed with the institutional record holders, but it [665] was more complex. First, the cards for each broker or institution were gathered together — both white consents and blue revokes. The consent cards were then inspected to see if there were "clear duplicates." Some institutions — banks typically, but more rarely, brokers — noted their own subaccount number on the consent cards; these numbers were taken to refer to a beneficial owner's account with the institution, and when the same number appeared on a later dated consent, it was taken as a duplicate of an earlier one having the same number. Accordingly, in those instances, the earlier consent was not counted. Brokers, however, do not tend to show subaccount numbers, and with respect to brokerage accounts, there is generally no way for an inspector to know whether a later consent was intended to substitute for an earlier one, unless the earlier one voted all of the shares registered in the name of that broker (or more correctly, all of the shares which Cede & Co. holds for that broker).[10]
The judges matched later revocations with consents. Since most financial institution cards did not have subaccount numbers or otherwise identify the beneficial owner of the shares being voted, there was no way to be sure that a later revocation for, e.g., 2,000 shares was intended to revoke pro tanto an earlier consent for, e.g., 5,000 shares, or whether it represented an altogether different 2,000 shares. The judges sought independent legal advice on how they should handle this question. They were advised the following day that they should not seek information beyond that which the cards afforded, and where a record holder revoked consent for some number of shares, that card should be given effect by subtracting from the number of consents submitted by that record holder, the number of shares represented by later dated revocations. This was then done. In some instances, the number of later dated consents exceeded the number of consents submitted by that registered owner.
The judges realized that if the institutions (or IECA who had acted for many of them) had already matched later dated revocations with earlier consents from the same beneficial owner, and had, with respect to any beneficial holder, sent only a consent reflecting a net position, then the process of netting that the judges used would result in disenfranchising some shareholders. The judges adopted the tack of proceeding as if the record holder (or IECA) had not discarded prior consents that had been revoked. They filed a qualified report, however, noting this choice and reporting the results of the vote on the contrary assumption. That report shows that between 56,000 and 59,000 consents (depending upon which of the five propositions are considered) were counted as revoked by reason of this netting process. (About half of those were consents sent by IECA and half directly from institutional record holders). Had no netting been done, the judges would have reported that each of the propositions had been consented to by a very small majority of all shares.
During the course of the count, at the instigation of Blasius, an IECA official telephoned one of the judges of election and explained the process that IECA used in its task as agent for various brokers and banks in sending consent materials, receiving them back, computing totals by beneficial owners, and then creating master consents or revoke cards. That process deletes prior consents from a particular beneficial owner before reporting (or sending in to the judges) net positions. Discovery in this case, and evidence admitted at trial, establishes that this report to the judges of the IECA process was correct. The judges, however, elected, in good faith, to exclude this information from their report (except insofar as they noted the problem and the results on the alternative assumption).
[666] Blasius contends that this course resulted in a clear miscount that now must be corrected.
Atlas' Position
Atlas responds in two principal ways.[11] First, it says that where the judges act in good faith, neither they nor the court may consider any information except that which appears on the cards. Since the cards in issue do not disclose beneficial ownership, the only course open to the judges, based the upon the information on the cards, was to assume that the later dated revocation cards did revoke consents that were in hand.[12] The demands of a feasible administration of the corporate franchise require that, absent fraud or other wrongdoing, proxy contests or consent contests be judged on the "ballots" and not on extrinsic evidence. On that basis, Atlas asserts the judges' tally must be affirmed.
Atlas' second position is that if one is to inquire beyond the face of the consent cards themselves, then one — in this instance — will see that many, many mistakes were made in this process, a few by the judges and a more significant number by the record holders; if all of those mistakes are to be reviewed and corrected, the result, as declared by the judges, would remain unchanged. A good deal of discovery was conducted, and testimony admitted, concerning this matter. A few examples of the sort of errors to which Atlas here refers are necessary to appreciate its argument. Its discovery program uncovered many instances of what it contends are errors in executing the wishes of the beneficial owners. Its brief focuses on 14 of these. In this opinion, I will limit the discussion to a handful, as I think that is sufficient to understand the nature and scale of the argument.
A.G. Edwards
A.G. Edwards returned four cards, two each on management's blue revocation form and two on Blasius' white consent form. The two blue cards were dated February 19 and March 4, respectively. The later of the two management cards was also dated March 4. Both of the March 4 cards were stamped "previous proxy will not be counted." In tabulating the total number of consents executed by A.G. Edwards, the judges summed the number of consents given on Blasius' February 19 card, the number of consents given on Blasius' March 4 and the number of consents given on management's February 19 revocation card. The March 4 management card was received too late and was not given effect.
In counting the February 19 Blasius card evidencing consent for 2,425 shares on all propositions in addition to the March 4 Blasius card evidencing consent for 12,099 shares on all propositions and stamped "previous proxy will not be counted," the proxy judges clearly acted contrary to instructions on the face of the card.
Northern Trust
The February 24 Blasius card evidencing consent for 16,700 shares on all propositions was counted in addition to a later dated (March 4) Blasius card evidencing consent for 18,820 shares. Northern Trust's total position in Atlas stock was 21,159 and the total of these two consents, of course, far exceeded that. The judges did not interpret the March 4 card as superseding the February 24 card, but rather interpreted the two cards as independent (and as an implicit attempt to vote far more shares than the shareholder owned). They counted the two consents as voting the full 21,159 shares. This was not the intention of Northern Trust. It has testified that it [667] intended its March 4 card to supersede its earlier card and to vote only 18,820 of its shares in favor of the consent.
State Street Bank
According to Atlas, State Street Bank received oral instructions from Champion Spark Plug, a beneficial holder of 26,890 shares, to vote against the Blasius proposals. State Street then instructed its agent, IECA, to vote the 26,890 shares against the Blasius proposal. Despite these instructions, IECA delivered a card voting 26,890 shares for the proposals and the independent judges recorded the 26,890 shares as voting for the proposals. Blasius contends the record does not show a mistake in this instance.
E.F. Hutton
E.F. Hutton returned both a Blasius consent and a management revocation card dated March 2. The management revocation card was marked as follows:
(1) -240- FOR -5,873- AGST. -110-ABS.
(2) -200- FOR -6,023- WITHHOLD
(3) -244- FOR -5,873- AGST. -110-ABS.
(4) -244- FOR -5,873- AGST. -110-ABS.
While the evidence discloses that Hutton intended a "for" vote to be in favor of the consent proposal, or a consent, and the much larger "against" vote to be a withholding of consent (but apparently not a revocation of a prior consent), the judges of election counted the votes in the reverse fashion because they appeared on a management revocation card. That is, they interpreted this vote as 240 revocations and 5,873 consents.
B.C. Christopher
B.C. Christopher Securities Co. is neither a record nor a beneficial stockholder of Atlas. Purporting to act on behalf of some of its customers, it sent to Securities Settlement Corporation, a clearing house with authority to vote Atlas stock by virtue of an omnibus proxy executed by Cede & Co. authority to "vote the 30,000+ shares of Atlas Corp. in favor of ... Blasius." (DX RRR; Spear Dep. at 6-7). At the time this telex was sent, B.C. Christopher did not know how many shares its customers owned; the figure was given to one Gordon Spear, a B.C. Christopher stock broker, by plaintiff, Warren Delano. Securities Settlement rejected this attempt to vote all shares and requested a list of the shareholders consenting. B.C. Christopher then provided Securities Settlement with a list containing the names and positions of all customers serviced in its Denver office whom B.C. Christopher believed owned stock aggregating 23,800 shares.
Securities Settlement, based only upon this list, directed IECA to vote the positions of all those shareholders as consenting to the Blasius proposal. All customers were tabulated by IECA as consenting to their full share amounts. Evidence in this case, however, establishes that a number of the B.C. Christopher customers never gave B.C. Christopher any authority to consent. The shareholdings of B.C. Christopher customers, affirmatively shown not to have authorized consents, totalled some 3,550. Some of these shareholders had indeed sent in revocation cards intending to withhold consent prior to the B.C. Christopher involvement, and the unauthorized advice from the broker, apparently stimulated by plaintiff Delano, was treated as overriding that direct action. Other B.C. Christopher customers were unavailable or refused to give deposition testimony in this case, but documentary evidence indicates that they have denied giving B.C. Christopher authority to exercise power to consent on their behalfs. (See DX CCCCC; DX DDDDD) (1,600 shares).
In addition, although some of B.C. Christopher's customers did in fact deliver white consent cards to IECA, IECA did not receive cards indicating consent to Blasius' proposal from some 12 shareholders representing approximately 13,500 shares. B.C. Christopher could produce no written evidence that these or any of the other shareholders in fact authorized it to consent on their behalf.
* * *
[668] Atlas, therefore, in summary, replies to Blasius' position by contending that the judges of election, acting in good faith, handled the ministerial duty of calculating unrevoked consents properly — according to the face of the consent itself, and not on the basis of external matters. It relies upon the Supreme Court case Williams v. Sterling Oil of Oklahoma, Inc., Del.Supr., 273 A.2d 264 (1971) in that connection.
Beyond that, it contends that if the court is to go beyond the face of the consents to consider extraneous matters, that the record developed shows that the Blasius proposal did not garner the support of a majority of the beneficial owners, even if the court were to deem it appropriate to reverse the "netting" procedure followed by the judges. It contends that one need not get to that level of review, however, because a ministerial review of the consents delivered is sufficient and, under that approach, it would prevail.
Finally, I should note Blasius' rebuttal, which is as follows: It contends that the face of the consents is what governs, but that the judges neglected to engage in a presumption that exists as a matter of law. The limited evidence of record holders that it submits simply confirms that presumption to in fact be true here. Once that legal presumption is correctly understood, and the "netting" is reversed due to its application, Blasius says that its proposals have been adopted. The presumption arises from the case of Schott v. Climax Molybdenum Company, Del. Ch., 154 A.2d 221 (1959). Blasius says that the other evidence of "errors" is irrelevant.
I turn to my analysis of these positions now.
VI.
The multilevel system of beneficial ownership of stock and the interposition of other institutional players between investors and corporations (e.g., IECA or brokers whose customers hold stock beneficially) renders the process of corporate voting complex. This case demonstrates that the currently employed process by which consents are solicited and counted is even more prone to problems than is the process of proxy counting. In reviewing the computating of the outcome of a proxy fight or a consent contest, the law does not inquire into the subjective intent of either the record owner or the beneficial owner in the usual case.[13]
A legal test that made inquiry into the subjective wishes of ultimate owners relevant would, of course, threaten to convert every close proxy fight into protracted and costly litigation. The law has avoided that risk while attempting to preserve a credible claim to corporate democracy by announcing the rule that only record owners are entitled to vote and if any investor chooses to hold his stock in some fashion other than his own name, he thereby assumes the risk that involving intermediaries will entail. See, e.g., The American Hardware Corporation v. Savage Arms Corporation, Del.Supr., 136 A.2d 690 (1957); ENSTAR Corp. v. Senouf, Del. Supr., 535 A.2d 1351 (1987). Moreover, even as to record owners, the administrative need for expedition and certainty are such that judges of election (and reviewing courts absent fraud or breach of duty) are not to inquire into their intention except as expressed on the face of the proxy, consent or other "ballot." The Supreme Court has held:
We hold the proper rule to be that, in the exercise of their ministerial functions and powers, the inspectors of an election must reject all identical but conflicting proxies when the conflict cannot be resolved from the face of the proxies themselves or from the regular books and records of the corporation. Otherwise stated, conflicting proxies, irreconcilable on their faces or from the books and records of the corporation, may not be reconciled by extrinsic evidence. See Pope v. Whitridge, 110 Md. 468, 73 A. 281, 286 (1909); 5 Fletcher, Cyclopedia of [669] Corporations, § 2062 (Perm.Ed.1967); 2 Thompson on Corporations, § 1021 (3rd Ed.1927); Rogers, Proxy Guide for Meetings of Stockholders, §§ 19, 39 (1969). This rule is dictated by the necessity for practical and certain procedures in the fair handling of proxies and the expeditious conclusion of corporate elections.
* * * * * *
The policy favoring correction of mistake must be limited to corrections that can be made from the face of the proxy itself or from the regular books and records of the corporation. The acceptance and consideration of extrinsic evidence for the purpose, especially when questioned and controverted as here, improperly take the inspectors over the line from the realm of the ministerial to that of the quasi-judicial.
Williams v. Sterling Oil of Oklahoma, Inc., 273 A.2d at 265-66.
Both sides to this contest invoke the authority of Williams. Defendant does so straightforwardly, plaintiff with the addition of another precedent, Schott v. Climax Molybdenum Company, Del.Ch., 154 A.2d 221 (1959). Schott is said by plaintiff to establish a legal rule (which the judges of election here are said to have violated) that later proxies (and, by extension, consents) from brokers are presumed to be with respect to stock held for different beneficial owners than earlier proxies from the same broker, unless otherwise noted on the face of the proxy. In Schott, the court was asked to review the vote that authorized a merger. The judges had counted several proxies received sequentially from a broker (actually there were a number of brokers in the same position). Together those proxies covered less than the total number of shares registered in the name of the broker. On their face, the proxies did not revoke prior proxies. The judges counted all such proxies.
On review, plaintiffs contended that this was error. Their theory was that a later proxy revokes an earlier one. The court held:
Clearly a later proxy revokes an earlier one when such instructions appear on the face of the later proxy. And there is no question but that a later proxy revokes an earlier one where the total number of shares registered in the name of the person giving the proxies is included in each proxy. But is the rule that a later proxy revokes an earlier one applied indiscriminately?
As noted, the various proxies in each series were not, in toto, in excess of the total registered in the particular stockholder's name. Nor were any instructions contained on the proxies. Thus, there is nothing on the face of the proxies which rendered the counting of all of such shares inconsistent. Although not the case here, such a later proxy might be intended to revoke an earlier one. Since it is not necessarily so, I believe the inspectors of election properly resolved the doubt in favor of counting both. My conclusion is based in part on a general policy against disenfranchisement. See Gow v. Consolidated Coppermines Corp. [19 Del.Ch. 172, 165 A. 136] above; Investment Associates v. Standard Power & Light Corp., 29 Del.Ch. 225, 48 A.2d 501, affirmed 29 Del.Ch. 593, 51 A.2d 572. It is also based upon the fact, as here, that this problem arises largely from broker given proxies. Such brokers are undoubtedly expressing the varying wishes of beneficial owners.
Obviously, brokers should, as the Stock Exchange Rule provides, make their intention clear on the face of the proxy. Nevertheless, I think my conclusion is more likely to implement the true intent of the beneficial owner. I conclude that the particular proxies here involved were properly counted by the inspectors. Nor is there any basis in the evidence for rejecting such votes. The evidence adduced shows that in fact the shares, with one exception, were voted in accordance with the wishes of the beneficial owners.
Schott v. Climax Molybdenum Company, supra at 223. (emphasis added).
I do not read Schott as establishing a rule that, in a consent solicitation, a later [670] dated revocation from a broker-registered owner is to be assumed to be with respect to a different beneficial owner than an earlier dated consent unless the reverse appears from the face of the card. Such a rule would require judges to assume that the submission of revocation cards (at least those that contained no consents as well) was a futile act since the "assumption" would leave such revocations in each instance revoking nothing. The proxy setting with which Schott dealt is different than the consent setting in a significant respect. There, to hold that a later dated proxy by a broker-registered owner was not intended to revoke an earlier one (on the assumption that it is with respect to a different beneficial owner) is to give effect to both submissions. It accords to each submission the effect that it calls for on its face. The later Williams opinion of the Supreme Court affirms that, absent fraud, or breach of duty, effect must be given to properly submitted proxies that are not inconsistent. Plaintiffs' interpretation of Schott would accord no effect to a properly submitted revocation, and is not required by Schott itself. It must, therefore, be rejected; it is, in my opinion, inconsistent with Williams.
There were mistakes made by the judges (see, e.g., footnotes 9 and 10 above) and by record owners and their agents; there appears to have been unauthorized and perhaps even wrongful behavior (e.g., B.C. Christopher & Co.). Much of the problem arises from the perhaps thoughtless utilization of proxy contest procedures for a consent solicitation contest. But the mistakes of the judges, on balance, tend to cut against plaintiff. The "netting" procedure did not, in my opinion, constitute a mistake of theirs. Rather, it resulted from the actions of record holders or their IECA agent. As such, I see it as not different in principle from other execution errors of record holders (e.g., E.F. Hutton, and possibly, State Street Bank).
We cannot know, in these circumstances, what the outcome of this close contest would have been if the true wishes of all beneficial owners had been accurately measured. The parties must, in my opinion, be content with the result announced by the judges. Those mistakes that were made by the judges do not alter the outcome.
Judgment will be entered in favor of defendants. An appropriate form of order may be submitted on notice.
[1] See, e.g., E. Rostow, To Whom and For What Ends Is Corporate Management Responsible, in The Corporation in Modern Society (E.S. Mason ed.1959). The late Professor A.A. Berle once dismissed the shareholders' meeting as a "kind of ancient, meaningless ritual like some of the ceremonies that go with the mace in the House of Lords." Berle, Economic Power and the Free Society (1957), quoted in Balotti, Finkelstein, Williams, Meetings of Shareholders (1987) at 2.
[2] Delaware courts have long exercised a most sensitive and protective regard for the free and effective exercise of voting rights. This concern suffuses our law, manifesting itself in various settings. For example, the perceived importance of the franchise explains the cases that hold that a director's fiduciary duty requires disclosure to shareholders asked to authorize a transaction of all material information in the corporation's possession, even if the transaction is not a self-dealing one. See, e.g., Smith v. Van Gorkom, Del.Supr., 488 A.2d 858 (1985); In re Anderson Clayton Shareholders' Litigation, Del. Ch., 519 A.2d 669, 675 (1986).
A similar concern, for credible corporate democracy, underlies those cases that strike down board action that sets or moves an annual meeting date upon a finding that such action was intended to thwart a shareholder group from effectively mounting an election campaign. See, e.g., Schnell v. Chris Craft, supra; Lerman v. Diagnostic Data, Inc., Del.Ch., 421 A.2d 906 (1980); Aprahamian v. HBO, Del.Ch., 531 A.2d 1204 (1987).
The cases invalidating stock issued for the primary purpose of diluting the voting power of a control block also reflect the law's concern that a credible form of corporate democracy be maintained. See Canada Southern Oils, Ltd. v. Manabi Exploration Co., Inc., Del.Ch., 96 A.2d 810 (1953); Condec Corporation v. Lunkenheimer Company, Del.Ch., 230 A.2d 769 (1967); Phillips v. Insituform of North America, Inc., Del. Ch., C.A. No. 9173, Allen, C., 1987 WL 16285 (August 27, 1987).
Similarly, a concern for corporate democracy is reflected (1) in our statutory requirement of annual meetings (8 Del.C. § 211), and in the cases that aggressively and summarily enforce that right. See, e.g., Coaxial Communications, Inc. v. CNA Financial Corp., Del.Supr., 367 A.2d 994 (1976); Speiser v. Baker, Del.Ch., 525 A.2d 1001 (1987), and (2) in our consent statute (8 Del.C. § 228) and the interpretation it has been accorded. See Datapoint Corp. v. Plaza Securities Co., Del.Supr., 496 A.2d 1031 (1985) (order); Allen v. Prime Computer, Inc., Del.Supr., No. 26, 1988 [538 A.2d 1113 (table)] (Jan. 26, 1988); Frantz Manufacturing Company v. EAC Industries, Del.Supr., 501 A.2d 401 (1985).
[3] I thus am unable to be guided by the somewhat different view expressed in the unreported case American Rent-A-Car, Inc. v. Cross, Del. Ch., C.A. No. 7583, 1984 WL 8204 (May 9, 1984).
[4] While it must be admitted that any rule that requires for its invocation the finding of a subjective mental state (i.e., a primary purpose) necessarily will lead to controversy concerning whether it applies or not, nevertheless, once it is determined to apply, this per se rule would be clearer than the alternative discussed below.
[5] Imagine the facts of Condec changed very slightly and coming up in today's world of corporate control transactions. Assume an acquiring company buys 25% of the target's stock in a small number of privately negotiated transactions. It then commences a public tender offer for 26% of the company stock at a cash price that the board, in good faith, believes is inadequate. Moreover, the acquiring corporation announces that it may or may not do a second-step merger, but if it does one, the consideration will be junk bonds that will have a value, when issued, in the opinion of its own investment banker, of no more than the cash being offered in the tender offer. In the face of such an offer, the board may have a duty to seek to protect the company's shareholders from the coercive effects of this inadequate offer. Assume, for purposes of the hypothetical, that neither newly amended Section 203, nor any defensive device available to the target specifically, offers protection. Assume that the target's board turns to the market for corporate control to attempt to locate a more fairly priced alternative that would be available to all shareholders. And assume that just as the tender offer is closing, the board locates an all cash deal for all shares at a price materially higher than that offered by the acquiring corporation. Would the board of the target corporation be justified in issuing sufficient shares to the second acquiring corporation to dilute the 51% stockholder down so that it no longer had a practical veto over the merger or sale of assets that the target board had arranged for the benefit of all shares? It is not necessary to now hazard an opinion on that abstraction. The case is clearly close enough, however, despite the existence of the Condec precedent, to demonstrate, to my mind at least, the utility of a rule that permits, in some extreme circumstances, an incumbent board to act in good faith for the purpose of interfering with the outcome of a contemplated vote. See also American International Rent-A-Car, Inc. v. Cross, supra, n. 3.
[6] Having decided that the board action of December 31 was invalid in equity, I pass over the dispute whether Messrs. Winter and Devaney could be removed from office by shareholders only for cause.
[7] The report of the count was as follows:
Proposition 1 (precatory resolution) 1,444,807 Proposition 2 (amend bylaws to increase 1,443,464 board from 7 to 15) Proposition 3 (removal of Winters and 1,446,209 Devaney) Proposition 4 (election of eight new 1,442,023 directors) Proposition 5 (election of up to seven 1,441,234 new directors in event Atlas has more than seven directors validly)
[8] Since a consent solicitation requires the affirmative vote of all shares authorized to vote on the question, an "abstain" is the functional equivalent of a "consent withheld" vote.
[9] This instruction was interpreted by the judges to mean that a signed card on which a shareholder had indicated a position on a single proposition counted as an affirmative vote on each of the other propositions. Literally, a consent card that marks only one of several propositions is not "an unmarked consent." The judges of election clearly erred in counting such cards as consents for unmarked propositions. The cards on their face did not indicate that a consent had been granted in such instances. There were between 400 and 1,000 consents counted as a result of partially completed cards from individuals, many of whom simply marked "withhold" or "abstain" as to one proposition. From institutions, 1,660 consents were counted where only a "withhold" or "abstain" was marked and approximately 15,500 consents were counted where one proposition was consented to, but others were unmarked.
[10] In one instance, a later dated consent for 12,099 shares noted, "[p]revious proxy will not be counted." The previous consent had been for 2,425 shares. Since the record shareholder owned more than 14,524 shares, the judges counted both as not including a "clear duplicate." This was, in my opinion, clear error. See pp. 666, infra.
[11] A third argument that, with respect to two of the five proposals, more than 60 days provided in Section 228 elapsed before the consents were delivered, will not need to be addressed.
[12] The problem apparently arises, in part, from the fact that IECA and other institutional record holders not only gave effect to the revocations from beneficial owners (thus dissipating the effect of those revocations), but also sent a revocation card to the judges reflecting that revocation. This process works in a proxy contest where a later proxy not only revokes an earlier one, but acts as an affirmative vote. It does not, however, make much sense in a consent contest where a revocation has only one effect, and once it is given that effect, is inoperative.
[13] A different approach, at least by the court, might well be appropriate where fraud or the breach of fiduciary duty is alleged. See, e.g., In re Canal Construction Co., Del.Ch., 182 A. 545 (1936).
1.1.3 Proxy Access 1.1.3 Proxy Access
Proxy access has been the most contested corporate governance regulation for over a decade. Proxy access means the ability of shareholders to have one or more shareholder nominees included on the corporation's proxy card.
In this millennium, the SEC first proposed formal rules dealing with proxy access in 2003 and 2007. In 2009, the SEC again proposed to require proxy access in a new rule 14a-11. In response, it received about 700 comments. The comments were sharply divided on the merits of the proposed rule. Major corporations and their law firms opposed it, whereas institutional investors supported it. Congress weighed in with Section 971 of the Dodd-Frank Act of 2010, which amended section 14 of the Securities Exchange Act to give the SEC explicit authority to require proxy access. The SEC ultimately adopted a modified rule 14a-11 in 2010. In Business Roundtable v. SEC (2011), however, the D.C. Circuit struck down this new rule as "arbitrary and capricious" under the Administrative Procedure Act. Judge Ginsburg's opinion is noticeable for its hostility towards the SEC and its strict demands of cost-benefit analysis. The SEC seems intent on trying it again, but has not mustered the resources to do so yet.
Why might proxy access matter?: The shareholder collective action problem
As you know, shareholders have the right to nominate director candidates and to solicit proxies to vote for them. But under the default rules, shareholders do not have the right to have these candidates included in the corporation's proxy materials, which are mailed and paid for by the corporation. (What about rule 14a-8?) Nor do shareholders have the right to be reimbursed for their costs of running their own proxy campaign (hundreds of thousands or even millions of dollars). The board may reimburse a challenger's cost if the contest was about corporate policy rather than mere personnel issues. But realistically, no incumbent board will do so. The only practical way for a challenger to be reimbursed is to win control of the board.
Given these costs, shareholder opposition faces a considerable collective action problem. An activist shareholder would need to spend a lot of money to run a proxy fight, yet reap only a fraction of the returns.
Let’s look at the incentives in a simple numerical example. Imagine better management could increase the value of a corporation’s shares by $100m (say, from $1 billion to $1.1 billion). You own 1% of those shares. Your individual benefit from better management would hence be $1m. Let’s say a proxy contest would cost $2m.
If you win and replace the board, your candidates will vote to reimburse you. You will hence make a $1m gain because your shares are worth more with better management. But if you lose, you won’t be reimbursed, your shares’ value does not appreciate, and you are stuck with the $2m costs.
Imagine the chances of winning the proxy contest are 50-50 (in practice, that’s high — people tend to be suspicious of insurgents). In expectation, you would lose $500,000 (50% × $1m – 50% × $2m = -$500,000). Thus, you won’t do it. And this happens even though in this example (1) you own $10m worth of shares of this one corporation— a big stake for most investors, and (2) the expected collective benefit to all shareholders combined is $48m (50% × $100m - $2m = $48m).
Variations in the bylaws or the charter
As usual, these default rules can be changed in the charter (cf. DGCL 102(b)(1)) or in the bylaws (cf. DGCL 109). Details of permissible bylaws were disputed, prompting the adoption of DGCL 112 and 113 in 2009 (read!).
Shareholders can use bylaw amendments to obtain the right to proxy access and/or to proxy expense reimbursement even against the opposition of the board (why can shareholders not use charter amendments for this purpose?). And SEC rule 14a-8 allows them to collect "votes" for such amendments using the corporation's proxy. Rule 14a-8(i)(8) excludes director nominations from 14a-8, but it does not exclude bylaw proposals relating to such nominations in subsequent meetings. In 2014/15, activist shareholders — in particular, New York City's Comptroller, responsible for the City's pension funds— used this route at dozens of US corporations, and many of these proxy access proposals passed.
A skeptical note: Why are proxy campaigns so costly?
It remains to be seen if any shareholders will actually use these new proxy access rights. As explained above, the idea is that proxy access will make it much cheaper for an activist to propose a candidate, and hence alleviate the collective action problem. But let's take a closer look at the costs, and whether proxy access really reduces them.
Traditionally, an important expense in running proxy campaigns was mailing costs. These seem relatively minor now that challengers can make their materials available electronically (cf. rule 14a-16(l)) or solicit only a small number of large institutional investors, who now hold a large fraction of most corporations’ shares. But challengers still need to buy a lot of lawyer time to comply with SEC requirements and to avoid fraud lawsuits under rule 14a-9. A successful campaign also tends to require lots of canvassing by proxy solicitors and campaigning with the help of public relations firms. After all, the insurgent must compete with the board, who buys the same services (including litigation) with the corporation’s coffers. Costs for legal and other advice are rather independent of proxy access.
The Ideology of Proxy Access
If proxy access does not indeed reduce costs for “insurgent” shareholders, why would everyone fight about it? The answer is suggested by the following comment from Ted Mirvis of Wachtell, Lipton, Rosen, & Katz in response to the 2007 proposals:
“Wars have many fronts. The battle lines in the fight between the director-centric and the shareholder-centric models of the world now once again include the SEC, as it considers whether to allow shareholders to use a company’s proxy statement for director nominations.”
1.2 Fiduciary Duties 1.2 Fiduciary Duties
As previously mentioned, fiduciary duties originate in equity and comprise the duty of care and the duty of loyalty. Both duties apply equally to directors and officers (Gantler v. Stephens, Del. 2009). Controlling stockholders are subject to fiduciary duties as well and generate some of the most important duty-of-loyalty cases (cf. Weinberger and Sinclair, infra).As a first approximation, the duties of care and loyalty target what their names imply: the duty of care demands that the fiduciary act with appropriate care, while the duty of loyalty demands that the fiduciary act loyally, i.e., guided by the interests of the principal. In other words, the former addresses simple mistakes, while the latter addresses conflicts of interest, i.e., self-dealing. Delaware courts vigilantly police self-dealing but are unreceptive to claims of honest mistakes.
1.2.1 Conflicted behavior (self-dealing): The Duty of Loyalty 1.2.1 Conflicted behavior (self-dealing): The Duty of Loyalty
(Minority) Shareholders' interests are most at risk in transactions between the corporation and its controllers, be it management or large shareholders. The risk is obvious: the controllers may attempt to extract a disproportionate share of the corporation’s value for themselves, at the expense of (minority) shareholders.*Some (not so) fictitious examplesHere are three typical ways controlling shareholders do it. I will illustrate using a fictitious oil company, OilCo, with a controlling stockholder, Mikhail. Mikhail owns 50% of OilCo, and 100% of another fictitious company, Honeypot.1. The first thing Mikhail can do is to have OilCo sell its oil to Honeypot at below-market prices. For example, if the market price of oil is $16 per barrel, Mikhail might arrange for OilCo to sell its oil to Honeypot for $10. For every barrel of oil, this redistributes $3 from minority shareholders to Mikhail. Why? Because if OilCo had sold its oil on the market instead, it would have received $16 per barrel. These $16 would have been shared equally between Mikhail and the minority shareholders. Each would have received $8. But when OilCo instead sells to Honeypot for $10 per barrel, minority shareholders get only $5 (half of $10). The difference of $3 is captured by Mikhail: per barrel of oil, he gets $5 as a shareholder of OilCo and $6 as the sole shareholder of Honeypot (because Honeypot buys for $10 and sells for $16, generating a $6 profit), or a total of $11. The use of artificially inflated or deflated prices to shift value from one company to another is called a transfer pricing scheme. It is also used for tax avoidance purposes.2. Mikhail can also have OilCo issue new shares to himself or to Honeypot at low prices. For example, imagine that OilCo owns oil fields worth $100 million, and that OilCo has one million shares outstanding. That means each share is worth $100 (assuming no transfer pricing scheme), and Mikhail’s 50% stake and the 50% minority shares as a group each comprise 500,000 shares worth $50 million in total. Mikhail now has OilCo issue 100 million shares to himself at $0.01 per share for an overall price of $1 million. This means three things. First, OilCo is now worth $101 million: In addition to the $100 oil field, it now has the $1m that Mikhail put in for the new shares. Second, Mikhail now owns almost the entire company, owning 100.5 million out of 101 million shares (99.5%). Third, the transaction earned him $49.5 million: Before the transaction, Mikhail owned OilCo shares worth $50m (50% × $100m). After buying the new shares, Mikhail now owns shares worth $100.5m (99.5% × $101 million). Thus, Mikhail spent $1m to increase his OilCo holding by $50.5m ($100.5m - $50m), generating a pure profit of $49.5m ($50.5m – $1m). Mikhail’s gain is the minority shareholders’ loss: they lost $49.5 million in this dilution of their share.3. Finally, Mikhail can also dispense with the minority altogether by selling OilCo’s assets to Honeypot for a low price. To wit, he could have OilCo sell its oil fields to Honeypot for less than their $100 million value. This is another transfer pricing scheme, but executed on OilCo’s productive assets rather than its products. As with other transfer pricing schemes, it can also be done in reverse: Mikhail could have OilCo buy an asset from Honeypot at an inflated price.None of these schemes is fictitious at all. For example, they are stylized versions of what Mikhail Khodorkovsky and all the other Russian oligarchs are said to have done to the oil companies they came to control in Russia in the 1990s. Russian corporate law erected barriers to such self-dealing. But corrupt, scared, or just plain incompetent courts breached those barriers. It is a vivid illustration of the importance of the general “legal infrastructure” for the enforcement of corporate law. See generally Bernard Black, Reinier Kraakman, and Anna Tarassova, Russian Privatization and Corporate Governance: What Went Wrong?, 52 STAN. L. REV. 1731 (2000).The U.S. approachNow back to the U.S., where we nowadays take a functioning “legal infrastructure” for granted. What protections does it offer against minority expropriation?First, public corporations must disclose all self-dealing transactions in an amount above $120,000 in their annual report (item 404 of the SEC’s Regulation S-K). Managers or a controlling shareholder may choose to not comply with this rule, but only at the risk of becoming the target of an SEC enforcement action.The only provision of the DGCL that explicitly addresses self-dealing is DGCL 144. On its face, DGCL 144 merely declares that transactions between the corporation and its officers and directors are not void or voidable solely because of the conflict of interest, provided the transaction fulfills one of the three conditions in subparagraphs (a)(1)-(3). This statutory text implies that transactions not fulfilling either of these conditions are automatically void or voidable. But the text leaves open the possibility that some conflicted transactions might be void or voidable even though they do fulfill one of the three conditions of DGCL 144(a)(1)-(3).Notwithstanding, Delaware courts do treat the three conditions as individually sufficient and jointly necessary for the permissibility of self-dealing by directors and officers. That is, self-dealing by officers and directors is beyond judicial reproach if and only if it has been approved in good faith by a majority of fully informed, disinterested directors or shareholders, or it is otherwise shown to be "entirely fair." The courts do not derive this formulation from DGCL 144, however, but from "equitable principles." Moreover, controlling shareholders are subject to more stringent review: their self-dealing is always reviewed for "entire fairness;" approval by a “well-functioning committee of independent directors” or by fully informed disinterested shareholders merely shifts the burden of proof (subject to the recent doctrinal-transactional innovation of Kahn v. MFW, covered in the M&A part of the course).Before diving into the details of this self-dealing jurisprudence, consider a preliminary question: why permit any self-dealing? Delaware law can be characterized as an attempt to differentiate self-dealing that expropriates shareholders, from self-dealing that does not. It is likely that courts will make mistakes, however, and that some expropriation will slip through the judicial cracks.** Why not seal those cracks by prohibiting all self-dealing? The potential harm from self-dealing is great. What is the redeeming benefit, if any?Notes* There is nothing intrinsically wrong with “disproportionate” value sharing if “disproportionate” is measured against some extra-contractual standard such as equal dollar per person. Rather, what I mean by “disproportionate” here is disproportionate relative to the contractually agreed split.** The transactions at issue in Sinclair (the oil sales), Weinberger, and Americas Mining below resemble the three Mikhail examples above. While they were ultimately caught, the controlling shareholders in these Delaware corporations must have thought they might get away with the expropriation. And sometimes, they arguably do, as in Aronson (which, viewed in a skeptical light, resembles the first Mikhail example above).
1.2.1.1 Guth v. Loft 1.2.1.1 Guth v. Loft
Guth is the mother of all Delaware duty of loyalty cases. The decision introduces the basic idea that it is incumbent on the fiduciary to prove that the fiduciary acted “in the utmost good faith” (or, in modern parlance, with “entire fairness”) to the corporation in spite of the fiduciary’s conflict of interest. As mentioned above, approval by a majority of fully informed, disinterested directors or shareholders can absolve the fiduciary or at least shift the burden of proof. In Guth, however, the Court of Chancery had found that Guth had not obtained such approval from his board.The decision deals with two separate aspects of Guth’s behavior. The corporate resources that Guth used for his business, such as Loft’s funds and personnel, clearly belonged to Loft, and there was little question that Guth had to compensate Loft for their use. The contentious part of the decision, however, deals with a difficult line-drawing problem: which transactions come within the purview of the duty of loyalty in the first place? Surely fiduciaries must retain the right to self-interested behavior in some corner of their life. Where is the line? In particular, which business opportunities are “corporate opportunities” belonging to the corporation, and which are open to the fiduciaries to pursue for their own benefit? Cf. DGCL 122(17). And why does it matter here, seeing that some of Guth's actions clearly were actionable self-dealing? Hint: Which remedy is available for which action?
5 A.2d 503
GUTH et al.
v.
LOFT, Inc.
Supreme Court of Delaware.
April 11, 1939.
[5 A.2d 504] Appeal from Chancery Court, New Castle County.
Suit by Loft, Inc., against Charles G. Guth and others to impress a trust in favor of the complainant on all shares of stock of the Pepsi-Cola Company, registered in the name of the defendant Charles G. Guth, and in the name of the defendant the Grace Company, Inc., of Delaware, to secure a transfer of those shares to the complainant, and for an accounting. From [5 A.2d 505] a decree in favor of the complainant, 2 A. 2d 225, the defendants appeal.
Decree sustained.
LAYTON, C. J., RICHARDS, RODNEY, SPEAKMAN, and TERRY, JJ., sitting.
Caleb S. Layton, of Wilmington, and George Wharton Pepper, of Philadelphia, Pa. (Richards, Layton & Finger, of Wilmington, and John Sailer, James A. Montgomery, Jr., and Pepper, Bodine, Stokes & Schoch, all of Philadelphia, Pa., of counsel), for appellants.
Clarence A. Southerland, of Wilmington (David L. Podell, Hays, Podell & Shulman, and Levien, Singer & Neuburger, all of New York City, of counsel), for appellee.
Supreme Court, January Term, 1939. Appeal from the Court of Chancery.
For convenience, Loft Incorporated, will be referred to as Loft; the Grace Company, Inc., of Delaware, as Grace; and Pepsi-Cola Company, a corporation of Delaware, as Pepsi.
Loft filed a bill in the Court of Chancery against Charles G. Guth, Grace and Pepsi seeking to impress a trust in favor of the complainant upon all shares of the capital stock of Pepsi registered in the name of Guth and in the name of Grace (approximately 91% of the capital stock), to secure a transfer of those shares to the complainant, and for an accounting.
The cause was heard at great length by the Chancellor who, on September 17, 1938, rendered a decision in favor of the complainant in accordance with the prayers of the bill. Loft, Inc., v. Guth, Del.Ch., 2 A.2d 225. An interlocutory decree, and an interlocutory order fixing terms of stay and amounts of supersedeas bonds, were entered on October 4, 1938; and, thereafter, an appeal was duly prosecuted to this Court.
The essential facts, admitted or found by the Chancellor, briefly stated, are these: Loft was, and is, a corporation engaged in the manufacturing and selling of candies, syrups, beverages and foodstuffs, having its executive offices and main plant at Long Island City, New York. In 1931 Loft operated 115 stores largely located in the congested centers of population along the Middle Atlantic seaboard. While its operations chiefly were of a retail nature, its wholesale activities were not unimportant, amounting in 1931 to over $800,000. It had the equipment and the personnel to carry on syrup making operations, and was engaged in manufacturing fountain syrups to supply its own extensive needs. It had assets exceeding $9,000,000 in value, excluding goodwill; and from 1931 to 1935, it had sufficient working capital for its own cash requirements.
Guth, a man of long experience in the candy, chocolate and soft drink business, became Vice President of Loft in August, 1929, and its president in March 1930.
Grace was owned by Guth and his family. It owned a plant in Baltimore, Maryland, where it was engaged in the manufacture of syrups for soft drinks, and it had been supplying Loft with "Lady Grace Chocolate Syrup".
In 1931, Coca-Cola was dispensed at all of the Loft Stores, and of the Coca-Cola syrup Loft made large purchases, averaging over 30,000 gallons annually. The cost of the syrup was $1.48 per gallon. Guth requested the Coca-Cola Company to give Loft a jobber's discount in view of its large requirements of syrups which exceeded greatly the purchases of some other users of the syrup to whom such discount had been granted. After many conferences, the Coca-Cola Company refused to give the discount. Guth became incensed, and contemplated the replacement of the Coca-Cola beverage with some other cola drink. On May 19, 1931, he addressed a memorandum to V. O. Robertson, Loft's vice-president, asking "Why are we paying a full price for Coca-Cola? Can you handle this, or would you suggest our buying Pebsaco (Pepsi-Cola) at about $1.00 per gallon?" To this Robertson replied that Loft was not paying quite full price for Coca-Cola, it paying $1.48 per gallon instead of $1.60, but that it was too much, and that he was investigating as to Pepsi-Cola.
Pepsi-Cola was a syrup compounded and marketed by National Pepsi-Cola Company, controlled by one Megargel. The Pepsi-Cola beverage had been on the market for upwards of twenty five years, but chiefly in southern territory. It was possessed of a secret formula and trademark. This company, as it happened, was adjudicated a bankrupt on May 26, 1931, upon a petition filed on May 18, the day before the date of Guth's memorandum to Robertson suggesting a trial of Pepsi-Cola syrup by Loft.
[5 A.2d 506] Megargel was not unknown to Guth. In 1928, when Guth had no connection with Loft, Megargel had tried unsuccessfully to interest Guth and.one Hoodless, vice-president and general manager of a sugar company, in National Pepsi-Cola Company. Upon the bankruptcy of this company Hoodless, who apparently had had some communication with Megargel, informed Guth that Megargel would communicate with him, and Megargel did inform Guth of his company's bankruptcy and that he was in a position to acquire from the trustee in bankruptcy, the secret formula and trademark for the manufacture and sale of Pepsi-Cola.
In July, 1931, Megargel and Guth entered into an agreement whereby Megargel would acquire the Pepsi-Cola formula and trademark; would form a new corporation, with an authorized capital of 300,000 shares of the par value of $5, to which corporation Megargel would transfer the formula and trademark; would keep 100,000 shares for himself, transfer a like number to Guth, and turn back 100,000 shares to the company as treasury stock, all or a part thereof to be sold to provide working capital. By the agreement between the two Megargel was to receive $25,000 annually for the first six years, and, thereafter, a royalty of 2 1/2 cents on each gallon of syrup.
Megargel had no money. The price of the formula and trademark was $10,000. Guth loaned Megargel $12,000 upon his agreement to repay him out of the first $25,000 coming to him under the agreement between the two, and Megargel made a formal assignment to Guth to that effect. The $12,000 was paid to Megargel in this way: $5000 directly to Megargel by Guth, and $7,000 by Loft's certified check, Guth delivering to Loft simultaneously his two checks aggregating $7000. Guth also advanced $426.40 to defray the cost of incorporating the company. This amount and the sum of $12,000 were afterwards repaid to Guth.
Pepsi-Cola Company was organized under the laws of Delaware in August, 1931. The formula and trademark were acquired from the trustee in bankruptcy of National Pepsi-Cola Company, and its capital stock was distributed as agreed, except that 100,000 shares were placed in the name of Grace.
At this time Megargel could give no financial assistance to the venture directly or indirectly. Grace, upon a comparison of its assets with its liabilities, was insolvent. Only $13,000 of Pepsi's treasury stock was ever sold. Guth was heavily indebted to Loft, and, generally, he was in most serious financial straits, and was entirely unable to finance the enterprise. On the other hand, Loft was well able to finance it.
Guth, during the years 1931 to 1935 dominated Loft through his control of the Board of Directors. He has completely controlled Pepsi. Without the knowledge or consent of Loft's Board of Directors he drew upon Loft without limit to further the Pepsi enterprise having at one time almost the entire working capital of Loft engaged therein. He used Loft's plant facilities, materials, credit, executives and employees as he willed. Pepsi's payroll sheets were a part of Loft's and a single Loft check was drawn for both.
An attempt was made to keep an account of the time spent by Loft's workmen on Pepsi's enterprises, and in 1935, when Pepsi had available profits, the account was paid; but no charge was made by Loft as against Pepsi for the services rendered by Loft's executives, higher ranking office employees or chemist, nor for the use of its plant and facilities.
The course of dealing between Loft, Grace and Pepsi was this: Loft, under the direction of its chemist, made the concentrate for the syrup and prepared the directions for its mixing. It was sent to Grace in Baltimore, and Grace was charged with the cost plus ten percent. Grace added the necessary sugar and water. Grace billed the syrup to Pepsi at an undoubted profit, but shipped the syrup direct to Pepsi's customers, of whom Loft was the chief, at a profit. Whether Loft made or lost money on its dealings with Grace was disputed. It profited to little or no extent, and probably lost money. As between Loft and Grace, the latter was extended credit for three and one half years during which time nothing was paid, and it was heavily indebted to Loft. As between Grace and Pepsi, the latter paid for the syrup on account, owing always, however, a substantial balance. But, as between Loft and Pepsi, Loft paid, generally, on delivery, in one instance in advance, and never longer than thirty days. By June, 1934, Loft's total cash and credit advances to Grace and Pepsi were in excess of $100,000.
[5 A.2d 507] All the while Guth was carrying forward his plan to replace Coca-Cola with Pepsi-Cola at all of the Loft stores. Loft spent at least $20,000 in advertising the beverage, whereas it never had to advertise Coca-Cola. Loft, also, suffered large losses of profits at its stores resulting from the discarding of Coca-Cola. These losses were estimated at $300,000. They undoubtedly were large.
When Pepsi was organized in 1931, 100,000 shares of its stock were transferred to Grace. At that time Guth, in his own name, had no shares at all. Sometime in or after August, 1933, a settlement was made of Megargel's claim against Pepsi for arrearages due him under the contract hereinbefore mentioned. That settlement called for the payment of $35,000 in cash by Pepsi. Guth provided $500, Loft $34,500. In the settlement, 97,500 shares of Pepsi stock owned by Megargel were received by Pepsi and left with Loft as security for the advance, as the defendants claimed. These shares came into Guth's possession. Guth claimed that, at the January, 1934, meeting of the Loft Board of Directors, the Megargel settlement, Loft's advance of $34,500 and Pepsi's receipt of the Megargel stock were reported to the Board, and that the directors authorized the continuance of Loft's unlimited financing of Pepsi, but no record of the authorization exists.
In December, 1934, Pepsi issued 40,000 of its shares to Grace in settlement of Pepsi's indebtedness to it in the amount as Grace claimed of $46,286.49, but Loft claimed that the balance due Grace from Pepsi was $38,952.14. At this time Grace was indebted to Loft in the sum of $26,493.07. Pepsi owed Loft $39,231.86; and Guth owed Loft over $100,000.
Guth claimed that he offered Loft the opportunity to take over the Pepsi-Cola enterprise, frankly stating to the directors that if Loft did not, he would; but that the Board declined because Pepsi-Cola had proved a failure, and that for Loft to sponsor a company to compete with Coca-Cola would cause trouble; that the proposition was not in line with Loft's business; that it was not equipped to carry on such business on an extensive scale; and that it would involve too great a financial risk. Yet, he claimed that, in August, 1933, the Loft directors consented, without a vote, that Loft should extend to Guth its facilities and resources without limit upon Guth's guarantee of all advances, and upon Guth's contract to furnish Loft a continuous supply of syrup at a favorable price. The guaranty was not in writing if one was made, and the contract was not produced.
The appellants claimed that the franchise and trademark were acquired by Pepsi without the aid of Loft; that Grace made an essential contribution to the enterprise by way of its Baltimore plant, since it would have been necessary for Pepsi to erect such plant if the Grace plant had not been available; that the valuable services of G. H. Robertson who had a wide experience in the field of manufacturing and distributing bottled beverages were secured; that no part of the $13,000 paid for Pepsi's stock by the purchasers thereof was Loft's money; that Pepsi and Grace made large purchases of sugar and containers from other concerns than Loft; that Loft in 1934 and 1935 bought a very small part of Pepsi's output of syrup; that Guth rendered invaluable services to Pepsi, and was the genius responsible for its success; that the success of Pepsi was due to Guth's idea of furnishing Pepsi-Cola in 12 ounce bottles at 5 cents, and to his making license agreements with bottlers; and that all of the indebtedness of Guth, Grace and Pepsi had been made good to Loft except $30,000 which Guth owed Loft, and which could be liquidated at any time.
The Chancellor found that Guth had never offered the Pepsi opportunity to Loft; that his negotiations with Megargel in 1931 was not a renewal of a prior negotiation with him in 1928; that Guth's use of Loft's money, credit, facilities and personnel in the furtherance of the Pepsi venture was without the knowledge or authorization of Loft's directors; that Guth's alleged personal guaranty to Loft against loss resulting from the venture was not in writing, and otherwise was worthless; that no contract existed between Pepsi and Loft whereby the former was to furnish the latter with a constant supply of syrup for a definite time and at a definite price; that as against Loft's contribution to the Pepsi-Cola venture, the appellants had contributed practically nothing; that after the repayment of the sum of $12,000 which had been loaned by Guth to Megargel, Guth had not a dollar invested in Pepsi stock; that Guth was a full time president of Loft at an attractive salary, and could not claim to have invested [5 A.2d 508]his services in the enterprise; that in 1933, Pepsi was insolvent; that Loft, until July, 1934, bore practically the entire financial burdens of Pepsi, but for which it must have failed disastrously to the great loss of Loft.
Reference is made to the opinion of the Chancellor (2 A.2d 225) for a more detailed statement of the facts.
By the decree entered the Chancellor found, inter alia, that Guth was estopped to deny that opportunity of acquiring the Pepsi-Cola trademark and formula was received by him on behalf of Loft, and that the opportunity was wrongfully appropriated by Guth to himself; that the value inhering in and represented by the 97,500 shares of Pepsi stock standing in the name of Guth and the 140,000 shares standing in the name of Grace, were, in equity, the property of Loft; that the dividends declared and paid on the shares of stock were, and had been, the property of Loft; and that for all practical purposes Guth and Grace were one.
The Chancellor ordered Guth and Grace to transfer the shares of stock to Loft; the sequestrator to pay to Loft certain money representing dividends declared on the stock for the year 1936; Grace and Guth to pay to Loft certain money, representing dividends declared and paid for the same year; Guth to account for and pay over to Loft any other dividends, profits, gains, etc., attributable or allocable to the 97,500 shares of Pepsi stock standing in his name; Grace to do likewise with respect to the 140,000 shares standing in its name; Guth to pay to Loft all salary or compensation paid him by Pepsi prior to October 21, 1935; and all salary paid by Pepsi to him subsequent to October 21, 1935, in excess of what should be determined to be reasonable; Guth and Grace to be credited with such sums of money as may be found due them from Loft or from Pepsi in respect of matters set forth in the bill of complaint; and a master to be appointed to take and state the accounts.
Assignments of error, thirty in number, were filed, covering practically all of the essential findings and conclusions of the Chancellor.
LAYTON, Chief Justice, delivering the opinion of the Court:
In the Court below the appellants took the position that, on the facts, the complainant was entitled to no equitable relief whatever. In this Court, they seek only a modification of the Chancellor's decree, not a reversal of it. They now contend that the question is one of equitable adjustment based upon the extent and value of the respective contributions of the appellants and the appellee. This change of position is brought about, as it is said, because of certain basic fact findings of the Chancellor which are admittedly unassailable in this Court. The appellants accept the findings of fact; but they contend that the Chancellor's inferences from them were unwarrantable in material instances, and far more favorable to the complainant than they would have been had not he felt justified in penalizing Guth for what seemed to him serious departures from a strict standard of official conduct. They say that this attitude of mind of the Chancellor was brought about by attacking Guth's official conduct in such manner as to create an impression of ruthlessness, thereby causing the Chancellor to be less critical of equitable theory, and more inclined to do what amounted to an infliction of a penalty.
As stated by the appellants, there were certain questions before the Chancellor for determination: (1) was Guth at the time the Pepsi-Cola opportunity came to him obligated, in view of his official connection with Loft, to take the opportunity for Loft rather than for himself? On this point the appellants contend no finding was made.
(2) Was Guth, nevertheless, estopped from denying that the opportunity belonged to Loft; and was he rightfully penalized to the extent of his whole interest therein, merely because resources borrowed from Loft had contributed in some measure to its development; and did Loft's contributions create the whole value behind the interests of Guth and Grace in Pepsi, thereby constituting Loft the equitable owner of those interests? These questions were answered in the affirmative; and because of the answers, the Chancellor, it is said, did not answer the last question before him, that is, Upon what theory and to what extent should Loft share in the proceeds of the Pepsi-Cola enterprise?
The appellants contend, at length and earnestly, that the Chancellor made no finding of fact with respect to corporate opportunity. They admit that if the Chancellor had found, or if this Court should find, that the Pepsi-Cola opportunity was [5 A.2d 509] one which Guth, as president and dominant director of Loft, was bound to embrace for it, such finding would create, as it is said, an obstacle to the appellants' right to a reappraisement of the Loft contributions to the Pepsi-Cola enterprise; and as the oral argument is remembered, it was stated in more direct and explicit terms, that if the Chancellor had so found, or if this Court should find, in favor of Loft upon the issue, the case would be at an end.
The appellants offer a comparison of the preliminary draft of a decree, submitted by the complainant as Finding A, with the final draft of that finding. Briefly, the substantial difference is, that in the preliminary draft it was stated that the opportunity to acquire the formula, goodwill and business incident to the manufacture and sale of Pepsi-Cola, belonged to the complainant; whereas, in the decree as signed, it was stated that Guth was estopped to deny that he had received the opportunity on behalf of the complainant. The appellants say that strenuous objection was made to the draft submitted by the appellee on the ground that nowhere in the Chancellor's opinion did it appear that he had found, as a fact, that the opportunity belonged to Loft, and after full consideration, the Chancellor acquiesced, and the modification was made. The appellee contends that the chancellor did find that the Pepsi-Cola opportunity belonged to it, and that the modification was made for other reasons.
In these circumstances of contention, certain questions suggest themselves for consideration, and some of them for answer: Did the Chancellor make an explicit finding that the Pepsi-Cola opportunity belonged in equity to Loft, and if so, was such finding justifiable in fact and in law? If the Chancellor made no such explicit finding, should he have done so, or should this Court make such finding? Assuming that the Chancellor made no explicit finding and that this Court should not feel justified in making such finding, was, and is, the doctrine of estoppel properly invocable in favor of the complainant?
The complainant is not, of course, precluded from making the argument that, upon the law and the facts, the Pepsi-Cola opportunity belonged to it; nor is this Court prohibited from so finding.
It is necessary briefly to notice what the Chancellor said with respect to the question of corporate opportunity. As a preliminary to the discussion of the question, the Chancellor stated generally the principles governing officers and directors of a corporation with respect to their fiduciary relation to the corporation and its stockholders, and their liability to account to the corporation for profits and advantages resulting from unlawful acts and breaches of trust done and committed in the promotion of their own interests. He then proceeded to say that Guth, being not only a director of Loft but its president as well, and dominant in the management of its affairs, the principles and rules governing trustees in their relations with their correlates applied to him with peculiar and exceptional force. He particularly noticed a proposition of law stated by the defendants, that when a business opportunity comes to an officer or director in his individual capacity rather than in his official capacity, and is one which, because of its nature, is not essential to the corporation, and is one in which it has no interest or expectancy, the officer or director is entitled to treat the opportunity as his own. As stated, he found the proposition acceptable in the main; but he observed that the cases cited by the defendant recognized as true also the converse of the proposition, and that in all of them the fundamental fact of good faith was found in favor of the officer or director charged with the dereliction. He then proceeded to say [2 A.2d 240]:
"Now the evidence in the case subjudice does not warrant the view that any one of these features may be affirmed as existing here. The brief review of some of its salient features which I have hereinbefore made, shows the opposite of every one of them to have been the fact. That Loft had the means to finance and establish the business is clearly demonstrated. In every aspect of essential fact it did so. That Guth did not use his own funds and risk his own resources in acquiring and developing the Pepsi business is equally demonstrated. He was in fact unable to do so. I dismiss from consideration his claim of a parol contract of guaranty with Loft by which he engaged to save it harmless from any loss it might suffer from its advances. I conclude that no such guaranty was given. Even if it was, it was worthless. That the business of producing Pepsi-Cola syrup was in the line of Loft's business and of practical and not theoretical interest to it, is shown by the fact that Loft was engaged in manufacturing [5 A.2d 510] fountain syrups of numerous kinds to supply its own extensive needs. Indeed the outstanding justification which Guth offers for his utilization of Loft's resources on the scale he did, was Loft's need for a constant and reliable supply of Pepsi-Cola syrup. The former directors now allied with Guth, a minority of the former board, offer a like justification for their alleged approval of Guth's acts in plunging Loft deep into the Pepsi venture. It does not become either Guth or the minority group of directors now associated with him to claim that Pepsi was an enterprise which was foreign to Loft's purposes and alien to its business interests. The very claim, if accepted, denounces as a shocking breach of their duty as directors their act of agreeing, as they now say they did, to Guth's free use of Loft's resources of all kinds to an unlimited extent to promote and develop the enterprise.
"I am of the opinion that under such circumstances as are disclosed in this case, Guth is estopped by what he subsequently caused Loft to do, to deny that when he embraced the Megargel offer he did so in behalf of Loft. The offer cannot be viewed in any light other than an expectancy that was Loft's. Guth is estopped to contend to the contrary. The case of Bailey v. Jacobs, 325 Pa. 187, 189 A. 320, cited at an earlier point in this opinion, is a pertinent and persuasive authority in support of that view."
Manifestly, the Chancellor found to exist facts and circumstances from which the conclusion could be reached that the Pepsi-Cola opportunity belonged in equity to Loft.
Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. While technically not trustees, they stand in a fiduciary relation to the corporation and its stockholders. A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it, or to enable it to make in the reasonable and lawful exercise of its powers. The rule that requires an undivided and unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest. The occasions for the determination of honesty, good faith and loyal conduct are many and varied, and no hard and fast rule can be formulated. The standard of loyalty is measured by no fixed scale.
If an officer or director of a corporation, in violation of his duty as such, acquires gain or advantage for himself, the law charges the interest so acquired with a trust for the benefit of the corporation, at its election, while it denies to the betrayer all benefit and profit. The rule, inveterate and uncompromising in its rigidity, does not rest upon the narrow ground of injury or damage to the corporation resulting from a betrayal of confidence, but upon a broader foundation of a wise public policy that, for the purpose of removing all temptation, extinguishes all possibility of profit flowing from a breach of the confidence imposed by the fiduciary relation. Given the relation between the parties, a certain result follows; and a constructive trust is the remedial device through which precedence of self is compelled to give way to the stern demands of loyalty. Lofland et al. v. Cahall, 13 Del. Ch. 384, 118 A. 1; Bodell v. General Gas & Elec. Corp., 15 Dcl.Ch. 119, 132 A. 442, affirmed 15 Del.Ch. 420, 140 A. 264; Trice et al. v. Comstock, 8 Cir., 121 F. 620, 61 L.R.A. 176; Jasper v. Appalachian Gas Co., 152 Ky. 68, 153 S.W. 50, Ann.Cas. 1915B, 192; Meinhard v. Salmon, 249 N. Y. 458, 164 N.E. 545, 62 A.L.R. 1; Wendt v. Fischer, 243 N.Y. 439, 154 N.E. 303; Bailey v. Jacobs, 325 Pa. 187, 189 A. 320; Cook v. Deeks, [1916] L.R. 1 A.C. 554.
The rule, referred to briefly as the rule of corporate opportunity, is merely one of the manifestations of the general rule that demands of an officer or director the utmost good faith in his relation to the corporation which he represents.
It is true that when a business opportunity comes to a corporate officer or director in his individual capacity rather than in his official capacity, and the opportunity is one which, because of the nature of the enterprise, is not essential to his corporation, and is one in which it has no interest or expectancy, the officer or director is entitled to treat the opportunity as his own, and the corporation has no interest in it, if, of course, the officer or director has not wrongfully embarked the [5 A.2d 511] corporation's resources therein. Colorado & Utah Coal Co. v. Harris et al., 97 Colo. 309, 49 P.2d 429; Lagarde v. Anniston Lime & Stone Co., 126 Ala. 496, 28 So. 199; Pioneer Oil & Gas Co. v. Anderson, 168 Miss. 334, 151 So. 161; Sandy River R. Co. v. Stubbs, 77 Me. 594, 2 A. 9; Lancaster Loose Leaf Tobacco Co. v. Robinson, 199 Ky. 313, 250 S.W. 997. But, in all of these cases, except, perhaps, in one, there was no infidelity on the part of the corporate officer sought to be charged. In the first case, it was found that the corporation had no practical use for the property acquired by Harris. In the Pioneer Oil & Gas Co. case, Anderson used no funds or assets of the corporation, did not know that the corporation was negotiating for the oil lands and, further, the corporation could not, in any event have acquired them, because their proprietors objected to the corporation's having an interest in them, and because the corporation was in no financial position to pay for them. In the Stubbs case, the railroad company, desiring to purchase from Porter such part of his land as was necessary for its right of way, station, water-tank, and woodshed, declined to accede to his price. Stubbs, a director, made every effort to buy the necessary land for the company and failed. He then bought the entire tract, and offered to sell to the company what it needed. The company repudiated expressly all participation in the purchase. Later the company located its tracks and buildings on a part of the land, but could not agree with Stubbs as to damages or terms of the conveyance. Three and one-half years thereafter, Stubbs was informed for the first time that the company claimed that he held the land in trust for it. In the Lancaster Loose Leaf Tobacco Co. case, the company had never engaged in the particular line of business, and its established policy had been not to engage in it. The only interest which the company had in the burley tobacco bought by Robinson was its commissions in selling it on its floors, and these commissions it received. In the Lagarde case, it was said that the proprietorship of the property acquired by the Legardes may have been important to the corporation, but was not shown to have been necessary to the continuance of its business, or that its purchase by the Legardes had in any way impaired the value of the corporation's property. This decision is, perhaps, the strongest cited on behalf of the appellants. With deference to the Court that rendered it, a different view of the correctness of the conclusion reached may be entertained.
On the other hand, it is equally true that, if there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake, is, from its nature, in the line of the corporation's business and is of practical advantage to it, is one in which the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself. And, if, in such circumstances, the interests of the corporation are betrayed, the corporation may elect to claim all of the benefits of the transaction for itself, and the law will impress a trust in favor of the corporation upon the property, interests and profits so acquired. Du Pont v. Du Pont et al, D.C, 242 F. 98, reversed on facts, 3 Cir, 256 F. 129; Beatty v. Guggenheim Exploration Co., 225 N.Y. 380, 122 N.E. 378; Irving Trust Co. v. Deutsch, 2 Cir, 73 F.2d 121, certiorari denied Biddle v. Irving Trust Co., 294 U. S. 708, 55 S.Ct. 405, 79 L.Ed. 1243; Bailey v. Jacobs, supra; Beaudette et al. v. Graham et al, 267 Mass. 7, 165 N.E. 671; McKey v. Swenson, 232 Mich. 505, 205 N.W. 583.
But, there is little profit in a discussion of the particular cases cited. In none of them are the facts and circumstances comparable to those of the case under consideration. The question is not one to be decided on narrow or technical grounds, but upon broad considerations of corporate duty and loyalty.
As stated in 3 Fletcher Cyclopedia, Corporations, § 862, an authority seemingly relied on by the appellants, "There is a vast field for individual activity outside the duty of a director, yet well within the general scope of the corporation's business. The test seems to be whether there was a specific duty, on the part of the officer sought to be held liable, to act or contract in regard to the particular matter as the representative of the corporation—all of which is largely a question of fact".
Duty and loyalty are inseparably connected. Duty is that which is required by one's station or occupation; is that which one is bound by legal or moral obligation to do or refrain from doing; and it is with [5 A.2d 512] this conception of duty as the underlying basis of the principle applicable to the situation disclosed, that the conduct and acts of Guth with respect to his acquisition of the Pepsi-Cola enterprise will be scrutinized. Guth was not merely a director and the president of Loft. He was its master. It is admitted that Guth manifested some of the qualities of a dictator. The directors were selected by him. Some of them held salaried positions in the company. All of them held their positions at his favor. Whether they were supine merely, or for sufficient reasons entirely subservient to Guth, it is not profitable to inquire. It is sufficient to say that they either wilfully or negligently allowed Guth absolute freedom of action in the management of Loft's activities, and theirs is an unenviable position whether testifying for or against the appellants.
Prior to May, 1931, Guth became convinced that Loft was being unfairly discriminated against by the Coca-Cola Company of whose syrup it was a large purchaser, in that Loft had been refused a jobber's discount on the syrup, although others, whose purchases were of far less importance, had been given such discount. He determined to replace Coca-Cola as a beverage at the Loft stores with some other cola drink, if that could be accomplished. So, on May 19, 1931, he suggested an inquiry with respect to desirability of discontinuing the use of Coca-Cola, and replacing it with Pepsi-Cola at a greatly reduced price. Pepsi-Cola was the syrup produced by National Pepsi-Cola Company. As a beverage it had been on the market for over twenty-five years, and while it was not known to consumers in the area of the Loft stores, its formula and trademark were well established. Guth's purpose was to deliver Loft from the thraldom of the Coca-Cola Company, which practically dominated the field of cola beverages, and, at the same time, to gain for Loft a greater margin of profit on its sales of cola beverages. Certainly, the choice of an acceptable substitute for Coca-Cola was not a wide one, and, doubtless, his experience in the field of bottled beverages convinced him that it was necessary for him to obtain a cola syrup whose formula and trademark were secure against attack. Although the difficulties and dangers were great, he concluded to make the change. Almost simultaneously, National Pepsi-Cola Company, in which Megargel was predominant and whom Guth knew, went into bankruptcy; and Guth was informed that the long established Pepsi-Cola formula and trademark could be had at a small price. Guth, of course, was Loft; and Loft's determination to replace Coca-Cola with some other cola beverage in its many stores was practically co-incidental with the opportunity to acquire the Pepsi-Cola formula and trademark. This was the condition of affairs when Megargel approached Guth. Guth contended that his negotiation with Megargel in 1931 was but a continuation of a negotiation begun in 1928, when he had no connection with Loft; but the Chancellor found to the contrary, and his finding is accepted.
It is urged by the appellants that Megargel offered the Pepsi-Cola opportunity to Guth personally, and not to him as president of Loft. The Chancellor said that there was no way of knowing the fact, as Megargel was dead, and the benefit of his testimony could not be had; but that it was not important, for the matter of consequence was how Guth received the proposition.
It was incumbent upon Guth to show that his every act in dealing with the opportunity presented was in the exercise of the utmost good faith to Loft; and the burden was cast upon him satisfactorily to prove that the offer was made to him individually. Reasonable inferences, drawn from acknowledged facts and circumstances, are powerful factors in arriving at the truth of a disputed matter, and such inferences are not to be ignored in considering the acts and conduct of Megargel. He had been for years engaged in the manufacture and sale of a cola syrup in competition with Coca-Cola. He knew of the difficulties of competition with such a powerful opponent in general, and in particular in the securing of a necessary foothold in a new territory where Coca-Cola was supreme. He could not hope to establish the popularity and use of his syrup in a strange field, and in competition with the assured position of Coca-Cola, by the usual advertising means, for he, himself, had no money or resources, and it is entirely unbelievable that he expected Guth to have command of the vast amount of money necessary to popularize Pepsi-Cola by the ordinary methods. He knew of the difficulty, not to say impossibility, of inducing proprietors of soft drink establishments to use a cola drink utterly unknown [5 A.2d 513] to their patrons. It would seem clear, from any reasonable point of view, that Megargel sought to interest someone who controlled an existing opportunity to popularize his product by an actual presentation of it to the consuming public. Such person was Guth, the president of Loft. It is entirely reasonable to infer that Megargel approached Guth as president of Loft, operating, as it did, many soft drink fountains in a most necessary and desirable territory where Pepsi-Cola was little known, he well knowing that if the drink could be established in New York and circumjacent territory, its success would be assured. Every reasonable inference points to this conclusion. What was finally agreed upon between Megargel and Guth, and what outward appearance their agreement assumed, is of small importance. It was a matter of indifference to Megargel whether his co-adventurer was Guth personally, or Loft, so long as his terms were met and his object attained.
Leaving aside the manner of the offer of the opportunity, certain other matters are to be considered in determining whether the opportunity, in the circumstances, belonged to Loft; and in this we agree that Guth's right to appropriate the Pepsi-Cola opportunity to himself depends upon the circumstances existing at the time it presented itself to him without regard to subsequent events, and that due weight should be given to character of the opportunity which Megargel envisioned and brought to Guth's door.
The real issue is whether the opportunity to secure a very substantial stock interest in a corporation to be formed for the purpose of exploiting a cola beverage on a wholesale scale was so closely associated with the existing business activities of Loft, and so essential thereto, as to bring the transaction within that class of cases where the acquisition of the property would throw the corporate officer purchasing it into competition with his company. This is a factual question to be decided by reasonable inferences from objective facts.
It is asserted that, no matter how diversified the scope of Loft's activities, its primary business was the manufacturing and selling of candy in its own chain of retail stores, and that it never had the idea of turning a subsidiary product into a highly advertised, nation-wide specialty. Therefore, it had never initiated any investigation into the possibility of acquiring a stock interest in a corporation to be formed to exploit Pepsi-Cola on the scale envisioned by Megargel, necessitating sales of at least 1,000,000 gallons a year. It is said that the most effective argument against the proposition that Guth was obligated to take the opportunity for Loft is to be found in the complainant's own assertion that Guth was guilty of an improper exercise of business judgment when he replaced Coca-Cola with Pepsi-Cola at the Loft Stores. Assuming that the complainant's argument in this respect is incompatible with its contention that the Pepsi-Cola opportunity belonged to Loft, it is no more inconsistent than is the position of the appellants on the question. In the Court below, the defendants strove strenuously to show, and to have it believed, that the Pepsi-Cola opportunity was presented to Loft by Guth, with a full disclosure by him that if the company did not embrace it, he would. This, manifestly, was a recognition of the necessity for his showing complete good faith on his part as a corporate officer of Loft. In this Court, the Chancellor having found as a fact that Guth did not offer the opportunity to his corporation, it is asserted that no question of good faith is involved for the reason that the opportunity was of such character that Guth, although Loft's president, was entirely free to embrace it for himself. The issue is not to be enmeshed in the cobwebs of sophistry. It rises far above inconsistencies in argument.
The appellants suggest a doubt whether Loft would have been able to finance the project along the lines contemplated by Megargel, viewing the situation as of 1931. The answer to this suggestion is two-fold. The Chancellor found that Loft's net asset position at that time was amply sufficient to finance the enterprise, and that its plant, equipment, executives, personnel and facilities, supplemented by such expansion for the necessary development of the business as it was well able to provide, were in all respects adequate. The second answer is that Loft's resources were found to be sufficient, for Guth made use of no other to any important extent.
Next it is contended that the Pepsi-Cola opportunity was not in the line of Loft's activities which essentially were of a retail nature. It is pointed out that, in 1931, the retail stores operated by Loft were largely located in the congested areas along the Middle Atlantic Seaboard, that its manufacturing [5 A.2d 514] operations were centered in its New York factory, and that it was a definitely localized business, and not operated on a national scale; whereas, the Megargel proposition envisaged annual sales of syrup at least a million gallons, which could be accomplished only by a wholesale distribution. Loft, however, had many wholesale activities. Its wholesale business in 1931 amounted to over $800,000. It was a large company by any standard. It had an enormous plant. It paid enormous rentals. Guth, himself, said that Loft's success depended upon the fullest utilization of its large plant facilities. Moreover, it was a manufacturer of syrups and, with the exception of cola syrup, it supplied its own extensive needs. The appellants admit that wholsesale distribution of bottled beverages can best be accomplished by license agreements with bottlers. Guth, president of Loft, was an able and experienced man in that field. Loft, then, through its own personnel, possessed the technical knowledge, the practical business experience, and the resources necessary for the development of the Pepsi-Cola enterprise.
But, the appellants say that the expression, "in the line" of a business, is a phrase so elastic as to furnish no basis for a useful inference. The phrase is not within the field of precise definition, nor is it one that can be bounded by a set formula. It has a flexible meaning, which is to be applied reasonably and sensibly to the facts and circumstances of the particular case. Where a corporation is engaged in a certain business, and an opportunity is presented to it embracing an activity as to which it has fundamental knowledge, practical experience and ability to pursue, which, logically and naturally, is adaptable to its business having regard for its financial position, and is one that is consonant with its reasonable needs and aspirations for expansion, it may be properly said that the opportunity is in the line of the corporation's business.
The manufacture of syrup was the core of the Pepsi-Cola opportunity. The manufacture of syrups was one of Loft's not unimportant activities. It had the necessary resources, facilities, equipment, technical and practical knowledge and experience. The tie was close between the business of Loft and the Pepsi-Cola enterprise. Beatty v. Guggenheim Exploration Co., 225 N.Y. 380, 122 N.E. 378; Transvaal Cold Storage Co., Ltd., v. Palmer, [1904] T. S. Transvaal L. R. 4. Conceding that the essential of an opportunity is reasonably within the scope of a corporation's activities, latitude should be allowed for development and expansion. To deny this would be to deny the history of industrial development.
It is urged that Loft had no interest or expectancy in the Pepsi-Cola opportunity. That it had no existing property right therein is manifest; but we cannot agree that it had no concern or expectancy in the opportunity within the protection of remedial equity. Loft had a practical and essential concern with respect to some cola syrup with an established formula and trademark. A cola beverage has come to be a business necessity for soft drink establishments; and it was essential to the success of Loft to serve at its soda fountains an acceptible five cent cola drink in order to attract into its stores the great multitude of people who have formed the habit of drinking cola beverages. When Guth determined to discontinue the sale of Coca-Cola in the Loft stores, it became, by his own act, a matter of urgent necessity for Loft to acquire a constant supply of some satisfactory cola syrup, secure against probable attack, as a replacement; and when the Pepsi-Cola opportunity presented itself, Guth having already considered the availability of the syrup, it became impressed with a Loft interest and expectancy arising out of the circumstances and the urgent and practical need created by him as the directing head of Loft.
As a general proposition it may be said that a corporate officer or director is entirely free to engage in an independent, competitive business, so long as he violates no legal or moral duty with respect to the fiduciary relation that exists between the corporation and himself. The appellants contend that no conflict of interest between Guth and Loft resulted from his acquirement and exploitation of the Pepsi-Cola opportunity. They maintain that the acquisition did not place Guth in competition with Loft any more than a manufacturer can be said to compete with a retail merchant whom the manufacturer supplies with goods to be sold. However true the statement, applied generally, may be, we emphatically dissent from the application of the analogy to the situation of the parties here. There is no unity between the ordinary manufacturer and the retailer of his goods. Generally, the retailer, if he [5 A.2d 515] becomes dissatisfied with one supplier of merchandise, can turn to another. He is under no compulsion and no restraint. In the instant case Guth was Loft, and Guth was Pepsi. He absolutely controlled Loft. His authority over Pepsi was supreme. As Pepsi, he created and controlled the supply of Pepsi-Cola syrup, and he determined the price and the terms. What he offered, as Pepsi, he had the power, as Loft, to accept. Upon any consideration of human characteristics and motives, he created a conflict between self-interest and duty. He made himself the judge in his own cause. This was the inevitable result of the dual personality which Guth assumed, and his position was one which, upon the least austere view of corporate duty, he had no right to assume. Moreover, a reasonable probability of injury to Loft resulted from the situation forced upon it. Guth was in the same position to impose his terms upon Loft as had been the Coca-Cola Company. If Loft had been in servitude to that company with respect to its need for a cola syrup, its condition did not change when its supply came to depend upon Pepsi, for, it was found by the Chancellor, against Guth's contention, that he had not given Loft the protection of a contract which secured to it a constant supply of Pepsi-Cola syrup at any definite price or for any definite time.
It is useless to pursue the argument. The facts and circumstances demonstrate that Guth's appropriation of the Pepsi-Cola opportunity to himself placed him in a competitive position with Loft with respect to a commodity essential to it, thereby rendering his personal interests incompatible with the superior interests of his corporation; and this situation was accomplished, not openly and with his own resources, but secretly and with the money and facilities of the corporation which was committed to his protection.
Although the facts and circumstances disclosed by the voluminous record clearly show gross violations of legal and moral duties by Guth in his dealings with Loft, the appellants make bold to say that no duty was cast upon Guth, hence he was guilty of no disloyalty. The fiduciary relation demands something more than the morals of the market place. Meinhard v. Salmon, supra. Guth's abstractions of Loft's money and materials are complacently referred to as borrowings. Whether his acts are to be deemed properly cognizable in a civil court at all, we need not inquire, but certain it is that borrowing is not descriptive of them. A borrower presumes a lender acting freely. Guth took without limit or stint from a helpless corporation, in violation of a statute enacted for the protection of corporations against such abuses, and without the knowledge or authority of the corporation's Board of Directors. Cunning and craft supplanted sincerity. Frankness gave way to concealment. He did not offer the Pepsi-Cola opportunity to Loft, but captured it for himself. He invested little or no money of his own in the venture, but commandeered for his own benefit and advantage the money, resources and facilities of his corporation and the services of its officials. He thrust upon Loft the hazard, while he reaped the benefit. His time was paid for by Loft. The use of the Grace plant was not essential to the enterprise. In such manner he acquired for himself and Grace ninety one percent of the capital stock of Pepsi, now worth many millions. A genius in his line he may be, but the law makes no distinction between the wrong doing genius and the one less endowed.
Upon a consideration of all the facts and circumstances as disclosed we are convinced that the opportunity to acquire the Pepsi-Cola trademark and formula, goodwill and business belonged to the complainant, and that Guth, as its President, had no right to appropriate the opportunity to himself.
The Chancellor's opinion may be said to leave in some doubt whether he found as a fact that the Pepsi-Cola opportunity belonged to Loft. Certain it is that he found all of the elements of a business opportunity to exist. Whether he made use of the word "estopped" as meaning that he found in the facts and circumstances all of the elements of an equitable estoppel, or whether the word was used loosely in the sense that the facts and circumstances were so overwhelming as to render it impossible for Guth to rebut the conclusion that the opportunity belonged to Loft, it is needless to argue. It may be said, however, that we are not at all convinced that the elements of an equitable estoppel may not be found having regard for the dual personality which Guth assumed.
The decree of the Chancellor is sustained.
1.2.1.2 Sinclair Oil Corp. v. Levien 1.2.1.2 Sinclair Oil Corp. v. Levien
As we learned in Guth and will see in more detail in Weinberger, the standard of review for self-dealing — “utmost good faith” or “intrinsic fairness” or, nowadays, “entire fairness” — is demanding. It is, thus, extremely important to determine which transactions count as self-dealing. What is Sinclair‘s answer? Do you agree with it? May Sinclair's answer condone abuse of minority stockholders? What would happen if Sinclair had accepted the plaintiff’s broader view, not just in the short run but also in the long run (when a corporate group has time to restructure)?
SINCLAIR OIL CORPORATION, Defendant Below, Appellant,
v.
Francis S. LEVIEN, Plaintiff Below, Appellee.
Supreme Court of Delaware.
June 18, 1971.
Henry M. Canby, of Richards, Layton & Finger, Wilmington, and Paul W. Williams, Floyd Abrams and Eugene R. Scheiman of Cahill, Gordon, Sonnett, Reindel & Ohl, New York City, for appellant.
Richard F. Corroon, Robert K. Payson, of Potter, Anderson & Corroon, Leroy A. Brill of Bayard, Brill & Handelman, Wilmington, and J. Lincoln Morris, Edward S. Cowen and Pollock & Singer, New York City, for appellee.
WOLCOTT, C. J., CAREY, J., and CHRISTIE, Judge, sitting.
[719] WOLCOTT, Chief Justice.
This is an appeal by the defendant, Sinclair Oil Corporation (hereafter Sinclair), from an order of the Court of Chancery, 261 A.2d 911 in a derivative action requiring Sinclair to account for damages sustained by its subsidiary, Sinclair Venezuelan Oil Company (hereafter Sinven), organized by Sinclair for the purpose of operating in Venezuela, as a result of dividends paid by Sinven, the denial to Sinven of industrial development, and a breach of contract between Sinclair's wholly-owned subsidiary, Sinclair International Oil Company, and Sinven.
Sinclair, operating primarily as a holding company, is in the business of exploring for oil and of producing and marketing crude oil and oil products. At all times relevant to this litigation, it owned about 97% of Sinven's stock. The plaintiff owns about 3000 of 120,000 publicly held shares of Sinven. Sinven, incorporated in 1922, has been engaged in petroleum operations primarily in Venezuela and since 1959 has operated exclusively in Venezuela.
Sinclair nominates all members of Sinven's board of directors. The Chancellor found as a fact that the directors were not independent of Sinclair. Almost without exception, they were officers, directors, or employees of corporations in the Sinclair complex. By reason of Sinclair's domination, it is clear that Sinclair owed Sinven a fiduciary duty. Getty Oil Company v. Skelly Oil Co., 267 A.2d 883 (Del.Supr. 1970); Cottrell v. Pawcatuck Co., 35 Del. Ch. 309, 116 A.2d 787 (1955). Sinclair concedes this.
The Chancellor held that because of Sinclair's fiduciary duty and its control over Sinven, its relationship with Sinven must meet the test of intrinsic fairness. The [720] standard of intrinsic fairness involves both a high degree of fairness and a shift in the burden of proof. Under this standard the burden is on Sinclair to prove, subject to careful judicial scrutiny, that its transactions with Sinven were objectively fair. Guth v. Loft, Inc., 23 Del.Ch. 255, 5 A.2d 503 (1939); Sterling v. Mayflower Hotel Corp., 33 Del.Ch. 293, 93 A.2d 107, 38 A. L.R.2d 425 (Del.Supr.1952); Getty Oil Co. v. Skelly Oil Co., supra.
Sinclair argues that the transactions between it and Sinven should be tested, not by the test of intrinsic fairness with the accompanying shift of the burden of proof, but by the business judgment rule under which a court will not interfere with the judgment of a board of directors unless there is a showing of gross and palpable overreaching. Meyerson v. El Paso Natural Gas Co., 246 A.2d 789 (Del.Ch. 1967). A board of directors enjoys a presumption of sound business judgment, and its decisions will not be disturbed if they can be attributed to any rational business purpose. A court under such circumstances will not substitute its own notions of what is or is not sound business judgment.
We think, however, that Sinclair's argument in this respect is misconceived. When the situation involves a parent and a subsidiary, with the parent controlling the transaction and fixing the terms, the test of intrinsic fairness, with its resulting shifting of the burden of proof, is applied. Sterling v. Mayflower Hotel Corp., supra; David J. Greene & Co. v. Dunhill International, Inc., 249 A.2d 427 (Del.Ch.1968); Bastian v. Bourns, Inc., 256 A.2d 680 (Del.Ch.1969) aff'd. Per Curiam (unreported) (Del.Supr.1970). The basic situation for the application of the rule is the one in which the parent has received a benefit to the exclusion and at the expense of the subsidiary.
Recently, this court dealt with the question of fairness in parent-subsidiary dealings in Getty Oil Co. v. Skelly Oil Co., supra. In that case, both parent and subsidiary were in the business of refining and marketing crude oil and crude oil products. The Oil Import Board ruled that the subsidiary, because it was controlled by the parent, was no longer entitled to a separate allocation of imported crude oil. The subsidiary then contended that it had a right to share the quota of crude oil allotted to the parent. We ruled that the business judgment standard should be applied to determine this contention. Although the subsidiary suffered a loss through the administration of the oil import quotas, the parent gained nothing. The parent's quota was derived solely from its own past use. The past use of the subsidiary did not cause an increase in the parent's quota. Nor did the parent usurp a quota of the subsidiary. Since the parent received nothing from the subsidiary to the exclusion of the minority stockholders of the subsidiary, there was no self-dealing. Therefore, the business judgment standard was properly applied.
A parent does indeed owe a fiduciary duty to its subsidiary when there are parent-subsidiary dealings. However, this alone will not evoke the intrinsic fairness standard. This standard will be applied only when the fiduciary duty is accompanied by self-dealing — the situation when a parent is on both sides of a transaction with its subsidiary. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary.
We turn now to the facts. The plaintiff argues that, from 1960 through 1966, Sinclair caused Sinven to pay out such excessive dividends that the industrial development of Sinven was effectively prevented, and it became in reality a corporation in dissolution.
From 1960 through 1966, Sinven paid out $108,000,000 in dividends ($38,000,000 [721] in excess of Sinven's earnings during the same period). The Chancellor held that Sinclair caused these dividends to be paid during a period when it had a need for large amounts of cash. Although the dividends paid exceeded earnings, the plaintiff concedes that the payments were made in compliance with 8 Del.C. § 170, authorizing payment of dividends out of surplus or net profits. However, the plaintiff attacks these dividends on the ground that they resulted from an improper motive — Sinclair's need for cash. The Chancellor, applying the intrinsic fairness standard, held that Sinclair did not sustain its burden of proving that these dividends were intrinsically fair to the minority stockholders of Sinven.
Since it is admitted that the dividends were paid in strict compliance with 8 Del.C. § 170, the alleged excessiveness of the payments alone would not state a cause of action. Nevertheless, compliance with the applicable statute may not, under all circumstances, justify all dividend payments. If a plaintiff can meet his burden of proving that a dividend cannot be grounded on any reasonable business objective, then the courts can and will interfere with the board's decision to pay the dividend.
Sinclair contends that it is improper to apply the intrinsic fairness standard to dividend payments even when the board which voted for the dividends is completely dominated. In support of this contention, Sinclair relies heavily on American District Telegraph Co. [ADT] v. Grinnell Corp., (N.Y.Sup.Ct.1969) aff'd. 33 A.D.2d 769, 306 N.Y.S.2d 209 (1969). Plaintiffs were minority stockholders of ADT, a subsidiary of Grinnell. The plaintiffs alleged that Grinnell, realizing that it would soon have to sell its ADT stock because of a pending anti-trust action, caused ADT to pay excessive dividends. Because the dividend payments conformed with applicable statutory law, and the plaintiffs could not prove an abuse of discretion, the court ruled that the complaint did not state a cause of action. Other decisions seem to support Sinclair's contention. In Metropolitan Casualty Ins. Co. v. First State Bank of Temple, 54 S.W.2d 358 (Tex.Civ.App.1932), rev'd. on other grounds, 79 S.W.2d 835 (Sup.Ct. 1935), the court held that a majority of interested directors does not void a declaration of dividends because all directors, by necessity, are interested in and benefited by a dividend declaration. See, also, Schwartz v. Kahn, 183 Misc. 252, 50 N.Y.S. 2d 931 (1944); Weinberger v. Quinn, 264 A.D. 405, 35 N.Y.S.2d 567 (1942).
We do not accept the argument that the intrinsic fairness test can never be applied to a dividend declaration by a dominated board, although a dividend declaration by a dominated board will not inevitably demand the application of the intrinsic fairness standard. Moskowitz v. Bantrell, 41 Del.Ch. 177, 190 A.2d 749 (Del.Supr. 1963). If such a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard is the proper standard. For example, suppose a parent dominates a subsidiary and its board of directors. The subsidiary has outstanding two classes of stock, X and Y. Class X is owned by the parent and Class Y is owned by minority stockholders of the subsidiary. If the subsidiary, at the direction of the parent, declares a dividend on its Class X stock only, this might well be self-dealing by the parent. It would be receiving something from the subsidiary to the exclusion of and detrimental to its minority stockholders. This self-dealing, coupled with the parent's fiduciary duty, would make intrinsic fairness the proper standard by which to evaluate the dividend payments.
Consequently it must be determined whether the dividend payments by Sinven were, in essence, self-dealing by Sinclair. The dividends resulted in great sums of money being transferred from Sinven to Sinclair. However, a proportionate share of this money was received by the minority shareholders of Sinven. Sinclair received nothing from Sinven to the exclusion of its [722] minority stockholders. As such, these dividends were not self-dealing. We hold therefore that the Chancellor erred in applying the intrinsic fairness test as to these dividend payments. The business judgment standard should have been applied.
We conclude that the facts demonstrate that the dividend payments complied with the business judgment standard and with 8 Del.C. § 170. The motives for causing the declaration of dividends are immaterial unless the plaintiff can show that the dividend payments resulted from improper motives and amounted to waste. The plaintiff contends only that the dividend payments drained Sinven of cash to such an extent that it was prevented from expanding.
The plaintiff proved no business opportunities which came to Sinven independently and which Sinclair either took to itself or denied to Sinven. As a matter of fact, with two minor exceptions which resulted in losses, all of Sinven's operations have been conducted in Venezuela, and Sinclair had a policy of exploiting its oil properties located in different countries by subsidiaries located in the particular countries.
From 1960 to 1966 Sinclair purchased or developed oil fields in Alaska, Canada, Paraguay, and other places around the world. The plaintiff contends that these were all opportunities which could have been taken by Sinven. The Chancellor concluded that Sinclair had not proved that its denial of expansion opportunities to Sinven was intrinsically fair. He based this conclusion on the following findings of fact. Sinclair made no real effort to expand Sinven. The excessive dividends paid by Sinven resulted in so great a cash drain as to effectively deny to Sinven any ability to expand. During this same period Sinclair actively pursued a company-wide policy of developing through its subsidiaries new sources of revenue, but Sinven was not permitted to participate and was confined in its activities to Venezuela.
However, the plaintiff could point to no opportunities which came to Sinven. Therefore, Sinclair usurped no business opportunity belonging to Sinven. Since Sinclair received nothing from Sinven to the exclusion of and detriment to Sinven's minority stockholders, there was no self-dealing. Therefore, business judgment is the proper standard by which to evaluate Sinclair's expansion policies.
Since there is no proof of self-dealing on the part of Sinclair, it follows that the expansion policy of Sinclair and the methods used to achieve the desired result must, as far as Sinclair's treatment of Sinven is concerned, be tested by the standards of the business judgment rule. Accordingly, Sinclair's decision, absent fraud or gross overreaching, to achieve expansion through the medium of its subsidiaries, other than Sinven, must be upheld.
Even if Sinclair was wrong in developing these opportunities as it did, the question arises, with which subsidiaries should these opportunities have been shared? No evidence indicates a unique need or ability of Sinven to develop these opportunities. The decision of which subsidiaries would be used to implement Sinclair's expansion policy was one of business judgment with which a court will not interfere absent a showing of gross and palpable overreaching. Meyerson v. El Paso Natural Gas Co., 246 A.2d 789 (Del.Ch.1967). No such showing has been made here.
Next, Sinclair argues that the Chancellor committed error when he held it liable to Sinven for breach of contract.
In 1961 Sinclair created Sinclair International Oil Company (hereafter International), a wholly owned subsidiary used for the purpose of coordinating all of Sinclair's foreign operations. All crude purchases by Sinclair were made thereafter through International.
On September 28, 1961, Sinclair caused Sinven to contract with International whereby Sinven agreed to sell all of its [723] crude oil and refined products to International at specified prices. The contract provided for minimum and maximum quantities and prices. The plaintiff contends that Sinclair caused this contract to be breached in two respects. Although the contract called for payment on receipt, International's payments lagged as much as 30 days after receipt. Also, the contract required International to purchase at least a fixed minimum amount of crude and refined products from Sinven. International did not comply with this requirement.
Clearly, Sinclair's act of contracting with its dominated subsidiary was self-dealing. Under the contract Sinclair received the products produced by Sinven, and of course the minority shareholders of Sinven were not able to share in the receipt of these products. If the contract was breached, then Sinclair received these products to the detriment of Sinven's minority shareholders. We agree with the Chancellor's finding that the contract was breached by Sinclair, both as to the time of payments and the amounts purchased.
Although a parent need not bind itself by a contract with its dominated subsidiary, Sinclair chose to operate in this manner. As Sinclair has received the benefits of this contract, so must it comply with the contractual duties.
Under the intrinsic fairness standard, Sinclair must prove that its causing Sinven not to enforce the contract was intrinsically fair to the minority shareholders of Sinven. Sinclair has failed to meet this burden. Late payments were clearly breaches for which Sinven should have sought and received adequate damages. As to the quantities purchased, Sinclair argues that it purchased all the products produced by Sinven. This, however, does not satisfy the standard of intrinsic fairness. Sinclair has failed to prove that Sinven could not possibly have produced or someway have obtained the contract minimums. As such, Sinclair must account on this claim.
Finally, Sinclair argues that the Chancellor committed error in refusing to allow it a credit or setoff of all benefits provided by it to Sinven with respect to all the alleged damages. The Chancellor held that setoff should be allowed on specific transactions, e. g., benefits to Sinven under the contract with International, but denied an over all setoff against all damages claimed. We agree with the Chancellor, although the point may well be moot in view of our holding that Sinclair is not required to account for the alleged excessiveness of the dividend payments.
We will therefore reverse that part of the Chancellor's order that requires Sinclair to account to Sinven for damages sustained as a result of dividends paid between 1960 and 1966, and by reason of the denial to Sinven of expansion during that period. We will affirm the remaining portion of that order and remand the cause for further proceedings.
1.2.1.3 Weinberger v. UOP, Inc. 1.2.1.3 Weinberger v. UOP, Inc.
This decision introduces the modern standard of review for conflicted transactions involving a controlling shareholder.What is that standard of review, generally speaking?Can the controlling shareholder do anything to obtain a more favorable standard, or at least a more sympathetic application of the standard (cf. footnote 7)?How does the judicial treatment of self-dealing by a controlling shareholder compare to that of self-dealing by simple officers and directors (as described in the introduction to this section 2.2.1)?Does the harsher treatment of controlling shareholders make sense?Some terminology (for details, see the M&A section of the course):Cash-out merger: A transaction in which some group of shareholders, generally minority shareholders, are “squeezed out” of the corporation. That is, they cease to be shareholders of the corporation in return for a cash payment, whether they like it or not. The name comes from the fact that the transaction is technically a merger between the corporation and some other corporation. The other corporation is usually a mere shell corporation, meaning it has been set up only for the merger and does not have any assets. While DGCL 251(c) requires shareholder approval for a merger, a simple majority vote is sufficient and hence minority approval is unnecessary. DGCL 251(b)(5) expressly allows conversion of existing shares into cash. Minority shareholders' only statutory remedy is an appraisal of the “fair value” of their shares under DGCL 262.Tender offer: An offer to purchase shares addressed to all shareholders.
William B. WEINBERGER, Plaintiff Below, Appellant,
v.
UOP, INC., et al., Defendants Below, Appellees.
Supreme Court of Delaware.
William Prickett (argued), John H. Small, and George H. Seitz, III, of Prickett, Jones, Elliott, Kristol & Schnee, Wilmington, for plaintiff.
A. Gilchrist Sparks, III, of Morris, Nichols, Arsht & Tunnell, Wilmington, for defendant UOP, Inc.
Robert K. Payson and Peter M. Sieglaff, of Potter, Anderson & Corroon, Wilmington, and Alan N. Halkett (argued) of Latham & Watkins, Los Angeles, Cal., for defendant The Signal Companies, Inc.
Before HERRMANN, C.J., McNEILLY, QUILLEN, HORSEY and MOORE, JJ., constituting the Court en Banc.
[702] MOORE, Justice:
This post-trial appeal was reheard en banc from a decision of the Court of Chancery.[1] [703] It was brought by the class action plaintiff below, a former shareholder of UOP, Inc., who challenged the elimination of UOP's minority shareholders by a cash-out merger between UOP and its majority owner, The Signal Companies, Inc.[2] Originally, the defendants in this action were Signal, UOP, certain officers and directors of those companies, and UOP's investment banker, Lehman Brothers Kuhn Loeb, Inc.[3] The present Chancellor held that the terms of the merger were fair to the plaintiff and the other minority shareholders of UOP. Accordingly, he entered judgment in favor of the defendants.
Numerous points were raised by the parties, but we address only the following questions presented by the trial court's opinion:
1) The plaintiff's duty to plead sufficient facts demonstrating the unfairness of the challenged merger;
2) The burden of proof upon the parties where the merger has been approved by the purportedly informed vote of a majority of the minority shareholders;
3) The fairness of the merger in terms of adequacy of the defendants' disclosures to the minority shareholders;
4) The fairness of the merger in terms of adequacy of the price paid for the minority shares and the remedy appropriate to that issue; and
5) The continued force and effect of Singer v. Magnavox Co., Del.Supr., 380 A.2d 969, 980 (1977), and its progeny.
In ruling for the defendants, the Chancellor re-stated his earlier conclusion that the plaintiff in a suit challenging a cash-out merger must allege specific acts of fraud, misrepresentation, or other items of misconduct to demonstrate the unfairness of the merger terms to the minority.[4] We approve this rule and affirm it.
The Chancellor also held that even though the ultimate burden of proof is on the majority shareholder to show by a preponderance of the evidence that the transaction is fair, it is first the burden of the plaintiff attacking the merger to demonstrate some basis for invoking the fairness obligation. We agree with that principle. However, where corporate action has been approved by an informed vote of a majority of the minority shareholders, we conclude that the burden entirely shifts to the plaintiff to show that the transaction was unfair to the minority. See, e.g., Michelson v. Duncan, Del.Supr., 407 A.2d 211, 224 (1979). But in all this, the burden clearly remains on those relying on the vote to show that they completely disclosed all material facts relevant to the transaction.
Here, the record does not support a conclusion that the minority stockholder vote was an informed one. Material information, necessary to acquaint those shareholders with the bargaining positions of Signal and UOP, was withheld under circumstances amounting to a breach of fiduciary duty. We therefore conclude that this merger does not meet the test of fairness, at least as we address that concept, and no burden thus shifted to the plaintiff by reason of the minority shareholder vote. Accordingly, we reverse and remand for further proceedings consistent herewith.
In considering the nature of the remedy available under our law to minority shareholders in a cash-out merger, we believe that it is, and hereafter should be, an appraisal under 8 Del.C. § 262 as hereinafter construed. We therefore overrule Lynch v. Vickers Energy Corp., Del.Supr., [704] 429 A.2d 497 (1981) (Lynch II) to the extent that it purports to limit a stockholder's monetary relief to a specific damage formula. See Lynch II, 429 A.2d at 507-08 (McNeilly & Quillen, JJ., dissenting). But to give full effect to section 262 within the framework of the General Corporation Law we adopt a more liberal, less rigid and stylized, approach to the valuation process than has heretofore been permitted by our courts. While the present state of these proceedings does not admit the plaintiff to the appraisal remedy per se, the practical effect of the remedy we do grant him will be co-extensive with the liberalized valuation and appraisal methods we herein approve for cases coming after this decision.
Our treatment of these matters has necessarily led us to a reconsideration of the business purpose rule announced in the trilogy of Singer v. Magnavox Co., supra; Tanzer v. International General Industries, Inc., Del.Supr., 379 A.2d 1121 (1977); and Roland International Corp. v. Najjar, Del.Supr., 407 A.2d 1032 (1979). For the reasons hereafter set forth we consider that the business purpose requirement of these cases is no longer the law of Delaware.
I.
The facts found by the trial court, pertinent to the issues before us, are supported by the record, and we draw from them as set out in the Chancellor's opinion.[5]
Signal is a diversified, technically based company operating through various subsidiaries. Its stock is publicly traded on the New York, Philadelphia and Pacific Stock Exchanges. UOP, formerly known as Universal Oil Products Company, was a diversified industrial company engaged in various lines of business, including petroleum and petro-chemical services and related products, construction, fabricated metal products, transportation equipment products, chemicals and plastics, and other products and services including land development, lumber products and waste disposal. Its stock was publicly held and listed on the New York Stock Exchange.
In 1974 Signal sold one of its wholly-owned subsidiaries for $420,000,000 in cash. See Gimbel v. Signal Companies, Inc., Del. Ch., 316 A.2d 599, aff'd, Del.Supr., 316 A.2d 619 (1974). While looking to invest this cash surplus, Signal became interested in UOP as a possible acquisition. Friendly negotiations ensued, and Signal proposed to acquire a controlling interest in UOP at a price of $19 per share. UOP's representatives sought $25 per share. In the arm's length bargaining that followed, an understanding was reached whereby Signal agreed to purchase from UOP 1,500,000 shares of UOP's authorized but unissued stock at $21 per share.
This purchase was contingent upon Signal making a successful cash tender offer for 4,300,000 publicly held shares of UOP, also at a price of $21 per share. This combined method of acquisition permitted Signal to acquire 5,800,000 shares of stock, representing 50.5% of UOP's outstanding shares. The UOP board of directors advised the company's shareholders that it had no objection to Signal's tender offer at that price. Immediately before the announcement of the tender offer, UOP's common stock had been trading on the New York Stock Exchange at a fraction under $14 per share.
The negotiations between Signal and UOP occurred during April 1975, and the resulting tender offer was greatly oversubscribed. However, Signal limited its total purchase of the tendered shares so that, when coupled with the stock bought from UOP, it had achieved its goal of becoming a 50.5% shareholder of UOP.
Although UOP's board consisted of thirteen directors, Signal nominated and elected only six. Of these, five were either directors or employees of Signal. The sixth, a partner in the banking firm of Lazard Freres & Co., had been one of Signal's representatives in the negotiations and bargaining with UOP concerning the tender offer and purchase price of the UOP shares.
[705] However, the president and chief executive officer of UOP retired during 1975, and Signal caused him to be replaced by James V. Crawford, a long-time employee and senior executive vice president of one of Signal's wholly-owned subsidiaries. Crawford succeeded his predecessor on UOP's board of directors and also was made a director of Signal.
By the end of 1977 Signal basically was unsuccessful in finding other suitable investment candidates for its excess cash, and by February 1978 considered that it had no other realistic acquisitions available to it on a friendly basis. Once again its attention turned to UOP.
The trial court found that at the instigation of certain Signal management personnel, including William W. Walkup, its board chairman, and Forrest N. Shumway, its president, a feasibility study was made concerning the possible acquisition of the balance of UOP's outstanding shares. This study was performed by two Signal officers, Charles S. Arledge, vice president (director of planning), and Andrew J. Chitiea, senior vice president (chief financial officer). Messrs. Walkup, Shumway, Arledge and Chitiea were all directors of UOP in addition to their membership on the Signal board.
Arledge and Chitiea concluded that it would be a good investment for Signal to acquire the remaining 49.5% of UOP shares at any price up to $24 each. Their report was discussed between Walkup and Shumway who, along with Arledge, Chitiea and Brewster L. Arms, internal counsel for Signal, constituted Signal's senior management. In particular, they talked about the proper price to be paid if the acquisition was pursued, purportedly keeping in mind that as UOP's majority shareholder, Signal owed a fiduciary responsibility to both its own stockholders as well as to UOP's minority. It was ultimately agreed that a meeting of Signal's executive committee would be called to propose that Signal acquire the remaining outstanding stock of UOP through a cash-out merger in the range of $20 to $21 per share.
The executive committee meeting was set for February 28, 1978. As a courtesy, UOP's president, Crawford, was invited to attend, although he was not a member of Signal's executive committee. On his arrival, and prior to the meeting, Crawford was asked to meet privately with Walkup and Shumway. He was then told of Signal's plan to acquire full ownership of UOP and was asked for his reaction to the proposed price range of $20 to $21 per share. Crawford said he thought such a price would be "generous", and that it was certainly one which should be submitted to UOP's minority shareholders for their ultimate consideration. He stated, however, that Signal's 100% ownership could cause internal problems at UOP. He believed that employees would have to be given some assurance of their future place in a fully-owned Signal subsidiary. Otherwise, he feared the departure of essential personnel. Also, many of UOP's key employees had stock option incentive programs which would be wiped out by a merger. Crawford therefore urged that some adjustment would have to be made, such as providing a comparable incentive in Signal's shares, if after the merger he was to maintain his quality of personnel and efficiency at UOP.
Thus, Crawford voiced no objection to the $20 to $21 price range, nor did he suggest that Signal should consider paying more than $21 per share for the minority interests. Later, at the executive committee meeting the same factors were discussed, with Crawford repeating the position he earlier took with Walkup and Shumway. Also considered was the 1975 tender offer and the fact that it had been greatly oversubscribed at $21 per share. For many reasons, Signal's management concluded that the acquisition of UOP's minority shares provided the solution to a number of its business problems.
Thus, it was the consensus that a price of $20 to $21 per share would be fair to both Signal and the minority shareholders of UOP. Signal's executive committee authorized [706] its management "to negotiate" with UOP "for a cash acquisition of the minority ownership in UOP, Inc., with the intention of presenting a proposal to [Signal's] board of directors ... on March 6, 1978". Immediately after this February 28, 1978 meeting, Signal issued a press release stating:
The Signal Companies, Inc. and UOP, Inc. are conducting negotiations for the acquisition for cash by Signal of the 49.5 per cent of UOP which it does not presently own, announced Forrest N. Shumway, president and chief executive officer of Signal, and James V. Crawford, UOP president.
Price and other terms of the proposed transaction have not yet been finalized and would be subject to approval of the boards of directors of Signal and UOP, scheduled to meet early next week, the stockholders of UOP and certain federal agencies.
The announcement also referred to the fact that the closing price of UOP's common stock on that day was $14.50 per share.
Two days later, on March 2, 1978, Signal issued a second press release stating that its management would recommend a price in the range of $20 to $21 per share for UOP's 49.5% minority interest. This announcement referred to Signal's earlier statement that "negotiations" were being conducted for the acquisition of the minority shares.
Between Tuesday, February 28, 1978 and Monday, March 6, 1978, a total of four business days, Crawford spoke by telephone with all of UOP's non-Signal, i.e., outside, directors. Also during that period, Crawford retained Lehman Brothers to render a fairness opinion as to the price offered the minority for its stock. He gave two reasons for this choice. First, the time schedule between the announcement and the board meetings was short (by then only three business days) and since Lehman Brothers had been acting as UOP's investment banker for many years, Crawford felt that it would be in the best position to respond on such brief notice. Second, James W. Glanville, a long-time director of UOP and a partner in Lehman Brothers, had acted as a financial advisor to UOP for many years. Crawford believed that Glanville's familiarity with UOP, as a member of its board, would also be of assistance in enabling Lehman Brothers to render a fairness opinion within the existing time constraints.
Crawford telephoned Glanville, who gave his assurance that Lehman Brothers had no conflicts that would prevent it from accepting the task. Glanville's immediate personal reaction was that a price of $20 to $21 would certainly be fair, since it represented almost a 50% premium over UOP's market price. Glanville sought a $250,000 fee for Lehman Brothers' services, but Crawford thought this too much. After further discussions Glanville finally agreed that Lehman Brothers would render its fairness opinion for $150,000.
During this period Crawford also had several telephone contacts with Signal officials. In only one of them, however, was the price of the shares discussed. In a conversation with Walkup, Crawford advised that as a result of his communications with UOP's non-Signal directors, it was his feeling that the price would have to be the top of the proposed range, or $21 per share, if the approval of UOP's outside directors was to be obtained. But again, he did not seek any price higher than $21.
Glanville assembled a three-man Lehman Brothers team to do the work on the fairness opinion. These persons examined relevant documents and information concerning UOP, including its annual reports and its Securities and Exchange Commission filings from 1973 through 1976, as well as its audited financial statements for 1977, its interim reports to shareholders, and its recent and historical market prices and trading volumes. In addition, on Friday, March 3, 1978, two members of the Lehman Brothers team flew to UOP's headquarters in Des Plaines, Illinois, to perform a "due diligence" visit, during the course of which they interviewed Crawford as well as UOP's general counsel, its chief financial officer, and other key executives and personnel.
[707] As a result, the Lehman Brothers team concluded that "the price of either $20 or $21 would be a fair price for the remaining shares of UOP". They telephoned this impression to Glanville, who was spending the weekend in Vermont.
On Monday morning, March 6, 1978, Glanville and the senior member of the Lehman Brothers team flew to Des Plaines to attend the scheduled UOP directors meeting. Glanville looked over the assembled information during the flight. The two had with them the draft of a "fairness opinion letter" in which the price had been left blank. Either during or immediately prior to the directors' meeting, the two-page "fairness opinion letter" was typed in final form and the price of $21 per share was inserted.
On March 6, 1978, both the Signal and UOP boards were convened to consider the proposed merger. Telephone communications were maintained between the two meetings. Walkup, Signal's board chairman, and also a UOP director, attended UOP's meeting with Crawford in order to present Signal's position and answer any questions that UOP's non-Signal directors might have. Arledge and Chitiea, along with Signal's other designees on UOP's board, participated by conference telephone. All of UOP's outside directors attended the meeting either in person or by conference telephone.
First, Signal's board unanimously adopted a resolution authorizing Signal to propose to UOP a cash merger of $21 per share as outlined in a certain merger agreement and other supporting documents. This proposal required that the merger be approved by a majority of UOP's outstanding minority shares voting at the stockholders meeting at which the merger would be considered, and that the minority shares voting in favor of the merger, when coupled with Signal's 50.5% interest would have to comprise at least two-thirds of all UOP shares. Otherwise the proposed merger would be deemed disapproved.
UOP's board then considered the proposal. Copies of the agreement were delivered to the directors in attendance, and other copies had been forwarded earlier to the directors participating by telephone. They also had before them UOP financial data for 1974-1977, UOP's most recent financial statements, market price information, and budget projections for 1978. In addition they had Lehman Brothers' hurriedly prepared fairness opinion letter finding the price of $21 to be fair. Glanville, the Lehman Brothers partner, and UOP director, commented on the information that had gone into preparation of the letter.
Signal also suggests that the Arledge-Chitiea feasibility study, indicating that a price of up to $24 per share would be a "good investment" for Signal, was discussed at the UOP directors' meeting. The Chancellor made no such finding, and our independent review of the record, detailed infra, satisfies us by a preponderance of the evidence that there was no discussion of this document at UOP's board meeting. Furthermore, it is clear beyond peradventure that nothing in that report was ever disclosed to UOP's minority shareholders prior to their approval of the merger.
After consideration of Signal's proposal, Walkup and Crawford left the meeting to permit a free and uninhibited exchange between UOP's non-Signal directors. Upon their return a resolution to accept Signal's offer was then proposed and adopted. While Signal's men on UOP's board participated in various aspects of the meeting, they abstained from voting. However, the minutes show that each of them "if voting would have voted yes".
On March 7, 1978, UOP sent a letter to its shareholders advising them of the action taken by UOP's board with respect to Signal's offer. This document pointed out, among other things, that on February 28, 1978 "both companies had announced negotiations were being conducted".
Despite the swift board action of the two companies, the merger was not submitted to UOP's shareholders until their annual [708] meeting on May 26, 1978. In the notice of that meeting and proxy statement sent to shareholders in May, UOP's management and board urged that the merger be approved. The proxy statement also advised:
The price was determined after discussions between James V. Crawford, a director of Signal and Chief Executive Officer of UOP, and officers of Signal which took place during meetings on February 28, 1978, and in the course of several subsequent telephone conversations. (Emphasis added.)
In the original draft of the proxy statement the word "negotiations" had been used rather than "discussions". However, when the Securities and Exchange Commission sought details of the "negotiations" as part of its review of these materials, the term was deleted and the word "discussions" was substituted. The proxy statement indicated that the vote of UOP's board in approving the merger had been unanimous. It also advised the shareholders that Lehman Brothers had given its opinion that the merger price of $21 per share was fair to UOP's minority. However, it did not disclose the hurried method by which this conclusion was reached.
As of the record date of UOP's annual meeting, there were 11,488,302 shares of UOP common stock outstanding, 5,688,302 of which were owned by the minority. At the meeting only 56%, or 3,208,652, of the minority shares were voted. Of these, 2,953,812, or 51.9% of the total minority, voted for the merger, and 254,840 voted against it. When Signal's stock was added to the minority shares voting in favor, a total of 76.2% of UOP's outstanding shares approved the merger while only 2.2% opposed it.
By its terms the merger became effective on May 26, 1978, and each share of UOP's stock held by the minority was automatically converted into a right to receive $21 cash.
II.
A.
A primary issue mandating reversal is the preparation by two UOP directors, Arledge and Chitiea, of their feasibility study for the exclusive use and benefit of Signal. This document was of obvious significance to both Signal and UOP. Using UOP data, it described the advantages to Signal of ousting the minority at a price range of $21-$24 per share. Mr. Arledge, one of the authors, outlined the benefits to Signal:[6]
Purpose Of The Merger
1) Provides an outstanding investment opportunity for Signal — (Better than any recent acquisition we have seen.)
2) Increases Signal's earnings.
3) Facilitates the flow of resources between Signal and its subsidiaries — (Big factor — works both ways.)
4) Provides cost savings potential for Signal and UOP.
5) Improves the percentage of Signal's `operating earnings' as opposed to `holding company earnings'.
6) Simplifies the understanding of Signal.
7) Facilitates technological exchange among Signal's subsidiaries.
8) Eliminates potential conflicts of interest.
Having written those words, solely for the use of Signal, it is clear from the record that neither Arledge nor Chitiea shared this report with their fellow directors of UOP. We are satisfied that no one else did either. This conduct hardly meets the fiduciary standards applicable to such a transaction. While Mr. Walkup, Signal's chairman of the board and a UOP director, attended the March 6, 1978 UOP board meeting and testified at trial that he had discussed the Arledge-Chitiea report with the UOP directors at this meeting, the record does not support this assertion. Perhaps it is the result of some confusion on Mr. Walkup's [709] part. In any event Mr. Shumway, Signal's president, testified that he made sure the Signal outside directors had this report prior to the March 6, 1978 Signal board meeting, but he did not testify that the Arledge-Chitiea report was also sent to UOP's outside directors.
Mr. Crawford, UOP's president, could not recall that any documents, other than a draft of the merger agreement, were sent to UOP's directors before the March 6, 1978 UOP meeting. Mr. Chitiea, an author of the report, testified that it was made available to Signal's directors, but to his knowledge it was not circulated to the outside directors of UOP. He specifically testified that he "didn't share" that information with the outside directors of UOP with whom he served.
None of UOP's outside directors who testified stated that they had seen this document. The minutes of the UOP board meeting do not identify the Arledge-Chitiea report as having been delivered to UOP's outside directors. This is particularly significant since the minutes describe in considerable detail the materials that actually were distributed. While these minutes recite Mr. Walkup's presentation of the Signal offer, they do not mention the Arledge-Chitiea report or any disclosure that Signal considered a price of up to $24 to be a good investment. If Mr. Walkup had in fact provided such important information to UOP's outside directors, it is logical to assume that these carefully drafted minutes would disclose it. The post-trial briefs of Signal and UOP contain a thorough description of the documents purportedly available to their boards at the March 6, 1978, meetings. Although the Arledge-Chitiea report is specifically identified as being available to the Signal directors, there is no mention of it being among the documents submitted to the UOP board. Even when queried at a prior oral argument before this Court, counsel for Signal did not claim that the Arledge-Chitiea report had been disclosed to UOP's outside directors. Instead, he chose to belittle its contents. This was the same approach taken before us at the last oral argument.
Actually, it appears that a three-page summary of figures was given to all UOP directors. Its first page is identical to one page of the Arledge-Chitiea report, but this dealt with nothing more than a justification of the $21 price. Significantly, the contents of this three-page summary are what the minutes reflect Mr. Walkup told the UOP board. However, nothing contained in either the minutes or this three-page summary reflects Signal's study regarding the $24 price.
The Arledge-Chitiea report speaks for itself in supporting the Chancellor's finding that a price of up to $24 was a "good investment" for Signal. It shows that a return on the investment at $21 would be 15.7% versus 15.5% at $24 per share. This was a difference of only two-tenths of one percent, while it meant over $17,000,000 to the minority. Under such circumstances, paying UOP's minority shareholders $24 would have had relatively little long-term effect on Signal, and the Chancellor's findings concerning the benefit to Signal, even at a price of $24, were obviously correct. Levitt v. Bouvier, Del.Supr., 287 A.2d 671, 673 (1972).
Certainly, this was a matter of material significance to UOP and its shareholders. Since the study was prepared by two UOP directors, using UOP information for the exclusive benefit of Signal, and nothing whatever was done to disclose it to the outside UOP directors or the minority shareholders, a question of breach of fiduciary duty arises. This problem occurs because there were common Signal-UOP directors participating, at least to some extent, in the UOP board's decision-making processes without full disclosure of the conflicts they faced.[7]
[710] B.
In assessing this situation, the Court of Chancery was required to:
examine what information defendants had and to measure it against what they gave to the minority stockholders, in a context in which `complete candor' is required. In other words, the limited function of the Court was to determine whether defendants had disclosed all information in their possession germane to the transaction in issue. And by `germane' we mean, for present purposes, information such as a reasonable shareholder would consider important in deciding whether to sell or retain stock.
* * * * * *
... Completeness, not adequacy, is both the norm and the mandate under present circumstances.
Lynch v. Vickers Energy Corp., Del.Supr., 383 A.2d 278, 281 (1977) (Lynch I). This is merely stating in another way the long-existing principle of Delaware law that these Signal designated directors on UOP's board still owed UOP and its shareholders an uncompromising duty of loyalty. The classic language of Guth v. Loft, Inc., Del.Supr., 5 A.2d 503, 510 (1939), requires no embellishment:
A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it, or to enable it to make in the reasonable and lawful exercise of its powers. The rule that requires an undivided and unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest.
Given the absence of any attempt to structure this transaction on an arm's length basis, Signal cannot escape the effects of the conflicts it faced, particularly when its designees on UOP's board did not totally abstain from participation in the matter. There is no "safe harbor" for such divided loyalties in Delaware. When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain. Gottlieb v. Heyden Chemical Corp., Del.Supr., 91 A.2d 57, 57-58 (1952). The requirement of fairness is unflinching in its demand that where one stands on both sides of a transaction, he has the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts. Sterling v. Mayflower Hotel Corp., Del.Supr., 93 A.2d 107, 110 (1952); Bastian v. Bourns, Inc., Del.Ch., 256 A.2d 680, 681 (1969), aff'd, Del.Supr., 278 A.2d 467 (1970); David J. Greene & Co. v. Dunhill International Inc., Del.Ch., 249 A.2d 427, 431 (1968).
There is no dilution of this obligation where one holds dual or multiple directorships, as in a parent-subsidiary context. Levien v. Sinclair Oil Corp., Del.Ch., 261 A.2d 911, 915 (1969). Thus, individuals who act in a dual capacity as directors of two corporations, one of whom is parent and the other subsidiary, owe the same duty of good management to both corporations, and in the absence of an independent negotiating [711] structure (see note 7, supra), or the directors' total abstention from any participation in the matter, this duty is to be exercised in light of what is best for both companies. Warshaw v. Calhoun, Del. Supr., 221 A.2d 487, 492 (1966). The record demonstrates that Signal has not met this obligation.
C.
The concept of fairness has two basic aspects: fair dealing and fair price. The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained. The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock. Moore, The "Interested" Director or Officer Transaction, 4 Del.J. Corp.L. 674, 676 (1979); Nathan & Shapiro, Legal Standard of Fairness of Merger Terms Under Delaware Law, 2 Del.J. Corp.L. 44, 46-47 (1977). See Tri-Continental Corp. v. Battye, Del.Supr., 74 A.2d 71, 72 (1950); 8 Del.C. § 262(h). However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness. However, in a non-fraudulent transaction we recognize that price may be the preponderant consideration outweighing other features of the merger. Here, we address the two basic aspects of fairness separately because we find reversible error as to both.
D.
Part of fair dealing is the obvious duty of candor required by Lynch I, supra. Moreover, one possessing superior knowledge may not mislead any stockholder by use of corporate information to which the latter is not privy. Lank v. Steiner, Del. Supr., 224 A.2d 242, 244 (1966). Delaware has long imposed this duty even upon persons who are not corporate officers or directors, but who nonetheless are privy to matters of interest or significance to their company. Brophy v. Cities Service Co., Del. Ch., 70 A.2d 5, 7 (1949). With the well-established Delaware law on the subject, and the Court of Chancery's findings of fact here, it is inevitable that the obvious conflicts posed by Arledge and Chitiea's preparation of their "feasibility study", derived from UOP information, for the sole use and benefit of Signal, cannot pass muster.
The Arledge-Chitiea report is but one aspect of the element of fair dealing. How did this merger evolve? It is clear that it was entirely initiated by Signal. The serious time constraints under which the principals acted were all set by Signal. It had not found a suitable outlet for its excess cash and considered UOP a desirable investment, particularly since it was now in a position to acquire the whole company for itself. For whatever reasons, and they were only Signal's, the entire transaction was presented to and approved by UOP's board within four business days. Standing alone, this is not necessarily indicative of any lack of fairness by a majority shareholder. It was what occurred, or more properly, what did not occur, during this brief period that makes the time constraints imposed by Signal relevant to the issue of fairness.
The structure of the transaction, again, was Signal's doing. So far as negotiations were concerned, it is clear that they were modest at best. Crawford, Signal's man at UOP, never really talked price with Signal, except to accede to its management's statements on the subject, and to convey to Signal the UOP outside directors' view that as between the $20-$21 range under consideration, it would have to be $21. The latter is not a surprising outcome, but hardly arm's length negotiations. Only the protection of benefits for UOP's key employees and the issue of Lehman Brothers' fee approached any concept of bargaining.
[712] As we have noted, the matter of disclosure to the UOP directors was wholly flawed by the conflicts of interest raised by the Arledge-Chitiea report. All of those conflicts were resolved by Signal in its own favor without divulging any aspect of them to UOP.
This cannot but undermine a conclusion that this merger meets any reasonable test of fairness. The outside UOP directors lacked one material piece of information generated by two of their colleagues, but shared only with Signal. True, the UOP board had the Lehman Brothers' fairness opinion, but that firm has been blamed by the plaintiff for the hurried task it performed, when more properly the responsibility for this lies with Signal. There was no disclosure of the circumstances surrounding the rather cursory preparation of the Lehman Brothers' fairness opinion. Instead, the impression was given UOP's minority that a careful study had been made, when in fact speed was the hallmark, and Mr. Glanville, Lehman's partner in charge of the matter, and also a UOP director, having spent the weekend in Vermont, brought a draft of the "fairness opinion letter" to the UOP directors' meeting on March 6, 1978 with the price left blank. We can only conclude from the record that the rush imposed on Lehman Brothers by Signal's timetable contributed to the difficulties under which this investment banking firm attempted to perform its responsibilities. Yet, none of this was disclosed to UOP's minority.
Finally, the minority stockholders were denied the critical information that Signal considered a price of $24 to be a good investment. Since this would have meant over $17,000,000 more to the minority, we cannot conclude that the shareholder vote was an informed one. Under the circumstances, an approval by a majority of the minority was meaningless. Lynch I, 383 A.2d at 279, 281; Cahall v. Lofland, Del.Ch., 114 A. 224 (1921).
Given these particulars and the Delaware law on the subject, the record does not establish that this transaction satisfies any reasonable concept of fair dealing, and the Chancellor's findings in that regard must be reversed.
E.
Turning to the matter of price, plaintiff also challenges its fairness. His evidence was that on the date the merger was approved the stock was worth at least $26 per share. In support, he offered the testimony of a chartered investment analyst who used two basic approaches to valuation: a comparative analysis of the premium paid over market in ten other tender offer-merger combinations, and a discounted cash flow analysis.
In this breach of fiduciary duty case, the Chancellor perceived that the approach to valuation was the same as that in an appraisal proceeding. Consistent with precedent, he rejected plaintiff's method of proof and accepted defendants' evidence of value as being in accord with practice under prior case law. This means that the so-called "Delaware block" or weighted average method was employed wherein the elements of value, i.e., assets, market price, earnings, etc., were assigned a particular weight and the resulting amounts added to determine the value per share. This procedure has been in use for decades. See In re General Realty & Utilities Corp., Del.Ch., 52 A.2d 6, 14-15 (1947). However, to the extent it excludes other generally accepted techniques used in the financial community and the courts, it is now clearly outmoded. It is time we recognize this in appraisal and other stock valuation proceedings and bring our law current on the subject.
While the Chancellor rejected plaintiff's discounted cash flow method of valuing UOP's stock, as not corresponding with "either logic or the existing law" (426 A.2d at 1360), it is significant that this was essentially the focus, i.e., earnings potential of UOP, of Messrs. Arledge and Chitiea in their evaluation of the merger. Accordingly, the standard "Delaware block" or weighted average method of valuation, formerly [713] employed in appraisal and other stock valuation cases, shall no longer exclusively control such proceedings. We believe that a more liberal approach must include proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court, subject only to our interpretation of 8 Del.C. § 262(h), infra. See also D.R.E. 702-05. This will obviate the very structured and mechanistic procedure that has heretofore governed such matters. See Jacques Coe & Co. v. Minneapolis-Moline Co., Del.Ch., 75 A.2d 244, 247 (1950); Tri-Continental Corp. v. Battye, Del.Ch., 66 A.2d 910, 917-18 (1949); In re General Realty and Utilities Corp., supra.
Fair price obviously requires consideration of all relevant factors involving the value of a company. This has long been the law of Delaware as stated in Tri-Continental Corp., 74 A.2d at 72:
The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern. By value of the stockholder's proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger. In determining what figure represents this true or intrinsic value, the appraiser and the courts must take into consideration all factors and elements which reasonably might enter into the fixing of value. Thus, market value, asset value, dividends, earning prospects, the nature of the enterprise and any other facts which were known or which could be ascertained as of the date of merger and which throw any light on future prospects of the merged corporation are not only pertinent to an inquiry as to the value of the dissenting stockholders' interest, but must be considered by the agency fixing the value. (Emphasis added.)
This is not only in accord with the realities of present day affairs, but it is thoroughly consonant with the purpose and intent of our statutory law. Under 8 Del.C. § 262(h), the Court of Chancery:
shall appraise the shares, determining their fair value exclusive of any element of value arising from the accomplishment or expectation of the merger, together with a fair rate of interest, if any, to be paid upon the amount determined to be the fair value. In determining such fair value, the Court shall take into account all relevant factors ... (Emphasis added)
See also Bell v. Kirby Lumber Corp., Del. Supr., 413 A.2d 137, 150-51 (1980) (Quillen, J., concurring).
It is significant that section 262 now mandates the determination of "fair" value based upon "all relevant factors". Only the speculative elements of value that may arise from the "accomplishment or expectation" of the merger are excluded. We take this to be a very narrow exception to the appraisal process, designed to eliminate use of pro forma data and projections of a speculative variety relating to the completion of a merger. But elements of future value, including the nature of the enterprise, which are known or susceptible of proof as of the date of the merger and not the product of speculation, may be considered. When the trial court deems it appropriate, fair value also includes any damages, resulting from the taking, which the stockholders sustain as a class. If that was not the case, then the obligation to consider "all relevant factors" in the valuation process would be eroded. We are supported in this view not only by Tri-Continental Corp., 74 A.2d at 72, but also by the evolutionary amendments to section 262.
Prior to an amendment in 1976, the earlier relevant provision of section 262 stated:
(f) The appraiser shall determine the value of the stock of the stockholders ... The Court shall by its decree determine the value of the stock of the stockholders entitled to payment therefor ...
The first references to "fair" value occurred in a 1976 amendment to section 262(f), which provided:
[714] (f) ... the Court shall appraise the shares, determining their fair value exclusively of any element of value arising from the accomplishment or expectation of the merger....
It was not until the 1981 amendment to section 262 that the reference to "fair value" was repeatedly emphasized and the statutory mandate that the Court "take into account all relevant factors" appeared [section 262(h)]. Clearly, there is a legislative intent to fully compensate shareholders for whatever their loss may be, subject only to the narrow limitation that one can not take speculative effects of the merger into account.
Although the Chancellor received the plaintiff's evidence, his opinion indicates that the use of it was precluded because of past Delaware practice. While we do not suggest a monetary result one way or the other, we do think the plaintiff's evidence should be part of the factual mix and weighed as such. Until the $21 price is measured on remand by the valuation standards mandated by Delaware law, there can be no finding at the present stage of these proceedings that the price is fair. Given the lack of any candid disclosure of the material facts surrounding establishment of the $21 price, the majority of the minority vote, approving the merger, is meaningless.
The plaintiff has not sought an appraisal, but rescissory damages of the type contemplated by Lynch v. Vickers Energy Corp., Del.Supr., 429 A.2d 497, 505-06 (1981) (Lynch II). In view of the approach to valuation that we announce today, we see no basis in our law for Lynch II's exclusive monetary formula for relief. On remand the plaintiff will be permitted to test the fairness of the $21 price by the standards we herein establish, in conformity with the principle applicable to an appraisal — that fair value be determined by taking "into account all relevant factors" [see 8 Del.C. § 262(h), supra]. In our view this includes the elements of rescissory damages if the Chancellor considers them susceptible of proof and a remedy appropriate to all the issues of fairness before him. To the extent that Lynch II, 429 A.2d at 505-06, purports to limit the Chancellor's discretion to a single remedial formula for monetary damages in a cash-out merger, it is overruled.
While a plaintiff's monetary remedy ordinarily should be confined to the more liberalized appraisal proceeding herein established, we do not intend any limitation on the historic powers of the Chancellor to grant such other relief as the facts of a particular case may dictate. The appraisal remedy we approve may not be adequate in certain cases, particularly where fraud, misrepresentation, self-dealing, deliberate waste of corporate assets, or gross and palpable overreaching are involved. Cole v. National Cash Credit Association, Del.Ch., 156 A. 183, 187 (1931). Under such circumstances, the Chancellor's powers are complete to fashion any form of equitable and monetary relief as may be appropriate, including rescissory damages. Since it is apparent that this long completed transaction is too involved to undo, and in view of the Chancellor's discretion, the award, if any, should be in the form of monetary damages based upon entire fairness standards, i.e., fair dealing and fair price.
Obviously, there are other litigants, like the plaintiff, who abjured an appraisal and whose rights to challenge the element of fair value must be preserved.[8] Accordingly, the quasi-appraisal remedy we grant the plaintiff here will apply only to: (1) this case; (2) any case now pending on appeal to this Court; (3) any case now pending in the Court of Chancery which has not yet been appealed but which may be eligible for direct appeal to this Court; (4) any case challenging a cash-out merger, the effective date of which is on or before February 1, 1983; and (5) any proposed merger to be [715] presented at a shareholders' meeting, the notification of which is mailed to the stockholders on or before February 23, 1983. Thereafter, the provisions of 8 Del.C. § 262, as herein construed, respecting the scope of an appraisal and the means for perfecting the same, shall govern the financial remedy available to minority shareholders in a cash-out merger. Thus, we return to the well established principles of Stauffer v. Standard Brands, Inc., Del.Supr., 187 A.2d 78 (1962) and David J. Greene & Co. v. Schenley Industries, Inc., Del.Ch., 281 A.2d 30 (1971), mandating a stockholder's recourse to the basic remedy of an appraisal.
III.
Finally, we address the matter of business purpose. The defendants contend that the purpose of this merger was not a proper subject of inquiry by the trial court. The plaintiff says that no valid purpose existed — the entire transaction was a mere subterfuge designed to eliminate the minority. The Chancellor ruled otherwise, but in so doing he clearly circumscribed the thrust and effect of Singer. Weinberger v. UOP, 426 A.2d at 1342-43, 1348-50. This has led to the thoroughly sound observation that the business purpose test "may be ... virtually interpreted out of existence, as it was in Weinberger".[9]
The requirement of a business purpose is new to our law of mergers and was a departure from prior case law. See Stauffer v. Standard Brands, Inc., supra; David J. Greene & Co. v. Schenley Industries, Inc., supra.
In view of the fairness test which has long been applicable to parent-subsidiary mergers, Sterling v. Mayflower Hotel Corp., Del.Supr., 93 A.2d 107, 109-10 (1952), the expanded appraisal remedy now available to shareholders, and the broad discretion of the Chancellor to fashion such relief as the facts of a given case may dictate, we do not believe that any additional meaningful protection is afforded minority shareholders by the business purpose requirement of the trilogy of Singer, Tanzer,[10]Najjar,[11] and their progeny. Accordingly, such requirement shall no longer be of any force or effect.
The judgment of the Court of Chancery, finding both the circumstances of the merger and the price paid the minority shareholders to be fair, is reversed. The matter is remanded for further proceedings consistent herewith. Upon remand the plaintiff's post-trial motion to enlarge the class should be granted.
* * * * * *
REVERSED AND REMANDED.
[1] Accordingly, this Court's February 9, 1982 opinion is withdrawn.
[2] For the opinion of the trial court see Weinberger v. UOP, Inc., Del.Ch., 426 A.2d 1333 (1981).
[3] Shortly before the last oral argument, the plaintiff dismissed Lehman Brothers from the action. Thus, we do not deal with the issues raised by the plaintiff's claims against this defendant.
[4] In a pre-trial ruling the Chancellor ordered the complaint dismissed for failure to state a cause of action. See Weinberger v. UOP, Inc., Del.Ch., 409 A.2d 1262 (1979).
[5] Weinberger v. UOP, Inc., Del.Ch., 426 A.2d 1333, 1335-40 (1981).
[6] The parentheses indicate certain handwritten comments of Mr. Arledge.
[7] Although perfection is not possible, or expected, the result here could have been entirely different if UOP had appointed an independent negotiating committee of its outside directors to deal with Signal at arm's length. See, e.g., Harriman v. E.I. duPont de Nemours & Co., 411 F.Supp. 133 (D.Del.1975). Since fairness in this context can be equated to conduct by a theoretical, wholly independent, board of directors acting upon the matter before them, it is unfortunate that this course apparently was neither considered nor pursued. Johnston v. Greene, Del.Supr., 121 A.2d 919, 925 (1956). Particularly in a parent-subsidiary context, a showing that the action taken was as though each of the contending parties had in fact exerted its bargaining power against the other at arm's length is strong evidence that the transaction meets the test of fairness. Getty Oil Co. v. Skelly Oil Co., Del.Supr., 267 A.2d 883, 886 (1970); Puma v. Marriott, Del.Ch., 283 A.2d 693, 696 (1971).
[8] Under 8 Del.C. § 262(a), (d) & (e), a stockholder is required to act within certain time periods to perfect the right to an appraisal.
[9] Weiss, The Law of Take Out Mergers: A Historical Perspective, 56 N.Y.U.L.Rev. 624, 671, n. 300 (1981).
[10] Tanzer v. International General Industries, Inc., Del.Supr., 379 A.2d 1121, 1124-25 (1977).
[11] Roland International Corp. v. Najjar, Del. Supr., 407 A.2d 1032, 1036 (1979).
1.2.1.4 Hypo: board service? 1.2.1.4 Hypo: board service?
Imagine you are the in-house lawyer for a real estate developer, Rosalind Franklin Broes. Broes is doing business through RFB Condominiums Inc. ("RFBC"), a Delaware corporation. Broes is RFBC’s sole shareholder and president. You are technically an employee of RFBC. RFBC develops and administers condo complexes in the Midwestern United States, mainly in Michigan.
Broes now wants your opinion on the following issue. One of RFBC’s bankers, John Cash of Big Bank, has asked Broes to join the board of another real estate developer, CIS Inc., also a Delaware corporation. CIS is an erstwhile competitor of RFBC. It has been in chapter 11 for the last two years, however, and lost or sold most of its properties and contracts during that time. When it emerges from bankruptcy next month, it will only have interests in Texas. Cash sits on CIS’s creditor committee on behalf of Big Bank, a major creditor of CIS. Cash would like to get Broes’s experience onto CIS’s board.
Broes is concerned that service on CIS’s board will expose her to conflicts of interest. She has shared these concerns with Cash. In Cash’s view, the concerns are unfounded. After all, he, Cash, also has access to much confidential information from both CIS and RFBC in his role as their banker. Besides, he argues, CIS and RFBC will no longer be operating in the same areas. Lastly, even if CIS wanted to expand back into the Midwest, Cash points out that CIS would find it very difficult to do so under the restrictive post-bankruptcy loan covenants that prohibit most acquisitions or additional financing.
Broes is still worried though. She looked around the internet, and what she found did not reassure her. The most famous description of the duty of loyalty sounds rather ominous to her. It was penned by Judge Benjamin Cardozo, then Chief Judge of the New York Court of Appeals, in Meinhard v. Salmon, 249 N.Y. 458 (1928):
“Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions . . . . Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.”
Broes says she definitely does not want to sink to the “level . . . trodden by the crowd,” but she isn’t quite sure what “the punctilio of an honor the most sensitive” demands of her. Can she or can she not serve on CIS’s board without getting into trouble? What would you advise Broes to do?
1.2.2 Unconflicted behavior (mistakes): The Duty of Care 1.2.2 Unconflicted behavior (mistakes): The Duty of Care
Is there room for liability — and thus judicial involvement — in corporate decision-making, outside of self-dealing? Applying the business judgment rule, Delaware courts hardly ever sanction managers and boards absent self-dealing. Nor do other states’ courts. In a well-known case, the New York Supreme Court absolved American Express's board of liability even though they had forgone an $80 million tax benefit (in today's money) without any convincing countervailing benefit. Some have called this area of the law the “law of director non-liability.”This raises two questions: Why no liability? And if there truly is no liability, why not say so outright and save the expense and distraction of litigation?Importantly, the cases in this area still involve conflicts of interest, albeit of a subtler kind than the outright financial or similarly strong conflicts giving rise to claims of self-dealing. Boards' and managers' interests diverge from shareholders' interests at least inasmuch as the former have to do all the work but surrender most of the benefits to the latter, incentive compensation notwithstanding. As you read the cases, you should be on the lookout for more specific conflicts.
1.2.2.1 Smith v. Van Gorkom 1.2.2.1 Smith v. Van Gorkom
This is the one case where Delaware courts imposed monetary liability on disinterested directors for breach of the duty of care. It caused a storm. Liability insurance rates for directors skyrocketed. The Delaware legislature intervened by enacting DGCL 102(b)(7), which allows exculpatory charter provisions to eliminate damages for breaches of the duty of care. Such charter provisions are now standard. Even without them, however, it is unlikely that a Delaware court would impose liability on these facts today. The courts seem to have retrenched — not in their doctrine but in how they apply it. Cf. Disney below.You should, therefore, read the case not as an exemplary application of the duty of care, but as a policy experiment: why is the corporate world so opposed to monetary damages on these facts?Background: the Acquisition Process (more in M&A, infra)The case involves the acquisition of the Trans Union Corporation by Marmon Group, Inc. As is typical, the acquisition is structured as a merger. The acquired corporation (the “target”) merges with the acquiror (the “buyer”) or one of the buyer's subsidiaries. In the merger, shares in the target are extinguished. In exchange, target shareholders receive cash or other consideration (usually shares in the buyer).Under most U.S. statutes such as DGCL 251, the merger generally requires a merger agreement between the buyer and the target to be approved by the boards and a majority of the shareholders of each corporation. This entails two important consequences.First, the board controls the process because only the board can have the corporation enter into the merger agreement. This is one example of why it is at least misleading to call shareholders the “owners of the corporation.”Two, in public corporations, the requirement of shareholder approval means that several months will pass between signing the merger agreement and completion of the merger. This is the time it takes to convene the shareholder meeting and solicit proxies in accordance with the applicable corporate law and SEC proxy rules. Of course, many things can happen during this time. In particular, other potential buyers may appear on the scene.Questions1. According to the majority opinion, what did the directors do wrong? In other words, what should the directors have done differently? Why did the business judgment rule not apply?2. What are the dissenters’ counter-arguments?3. How do you think directors in other companies reacted to this decision — what, if anything, did they most likely do differently after Van Gorkom?
Alden SMITH and John W. Gosselin, Plaintiffs Below, Appellants,
v.
Jerome W. VAN GORKOM, Bruce S. Chelberg, William B. Johnson, Joseph B. Lanterman, Graham J. Morgan, Thomas P. O'Boyle, W. Allen Wallis, Sidney H. Bonser, William D. Browder, Trans Union Corporation, a Delaware corporation, Marmon Group, Inc., a Delaware corporation, GL Corporation, a Delaware corporation, and New T. Co., a Delaware corporation, Defendants Below, Appellees.
Supreme Court of Delaware.
Submitted: June 11, 1984.
Decided: January 29, 1985.
Opinion on Denial of Reargument: March 14, 1985.
William Prickett (argued) and James P. Dalle Pazze, of Prickett, Jones, Elliott, Kristol & Schnee, Wilmington, and Ivan Irwin, Jr. and Brett A. Ringle, of Shank, Irwin, Conant & Williamson, Dallas, Tex., of counsel, for plaintiffs below, appellants.
Robert K. Payson (argued) and Peter M. Sieglaff of Potter, Anderson & Corroon, Wilmington, for individual defendants below, appellees.
Lewis S. Black, Jr., A. Gilchrist Sparks, III (argued) and Richard D. Allen, of Morris, Nichols, Arsht & Tunnell, Wilmington, for Trans Union Corp., Marmon Group, Inc., GL Corp. and New T. Co., defendants below, appellees.
Before HERRMANN, C.J., and McNEILLY, HORSEY, MOORE and CHRISTIE, JJ., constituting the Court en banc.
[863] HORSEY, Justice (for the majority):
This appeal from the Court of Chancery involves a class action brought by shareholders of the defendant Trans Union Corporation ("Trans Union" or "the Company"), originally seeking rescission of a cash-out merger of Trans Union into the defendant New T Company ("New T"), a wholly-owned subsidiary of the defendant, Marmon Group, Inc. ("Marmon"). Alternate relief in the form of damages is sought against the defendant members of the Board of Directors of Trans Union, [864] New T, and Jay A. Pritzker and Robert A. Pritzker, owners of Marmon.[1]
Following trial, the former Chancellor granted judgment for the defendant directors by unreported letter opinion dated July 6, 1982.[2] Judgment was based on two findings: (1) that the Board of Directors had acted in an informed manner so as to be entitled to protection of the business judgment rule in approving the cash-out merger; and (2) that the shareholder vote approving the merger should not be set aside because the stockholders had been "fairly informed" by the Board of Directors before voting thereon. The plaintiffs appeal.
Speaking for the majority of the Court, we conclude that both rulings of the Court of Chancery are clearly erroneous. Therefore, we reverse and direct that judgment be entered in favor of the plaintiffs and against the defendant directors for the fair value of the plaintiffs' stockholdings in Trans Union, in accordance with Weinberger v. UOP, Inc., Del.Supr., 457 A.2d 701 (1983).[3]
We hold: (1) that the Board's decision, reached September 20, 1980, to approve the proposed cash-out merger was not the product of an informed business judgment; (2) that the Board's subsequent efforts to amend the Merger Agreement and take other curative action were ineffectual, both legally and factually; and (3) that the Board did not deal with complete candor with the stockholders by failing to disclose all material facts, which they knew or should have known, before securing the stockholders' approval of the merger.
I.
The nature of this case requires a detailed factual statement. The following facts are essentially uncontradicted:[4]
-A-
Trans Union was a publicly-traded, diversified holding company, the principal earnings of which were generated by its railcar leasing business. During the period here involved, the Company had a cash flow of hundreds of millions of dollars annually. However, the Company had difficulty in generating sufficient taxable income to offset increasingly large investment tax credits (ITCs). Accelerated depreciation deductions had decreased available taxable income against which to offset accumulating ITCs. The Company took these deductions, despite their effect on usable ITCs, because the rental price in the railcar leasing market had already impounded the purported tax savings.
In the late 1970's, together with other capital-intensive firms, Trans Union lobbied in Congress to have ITCs refundable in cash to firms which could not fully utilize the credit. During the summer of 1980, defendant Jerome W. Van Gorkom, Trans Union's Chairman and Chief Executive Officer, [865] testified and lobbied in Congress for refundability of ITCs and against further accelerated depreciation. By the end of August, Van Gorkom was convinced that Congress would neither accept the refundability concept nor curtail further accelerated depreciation.
Beginning in the late 1960's, and continuing through the 1970's, Trans Union pursued a program of acquiring small companies in order to increase available taxable income. In July 1980, Trans Union Management prepared the annual revision of the Company's Five Year Forecast. This report was presented to the Board of Directors at its July, 1980 meeting. The report projected an annual income growth of about 20%. The report also concluded that Trans Union would have about $195 million in spare cash between 1980 and 1985, "with the surplus growing rapidly from 1982 onward." The report referred to the ITC situation as a "nagging problem" and, given that problem, the leasing company "would still appear to be constrained to a tax breakeven." The report then listed four alternative uses of the projected 1982-1985 equity surplus: (1) stock repurchase; (2) dividend increases; (3) a major acquisition program; and (4) combinations of the above. The sale of Trans Union was not among the alternatives. The report emphasized that, despite the overall surplus, the operation of the Company would consume all available equity for the next several years, and concluded: "As a result, we have sufficient time to fully develop our course of action."
-B-
On August 27, 1980, Van Gorkom met with Senior Management of Trans Union. Van Gorkom reported on his lobbying efforts in Washington and his desire to find a solution to the tax credit problem more permanent than a continued program of acquisitions. Various alternatives were suggested and discussed preliminarily, including the sale of Trans Union to a company with a large amount of taxable income.
Donald Romans, Chief Financial Officer of Trans Union, stated that his department had done a "very brief bit of work on the possibility of a leveraged buy-out." This work had been prompted by a media article which Romans had seen regarding a leveraged buy-out by management. The work consisted of a "preliminary study" of the cash which could be generated by the Company if it participated in a leveraged buyout. As Romans stated, this analysis "was very first and rough cut at seeing whether a cash flow would support what might be considered a high price for this type of transaction."
On September 5, at another Senior Management meeting which Van Gorkom attended, Romans again brought up the idea of a leveraged buy-out as a "possible strategic alternative" to the Company's acquisition program. Romans and Bruce S. Chelberg, President and Chief Operating Officer of Trans Union, had been working on the matter in preparation for the meeting. According to Romans: They did not "come up" with a price for the Company. They merely "ran the numbers" at $50 a share and at $60 a share with the "rough form" of their cash figures at the time. Their "figures indicated that $50 would be very easy to do but $60 would be very difficult to do under those figures." This work did not purport to establish a fair price for either the Company or 100% of the stock. It was intended to determine the cash flow needed to service the debt that would "probably" be incurred in a leveraged buyout, based on "rough calculations" without "any benefit of experts to identify what the limits were to that, and so forth." These computations were not considered extensive and no conclusion was reached.
At this meeting, Van Gorkom stated that he would be willing to take $55 per share for his own 75,000 shares. He vetoed the suggestion of a leveraged buy-out by Management, however, as involving a potential conflict of interest for Management. Van Gorkom, a certified public accountant and lawyer, had been an officer of Trans Union [866] for 24 years, its Chief Executive Officer for more than 17 years, and Chairman of its Board for 2 years. It is noteworthy in this connection that he was then approaching 65 years of age and mandatory retirement.
For several days following the September 5 meeting, Van Gorkom pondered the idea of a sale. He had participated in many acquisitions as a manager and director of Trans Union and as a director of other companies. He was familiar with acquisition procedures, valuation methods, and negotiations; and he privately considered the pros and cons of whether Trans Union should seek a privately or publicly-held purchaser.
Van Gorkom decided to meet with Jay A. Pritzker, a well-known corporate takeover specialist and a social acquaintance. However, rather than approaching Pritzker simply to determine his interest in acquiring Trans Union, Van Gorkom assembled a proposed per share price for sale of the Company and a financing structure by which to accomplish the sale. Van Gorkom did so without consulting either his Board or any members of Senior Management except one: Carl Peterson, Trans Union's Controller. Telling Peterson that he wanted no other person on his staff to know what he was doing, but without telling him why, Van Gorkom directed Peterson to calculate the feasibility of a leveraged buy-out at an assumed price per share of $55. Apart from the Company's historic stock market price,[5] and Van Gorkom's long association with Trans Union, the record is devoid of any competent evidence that $55 represented the per share intrinsic value of the Company.
Having thus chosen the $55 figure, based solely on the availability of a leveraged buy-out, Van Gorkom multiplied the price per share by the number of shares outstanding to reach a total value of the Company of $690 million. Van Gorkom told Peterson to use this $690 million figure and to assume a $200 million equity contribution by the buyer. Based on these assumptions, Van Gorkom directed Peterson to determine whether the debt portion of the purchase price could be paid off in five years or less if financed by Trans Union's cash flow as projected in the Five Year Forecast, and by the sale of certain weaker divisions identified in a study done for Trans Union by the Boston Consulting Group ("BCG study"). Peterson reported that, of the purchase price, approximately $50-80 million would remain outstanding after five years. Van Gorkom was disappointed, but decided to meet with Pritzker nevertheless.
Van Gorkom arranged a meeting with Pritzker at the latter's home on Saturday, September 13, 1980. Van Gorkom prefaced his presentation by stating to Pritzker: "Now as far as you are concerned, I can, I think, show how you can pay a substantial premium over the present stock price and pay off most of the loan in the first five years. * * * If you could pay $55 for this Company, here is a way in which I think it can be financed."
Van Gorkom then reviewed with Pritzker his calculations based upon his proposed price of $55 per share. Although Pritzker mentioned $50 as a more attractive figure, no other price was mentioned. However, Van Gorkom stated that to be sure that $55 was the best price obtainable, Trans Union should be free to accept any better offer. Pritzker demurred, stating that his organization would serve as a "stalking horse" for an "auction contest" only if Trans Union would permit Pritzker to buy 1,750,000 shares of Trans Union stock at market price which Pritzker could then sell to any higher bidder. After further discussion on this point, Pritzker told Van Gorkom that he would give him a more definite reaction soon.
[867] On Monday, September 15, Pritzker advised Van Gorkom that he was interested in the $55 cash-out merger proposal and requested more information on Trans Union. Van Gorkom agreed to meet privately with Pritzker, accompanied by Peterson, Chelberg, and Michael Carpenter, Trans Union's consultant from the Boston Consulting Group. The meetings took place on September 16 and 17. Van Gorkom was "astounded that events were moving with such amazing rapidity."
On Thursday, September 18, Van Gorkom met again with Pritzker. At that time, Van Gorkom knew that Pritzker intended to make a cash-out merger offer at Van Gorkom's proposed $55 per share. Pritzker instructed his attorney, a merger and acquisition specialist, to begin drafting merger documents. There was no further discussion of the $55 price. However, the number of shares of Trans Union's treasury stock to be offered to Pritzker was negotiated down to one million shares; the price was set at $38-75 cents above the per share price at the close of the market on September 19. At this point, Pritzker insisted that the Trans Union Board act on his merger proposal within the next three days, stating to Van Gorkom: "We have to have a decision by no later than Sunday [evening, September 21] before the opening of the English stock exchange on Monday morning." Pritzker's lawyer was then instructed to draft the merger documents, to be reviewed by Van Gorkom's lawyer, "sometimes with discussion and sometimes not, in the haste to get it finished."
On Friday, September 19, Van Gorkom, Chelberg, and Pritzker consulted with Trans Union's lead bank regarding the financing of Pritzker's purchase of Trans Union. The bank indicated that it could form a syndicate of banks that would finance the transaction. On the same day, Van Gorkom retained James Brennan, Esquire, to advise Trans Union on the legal aspects of the merger. Van Gorkom did not consult with William Browder, a Vice-President and director of Trans Union and former head of its legal department, or with William Moore, then the head of Trans Union's legal staff.
On Friday, September 19, Van Gorkom called a special meeting of the Trans Union Board for noon the following day. He also called a meeting of the Company's Senior Management to convene at 11:00 a.m., prior to the meeting of the Board. No one, except Chelberg and Peterson, was told the purpose of the meetings. Van Gorkom did not invite Trans Union's investment banker, Salomon Brothers or its Chicago-based partner, to attend.
Of those present at the Senior Management meeting on September 20, only Chelberg and Peterson had prior knowledge of Pritzker's offer. Van Gorkom disclosed the offer and described its terms, but he furnished no copies of the proposed Merger Agreement. Romans announced that his department had done a second study which showed that, for a leveraged buy-out, the price range for Trans Union stock was between $55 and $65 per share. Van Gorkom neither saw the study nor asked Romans to make it available for the Board meeting.
Senior Management's reaction to the Pritzker proposal was completely negative. No member of Management, except Chelberg and Peterson, supported the proposal. Romans objected to the price as being too low;[6] he was critical of the timing and suggested that consideration should be given to the adverse tax consequences of an all-cash deal for low-basis shareholders; and he took the position that the agreement to sell Pritzker one million newly-issued shares at market price would inhibit other offers, as would the prohibitions against soliciting bids and furnishing inside information [868] to other bidders. Romans argued that the Pritzker proposal was a "lock up" and amounted to "an agreed merger as opposed to an offer." Nevertheless, Van Gorkom proceeded to the Board meeting as scheduled without further delay.
Ten directors served on the Trans Union Board, five inside (defendants Bonser, O'Boyle, Browder, Chelberg, and Van Gorkom) and five outside (defendants Wallis, Johnson, Lanterman, Morgan and Reneker). All directors were present at the meeting, except O'Boyle who was ill. Of the outside directors, four were corporate chief executive officers and one was the former Dean of the University of Chicago Business School. None was an investment banker or trained financial analyst. All members of the Board were well informed about the Company and its operations as a going concern. They were familiar with the current financial condition of the Company, as well as operating and earnings projections reported in the recent Five Year Forecast. The Board generally received regular and detailed reports and was kept abreast of the accumulated investment tax credit and accelerated depreciation problem.
Van Gorkom began the Special Meeting of the Board with a twenty-minute oral presentation. Copies of the proposed Merger Agreement were delivered too late for study before or during the meeting.[7] He reviewed the Company's ITC and depreciation problems and the efforts theretofore made to solve them. He discussed his initial meeting with Pritzker and his motivation in arranging that meeting. Van Gorkom did not disclose to the Board, however, the methodology by which he alone had arrived at the $55 figure, or the fact that he first proposed the $55 price in his negotiations with Pritzker.
Van Gorkom outlined the terms of the Pritzker offer as follows: Pritzker would pay $55 in cash for all outstanding shares of Trans Union stock upon completion of which Trans Union would be merged into New T Company, a subsidiary wholly-owned by Pritzker and formed to implement the merger; for a period of 90 days, Trans Union could receive, but could not actively solicit, competing offers; the offer had to be acted on by the next evening, Sunday, September 21; Trans Union could only furnish to competing bidders published information, and not proprietary information; the offer was subject to Pritzker obtaining the necessary financing by October 10, 1980; if the financing contingency were met or waived by Pritzker, Trans Union was required to sell to Pritzker one million newly-issued shares of Trans Union at $38 per share.
Van Gorkom took the position that putting Trans Union "up for auction" through a 90-day market test would validate a decision by the Board that $55 was a fair price. He told the Board that the "free market will have an opportunity to judge whether $55 is a fair price." Van Gorkom framed the decision before the Board not as whether $55 per share was the highest price that could be obtained, but as whether the $55 price was a fair price that the stockholders should be given the opportunity to accept or reject.[8]
Attorney Brennan advised the members of the Board that they might be sued if they failed to accept the offer and that a fairness opinion was not required as a matter of law.
Romans attended the meeting as chief financial officer of the Company. He told the Board that he had not been involved in the negotiations with Pritzker and knew nothing about the merger proposal until [869] the morning of the meeting; that his studies did not indicate either a fair price for the stock or a valuation of the Company; that he did not see his role as directly addressing the fairness issue; and that he and his people "were trying to search for ways to justify a price in connection with such a [leveraged buy-out] transaction, rather than to say what the shares are worth." Romans testified:
I told the Board that the study ran the numbers at 50 and 60, and then the subsequent study at 55 and 65, and that was not the same thing as saying that I have a valuation of the company at X dollars. But it was a way — a first step towards reaching that conclusion.
Romans told the Board that, in his opinion, $55 was "in the range of a fair price," but "at the beginning of the range."
Chelberg, Trans Union's President, supported Van Gorkom's presentation and representations. He testified that he "participated to make sure that the Board members collectively were clear on the details of the agreement or offer from Pritzker;" that he "participated in the discussion with Mr. Brennan, inquiring of him about the necessity for valuation opinions in spite of the way in which this particular offer was couched;" and that he was otherwise actively involved in supporting the positions being taken by Van Gorkom before the Board about "the necessity to act immediately on this offer," and about "the adequacy of the $55 and the question of how that would be tested."
The Board meeting of September 20 lasted about two hours. Based solely upon Van Gorkom's oral presentation, Chelberg's supporting representations, Romans' oral statement, Brennan's legal advice, and their knowledge of the market history of the Company's stock,[9] the directors approved the proposed Merger Agreement. However, the Board later claimed to have attached two conditions to its acceptance: (1) that Trans Union reserved the right to accept any better offer that was made during the market test period; and (2) that Trans Union could share its proprietary information with any other potential bidders. While the Board now claims to have reserved the right to accept any better offer received after the announcement of the Pritzker agreement (even though the minutes of the meeting do not reflect this), it is undisputed that the Board did not reserve the right to actively solicit alternate offers.
The Merger Agreement was executed by Van Gorkom during the evening of September 20 at a formal social event that he hosted for the opening of the Chicago Lyric Opera. Neither he nor any other director read the agreement prior to its signing and delivery to Pritzker.
* * *
On Monday, September 22, the Company issued a press release announcing that Trans Union had entered into a "definitive" Merger Agreement with an affiliate of the Marmon Group, Inc., a Pritzker holding company. Within 10 days of the public announcement, dissent among Senior Management over the merger had become widespread. Faced with threatened resignations of key officers, Van Gorkom met with Pritzker who agreed to several modifications of the Agreement. Pritzker was willing to do so provided that Van Gorkom could persuade the dissidents to remain on the Company payroll for at least six months after consummation of the merger.
Van Gorkom reconvened the Board on October 8 and secured the directors' approval of the proposed amendments — sight unseen. The Board also authorized the employment of Salomon Brothers, its investment [870] banker, to solicit other offers for Trans Union during the proposed "market test" period.
The next day, October 9, Trans Union issued a press release announcing: (1) that Pritzker had obtained "the financing commitments necessary to consummate" the merger with Trans Union; (2) that Pritzker had acquired one million shares of Trans Union common stock at $38 per share; (3) that Trans Union was now permitted to actively seek other offers and had retained Salomon Brothers for that purpose; and (4) that if a more favorable offer were not received before February 1, 1981, Trans Union's shareholders would thereafter meet to vote on the Pritzker proposal.
It was not until the following day, October 10, that the actual amendments to the Merger Agreement were prepared by Pritzker and delivered to Van Gorkom for execution. As will be seen, the amendments were considerably at variance with Van Gorkom's representations of the amendments to the Board on October 8; and the amendments placed serious constraints on Trans Union's ability to negotiate a better deal and withdraw from the Pritzker agreement. Nevertheless, Van Gorkom proceeded to execute what became the October 10 amendments to the Merger Agreement without conferring further with the Board members and apparently without comprehending the actual implications of the amendments.
* * *
Salomon Brothers' efforts over a three-month period from October 21 to January 21 produced only one serious suitor for Trans Union — General Electric Credit Corporation ("GE Credit"), a subsidiary of the General Electric Company. However, GE Credit was unwilling to make an offer for Trans Union unless Trans Union first rescinded its Merger Agreement with Pritzker. When Pritzker refused, GE Credit terminated further discussions with Trans Union in early January.
In the meantime, in early December, the investment firm of Kohlberg, Kravis, Roberts & Co. ("KKR"), the only other concern to make a firm offer for Trans Union, withdrew its offer under circumstances hereinafter detailed.
On December 19, this litigation was commenced and, within four weeks, the plaintiffs had deposed eight of the ten directors of Trans Union, including Van Gorkom, Chelberg and Romans, its Chief Financial Officer. On January 21, Management's Proxy Statement for the February 10 shareholder meeting was mailed to Trans Union's stockholders. On January 26, Trans Union's Board met and, after a lengthy meeting, voted to proceed with the Pritzker merger. The Board also approved for mailing, "on or about January 27," a Supplement to its Proxy Statement. The Supplement purportedly set forth all information relevant to the Pritzker Merger Agreement, which had not been divulged in the first Proxy Statement.
* * *
On February 10, the stockholders of Trans Union approved the Pritzker merger proposal. Of the outstanding shares, 69.9% were voted in favor of the merger; 7.25% were voted against the merger; and 22.85% were not voted.
II.
We turn to the issue of the application of the business judgment rule to the September 20 meeting of the Board.
The Court of Chancery concluded from the evidence that the Board of Directors' approval of the Pritzker merger proposal fell within the protection of the business judgment rule. The Court found that the Board had given sufficient time and attention to the transaction, since the directors had considered the Pritzker proposal on three different occasions, on September 20, and on October 8, 1980 and finally on January 26, 1981. On that basis, the Court reasoned that the Board had acquired, over the four-month period, sufficient information to reach an informed business judgment [871] on the cash-out merger proposal. The Court ruled:
... that given the market value of Trans Union's stock, the business acumen of the members of the board of Trans Union, the substantial premium over market offered by the Pritzkers and the ultimate effect on the merger price provided by the prospect of other bids for the stock in question, that the board of directors of Trans Union did not act recklessly or improvidently in determining on a course of action which they believed to be in the best interest of the stockholders of Trans Union.
The Court of Chancery made but one finding; i.e., that the Board's conduct over the entire period from September 20 through January 26, 1981 was not reckless or improvident, but informed. This ultimate conclusion was premised upon three subordinate findings, one explicit and two implied. The Court's explicit finding was that Trans Union's Board was "free to turn down the Pritzker proposal" not only on September 20 but also on October 8, 1980 and on January 26, 1981. The Court's implied, subordinate findings were: (1) that no legally binding agreement was reached by the parties until January 26; and (2) that if a higher offer were to be forthcoming, the market test would have produced it,[10] and Trans Union would have been contractually free to accept such higher offer. However, the Court offered no factual basis or legal support for any of these findings; and the record compels contrary conclusions.
This Court's standard of review of the findings of fact reached by the Trial Court following full evidentiary hearing is as stated in Levitt v. Bouvier, Del.Supr., 287 A.2d 671, 673 (1972):
[In an appeal of this nature] this court has the authority to review the entire record and to make its own findings of fact in a proper case. In exercising our power of review, we have the duty to review the sufficiency of the evidence and to test the propriety of the findings below. We do not, however, ignore the findings made by the trial judge. If they are sufficiently supported by the record and are the product of an orderly and logical deductive process, in the exercise of judicial restraint we accept them, even though independently we might have reached opposite conclusions. It is only when the findings below are clearly wrong and the doing of justice requires their overturn that we are free to make contradictory findings of fact.
Applying that standard and governing principles of law to the record and the decision of the Trial Court, we conclude that the Court's ultimate finding that the Board's conduct was not "reckless or imprudent" is contrary to the record and not the product of a logical and deductive reasoning process.
The plaintiffs contend that the Court of Chancery erred as a matter of law by exonerating the defendant directors under the business judgment rule without first determining whether the rule's threshold condition of "due care and prudence" was satisfied. The plaintiffs assert that the Trial Court found the defendant directors to have reached an informed business judgment on the basis of "extraneous considerations and events that occurred after September 20, 1980." The defendants deny that the Trial Court committed legal error in relying upon post-September 20, 1980 events and the directors' later acquired knowledge. The defendants further submit that their decision to accept $55 per share was informed because: (1) they were "highly qualified;" (2) they were "well-informed;" and (3) they deliberated over the "proposal" not once but three times. On [872] essentially this evidence and under our standard of review, the defendants assert that affirmance is required. We must disagree.
Under Delaware law, the business judgment rule is the offspring of the fundamental principle, codified in 8 Del.C. § 141(a), that the business and affairs of a Delaware corporation are managed by or under its board of directors.[11]Pogostin v. Rice, Del.Supr., 480 A.2d 619, 624 (1984); Aronson v. Lewis, Del.Supr., 473 A.2d 805, 811 (1984); Zapata Corp. v. Maldonado, Del.Supr., 430 A.2d 779, 782 (1981). In carrying out their managerial roles, directors are charged with an unyielding fiduciary duty to the corporation and its shareholders. Loft, Inc. v. Guth, Del.Ch., 2 A.2d 225 (1938), aff'd, Del.Supr., 5 A.2d 503 (1939). The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors. Zapata Corp. v. Maldonado, supra at 782. The rule itself "is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson, supra at 812. Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one. Id.
The determination of whether a business judgment is an informed one turns on whether the directors have informed themselves "prior to making a business decision, of all material information reasonably available to them." Id.[12]
Under the business judgment rule there is no protection for directors who have made "an unintelligent or unadvised judgment." Mitchell v. Highland-Western Glass, Del.Ch., 167 A. 831, 833 (1933). A director's duty to inform himself in preparation for a decision derives from the fiduciary capacity in which he serves the corporation and its stockholders. Lutz v. Boas, Del.Ch., 171 A.2d 381 (1961). See Weinberger v. UOP, Inc., supra; Guth v. Loft, supra. Since a director is vested with the responsibility for the management of the affairs of the corporation, he must execute that duty with the recognition that he acts on behalf of others. Such obligation does not tolerate faithlessness or self-dealing. But fulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. See Lutz v. Boas, supra; Guth v. Loft, supra at 510. Compare Donovan v. Cunningham, 5th Cir., 716 F.2d 1455, 1467 (1983); Doyle v. Union Insurance Company, Neb.Supr., 277 N.W.2d 36 (1979); Continental Securities Co. v. Belmont, N.Y. App., 99 N.E. 138, 141 (1912).
Thus, a director's duty to exercise an informed business judgment is in [873] the nature of a duty of care, as distinguished from a duty of loyalty. Here, there were no allegations of fraud, bad faith, or self-dealing, or proof thereof. Hence, it is presumed that the directors reached their business judgment in good faith, Allaun v. Consolidated Oil Co., Del. Ch., 147 A. 257 (1929), and considerations of motive are irrelevant to the issue before us.
The standard of care applicable to a director's duty of care has also been recently restated by this Court. In Aronson, supra, we stated:
While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence. (footnote omitted)
473 A.2d at 812.
We again confirm that view. We think the concept of gross negligence is also the proper standard for determining whether a business judgment reached by a board of directors was an informed one.[13]
In the specific context of a proposed merger of domestic corporations, a director has a duty under 8 Del.C. 251(b),[14] along with his fellow directors, to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. Certainly in the merger context, a director may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement. See Beard v. Elster, Del.Supr., 160 A.2d 731, 737 (1960). Only an agreement of merger satisfying the requirements of 8 Del.C. § 251(b) may be submitted to the shareholders under § 251(c). See generally Aronson v. Lewis, supra at 811-13; see also Pogostin v. Rice, supra.
It is against those standards that the conduct of the directors of Trans Union must be tested, as a matter of law and as a matter of fact, regarding their exercise of an informed business judgment in voting to approve the Pritzker merger proposal.
III.
The defendants argue that the determination of whether their decision to accept $55 per share for Trans Union represented an informed business judgment requires consideration, not only of that which they knew and learned on September 20, but also of that which they subsequently learned and did over the following four-month [874] period before the shareholders met to vote on the proposal in February, 1981. The defendants thereby seek to reduce the significance of their action on September 20 and to widen the time frame for determining whether their decision to accept the Pritzker proposal was an informed one. Thus, the defendants contend that what the directors did and learned subsequent to September 20 and through January 26, 1981, was properly taken into account by the Trial Court in determining whether the Board's judgment was an informed one. We disagree with this post hoc approach.
The issue of whether the directors reached an informed decision to "sell" the Company on September 20, 1980 must be determined only upon the basis of the information then reasonably available to the directors and relevant to their decision to accept the Pritzker merger proposal. This is not to say that the directors were precluded from altering their original plan of action, had they done so in an informed manner. What we do say is that the question of whether the directors reached an informed business judgment in agreeing to sell the Company, pursuant to the terms of the September 20 Agreement presents, in reality, two questions: (A) whether the directors reached an informed business judgment on September 20, 1980; and (B) if they did not, whether the directors' actions taken subsequent to September 20 were adequate to cure any infirmity in their action taken on September 20. We first consider the directors' September 20 action in terms of their reaching an informed business judgment.
-A-
On the record before us, we must conclude that the Board of Directors did not reach an informed business judgment on September 20, 1980 in voting to "sell" the Company for $55 per share pursuant to the Pritzker cash-out merger proposal. Our reasons, in summary, are as follows:
The directors (1) did not adequately inform themselves as to Van Gorkom's role in forcing the "sale" of the Company and in establishing the per share purchase price; (2) were uninformed as to the intrinsic value of the Company; and (3) given these circumstances, at a minimum, were grossly negligent in approving the "sale" of the Company upon two hours' consideration, without prior notice, and without the exigency of a crisis or emergency.
As has been noted, the Board based its September 20 decision to approve the cash-out merger primarily on Van Gorkom's representations. None of the directors, other than Van Gorkom and Chelberg, had any prior knowledge that the purpose of the meeting was to propose a cash-out merger of Trans Union. No members of Senior Management were present, other than Chelberg, Romans and Peterson; and the latter two had only learned of the proposed sale an hour earlier. Both general counsel Moore and former general counsel Browder attended the meeting, but were equally uninformed as to the purpose of the meeting and the documents to be acted upon.
Without any documents before them concerning the proposed transaction, the members of the Board were required to rely entirely upon Van Gorkom's 20-minute oral presentation of the proposal. No written summary of the terms of the merger was presented; the directors were given no documentation to support the adequacy of $55 price per share for sale of the Company; and the Board had before it nothing more than Van Gorkom's statement of his understanding of the substance of an agreement which he admittedly had never read, nor which any member of the Board had ever seen.
Under 8 Del.C. § 141(e),[15] "directors are fully protected in relying in [875] good faith on reports made by officers." Michelson v. Duncan, Del.Ch., 386 A.2d 1144, 1156 (1978); aff'd in part and rev'd in part on other grounds, Del.Supr., 407 A.2d 211 (1979). See also Graham v. Allis-Chalmers Mfg. Co., Del.Supr., 188 A.2d 125, 130 (1963); Prince v. Bensinger, Del. Ch., 244 A.2d 89, 94 (1968). The term "report" has been liberally construed to include reports of informal personal investigations by corporate officers, Cheff v. Mathes, Del.Supr., 199 A.2d 548, 556 (1964). However, there is no evidence that any "report," as defined under § 141(e), concerning the Pritzker proposal, was presented to the Board on September 20.[16] Van Gorkom's oral presentation of his understanding of the terms of the proposed Merger Agreement, which he had not seen, and Romans' brief oral statement of his preliminary study regarding the feasibility of a leveraged buy-out of Trans Union do not qualify as § 141(e) "reports" for these reasons: The former lacked substance because Van Gorkom was basically uninformed as to the essential provisions of the very document about which he was talking. Romans' statement was irrelevant to the issues before the Board since it did not purport to be a valuation study. At a minimum for a report to enjoy the status conferred by § 141(e), it must be pertinent to the subject matter upon which a board is called to act, and otherwise be entitled to good faith, not blind, reliance. Considering all of the surrounding circumstances — hastily calling the meeting without prior notice of its subject matter, the proposed sale of the Company without any prior consideration of the issue or necessity therefor, the urgent time constraints imposed by Pritzker, and the total absence of any documentation whatsoever — the directors were duty bound to make reasonable inquiry of Van Gorkom and Romans, and if they had done so, the inadequacy of that upon which they now claim to have relied would have been apparent.
The defendants rely on the following factors to sustain the Trial Court's finding that the Board's decision was an informed one: (1) the magnitude of the premium or spread between the $55 Pritzker offering price and Trans Union's current market price of $38 per share; (2) the amendment of the Agreement as submitted on September 20 to permit the Board to accept any better offer during the "market test" period; (3) the collective experience and expertise of the Board's "inside" and "outside" directors;[17] and (4) their reliance on Brennan's legal advice that the directors might be sued if they rejected the Pritzker proposal. We discuss each of these grounds seriatim:
(1)
A substantial premium may provide one reason to recommend a merger, but in the absence of other sound valuation information, the fact of a premium alone does not provide an adequate basis upon which to assess the fairness of an offering price. Here, the judgment reached as to the adequacy of the premium was based on a comparison between the historically depressed Trans Union market price and the amount of the Pritzker offer. Using market price as a basis for concluding that the premium adequately reflected the true value [876] of the Company was a clearly faulty, indeed fallacious, premise, as the defendants' own evidence demonstrates.
The record is clear that before September 20, Van Gorkom and other members of Trans Union's Board knew that the market had consistently undervalued the worth of Trans Union's stock, despite steady increases in the Company's operating income in the seven years preceding the merger. The Board related this occurrence in large part to Trans Union's inability to use its ITCs as previously noted. Van Gorkom testified that he did not believe the market price accurately reflected Trans Union's true worth; and several of the directors testified that, as a general rule, most chief executives think that the market undervalues their companies' stock. Yet, on September 20, Trans Union's Board apparently believed that the market stock price accurately reflected the value of the Company for the purpose of determining the adequacy of the premium for its sale.
In the Proxy Statement, however, the directors reversed their position. There, they stated that, although the earnings prospects for Trans Union were "excellent," they found no basis for believing that this would be reflected in future stock prices. With regard to past trading, the Board stated that the prices at which the Company's common stock had traded in recent years did not reflect the "inherent" value of the Company. But having referred to the "inherent" value of Trans Union, the directors ascribed no number to it. Moreover, nowhere did they disclose that they had no basis on which to fix "inherent" worth beyond an impressionistic reaction to the premium over market and an unsubstantiated belief that the value of the assets was "significantly greater" than book value. By their own admission they could not rely on the stock price as an accurate measure of value. Yet, also by their own admission, the Board members assumed that Trans Union's market price was adequate to serve as a basis upon which to assess the adequacy of the premium for purposes of the September 20 meeting.
The parties do not dispute that a publicly-traded stock price is solely a measure of the value of a minority position and, thus, market price represents only the value of a single share. Nevertheless, on September 20, the Board assessed the adequacy of the premium over market, offered by Pritzker, solely by comparing it with Trans Union's current and historical stock price. (See supra note 5 at 866.)
Indeed, as of September 20, the Board had no other information on which to base a determination of the intrinsic value of Trans Union as a going concern. As of September 20, the Board had made no evaluation of the Company designed to value the entire enterprise, nor had the Board ever previously considered selling the Company or consenting to a buy-out merger. Thus, the adequacy of a premium is indeterminate unless it is assessed in terms of other competent and sound valuation information that reflects the value of the particular business.
Despite the foregoing facts and circumstances, there was no call by the Board, either on September 20 or thereafter, for any valuation study or documentation of the $55 price per share as a measure of the fair value of the Company in a cash-out context. It is undisputed that the major asset of Trans Union was its cash flow. Yet, at no time did the Board call for a valuation study taking into account that highly significant element of the Company's assets.
We do not imply that an outside valuation study is essential to support an informed business judgment; nor do we state that fairness opinions by independent investment bankers are required as a matter of law. Often insiders familiar with the business of a going concern are in a better position than are outsiders to gather relevant information; and under appropriate circumstances, such directors may be fully protected in relying in good faith upon the valuation reports of their management. [877] See 8 Del.C. § 141(e). See also Cheff v. Mathes, supra.
Here, the record establishes that the Board did not request its Chief Financial Officer, Romans, to make any valuation study or review of the proposal to determine the adequacy of $55 per share for sale of the Company. On the record before us: The Board rested on Romans' elicited response that the $55 figure was within a "fair price range" within the context of a leveraged buy-out. No director sought any further information from Romans. No director asked him why he put $55 at the bottom of his range. No director asked Romans for any details as to his study, the reason why it had been undertaken or its depth. No director asked to see the study; and no director asked Romans whether Trans Union's finance department could do a fairness study within the remaining 36-hour[18] period available under the Pritzker offer.
Had the Board, or any member, made an inquiry of Romans, he presumably would have responded as he testified: that his calculations were rough and preliminary; and, that the study was not designed to determine the fair value of the Company, but rather to assess the feasibility of a leveraged buy-out financed by the Company's projected cash flow, making certain assumptions as to the purchaser's borrowing needs. Romans would have presumably also informed the Board of his view, and the widespread view of Senior Management, that the timing of the offer was wrong and the offer inadequate.
The record also establishes that the Board accepted without scrutiny Van Gorkom's representation as to the fairness of the $55 price per share for sale of the Company — a subject that the Board had never previously considered. The Board thereby failed to discover that Van Gorkom had suggested the $55 price to Pritzker and, most crucially, that Van Gorkom had arrived at the $55 figure based on calculations designed solely to determine the feasibility of a leveraged buy-out.[19] No questions were raised either as to the tax implications of a cash-out merger or how the price for the one million share option granted Pritzker was calculated.
We do not say that the Board of Directors was not entitled to give some credence to Van Gorkom's representation that $55 was an adequate or fair price. Under § 141(e), the directors were entitled to rely upon their chairman's opinion of value and adequacy, provided that such opinion was reached on a sound basis. Here, the issue is whether the directors informed themselves as to all information that was reasonably available to them. Had they done so, they would have learned of the source and derivation of the $55 price and could not reasonably have relied thereupon in good faith.
None of the directors, Management or outside, were investment bankers or financial analysts. Yet the Board did not consider recessing the meeting until a later hour that day (or requesting an extension of Pritzker's Sunday evening deadline) to give it time to elicit more information as to the sufficiency of the offer, either from [878] inside Management (in particular Romans) or from Trans Union's own investment banker, Salomon Brothers, whose Chicago specialist in merger and acquisitions was known to the Board and familiar with Trans Union's affairs.
Thus, the record compels the conclusion that on September 20 the Board lacked valuation information adequate to reach an informed business judgment as to the fairness of $55 per share for sale of the Company.[20]
(2)
This brings us to the post-September 20 "market test" upon which the defendants ultimately rely to confirm the reasonableness of their September 20 decision to accept the Pritzker proposal. In this connection, the directors present a two-part argument: (a) that by making a "market test" of Pritzker's $55 per share offer a condition of their September 20 decision to accept his offer, they cannot be found to have acted impulsively or in an uninformed manner on September 20; and (b) that the adequacy of the $17 premium for sale of the Company was conclusively established over the following 90 to 120 days by the most reliable evidence available — the marketplace. Thus, the defendants impliedly contend that the "market test" eliminated the need for the Board to perform any other form of fairness test either on September 20, or thereafter.
Again, the facts of record do not support the defendants' argument. There is no evidence: (a) that the Merger Agreement was effectively amended to give the Board freedom to put Trans Union up for auction sale to the highest bidder; or (b) that a public auction was in fact permitted to occur. The minutes of the Board meeting make no reference to any of this. Indeed, the record compels the conclusion that the directors had no rational basis for expecting that a market test was attainable, given the terms of the Agreement as executed during the evening of September 20. We rely upon the following facts which are essentially uncontradicted:
The Merger Agreement, specifically identified as that originally presented to the Board on September 20, has never been produced by the defendants, notwithstanding the plaintiffs' several demands for production before as well as during trial. No acceptable explanation of this failure to produce documents has been given to either the Trial Court or this Court. Significantly, neither the defendants nor their counsel have made the affirmative representation that this critical document has been produced. Thus, the Court is deprived of the best evidence on which to judge the merits of the defendants' position as to the care and attention which they gave to the terms of the Agreement on September 20.
Van Gorkom states that the Agreement as submitted incorporated the ingredients for a market test by authorizing Trans Union to receive competing offers over the next 90-day period. However, he concedes that the Agreement barred Trans Union from actively soliciting such offers and from furnishing to interested parties any information about the Company other than that already in the public domain. Whether the original Agreement of September 20 went so far as to authorize Trans Union to receive competitive proposals is arguable. The defendants' unexplained failure to produce and identify the original Merger Agreement permits the logical inference that the instrument would not support their assertions in this regard. Wilmington Trust Co. v. General Motors Corp., Del.Supr., 51 A.2d 584, 593 (1947); II Wigmore on Evidence § 291 (3d ed. 1940). It is a well established principle that the production of weak evidence when strong is, or should have been, available can lead only to the conclusion that the strong would have been adverse. Interstate Circuit v. United States, 306 U.S. [879] 208, 226, 59 S.Ct. 467, 474, 83 L.Ed. 610 (1939); Deberry v. State, Del.Supr., 457 A.2d 744, 754 (1983). Van Gorkom, conceding that he never read the Agreement, stated that he was relying upon his understanding that, under corporate law, directors always have an inherent right, as well as a fiduciary duty, to accept a better offer notwithstanding an existing contractual commitment by the Board. (See the discussion infra, part III B(3) at p. 55.)
The defendant directors assert that they "insisted" upon including two amendments to the Agreement, thereby permitting a market test: (1) to give Trans Union the right to accept a better offer; and (2) to reserve to Trans Union the right to distribute proprietary information on the Company to alternative bidders. Yet, the defendants concede that they did not seek to amend the Agreement to permit Trans Union to solicit competing offers.
Several of Trans Union's outside directors resolutely maintained that the Agreement as submitted was approved on the understanding that, "if we got a better deal, we had a right to take it." Director Johnson so testified; but he then added, "And if they didn't put that in the agreement, then the management did not carry out the conclusion of the Board. And I just don't know whether they did or not." The only clause in the Agreement as finally executed to which the defendants can point as "keeping the door open" is the following underlined statement found in subparagraph (a) of section 2.03 of the Merger Agreement as executed:
The Board of Directors shall recommend to the stockholders of Trans Union that they approve and adopt the Merger Agreement (`the stockholders' approval') and to use its best efforts to obtain the requisite votes therefor. GL acknowledges that Trans Union directors may have a competing fiduciary obligation to the shareholders under certain circumstances.
Clearly, this language on its face cannot be construed as incorporating either of the two "conditions" described above: either the right to accept a better offer or the right to distribute proprietary information to third parties. The logical witness for the defendants to call to confirm their construction of this clause of the Agreement would have been Trans Union's outside attorney, James Brennan. The defendants' failure, without explanation, to call this witness again permits the logical inference that his testimony would not have been helpful to them. The further fact that the directors adjourned, rather than recessed, the meeting without incorporating in the Agreement these important "conditions" further weakens the defendants' position. As has been noted, nothing in the Board's Minutes supports these claims. No reference to either of the so-called "conditions" or of Trans Union's reserved right to test the market appears in any notes of the Board meeting or in the Board Resolution accepting the Pritzker offer or in the Minutes of the meeting itself. That evening, in the midst of a formal party which he hosted for the opening of the Chicago Lyric Opera, Van Gorkom executed the Merger Agreement without he or any other member of the Board having read the instruments.
The defendants attempt to downplay the significance of the prohibition against Trans Union's actively soliciting competing offers by arguing that the directors "understood that the entire financial community would know that Trans Union was for sale upon the announcement of the Pritzker offer, and anyone desiring to make a better offer was free to do so." Yet, the press release issued on September 22, with the authorization of the Board, stated that Trans Union had entered into "definitive agreements" with the Pritzkers; and the press release did not even disclose Trans Union's limited right to receive and accept higher offers. Accompanying this press release was a further public announcement that Pritzker had been granted an option to purchase at any time one million shares of [880] Trans Union's capital stock at 75 cents above the then-current price per share.
Thus, notwithstanding what several of the outside directors later claimed to have "thought" occurred at the meeting, the record compels the conclusion that Trans Union's Board had no rational basis to conclude on September 20 or in the days immediately following, that the Board's acceptance of Pritzker's offer was conditioned on (1) a "market test" of the offer; and (2) the Board's right to withdraw from the Pritzker Agreement and accept any higher offer received before the shareholder meeting.
(3)
The directors' unfounded reliance on both the premium and the market test as the basis for accepting the Pritzker proposal undermines the defendants' remaining contention that the Board's collective experience and sophistication was a sufficient basis for finding that it reached its September 20 decision with informed, reasonable deliberation.[21]Compare Gimbel v. Signal Companies, Inc., Del. Ch., 316 A.2d 599 (1974), aff'd per curiam, Del. Supr., 316 A.2d 619 (1974). There, the Court of Chancery preliminary enjoined a board's sale of stock of its wholly-owned subsidiary for an alleged grossly inadequate price. It did so based on a finding that the business judgment rule had been pierced for failure of management to give its board "the opportunity to make a reasonable and reasoned decision." 316 A.2d at 615. The Court there reached this result notwithstanding the board's sophistication and experience; the company's need of immediate cash; and the board's need to act promptly due to the impact of an energy crisis on the value of the underlying assets being sold — all of its subsidiary's oil and gas interests. The Court found those factors denoting competence to be outweighed by evidence of gross negligence; that management in effect sprang the deal on the board by negotiating the asset sale without informing the board; that the buyer intended to "force a quick decision" by the board; that the board meeting was called on only one-and-a-half days' notice; that its outside directors were not notified of the meeting's purpose; that during a meeting spanning "a couple of hours" a sale of assets worth $480 million was approved; and that the Board failed to obtain a current appraisal of its oil and gas interests. The analogy of Signal to the case at bar is significant.
(4)
Part of the defense is based on a claim that the directors relied on legal advice rendered at the September 20 meeting by James Brennan, Esquire, who was present at Van Gorkom's request. Unfortunately, Brennan did not appear and testify at trial even though his firm participated in the defense of this action. There is no contemporaneous evidence of the advice given by Brennan on September 20, only the later deposition and trial testimony of certain directors as to their recollections or understanding of what was said at the meeting. Since counsel did not testify, and the advice attributed to Brennan is hearsay received by the Trial Court over the plaintiffs' objections, we consider it only in the context of the directors' present claims. In fairness to counsel, we make no findings that the advice attributed to him was in fact given. We focus solely on the efficacy of the [881] defendants' claims, made months and years later, in an effort to extricate themselves from liability.
Several defendants testified that Brennan advised them that Delaware law did not require a fairness opinion or an outside valuation of the Company before the Board could act on the Pritzker proposal. If given, the advice was correct. However, that did not end the matter. Unless the directors had before them adequate information regarding the intrinsic value of the Company, upon which a proper exercise of business judgment could be made, mere advice of this type is meaningless; and, given this record of the defendants' failures, it constitutes no defense here.[22]
* * *
We conclude that Trans Union's Board was grossly negligent in that it failed to act with informed reasonable deliberation in agreeing to the Pritzker merger proposal on September 20; and we further conclude that the Trial Court erred as a matter of law in failing to address that question before determining whether the directors' later conduct was sufficient to cure its initial error.
A second claim is that counsel advised the Board it would be subject to lawsuits if it rejected the $55 per share offer. It is, of course, a fact of corporate life that today when faced with difficult or sensitive issues, directors often are subject to suit, irrespective of the decisions they make. However, counsel's mere acknowledgement of this circumstance cannot be rationally translated into a justification for a board permitting itself to be stampeded into a patently unadvised act. While suit might result from the rejection of a merger or tender offer, Delaware law makes clear that a board acting within the ambit of the business judgment rule faces no ultimate liability. Pogostin v. Rice, supra. Thus, we cannot conclude that the mere threat of litigation, acknowledged by counsel, constitutes either legal advice or any valid basis upon which to pursue an uninformed course.
Since we conclude that Brennan's purported advice is of no consequence to the defense of this case, it is unnecessary for us to invoke the adverse inferences which may be attributable to one failing to appear at trial and testify.
-B-
We now examine the Board's post-September 20 conduct for the purpose of determining first, whether it was informed and not grossly negligent; and second, if informed, whether it was sufficient to legally rectify and cure the Board's derelictions of September 20.[23]
(1)
First, as to the Board meeting of October 8: Its purpose arose in the aftermath of the September 20 meeting: (1) the September 22 press release announcing that Trans Union "had entered into definitive agreements to merge with an affiliate of Marmon Group, Inc.;" and (2) Senior Management's ensuing revolt.
Trans Union's press release stated:
FOR IMMEDIATE RELEASE:
CHICAGO, IL — Trans Union Corporation announced today that it had entered into definitive agreements to merge with an affiliate of The Marmon Group, Inc. in a transaction whereby Trans Union stockholders would receive $55 per share in cash for each Trans Union share held. The Marmon Group, Inc. is controlled by the Pritzker family of Chicago.
The merger is subject to approval by the stockholders of Trans Union at a special meeting expected to be held [882] sometime during December or early January.
Until October 10, 1980, the purchaser has the right to terminate the merger if financing that is satisfactory to the purchaser has not been obtained, but after that date there is no such right.
In a related transaction, Trans Union has agreed to sell to a designee of the purchaser one million newly-issued shares of Trans Union common stock at a cash price of $38 per share. Such shares will be issued only if the merger financing has been committed for no later than October 10, 1980, or if the purchaser elects to waive the merger financing condition. In addition, the New York Stock Exchange will be asked to approve the listing of the new shares pursuant to a listing application which Trans Union intends to file shortly.
Completing of the transaction is also subject to the preparation of a definitive proxy statement and making various filings and obtaining the approvals or consents of government agencies.
The press release made no reference to provisions allegedly reserving to the Board the rights to perform a "market test" and to withdraw from the Pritzker Agreement if Trans Union received a better offer before the shareholder meeting. The defendants also concede that Trans Union never made a subsequent public announcement stating that it had in fact reserved the right to accept alternate offers, the Agreement notwithstanding.
The public announcement of the Pritzker merger resulted in an "en masse" revolt of Trans Union's Senior Management. The head of Trans Union's tank car operations (its most profitable division) informed Van Gorkom that unless the merger were called off, fifteen key personnel would resign.
Instead of reconvening the Board, Van Gorkom again privately met with Pritzker, informed him of the developments, and sought his advice. Pritzker then made the following suggestions for overcoming Management's dissatisfaction: (1) that the Agreement be amended to permit Trans Union to solicit, as well as receive, higher offers; and (2) that the shareholder meeting be postponed from early January to February 10, 1981. In return, Pritzker asked Van Gorkom to obtain a commitment from Senior Management to remain at Trans Union for at least six months after the merger was consummated.
Van Gorkom then advised Senior Management that the Agreement would be amended to give Trans Union the right to solicit competing offers through January, 1981, if they would agree to remain with Trans Union. Senior Management was temporarily mollified; and Van Gorkom then called a special meeting of Trans Union's Board for October 8.
Thus, the primary purpose of the October 8 Board meeting was to amend the Merger Agreement, in a manner agreeable to Pritzker, to permit Trans Union to conduct a "market test."[24] Van Gorkom understood that the proposed amendments were intended to give the Company an unfettered "right to openly solicit offers down through January 31." Van Gorkom presumably so represented the amendments to Trans Union's Board members on October 8. In a brief session, the directors approved Van Gorkom's oral presentation of the substance of the proposed amendments, [883] the terms of which were not reduced to writing until October 10. But rather than waiting to review the amendments, the Board again approved them sight unseen and adjourned, giving Van Gorkom authority to execute the papers when he received them.[25]
Thus, the Court of Chancery's finding that the October 8 Board meeting was convened to reconsider the Pritzker "proposal" is clearly erroneous. Further, the consequence of the Board's faulty conduct on October 8, in approving amendments to the Agreement which had not even been drafted, will become apparent when the actual amendments to the Agreement are hereafter examined.
The next day, October 9, and before the Agreement was amended, Pritzker moved swiftly to off-set the proposed market test amendment. First, Pritzker informed Trans Union that he had completed arrangements for financing its acquisition and that the parties were thereby mutually bound to a firm purchase and sale arrangement. Second, Pritzker announced the exercise of his option to purchase one million shares of Trans Union's treasury stock at $38 per share — 75 cents above the current market price. Trans Union's Management responded the same day by issuing a press release announcing: (1) that all financing arrangements for Pritzker's acquisition of Trans Union had been completed; and (2) Pritzker's purchase of one million shares of Trans Union's treasury stock at $38 per share.
The next day, October 10, Pritzker delivered to Trans Union the proposed amendments to the September 20 Merger Agreement. Van Gorkom promptly proceeded to countersign all the instruments on behalf of Trans Union without reviewing the instruments to determine if they were consistent with the authority previously granted him by the Board. The amending documents were apparently not approved by Trans Union's Board until a much later date, December 2. The record does not affirmatively establish that Trans Union's directors ever read the October 10 amendments.[26]
The October 10 amendments to the Merger Agreement did authorize Trans Union to solicit competing offers, but the amendments had more far-reaching effects. The most significant change was in the definition of the third-party "offer" available to Trans Union as a possible basis for withdrawal from its Merger Agreement with Pritzker. Under the October 10 amendments, a better offer was no longer sufficient to permit Trans Union's withdrawal. Trans Union was now permitted to terminate the Pritzker Agreement and abandon the merger only if, prior to February 10, 1981, Trans Union had either consummated a merger (or sale of assets) with a third party or had entered into a "definitive" merger agreement more favorable than Pritzker's and for a greater consideration — subject only to stockholder approval. Further, the "extension" of the market test period to February 10, 1981 was circumscribed by other amendments which required Trans Union to file its preliminary proxy statement on the Pritzker merger proposal by December 5, 1980 and use its best efforts to mail the statement to its shareholders by January 5, 1981. Thus, the market test period was effectively reduced, not extended. (See infra note 29 at 886.)
In our view, the record compels the conclusion that the directors' conduct on October [884] 8 exhibited the same deficiencies as did their conduct on September 20. The Board permitted its Merger Agreement with Pritzker to be amended in a manner it had neither authorized nor intended. The Court of Chancery, in its decision, over-looked the significance of the October 8-10 events and their relevance to the sufficiency of the directors' conduct. The Trial Court's letter opinion ignores: the October 10 amendments; the manner of their adoption; the effect of the October 9 press release and the October 10 amendments on the feasibility of a market test; and the ultimate question as to the reasonableness of the directors' reliance on a market test in recommending that the shareholders approve the Pritzker merger.
We conclude that the Board acted in a grossly negligent manner on October 8; and that Van Gorkom's representations on which the Board based its actions do not constitute "reports" under § 141(e) on which the directors could reasonably have relied. Further, the amended Merger Agreement imposed on Trans Union's acceptance of a third party offer conditions more onerous than those imposed on Trans Union's acceptance of Pritzker's offer on September 20. After October 10, Trans Union could accept from a third party a better offer only if it were incorporated in a definitive agreement between the parties, and not conditioned on financing or on any other contingency.
The October 9 press release, coupled with the October 10 amendments, had the clear effect of locking Trans Union's Board into the Pritzker Agreement. Pritzker had thereby foreclosed Trans Union's Board from negotiating any better "definitive" agreement over the remaining eight weeks before Trans Union was required to clear the Proxy Statement submitting the Pritzker proposal to its shareholders.
(2)
Next, as to the "curative" effects of the Board's post-September 20 conduct, we review in more detail the reaction of Van Gorkom to the KKR proposal and the results of the Board-sponsored "market test."
The KKR proposal was the first and only offer received subsequent to the Pritzker Merger Agreement. The offer resulted primarily from the efforts of Romans and other senior officers to propose an alternative to Pritzker's acquisition of Trans Union. In late September, Romans' group contacted KKR about the possibility of a leveraged buy-out by all members of Management, except Van Gorkom. By early October, Henry R. Kravis of KKR gave Romans written notice of KKR's "interest in making an offer to purchase 100%" of Trans Union's common stock.
Thereafter, and until early December, Romans' group worked with KKR to develop a proposal. It did so with Van Gorkom's knowledge and apparently grudging consent. On December 2, Kravis and Romans hand-delivered to Van Gorkom a formal letter-offer to purchase all of Trans Union's assets and to assume all of its liabilities for an aggregate cash consideration equivalent to $60 per share. The offer was contingent upon completing equity and bank financing of $650 million, which Kravis represented as 80% complete. The KKR letter made reference to discussions with major banks regarding the loan portion of the buy-out cost and stated that KKR was "confident that commitments for the bank financing * * * can be obtained within two or three weeks." The purchasing group was to include certain named key members of Trans Union's Senior Management, excluding Van Gorkom, and a major Canadian company. Kravis stated that they were willing to enter into a "definitive agreement" under terms and conditions "substantially the same" as those contained in Trans Union's agreement with Pritzker. The offer was addressed to Trans Union's Board of Directors and a meeting with the Board, scheduled for that afternoon, was requested.
Van Gorkom's reaction to the KKR proposal was completely negative; he did not view the offer as being firm because of its [885] financing condition. It was pointed out, to no avail, that Pritzker's offer had not only been similarly conditioned, but accepted on an expedited basis. Van Gorkom refused Kravis' request that Trans Union issue a press release announcing KKR's offer, on the ground that it might "chill" any other offer.[27] Romans and Kravis left with the understanding that their proposal would be presented to Trans Union's Board that afternoon.
Within a matter of hours and shortly before the scheduled Board meeting, Kravis withdrew his letter-offer. He gave as his reason a sudden decision by the Chief Officer of Trans Union's rail car leasing operation to withdraw from the KKR purchasing group. Van Gorkom had spoken to that officer about his participation in the KKR proposal immediately after his meeting with Romans and Kravis. However, Van Gorkom denied any responsibility for the officer's change of mind.
At the Board meeting later that afternoon, Van Gorkom did not inform the directors of the KKR proposal because he considered it "dead." Van Gorkom did not contact KKR again until January 20, when faced with the realities of this lawsuit, he then attempted to reopen negotiations. KKR declined due to the imminence of the February 10 stockholder meeting.
GE Credit Corporation's interest in Trans Union did not develop until November; and it made no written proposal until mid-January. Even then, its proposal was not in the form of an offer. Had there been time to do so, GE Credit was prepared to offer between $2 and $5 per share above the $55 per share price which Pritzker offered. But GE Credit needed an additional 60 to 90 days; and it was unwilling to make a formal offer without a concession from Pritzker extending the February 10 "deadline" for Trans Union's stockholder meeting. As previously stated, Pritzker refused to grant such extension; and on January 21, GE Credit terminated further negotiations with Trans Union. Its stated reasons, among others, were its "unwillingness to become involved in a bidding contest with Pritzker in the absence of the willingness of [the Pritzker interests] to terminate the proposed $55 cash merger."
* * *
In the absence of any explicit finding by the Trial Court as to the reasonableness of Trans Union's directors' reliance on a market test and its feasibility, we may make our own findings based on the record. Our review of the record compels a finding that confirmation of the appropriateness of the Pritzker offer by an unfettered or free market test was virtually meaningless in the face of the terms and time limitations of Trans Union's Merger Agreement with Pritzker as amended October 10, 1980.
(3)
Finally, we turn to the Board's meeting of January 26, 1981. The defendant directors rely upon the action there taken to refute the contention that they did not reach an informed business judgment in approving the Pritzker merger. The defendants contend that the Trial Court correctly concluded that Trans Union's directors were, in effect, as "free to turn down the Pritzker proposal" on January 26, as they were on September 20.
Applying the appropriate standard of review set forth in Levitt v. Bouvier, supra, we conclude that the Trial Court's finding in this regard is neither supported by the record nor the product of an orderly and logical deductive process. Without disagreeing with the principle that a business decision by an originally uninformed board of directors may, under appropriate circumstances, be timely cured so as to become informed and deliberate, Muschel v. Western Union Corporation, Del. Ch., 310 [886] A.2d 904 (1973),[28] we find that the record does not permit the defendants to invoke that principle in this case.
The Board's January 26 meeting was the first meeting following the filing of the plaintiffs' suit in mid-December and the last meeting before the previously-noticed shareholder meeting of February 10.[29] All ten members of the Board and three outside attorneys attended the meeting. At that meeting the following facts, among other aspects of the Merger Agreement, were discussed:
(a) The fact that prior to September 20, 1980, no Board member or member of Senior Management, except Chelberg and Peterson, knew that Van Gorkom had discussed a possible merger with Pritzker;
(b) The fact that the price of $55 per share had been suggested initially to Pritzker by Van Gorkom;
(c) The fact that the Board had not sought an independent fairness opinion;
(d) The fact that, at the September 20 Senior Management meeting, Romans and several members of Senior Management indicated both concern that the $55 per share price was inadequate and a belief that a higher price should and could be obtained;
(e) The fact that Romans had advised the Board at its meeting on September 20, that he and his department had prepared a study which indicated that the Company had a value in the range of $55 to $65 per share, and that he could not advise the Board that the $55 per share offer made by Pritzker was unfair.
The defendants characterize the Board's Minutes of the January 26 meeting as a "review" of the "entire sequence of events" from Van Gorkom's initiation of the negotiations on September 13 forward.[30] The defendants also rely on the [887] testimony of several of the Board members at trial as confirming the Minutes.[31] On the basis of this evidence, the defendants argue that whatever information the Board lacked to make a deliberate and informed judgment on September 20, or on October 8, was fully divulged to the entire Board on January 26. Hence, the argument goes, the Board's vote on January 26 to again "approve" the Pritzker merger must be found to have been an informed and deliberate judgment.
On the basis of this evidence, the defendants assert: (1) that the Trial Court was legally correct in widening the time frame for determining whether the defendants' approval of the Pritzker merger represented an informed business judgment to include the entire four-month period during which the Board considered the matter from September 20 through January 26; and (2) that, given this extensive evidence of the Board's further review and deliberations on January 26, this Court must affirm the Trial Court's conclusion that the Board's action was not reckless or improvident.
We cannot agree. We find the Trial Court to have erred, both as a matter of fact and as a matter of law, in relying on the action on January 26 to bring the defendants' conduct within the protection of the business judgment rule.
Johnson's testimony and the Board Minutes of January 26 are remarkably consistent. Both clearly indicate recognition that the question of the alternative courses of action, available to the Board on January 26 with respect to the Pritzker merger, was a legal question, presenting to the Board (after its review of the full record developed through pre-trial discovery) three options: (1) to "continue to recommend" the Pritzker merger; (2) to "recommend that [888] the stockholders vote against" the Pritzker merger; or (3) to take a noncommittal position on the merger and "simply leave the decision to [the] shareholders."
We must conclude from the foregoing that the Board was mistaken as a matter of law regarding its available courses of action on January 26, 1981. Options (2) and (3) were not viable or legally available to the Board under 8 Del.C. § 251(b). The Board could not remain committed to the Pritzker merger and yet recommend that its stockholders vote it down; nor could it take a neutral position and delegate to the stockholders the unadvised decision as to whether to accept or reject the merger. Under § 251(b), the Board had but two options: (1) to proceed with the merger and the stockholder meeting, with the Board's recommendation of approval; or (2) to rescind its agreement with Pritzker, withdraw its approval of the merger, and notify its stockholders that the proposed shareholder meeting was cancelled. There is no evidence that the Board gave any consideration to these, its only legally viable alternative courses of action.
But the second course of action would have clearly involved a substantial risk — that the Board would be faced with suit by Pritzker for breach of contract based on its September 20 agreement as amended October 10. As previously noted, under the terms of the October 10 amendment, the Board's only ground for release from its agreement with Pritzker was its entry into a more favorable definitive agreement to sell the Company to a third party. Thus, in reality, the Board was not "free to turn down the Pritzker proposal" as the Trial Court found. Indeed, short of negotiating a better agreement with a third party, the Board's only basis for release from the Pritzker Agreement without liability would have been to establish fundamental wrongdoing by Pritzker. Clearly, the Board was not "free" to withdraw from its agreement with Pritzker on January 26 by simply relying on its self-induced failure to have reached an informed business judgment at the time of its original agreement. See Wilmington Trust Company v. Coulter, Del.Supr., 200 A.2d 441, 453 (1964), aff'g Pennsylvania Company v. Wilmington Trust Company, Del.Ch., 186 A.2d 751 (1962).
Therefore, the Trial Court's conclusion that the Board reached an informed business judgment on January 26 in determining whether to turn down the Pritzker "proposal" on that day cannot be sustained.[32] The Court's conclusion is not supported by the record; it is contrary to the provisions of § 251(b) and basic principles of contract law; and it is not the product of a logical and deductive reasoning process.
* * *
Upon the basis of the foregoing, we hold that the defendants' post-September conduct did not cure the deficiencies of their September 20 conduct; and that, accordingly, the Trial Court erred in according to the defendants the benefits of the business judgment rule.
IV.
Whether the directors of Trans Union should be treated as one or individually in terms of invoking the protection of the business judgment rule and the applicability of 8 Del.C. § 141(c) are questions which were not originally addressed by the parties in their briefing of this case. This resulted in a supplemental briefing and a second rehearing en banc on two basic questions: (a) whether one or more of the directors were deprived of the protection of the business judgment rule by evidence of an absence of good faith; and (b) whether one or more of the outside directors were [889] entitled to invoke the protection of 8 Del.C. § 141(e) by evidence of a reasonable, good faith reliance on "reports," including legal advice, rendered the Board by certain inside directors and the Board's special counsel, Brennan.
The parties' response, including reargument, has led the majority of the Court to conclude: (1) that since all of the defendant directors, outside as well as inside, take a unified position, we are required to treat all of the directors as one as to whether they are entitled to the protection of the business judgment rule; and (2) that considerations of good faith, including the presumption that the directors acted in good faith, are irrelevant in determining the threshold issue of whether the directors as a Board exercised an informed business judgment. For the same reason, we must reject defense counsel's ad hominem argument for affirmance: that reversal may result in a multi-million dollar class award against the defendants for having made an allegedly uninformed business judgment in a transaction not involving any personal gain, self-dealing or claim of bad faith.
In their brief, the defendants similarly mistake the business judgment rule's application to this case by erroneously invoking presumptions of good faith and "wide discretion":
This is a case in which plaintiff challenged the exercise of business judgment by an independent Board of Directors. There were no allegations and no proof of fraud, bad faith, or self-dealing by the directors....
The business judgment rule, which was properly applied by the Chancellor, allows directors wide discretion in the matter of valuation and affords room for honest differences of opinion. In order to prevail, plaintiffs had the heavy burden of proving that the merger price was so grossly inadequate as to display itself as a badge of fraud. That is a burden which plaintiffs have not met.
However, plaintiffs have not claimed, nor did the Trial Court decide, that $55 was a grossly inadequate price per share for sale of the Company. That being so, the presumption that a board's judgment as to adequacy of price represents an honest exercise of business judgment (absent proof that the sale price was grossly inadequate) is irrelevant to the threshold question of whether an informed judgment was reached. Compare Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717 (1971); Kelly v. Bell, Del.Supr., 266 A.2d 878, 879 (1970); Cole v. National Cash Credit Association, Del.Ch., 156 A. 183 (1931); Allaun v. Consolidated Oil Co., supra; Allen Chemical & Dye Corp. v. Steel & Tube Co. of America, Del.Ch., 120 A. 486 (1923).
V.
The defendants ultimately rely on the stockholder vote of February 10 for exoneration. The defendants contend that the stockholders' "overwhelming" vote approving the Pritzker Merger Agreement had the legal effect of curing any failure of the Board to reach an informed business judgment in its approval of the merger.
The parties tacitly agree that a discovered failure of the Board to reach an informed business judgment in approving the merger constitutes a voidable, rather than a void, act. Hence, the merger can be sustained, notwithstanding the infirmity of the Board's action, if its approval by majority vote of the shareholders is found to have been based on an informed electorate. Cf. Michelson v. Duncan, Del.Supr., 407 A.2d 211 (1979), aff'g in part and rev'g in part, Del.Ch., 386 A.2d 1144 (1978). The disagreement between the parties arises over: (1) the Board's burden of disclosing to the shareholders all relevant and material information; and (2) the sufficiency of the evidence as to whether the Board satisfied that burden.
On this issue the Trial Court summarily concluded "that the stockholders of Trans Union were fairly informed as to the pending merger...." The Court provided no [890] supportive reasoning nor did the Court make any reference to the evidence of record.
The plaintiffs contend that the Court committed error by applying an erroneous disclosure standard of "adequacy" rather than "completeness" in determining the sufficiency of the Company's merger proxy materials. The plaintiffs also argue that the Board's proxy statements, both its original statement dated January 19 and its supplemental statement dated January 26, were incomplete in various material respects. Finally, the plaintiffs assert that Management's supplemental statement (mailed "on or about" January 27) was untimely either as a matter of law under 8 Del.C. § 251(c), or untimely as a matter of equity and the requirements of complete candor and fair disclosure.
The defendants deny that the Court committed legal or equitable error. On the question of the Board's burden of disclosure, the defendants state that there was no dispute at trial over the standard of disclosure required of the Board; but the defendants concede that the Board was required to disclose "all germane facts" which a reasonable shareholder would have considered important in deciding whether to approve the merger. Thus, the defendants argue that when the Trial Court speaks of finding the Company's shareholders to have been "fairly informed" by Management's proxy materials, the Court is speaking in terms of "complete candor" as required under Lynch v. Vickers Energy Corp., Del.Supr., 383 A.2d 278 (1978).
The settled rule in Delaware is that "where a majority of fully informed stockholders ratify action of even interested directors, an attack on the ratified transaction normally must fail." Gerlach v. Gillam, Del.Ch., 139 A.2d 591, 593 (1958). The question of whether shareholders have been fully informed such that their vote can be said to ratify director action, "turns on the fairness and completeness of the proxy materials submitted by the management to the ... shareholders." Michelson v. Duncan, supra at 220. As this Court stated in Gottlieb v. Heyden Chemical Corp., Del.Supr., 91 A.2d 57, 59 (1952):
[T]he entire atmosphere is freshened and a new set of rules invoked where a formal approval has been given by a majority of independent, fully informed stockholders....
In Lynch v. Vickers Energy Corp., supra, this Court held that corporate directors owe to their stockholders a fiduciary duty to disclose all facts germane to the transaction at issue in an atmosphere of complete candor. We defined "germane" in the tender offer context as all "information such as a reasonable stockholder would consider important in deciding whether to sell or retain stock." Id. at 281. Accord Weinberger v. UOP, Inc., supra; Michelson v. Duncan, supra; Schreiber v. Pennzoil Corp., Del.Ch., 419 A.2d 952 (1980). In reality, "germane" means material facts.
Applying this standard to the record before us, we find that Trans Union's stockholders were not fully informed of all facts material to their vote on the Pritzker Merger and that the Trial Court's ruling to the contrary is clearly erroneous. We list the material deficiencies in the proxy materials:
(1) The fact that the Board had no reasonably adequate information indicative of the intrinsic value of the Company, other than a concededly depressed market price, was without question material to the shareholders voting on the merger. See Weinberger, supra at 709 (insiders' report that cash-out merger price up to $24 was good investment held material); Michelson, supra at 224 (alleged terms and intent of stock option plan held not germane); Schreiber, supra at 959 (management fee of $650,000 held germane).
Accordingly, the Board's lack of valuation information should have been disclosed. Instead, the directors cloaked the absence of such information in both the Proxy Statement and the Supplemental [891] Proxy Statement. Through artful drafting, noticeably absent at the September 20 meeting, both documents create the impression that the Board knew the intrinsic worth of the Company. In particular, the Original Proxy Statement contained the following:
[a]lthough the Board of Directors regards the intrinsic value of the Company's assets to be significantly greater than their book value ..., systematic liquidation of such a large and complex entity as Trans Union is simply not regarded as a feasible method of realizing its inherent value. Therefore, a business combination such as the merger would seem to be the only practicable way in which the stockholders could realize the value of the Company.
The Proxy stated further that "[i]n the view of the Board of Directors ..., the prices at which the Company's common stock has traded in recent years have not reflected the inherent value of the Company." What the Board failed to disclose to its stockholders was that the Board had not made any study of the intrinsic or inherent worth of the Company; nor had the Board even discussed the inherent value of the Company prior to approving the merger on September 20, or at either of the subsequent meetings on October 8 or January 26. Neither in its Original Proxy Statement nor in its Supplemental Proxy did the Board disclose that it had no information before it, beyond the premium-over-market and the price/earnings ratio, on which to determine the fair value of the Company as a whole.
(2) We find false and misleading the Board's characterization of the Romans report in the Supplemental Proxy Statement. The Supplemental Proxy stated:
At the September 20, 1980 meeting of the Board of Directors of Trans Union, Mr. Romans indicated that while he could not say that $55,00 per share was an unfair price, he had prepared a preliminary report which reflected that the value of the Company was in the range of $55.00 to $65.00 per share.
Nowhere does the Board disclose that Romans stated to the Board that his calculations were made in a "search for ways to justify a price in connection with" a leveraged buy-out transaction, "rather than to say what the shares are worth," and that he stated to the Board that his conclusion thus arrived at "was not the same thing as saying that I have a valuation of the Company at X dollars." Such information would have been material to a reasonable shareholder because it tended to invalidate the fairness of the merger price of $55. Furthermore, defendants again failed to disclose the absence of valuation information, but still made repeated reference to the "substantial premium."
(3) We find misleading the Board's references to the "substantial" premium offered. The Board gave as their primary reason in support of the merger the "substantial premium" shareholders would receive. But the Board did not disclose its failure to assess the premium offered in terms of other relevant valuation techniques, thereby rendering questionable its determination as to the substantiality of the premium over an admittedly depressed stock market price.
(4) We find the Board's recital in the Supplemental Proxy of certain events preceding the September 20 meeting to be incomplete and misleading. It is beyond dispute that a reasonable stockholder would have considered material the fact that Van Gorkom not only suggested the $55 price to Pritzker, but also that he chose the figure because it made feasible a leveraged buy-out. The directors disclosed that Van Gorkom suggested the $55 price to Pritzker. But the Board misled the shareholders when they described the basis of Van Gorkom's suggestion as follows:
Such suggestion was based, at least in part, on Mr. Van Gorkom's belief that loans could be obtained from institutional lenders (together with about a $200 million [892] equity contribution) which would justify the payment of such price, ...
Although by January 26, the directors knew the basis of the $55 figure, they did not disclose that Van Gorkom chose the $55 price because that figure would enable Pritzker to both finance the purchase of Trans Union through a leveraged buy-out and, within five years, substantially repay the loan out of the cash flow generated by the Company's operations.
(5) The Board's Supplemental Proxy Statement, mailed on or after January 27, added significant new matter, material to the proposal to be voted on February 10, which was not contained in the Original Proxy Statement. Some of this new matter was information which had only been disclosed to the Board on January 26; much was information known or reasonably available before January 21 but not revealed in the Original Proxy Statement. Yet, the stockholders were not informed of these facts. Included in the "new" matter first disclosed in the Supplemental Proxy Statement were the following:
(a) The fact that prior to September 20, 1980, no Board member or member of Senior Management, except Chelberg and Peterson, knew that Van Gorkom had discussed a possible merger with Pritzker;
(b) The fact that the sale price of $55 per share had been suggested initially to Pritzker by Van Gorkom;
(c) The fact that the Board had not sought an independent fairness opinion;
(d) The fact that Romans and several members of Senior Management had indicated concern at the September 20 Senior Management meeting that the $55 per share price was inadequate and had stated that a higher price should and could be obtained; and
(e) The fact that Romans had advised the Board at its meeting on September 20 that he and his department had prepared a study which indicated that the Company had a value in the range of $55 to $65 per share, and that he could not advise the Board that the $55 per share offer which Pritzker made was unfair.
* * *
The parties differ over whether the notice requirements of 8 Del.C. § 251(c) apply to the mailing date of supplemental proxy material or that of the original proxy material.[33] The Trial Court summarily disposed of the notice issue, stating it was "satisfied that the proxy material furnished to Trans Union stockholders ... fairly presented the question to be voted on at the February 10, 1981 meeting."
The defendants argue that the notice provisions of § 251(c) must be construed as requiring only that stockholders receive notice of the time, place, and purpose of a meeting to consider a merger at least 20 days prior to such meeting; and since the Original Proxy Statement was disseminated more than 20 days before the meeting, the defendants urge affirmance of the Trial Court's ruling as correct as a matter of statutory construction. Apparently, the question has not been addressed by either the Court of Chancery or this Court; and authority in other jurisdictions is limited. See Electronic Specialty Co. v. Int'l Controls Corp., 2d Cir., 409 F.2d 937, 944 (1969) (holding that a tender offeror's September 16, 1968 correction of a previous misstatement, combined with an offer of withdrawal running for eight days until September 24, 1968, was sufficient to cure past violations and eliminate any need for rescission); Nicholson File Co. v. H.K. Porter Co., D.R.I., 341 F.Supp. 508, 513-14 (1972), aff'd, 1st Cir., 482 F.2d 421 (1973) [893] (permitting correction of a material misstatement by a mailing to stockholders within seven days of a tender offer withdrawal date). Both Electronic and Nicholson are federal security cases not arising under 8 Del.C. § 251(c) and they are otherwise distinguishable from this case on their facts.
Since we have concluded that Management's Supplemental Proxy Statement does not meet the Delaware disclosure standard of "complete candor" under Lynch v. Vickers, supra, it is unnecessary for us to address the plaintiffs' legal argument as to the proper construction of § 251(c). However, we do find it advisable to express the view that, in an appropriate case, an otherwise candid proxy statement may be so untimely as to defeat its purpose of meeting the needs of a fully informed electorate.
In this case, the Board's ultimate disclosure as contained in the Supplemental Proxy Statement related either to information readily accessible to all of the directors if they had asked the right questions, or was information already at their disposal. In short, the information disclosed by the Supplemental Proxy Statement was information which the defendant directors knew or should have known at the time the first Proxy Statement was issued. The defendants simply failed in their original duty of knowing, sharing, and disclosing information that was material and reasonably available for their discovery. They compounded that failure by their continued lack of candor in the Supplemental Proxy Statement. While we need not decide the issue here, we are satisfied that, in an appropriate case, a completely candid but belated disclosure of information long known or readily available to a board could raise serious issues of inequitable conduct. Schnell v. Chris-Craft Industries, Inc., Del.Supr., 285 A.2d 437, 439 (1971).
The burden must fall on defendants who claim ratification based on shareholder vote to establish that the shareholder approval resulted from a fully informed electorate. On the record before us, it is clear that the Board failed to meet that burden. Weinberger v. UOP, Inc., supra at 703; Michelson v. Duncan, supra.
* * *
For the foregoing reasons, we conclude that the director defendants breached their fiduciary duty of candor by their failure to make true and correct disclosures of all information they had, or should have had, material to the transaction submitted for stockholder approval.
VI.
To summarize: we hold that the directors of Trans Union breached their fiduciary duty to their stockholders (1) by their failure to inform themselves of all information reasonably available to them and relevant to their decision to recommend the Pritzker merger; and (2) by their failure to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the Pritzker offer.
We hold, therefore, that the Trial Court committed reversible error in applying the business judgment rule in favor of the director defendants in this case.
On remand, the Court of Chancery shall conduct an evidentiary hearing to determine the fair value of the shares represented by the plaintiffs' class, based on the intrinsic value of Trans Union on September 20, 1980. Such valuation shall be made in accordance with Weinberger v. UOP, Inc., supra at 712-715. Thereafter, an award of damages may be entered to the extent that the fair value of Trans Union exceeds $55 per share.
* * *
REVERSED and REMANDED for proceedings consistent herewith.
McNEILLY, Justice, dissenting:
The majority opinion reads like an advocate's closing address to a hostile jury. And I say that not lightly. Throughout the [894] opinion great emphasis is directed only to the negative, with nothing more than lip service granted the positive aspects of this case. In my opinion Chancellor Marvel (retired) should have been affirmed. The Chancellor's opinion was the product of well reasoned conclusions, based upon a sound deductive process, clearly supported by the evidence and entitled to deference in this appeal. Because of my diametrical opposition to all evidentiary conclusions of the majority, I respectfully dissent.
It would serve no useful purpose, particularly at this late date, for me to dissent at great length. I restrain myself from doing so, but feel compelled to at least point out what I consider to be the most glaring deficiencies in the majority opinion. The majority has spoken and has effectively said that Trans Union's Directors have been the victims of a "fast shuffle" by Van Gorkom and Pritzker. That is the beginning of the majority's comedy of errors. The first and most important error made is the majority's assessment of the directors' knowledge of the affairs of Trans Union and their combined ability to act in this situation under the protection of the business judgment rule.
Trans Union's Board of Directors consisted of ten men, five of whom were "inside" directors and five of whom were "outside" directors. The "inside" directors were Van Gorkom, Chelberg, Bonser, William B. Browder, Senior Vice-President-Law, and Thomas P. O'Boyle, Senior Vice-President-Administration. At the time the merger was proposed the inside five directors had collectively been employed by the Company for 116 years and had 68 years of combined experience as directors. The "outside" directors were A.W. Wallis, William B. Johnson, Joseph B. Lanterman, Graham J. Morgan and Robert W. Reneker. With the exception of Wallis, these were all chief executive officers of Chicago based corporations that were at least as large as Trans Union. The five "outside" directors had 78 years of combined experience as chief executive officers, and 53 years cumulative service as Trans Union directors.
The inside directors wear their badge of expertise in the corporate affairs of Trans Union on their sleeves. But what about the outsiders? Dr. Wallis is or was an economist and math statistician, a professor of economics at Yale University, dean of the graduate school of business at the University of Chicago, and Chancellor of the University of Rochester. Dr. Wallis had been on the Board of Trans Union since 1962. He also was on the Board of Bausch & Lomb, Kodak, Metropolitan Life Insurance Company, Standard Oil and others.
William B. Johnson is a University of Pennsylvania law graduate, President of Railway Express until 1966, Chairman and Chief Executive of I.C. Industries Holding Company, and member of Trans Union's Board since 1968.
Joseph Lanterman, a Certified Public Accountant, is or was President and Chief Executive of American Steel, on the Board of International Harvester, Peoples Energy, Illinois Bell Telephone, Harris Bank and Trust Company, Kemper Insurance Company and a director of Trans Union for four years.
Graham Morgan is achemist, was Chairman and Chief Executive Officer of U.S. Gypsum, and in the 17 and 18 years prior to the Trans Union transaction had been involved in 31 or 32 corporate takeovers.
Robert Reneker attended University of Chicago and Harvard Business Schools. He was President and Chief Executive of Swift and Company, director of Trans Union since 1971, and member of the Boards of seven other corporations including U.S. Gypsum and the Chicago Tribune.
Directors of this caliber are not ordinarily taken in by a "fast shuffle". I submit they were not taken into this multi-million dollar corporate transaction without being fully informed and aware of the state of the art as it pertained to the entire corporate panoroma of Trans Union. True, even [895] directors such as these, with their business acumen, interest and expertise, can go astray. I do not believe that to be the case here. These men knew Trans Union like the back of their hands and were more than well qualified to make on the spot informed business judgments concerning the affairs of Trans Union including a 100% sale of the corporation. Lest we forget, the corporate world of then and now operates on what is so aptly referred to as "the fast track". These men were at the time an integral part of that world, all professional business men, not intellectual figureheads.
The majority of this Court holds that the Board's decision, reached on September 20, 1980, to approve the merger was not the product of an informed business judgment, that the Board's subsequent efforts to amend the Merger Agreement and take other curative action were legally and factually ineffectual, and that the Board did not deal with complete candor with the stockholders by failing to disclose all material facts, which they knew or should have known, before securing the stockholders' approval of the merger. I disagree.
At the time of the September 20, 1980 meeting the Board was acutely aware of Trans Union and its prospects. The problems created by accumulated investment tax credits and accelerated depreciation were discussed repeatedly at Board meetings, and all of the directors understood the problem thoroughly. Moreover, at the July, 1980 Board meeting the directors had reviewed Trans Union's newly prepared five-year forecast, and at the August, 1980 meeting Van Gorkom presented the results of a comprehensive study of Trans Union made by The Boston Consulting Group. This study was prepared over an 18 month period and consisted of a detailed analysis of all Trans Union subsidiaries, including competitiveness, profitability, cash throw-off, cash consumption, technical competence and future prospects for contribution to Trans Union's combined net income.
At the September 20 meeting Van Gorkom reviewed all aspects of the proposed transaction and repeated the explanation of the Pritzker offer he had earlier given to senior management. Having heard Van Gorkom's explanation of the Pritzker's offer, and Brennan's explanation of the merger documents the directors discussed the matter. Out of this discussion arose an insistence on the part of the directors that two modifications to the offer be made. First, they required that any potential competing bidder be given access to the same information concerning Trans Union that had been provided to the Pritzkers. Second, the merger documents were to be modified to reflect the fact that the directors could accept a better offer and would not be required to recommend the Pritzker offer if a better offer was made. The following language was inserted into the agreement:
"Within 30 days after the execution of this Agreement, TU shall call a meeting of its stockholders (the `Stockholder's Meeting') for the purpose of approving and adopting the Merger Agreement. The Board of Directors shall recommend to the stockholders of TU that they approve and adopt the Merger Agreement (the `Stockholders' Approval') and shall use its best efforts to obtain the requisite vote therefor; provided, however, that GL and NTC acknowledge that the Board of Directors of TU may have a competing fiduciary obligation to the Stockholders under certain circumstances." (Emphasis added)
While the language is not artfully drawn, the evidence is clear that the intention underlying that language was to make specific the right that the directors assumed they had, that is, to accept any offer that they thought was better, and not to recommend the Pritzker offer in the face of a better one. At the conclusion of the meeting, the proposed merger was approved.
At a subsequent meeting on October 8, 1981 the directors, with the consent of the Pritzkers, amended the Merger Agreement so as to establish the right of Trans Union to solicit as well as to receive higher bids, [896] although the Pritzkers insisted that their merger proposal be presented to the stockholders at the same time that the proposal of any third party was presented. A second amendment, which became effective on October 10, 1981, further provided that Trans Union might unilaterally terminate the proposed merger with the Pritzker company in the event that prior to February 10, 1981 there existed a definitive agreement with a third party for a merger, consolidation, sale of assets, or purchase or exchange of Trans Union stock which was more favorable for the stockholders of Trans Union than the Pritzker offer and which was conditioned upon receipt of stockholder approval and the absence of an injunction against its consummation.
Following the October 8 board meeting of Trans Union, the investment banking firm of Salomon Brothers was retained by the corporation to search for better offers than that of the Pritzkers, Salomon Brothers being charged with the responsibility of doing "whatever possible to see if there is a superior bid in the marketplace over a bid that is on the table for Trans Union". In undertaking such project, it was agreed that Salomon Brothers would be paid the amount of $500,000 to cover its expenses as well as a fee equal to 3/8ths of 1% of the aggregate fair market value of the consideration to be received by the company in the case of a merger or the like, which meant that in the event Salomon Brothers should find a buyer willing to pay a price of $56.00 a share instead of $55.00, such firm would receive a fee of roughly $2,650,000 plus disbursements.
As the first step in proceeding to carry out its commitment, Salomon Brothers had a brochure prepared, which set forth Trans Union's financial history, described the company's business in detail and set forth Trans Union's operating and financial projections. Salomon Brothers also prepared a list of over 150 companies which it believed might be suitable merger partners, and while four of such companies, namely, General Electric, Borg-Warner, Bendix, and Genstar, Ltd. showed some interest in such a merger, none made a firm proposal to Trans Union and only General Electric showed a sustained interest.[1] As matters transpired, no firm offer which bettered the Pritzker offer of $55 per share was ever made.
On January 21, 1981 a proxy statement was sent to the shareholders of Trans Union advising them of a February 10, 1981 meeting in which the merger would be voted. On January 26, 1981 the directors held their regular meeting. At this meeting the Board discussed the instant merger as well as all events, including this litigation, surrounding it. At the conclusion of the meeting the Board unanimously voted to recommend to the stockholders that they approve the merger. Additionally, the directors reviewed and approved a Supplemental Proxy Statement which, among other things, advised the stockholders of what had occurred at the instant meeting and of the fact that General Electric had decided not to make an offer. On February 10, 1981 [897] the stockholders of Trans Union met pursuant to notice and voted overwhelmingly in favor of the Pritzker merger, 89% of the votes cast being in favor of it.
I have no quarrel with the majority's analysis of the business judgment rule. It is the application of that rule to these facts which is wrong. An overview of the entire record, rather than the limited view of bits and pieces which the majority has exploded like popcorn, convinces me that the directors made an informed business judgment which was buttressed by their test of the market.
At the time of the September 20 meeting the 10 members of Trans Union's Board of Directors were highly qualified and well informed about the affairs and prospects of Trans Union. These directors were acutely aware of the historical problems facing Trans Union which were caused by the tax laws. They had discussed these problems ad nauseam. In fact, within two months of the September 20 meeting the board had reviewed and discussed an outside study of the company done by The Boston Consulting Group and an internal five year forecast prepared by management. At the September 20 meeting Van Gorkom presented the Pritzker offer, and the board then heard from James Brennan, the company's counsel in this matter, who discussed the legal documents. Following this, the Board directed that certain changes be made in the merger documents. These changes made it clear that the Board was free to accept a better offer than Pritzker's if one was made. The above facts reveal that the Board did not act in a grossly negligent manner in informing themselves of the relevant and available facts before passing on the merger. To the contrary, this record reveals that the directors acted with the utmost care in informing themselves of the relevant and available facts before passing on the merger.
The majority finds that Trans Union stockholders were not fully informed and that the directors breached their fiduciary duty of complete candor to the stockholders required by Lynch v. Vickers Energy Corp., Del.Supr. 383 A.2d 278 (1978) [Lynch I], in that the proxy materials were deficient in five areas.
Here again is exploitation of the negative by the majority without giving credit to the positive. To respond to the conclusions of the majority would merely be unnecessary prolonged argument. But briefly what did the proxy materials disclose? The proxy material informed the shareholders that projections were furnished to potential purchasers and such projections indicated that Trans Union's net income might increase to approximately $153 million in 1985. That projection, what is almost three times the net income of $58,248,000 reported by Trans Union as its net income for December 31, 1979 confirmed the statement in the proxy materials that the "Board of Directors believes that, assuming reasonably favorable economic and financial conditions, the Company's prospects for future earnings growth are excellent." This material was certainly sufficient to place the Company's stockholders on notice that there was a reasonable basis to believe that the prospects for future earnings growth were excellent, and that the value of their stock was more than the stock market value of their shares reflected.
Overall, my review of the record leads me to conclude that the proxy materials adequately complied with Delaware law in informing the shareholders about the proposed transaction and the events surrounding it.
The majority suggests that the Supplemental Proxy Statement did not comply with the notice requirement of 8 Del.C. § 251(c) that notice of the time, place and purpose of a meeting to consider a merger must be sent to each shareholder of record at least 20 days prior to the date of the meeting. In the instant case an original proxy statement was mailed on January 18, 1981 giving notice of the time, place and purpose of the meeting. A Supplemental Proxy Statement was mailed January 26, 1981 in an effort to advise Trans Union's [898] shareholders as to what had occurred at the January 26, 1981 meeting, and that General Electric had decided not to make an offer. The shareholder meeting was held February 10, 1981 fifteen days after the Supplemental Proxy Statement had been sent.
All § 251(c) requires is that notice of the time, place and purpose of the meeting be given at least 20 days prior to the meeting. This was accomplished by the proxy statement mailed January 19, 1981. Nothing in § 251(c) prevents the supplementation of proxy materials within 20 days of the meeting. Indeed when additional information, which a reasonable shareholder would consider important in deciding how to vote, comes to light that information must be disclosed to stockholders in sufficient time for the stockholders to consider it. But nothing in § 251(c) requires this additional information to be disclosed at least 20 days prior to the meeting. To reach a contrary result would ignore the current practice and would discourage the supplementation of proxy materials in order to disclose the occurrence of intervening events. In my opinion, fifteen days in the instant case was a sufficient amount of time for the stockholders to receive and consider the information in the supplemental proxy statement.
CHRISTIE, Justice, dissenting:
I respectfully dissent.
Considering the standard and scope of our review under Levitt v. Bouvier, Del. Supr., 287 A.2d 671, 673 (1972), I believe that the record taken as a whole supports a conclusion that the actions of the defendants are protected by the business judgment rule. Aronson v. Lewis, Del.Supr., 473 A.2d 805, 812 (1984); Pogostin v. Rice, Del.Supr., 480 A.2d 619, 627 (1984). I also am satisfied that the record supports a conclusion that the defendants acted with the complete candor required by Lynch v. Vickers Energy Corp., Del.Supr., 383 A.2d 278 (1978). Under the circumstances I would affirm the judgment of the Court of Chancery.
ON MOTIONS FOR REARGUMENT
Following this Court's decision, Thomas P. O'Boyle, one of the director defendants, sought, and was granted, leave for change of counsel. Thereafter, the individual director defendants, other than O'Boyle, filed a motion for reargument and director O'Boyle, through newly-appearing counsel, then filed a separate motion for reargument. Plaintiffs have responded to the several motions and this matter has now been duly considered.
The Court, through its majority, finds no merit to either motion and concludes that both motions should be denied. We are not persuaded that any errors of law or fact have been made that merit reargument.
However, defendant O'Boyle's motion requires comment. Although O'Boyle continues to adopt his fellow directors' arguments, O'Boyle now asserts in the alternative that he has standing to take a position different from that of his fellow directors and that legal grounds exist for finding him not liable for the acts or omissions of his fellow directors. Specifically, O'Boyle makes a two-part argument: (1) that his undisputed absence due to illness from both the September 20 and the October 8 meetings of the directors of Trans Union entitles him to be relieved from personal liability for the failure of the other directors to exercise due care at those meetings, see Propp v. Sadacca, Del.Ch., 175 A.2d 33, 39 (1961), modified on other grounds, Bennett v. Propp, Del.Supr., 187 A.2d 405 (1962); and (2) that his attendance and participation in the January 26, 1981 Board meeting does not alter this result given this Court's precise findings of error committed at that meeting.
We reject defendant O'Boyle's new argument as to standing because not timely asserted. Our reasons are several. One, in connection with the supplemental briefing of this case in March, 1984, a special opportunity was afforded the individual defendants, [899] including O'Boyle, to present any factual or legal reasons why each or any of them should be individually treated. Thereafter, at argument before the Court on June 11, 1984, the following colloquy took place between this Court and counsel for the individual defendants at the outset of counsel's argument:
COUNSEL: I'll make the argument on behalf of the nine individual defendants against whom the plaintiffs seek more than $100,000,000 in damages. That is the ultimate issue in this case, whether or not nine honest, experienced businessmen should be subject to damages in a case where —
JUSTICE MOORE: Is there a distinction between Chelberg and Van Gorkom vis-a-vis the other defendants?
COUNSEL: No, sir.
JUSTICE MOORE: None whatsoever?
COUNSEL: I think not.
Two, in this Court's Opinion dated January 29, 1985, the Court relied on the individual defendants as having presented a unified defense. We stated:
The parties' response, including reargument, has led the majority of the Court to conclude: (1) that since all of the defendant directors, outside as well as inside, take a unified position, we are required to treat all of the directors as one as to whether they are entitled to the protection of the business judgment rule...
Three, previously O'Boyle took the position that the Board's action taken January 26, 1981 — in which he fully participated — was determinative of virtually all issues. Now O'Boyle seeks to attribute no significance to his participation in the January 26 meeting. Nor does O'Boyle seek to explain his having given before the directors' meeting of October 8, 1980 his "consent to the transaction of such business as may come before the meeting."[*] It is the view of the majority of the Court that O'Boyle's change of position following this Court's decision on the merits comes too late to be considered. He has clearly waived that right.
The Motions for Reargument of all defendants are denied.
McNEILLY and CHRISTIE, Justices, dissenting:
We do not disagree with the ruling as to the defendant O'Boyle, but we would have granted reargument on the other issues raised.
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[1] The plaintiff, Alden Smith, originally sought to enjoin the merger; but, following extensive discovery, the Trial Court denied the plaintiff's motion for preliminary injunction by unreported letter opinion dated February 3, 1981. On February 10, 1981, the proposed merger was approved by Trans Union's stockholders at a special meeting and the merger became effective on that date. Thereafter, John W. Gosselin was permitted to intervene as an additional plaintiff; and Smith and Gosselin were certified as representing a class consisting of all persons, other than defendants, who held shares of Trans Union common stock on all relevant dates. At the time of the merger, Smith owned 54,000 shares of Trans Union stock, Gosselin owned 23,600 shares, and members of Gosselin's family owned 20,000 shares.
[2] Following trial, and before decision by the Trial Court, the parties stipulated to the dismissal, with prejudice, of the Messrs. Pritzker as parties defendant. However, all references to defendants hereinafter are to the defendant directors of Trans Union, unless otherwise noted.
[3] It has been stipulated that plaintiffs sue on behalf of a class consisting of 10,537 shareholders (out of a total of 12,844) and that the class owned 12,734,404 out of 13,357,758 shares of Trans Union outstanding.
[4] More detailed statements of facts, consistent with this factual outline, appear in related portions of this Opinion.
[5] The common stock of Trans Union was traded on the New York Stock Exchange. Over the five year period from 1975 through 1979, Trans Union's stock had traded within a range of a high of $39½ and a low of $24¼. Its high and low range for 1980 through September 19 (the last trading day before announcement of the merger) was $38¼-$29½.
[6] Van Gorkom asked Romans to express his opinion as to the $55 price. Romans stated that he "thought the price was too low in relation to what he could derive for the company in a cash sale, particularly one which enabled us to realize the values of certain subsidiaries and independent entities."
[7] The record is not clear as to the terms of the Merger Agreement. The Agreement, as originally presented to the Board on September 20, was never produced by defendants despite demands by the plaintiffs. Nor is it clear that the directors were given an opportunity to study the Merger Agreement before voting on it. All that can be said is that Brennan had the Agreement before him during the meeting.
[8] In Van Gorkom's words: The "real decision" is whether to "let the stockholders decide it" which is "all you are being asked to decide today."
[9] The Trial Court stated the premium relationship of the $55 price to the market history of the Company's stock as follows:
* * * the merger price offered to the stockholders of Trans Union represented a premium of 62% over the average of the high and low prices at which Trans Union stock had traded in 1980, a premium of 48% over the last closing price, and a premium of 39% over the highest price at which the stock of Trans Union had traded any time during the prior six years.
[10] We refer to the underlined portion of the Court's ultimate conclusion (previously stated): "that given the market value of Trans Union's stock, the business acumen of the members of the board of Trans Union, the substantial premium over market offered by the Pritzkers and the ultimate effect on the merger price provided by the prospect of other bids for the stock in question, that the board of directors of Trans Union did not act recklessly or improvidently...."
[11] 8 Del.C. § 141 provides, in pertinent part:
(a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.
[12] See Kaplan v. Centex Corporation, Del.Ch., 284 A.2d 119, 124 (1971), where the Court stated:
Application of the [business judgment] rule of necessity depends upon a showing that informed directors did in fact make a business judgment authorizing the transaction under review. And, as the plaintiff argues, the difficulty here is that the evidence does not show that this was done. There were director-committee-officer references to the realignment but none of these singly or cumulative showed that the director judgment was brought to bear with specificity on the transactions.
[13] Compare Mitchell v. Highland-Western Glass, supra, where the Court posed the question as whether the board acted "so far without information that they can be said to have passed an unintelligent and unadvised judgment." 167 A. at 833. Compare also Gimbel v. Signal Companies, Inc., 316 A.2d 599, aff'd per curiam Del. Supr., 316 A.2d 619 (1974), where the Chancellor, after expressly reiterating the Highland-Western Glass standard, framed the question, "Or to put the question in its legal context, did the Signal directors act without the bounds of reason and recklessly in approving the price offer of Burmah?" Id.
[14] 8 Del.C. § 251(b) provides in pertinent part:
(b) The board of directors of each corporation which desires to merge or consolidate shall adopt a resolution approving an agreement of merger or consolidation. The agreement shall state: (1) the terms and conditions of the merger or consolidation; (2) the mode of carrying the same into effect; (3) such amendments or changes in the certificate of incorporation of the surviving corporation as are desired to be effected by the merger or consolidation, or, if no such amendments or changes are desired, a statement that the certificate of incorporation of one of the constituent corporations shall be the certificate of incorporation of the surviving or resulting corporation; (4) the manner of converting the shares of each of the constituent corporations... and (5) such other details or provisions as are deemed desirable.... The agreement so adopted shall be executed in accordance with section 103 of this title. Any of the terms of the agreement of merger or consolidation may be made dependent upon facts ascertainable outside of such agreement, provided that the manner in which such facts shall operate upon the terms of the agreement is clearly and expressly set forth in the agreement of merger or consolidation. (underlining added for emphasis)
[15] Section 141(e) provides in pertinent part:
A member of the board of directors ... shall, in the performance of his duties, be fully protected in relying in good faith upon the books of accounts or reports made to the corporation by any of its officers, or by an independent certified public accountant, or by an appraiser selected with reasonable care by the board of directors ..., or in relying in good faith upon other records of the corporation.
[16] In support of the defendants' argument that their judgment as to the adequacy of $55 per share was an informed one, the directors rely on the BCG study and the Five Year Forecast. However, no one even referred to either of these studies at the September 20 meeting; and it is conceded that these materials do not represent valuation studies. Hence, these documents do not constitute evidence as to whether the directors reached an informed judgment on September 20 that $55 per share was a fair value for sale of the Company.
[17] We reserve for discussion under Part III hereof, the defendants' contention that their judgment, reached on September 20, if not then informed became informed by virtue of their "review" of the Agreement on October 8 and January 26.
[18] Romans' department study was not made available to the Board until circulation of Trans Union's Supplementary Proxy Statement and the Board's meeting of January 26, 1981, on the eve of the shareholder meeting; and, as has been noted, the study has never been produced for inclusion in the record in this case.
[19] As of September 20 the directors did not know: that Van Gorkom had arrived at the $55 figure alone, and subjectively, as the figure to be used by Controller Peterson in creating a feasible structure for a leveraged buy-out by a prospective purchaser; that Van Gorkom had not sought advice, information or assistance from either inside or outside Trans Union directors as to the value of the Company as an entity or the fair price per share for 100% of its stock; that Van Gorkom had not consulted with the Company's investment bankers or other financial analysts; that Van Gorkom had not consulted with or confided in any officer or director of the Company except Chelberg; and that Van Gorkom had deliberately chosen to ignore the advice and opinion of the members of his Senior Management group regarding the adequacy of the $55 price.
[20] For a far more careful and reasoned approach taken by another board of directors faced with the pressures of a hostile tender offer, see Pogostin v. Rice, supra at 623-627.
[21] Trans Union's five "inside" directors had backgrounds in law and accounting, 116 years of collective employment by the Company and 68 years of combined experience on its Board. Trans Union's five "outside" directors included four chief executives of major corporations and an economist who was a former dean of a major school of business and chancellor of a university. The "outside" directors had 78 years of combined experience as chief executive officers of major corporations and 50 years of cumulative experience as directors of Trans Union. Thus, defendants argue that the Board was eminently qualified to reach an informed judgment on the proposed "sale" of Trans Union notwithstanding their lack of any advance notice of the proposal, the shortness of their deliberation, and their determination not to consult with their investment banker or to obtain a fairness opinion.
[22] Nonetheless, we are satisfied that in an appropriate factual context a proper exercise of business judgment may include, as one of its aspects, reasonable reliance upon the advice of counsel. This is wholly outside the statutory protections of 8 Del.C. § 141(e) involving reliance upon reports of officers, certain experts and books and records of the company.
[23] As will be seen, we do not reach the second question.
[24] As previously noted, the Board mistakenly thought that it had amended the September 20 draft agreement to include a market test.
A secondary purpose of the October 8 meeting was to obtain the Board's approval for Trans Union to employ its investment advisor, Salomon Brothers, for the limited purpose of assisting Management in the solicitation of other offers. Neither Management nor the Board then or thereafter requested Salomon Brothers to submit its opinion as to the fairness of Pritzker's $55 cash-out merger proposal or to value Trans Union as an entity.
There is no evidence of record that the October 8 meeting had any other purpose; and we also note that the Minutes of the October 8 Board meeting, including any notice of the meeting, are not part of the voluminous records of this case.
[25] We do not suggest that a board must read in haec verba every contract or legal document which it approves, but if it is to successfully absolve itself from charges of the type made here, there must be some credible contemporary evidence demonstrating that the directors knew what they were doing, and ensured that their purported action was given effect. That is the consistent failure which cast this Board upon its unredeemable course.
[26] There is no evidence of record that Trans Union's directors ever raised any objections, procedural or substantive, to the October 10 amendments or that any of them, including Van Gorkom, understood the opposite result of their intended effect — until it was too late.
[27] This was inconsistent with Van Gorkom's espousal of the September 22 press release following Trans Union's acceptance of Pritzker's proposal. Van Gorkom had then justified a press release as encouraging rather than chilling later offers.
[28] The defendants concede that Muschel is only illustrative of the proposition that a board may reconsider a prior decision and that it is otherwise factually distinguishable from this case.
[29] This was the meeting which, under the terms of the September 20 Agreement with Pritzker, was scheduled to be held January 10 and was later postponed to February 10 under the October 8-10 amendments. We refer to the document titled "Amendment to Supplemental Agreement" executed by the parties "as of" October 10, 1980. Under new Section 2.03(a) of Article A VI of the "Supplemental Agreement," the parties agreed, in part, as follows:
"The solicitation of such offers or proposals [i.e., `other offers that Trans Union might accept in lieu of the Merger Agreement'] by TU... shall not be deemed to constitute a breach of this Supplemental Agreement or the Merger Agreement provided that ... [Trans Union] shall not (1) delay promptly seeking all consents and approvals required hereunder ... [and] shall be deemed [in compliance] if it files its Preliminary Proxy Statement by December 5, 1980, uses its best efforts to mail its Proxy Statement by January 5, 1981 and holds a special meeting of its Stockholders on or prior to February 10, 1981 ...
* * * * * *
It is the present intention of the Board of Directors of TU to recommend the approval of the Merger Agreement to the Stockholders, unless another offer or proposal is made which in their opinion is more favorable to the Stockholders than the Merger Agreement."
[30] With regard to the Pritzker merger, the recently filed shareholders' suit to enjoin it, and relevant portions of the impending stockholder meeting of February 10, we set forth the Minutes in their entirety:
The Board then reviewed the necessity of issuing a Supplement to the Proxy Statement mailed to stockholders on January 21, 1981, for the special meeting of stockholders scheduled to be held on February 10, 1981, to vote on the proposed $55 cash merger with a subsidiary of GE Corporation. Among other things, the Board noted that subsequent to the printing of the Proxy Statement mailed to stockholders on January 21, 1981, General Electric Company had indicated that it would not be making an offer to acquire the Company. In addition, certain facts had been adduced in connection with pretrial discovery taken in connection with the lawsuit filed by Alden Smith in Delaware Chancery Court. After further discussion and review of a printer's proof copy of a proposed Supplement to the Proxy Statement which had been distributed to Directors the preceding day, upon motion duly made and seconded, the following resolution was unanimously adopted, each Director having been individually polled with respect thereto:
RESOLVED, that the Secretary of the Company be and he hereby is authorized and directed to mail to the stockholders a Supplement to Proxy Statement, substantially in the form of the proposed Supplement to Proxy Statement submitted to the Board at this meeting, with such changes therein and modifications thereof as he shall, with the advice and assistance of counsel, approve as being necessary, desirable, or appropriate.
The Board then reviewed and discussed at great length the entire sequence of events pertaining to the proposed $55 cash merger with a subsidiary of GE Corporation, beginning with the first discussion on September 13, 1980, between the Chairman and Mr. Jay Pritzker relative to a possible merger. Each of the Directors was involved in this discussion as well as counsel who had earlier joined the meeting. Following this review and discussion, such counsel advised the Directors that in light of their discussions, they could (a) continue to recommend to the stockholders that the latter vote in favor of the proposed merger, (b) recommend that the stockholders vote against the merger, or (c) take no position with respect to recommending the proposed merger and simply leave the decision to stockholders. After further discussion, it was moved, seconded, and unanimously voted that the Board of Directors continue to recommend that the stockholders vote in favor of the proposed merger, each Director being individually polled with respect to his vote.
[31] In particular, the defendants rely on the testimony of director Johnson on direct examination:
Q. Was there a regular meeting of the board of Trans Union on January 26, 1981?
A. Yes.
Q. And what was discussed at that meeting?
A. Everything relevant to this transaction.
You see, since the proxy statement of the 19th had been mailed, see, General Electric had advised that they weren't going to make a bid. It was concluded to suggest that the shareholders be advised of that, and that required a supplemental proxy statement, and that required authorization of the board, and that led to a total review from beginning to end of every aspect of the whole transaction and all relevant developments.
Since that was occurring and a supplemental statement was going to the shareholders, it also was obvious to me that there should be a review of the board's position again in the light of the whole record. And we went back from the beginning. Everything was examined and reviewed. Counsel were present. And the board was advised that we could recommend the Pritzker deal, we could submit it to the shareholders with no recommendation, or we could recommend against it.
The board voted to issue the supplemental statement to the shareholders. It voted unanimously — and this time we had a unanimous board, where one man was missing before — to recommend the Pritzker deal. Indeed, at that point there was no other deal. And, in truth, there never had been any other deal. And that's what transpired: a total review of the GE situation, KKR and everything else that was relevant.
[32] To the extent the Trial Court's ultimate conclusion to invoke the business judgment rule is based on other explicit criteria and supporting evidence (i.e., market value of Trans Union's stock, the business acumen of the Board members, the substantial premium over market and the availability of the market test to confirm the adequacy of the premium), we have previously discussed the insufficiency of such evidence.
[33] The pertinent provisions of 8 Del.C. § 251(c) provide:
(c) The agreement required by subsection (b) shall be submitted to the stockholders of each constituent corporation at an annual or special meeting thereof for the purpose of acting on the agreement. Due notice of the time, place and purpose of the meeting shall be mailed to each holder of stock, whether voting or non-voting, of the corporation at his address as it appears on the records of the corporation, at least 20 days prior to the date of the meeting....
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[1] Shortly after the announcement of the proposed merger in September senior members of Trans Union's management got in touch with KKR to discuss their possible participation in a leverage buyout scheme. On December 2, 1980 KKR through Henry Kravis actually made a bid of $60.00 per share for Trans Union stock on December 2, 1980 but the offer was withdrawn three hours after it was made because of complications arising out of negotiations with the Reichman family, extremely wealthy Canadians and a change of attitude toward the leveraged buyout scheme, by Jack Kruzenga, the member of senior management of Trans Union who most likely would have been President and Chief Operating Officer of the new company. Kruzenga was the President and Chief Operating Officer of the seven subsidiaries of Trans Union which constituted the backbone of Trans Union as shown through exhaustive studies and analysis of Trans Union's intrinsic value on the market place by the respected investment banking firm of Morgan Stanley. It is interesting to note that at no time during the market test period did any of the 150 corporations contacted by Salomon Brothers complain of the time frame or availability of corporate records in order to make an independent judgment of market value of 100% of Trans Union.
[*] We do not hereby determine that a director's execution of a waiver of notice of meeting and consent to the transaction of business constitutes an endorsement (or approval) by the absent director of any action taken at such a meeting.
1.2.2.2 In re Walt Disney Co. Derivative Litigation 1.2.2.2 In re Walt Disney Co. Derivative Litigation
After Smith v. Van Gorkom, Disney is the closest Delaware courts have come to imposing monetary liability on disinterested directors. The litigation was heavily colored by Disney's 102(b)(7) waiver, which Disney and most other large corporations had adopted after Van Gorkom. The Delaware Supreme Court, however, chose first to make an affirmative finding that the defendants met even the default standard of due care. As you read that part of the opinion (chiefly IV.A.1), ask yourself why the court reached the opposite result from Van Gorkom:1. Did the court apply different law, i.e., did it overrule Van Gorkom, explicitly or implicitly?2. Did the case present materially different facts? The Disney court certainly paints a more favorable picture of the board process than the Van Gorkom court. But were the processes substantively different? Imagine you are the plaintiffs' lawyer (or a judge in the Van Gorkom majority) and try to recast the Disney facts in a light less favorable to the defendants.The Disney court next addresses “good faith,” which is a necessary condition for liability protection under DGCL 102(b)(7) (as well as for indemnification under DGCL 145(a) and (b)).1. How does the court interpret “good faith”?2. How does “good faith” relate to the duty of care and the duty of loyalty?3. Was addressing both “good faith” and the default standard of due care necessary for the court’s decision of the case? If not, why did it?
In re the WALT DISNEY COMPANY DERIVATIVE LITIGATION.
William Brehm and Geraldine Brehm, as Trustees and Custodians; Michael Grening; Richard Kaplan and David Kaplan, as Trustees; Thomas M. Malloy; Richard J. Kager and Carol R. Kager, as Joint Tenants; Michael Caesar, as Trustee for Howard Gunty, Inc. Profit Sharing Plan; Robert S. [28] Goldberg, I.R.A.; Michael Shore; Michele DeBendictis; Peter Lawrence, I.R.A.; Melvin Zupnick; Judith B. Wohl, I.R.A. James C. Hays; and Barnett Stepak, Plaintiffs Below, Appellants,
v.
Michael D. Eisner, Michael S. Ovitz, Stephen F. Bollenbach, Sanford M. Litvack, Irwin Russell, Roy E. Disney, Stanley P. Gold, Richard A. Nunis, Sidney Poitier, Robert A.M. Stern, E. Cardon Walker, Raymond L. Watson, Gary L. Wilson, Reveta F. Bowers, Ignacio E. Lozano Jr., George J. Mitchell, Leo J. O'Donovan, Thomas S. Murphy and The Walt Disney Company, Defendants Below, Appellees.
Supreme Court of Delaware.
Joseph A. Rosenthal and Norman M. Monhait, Esquires, of Rosenthal, Monhait, Gross & Goddess, P.A., Wilmington, Delaware; Seth D. Rigrodsky, Esquire, of Milberg Weiss Bershad & Schulman LLP, Wilmington, Delaware; Of Counsel: Steven G. Schulman (argued), Joshua H. Vinik, Jennifer K. Hirsh, John B. Rediker and Laura H. Gundersheim, Esquires, of Milberg Weiss Bershad & Schulman LLP, New York, New York; for Appellants.
Lawrence C. Ashby, Richard D. Heins and Philip Trainer, Jr., Esquires, of Ashby & Geddes, P.A., Wilmington, Delaware; Of Counsel: Gary P. Naftalis (argued), Michael S. Oberman, Paul H. Schoeman and Shoshana Menu, Esquires; of Kramer Levin Naftalis & Frankel, LLP, New York, New York; for Appellee Eisner.
David C. McBride and Christian Douglas Wright, Esquires, of Young Conaway Stargatt & Taylor, LLP, Wilmington, Delaware; Of Counsel: Mark H. Epstein (argued), Bart H. Williams and Jason L. Haas, Esquires, of Munger, Tolles & Olson LLP, Los Angeles, California; for Appellee Ovitz.
Jesse A. Finkelstein, Gregory P. Williams (argued), Anne C. Foster, Lisa A. Schmidt, Evan O. Williford, and Michael R. Robinson, Esquires, of Richards, Layton & Finger, P.A., Wilmington, Delaware; [35] for Appellees Bollenbach, Russell, Nunis, Poitier, Stern, Walker, Watson, Wilson, Bowers, Lozano, Mitchell, O'Donovan, and Murphy.
Robert K. Payson, Stephen C. Norman and Kevin R. Shannon, Esquires, of Potter Anderson & Corroon LLP, Wilmington, Delaware; for Appellee Litvack.
A. Gilchrist Sparks, III and S. Mark Hurd, Esquires, of Morris, Nichols, Arsht & Tunnell, Wilmington, Delaware; Of Counsel: Stephen D. Alexander and Susan C. Chun, Esquires, of Bingham McCutchen LLP, Los Angeles, California; for Appellees Disney and Gold.
Andre G. Bouchard and Joel Friedlander, Esquires, of Bouchard Margules & Friedlander, Wilmington, Delaware; for Appellee The Walt Disney Company.
Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS and RIDGELY, Justices, constituting the Court en Banc.
[34] JACOBS, Justice.
In August 1995, Michael Ovitz ("Ovitz") and The Walt Disney Company ("Disney" or the "Company") entered into an employment agreement under which Ovitz would serve as President of Disney for five years. In December 1996, only fourteen months after he commenced employment, Ovitz was terminated without cause, resulting in a severance payout to Ovitz valued at approximately $130 million.
In January 1997, several Disney shareholders brought derivative actions in the Court of Chancery, on behalf of Disney, against Ovitz and the directors of Disney who served at the time of the events complained of (the "Disney defendants"). The plaintiffs claimed that the $130 million severance payout was the product of fiduciary duty and contractual breaches by Ovitz, and breaches of fiduciary duty by the Disney defendants, and a waste of assets. After the disposition of several pretrial motions and an appeal to this Court,[1] the case was tried before the Chancellor over 37 days between October 20, 2004 and January 19, 2005. In August 2005, the Chancellor handed down a well-crafted 174 page Opinion and Order, determining that "the director defendants did not breach their fiduciary duties or commit waste."[2] The Court entered judgment in favor of all defendants on all claims alleged in the amended complaint.
The plaintiffs have appealed from that judgment, claiming that the Court of Chancery committed multitudinous errors. We conclude, for the reasons that follow, that the Chancellor's factual findings and legal rulings were correct and not erroneous in any respect. Accordingly, the judgment [36] entered by the Court of Chancery will be affirmed.
I. THE FACTS
We next summarize the facts as found by the Court of Chancery that are material to the issues presented on this appeal.[3] The critical events flow from what turned out to be an unfortunate hiring decision at Disney, a company that for over half a century has been one of America's leading film and entertainment enterprises.
In 1994 Disney lost in a tragic helicopter crash its President and Chief Operating Officer, Frank Wells, who together with Michael Eisner, Disney's Chairman and Chief Executive Officer, had enjoyed remarkable success at the Company's helm. Eisner temporarily assumed Disney's presidency, but only three months later, heart disease required Eisner to undergo quadruple bypass surgery. Those two events persuaded Eisner and Disney's board of directors that the time had come to identify a successor to Eisner.
Eisner's prime candidate for the position was Michael Ovitz, who was the leading partner and one of the founders of Creative Artists Agency ("CAA"), the premier talent agency whose business model had reshaped the entire industry. By 1995, CAA had 550 employees and a roster of about 1400 of Hollywood's top actors, directors, writers, and musicians. That roster generated about $150 million in annual revenues and an annual income of over $20 million for Ovitz, who was regarded as one of the most powerful figures in Hollywood.
Eisner and Ovitz had enjoyed a social and professional relationship that spanned nearly 25 years. Although in the past the two men had casually discussed possibly working together, in 1995, when Ovitz began negotiations to leave CAA and join Music Corporation of America ("MCA"), Eisner became seriously interested in recruiting Ovitz to join Disney. Eisner shared that desire with Disney's board members on an individual basis.[4]
A. Negotiation Of The Ovitz Employment Agreement
Eisner and Irwin Russell, who was a Disney director and chairman of the compensation committee, first approached Ovitz about joining Disney. Their initial negotiations were unproductive, however, because at that time MCA had made Ovitz an offer that Disney could not match. The MCA-Ovitz negotiations eventually fell apart, and Ovitz returned to CAA in mid-1995. Business continued as usual, until Ovitz discovered that Ron Meyer, his close friend and the number two executive at CAA, was leaving CAA to join MCA. That news devastated Ovitz, who concluded that to remain with the company he and Meyer had built together was no longer palatable. At that point Ovitz became receptive to the idea of joining Disney. Eisner learned of these developments [37] and re-commenced negotiations with Ovitz in earnest. By mid-July 1995, those negotiations were in full swing.
Both Russell and Eisner negotiated with Ovitz, over separate issues and concerns. From his talks with Eisner, Ovitz gathered that Disney needed his skills and experience to remedy Disney's current weaknesses, which Ovitz identified as poor talent relationships and stagnant foreign growth. Seeking assurances from Eisner that Ovitz's vision for Disney was shared, at some point during the negotiations Ovitz came to believe that he and Eisner would run Disney, and would work together in a relation akin to that of junior and senior partner. Unfortunately, Ovitz's belief was mistaken, as Eisner had a radically different view of what their respective roles at Disney should be.
Russell assumed the lead in negotiating the financial terms of the Ovitz employment contract. In the course of negotiations, Russell learned from Ovitz's attorney, Bob Goldman, that Ovitz owned 55% of CAA and earned approximately $20 to $25 million a year from that company. From the beginning Ovitz made it clear that he would not give up his 55% interest in CAA without "downside protection." Considerable negotiation then ensued over downside protection issues. During the summer of 1995, the parties agreed to a draft version of Ovitz's employment agreement (the "OEA") modeled after Eisner's and the late Mr. Wells' employment contracts. As described by the Chancellor, the draft agreement included the following terms:
Under the proposed OEA, Ovitz would receive a five-year contract with two tranches of options. The first tranche consisted of three million options vesting in equal parts in the third, fourth, and fifth years, and if the value of those options at the end of the five years had not appreciated to $50 million, Disney would make up the difference. The second tranche consisted of two million options that would vest immediately if Disney and Ovitz opted to renew the contract.
The proposed OEA sought to protect both parties in the event that Ovitz's employment ended prematurely, and provided that absent defined causes, neither party could terminate the agreement without penalty. If Ovitz, for example, walked away, for any reason other than those permitted under the OEA, he would forfeit any benefits remaining under the OEA and could be enjoined from working for a competitor. Likewise, if Disney fired Ovitz for any reason other than gross negligence or malfeasance, Ovitz would be entitled to a non-fault payment (Non-Fault Termination or "NFT"), which consisted of his remaining salary, $7.5 million a year for unaccrued bonuses, the immediate vesting of his first tranche of options and a $10 million cash out payment for the second tranche of options.[5]
As the basic terms of the OEA were crystallizing, Russell prepared and gave Ovitz and Eisner a "case study" to explain those terms. In that study, Russell also expressed his concern that the negotiated terms represented an extraordinary level of executive compensation. Russell acknowledged, however, that Ovitz was an "exceptional corporate executive" and "highly successful and unique entrepreneur" who merited "downside protection and upside opportunity."[6] Both would be required to enable Ovitz to adjust to the reduced cash compensation he would receive [38] from a public company, in contrast to the greater cash distributions and other perquisites more typically available from a privately held business. But, Russell did caution that Ovitz's salary would be at the top level for any corporate officer and significantly above that of the Disney CEO. Moreover, the stock options granted under the OEA would exceed the standards applied within Disney and corporate America and would "raise very strong criticism."[7] Russell shared this original case study only with Eisner and Ovitz. He also recommended another, additional study of this issue.
To assist in evaluating the financial terms of the OEA, Russell recruited Graef Crystal, an executive compensation consultant, and Raymond Watson, a member of Disney's compensation committee and a past Disney board chairman who had helped structure Wells' and Eisner's compensation packages. Before the three met, Crystal prepared a comprehensive executive compensation database to accept various inputs and to conduct Black-Scholes analyses to output a range of values for the options.[8] Watson also prepared similar computations on spreadsheets, but without using the Black-Scholes method.
On August 10, Russell, Watson and Crystal met. They discussed and generated a set of values using different and various inputs and assumptions, accounting for different numbers of options, vesting periods, and potential proceeds of option exercises at various times and prices. After discussing their conclusions, they agreed that Crystal would memorialize his findings and fax them to Russell. Two days later, Crystal faxed to Russell a memorandum concluding that the OEA would provide Ovitz with approximately $23.6 million per year for the first five years, or $23.9 million a year over seven years if Ovitz exercised a two year renewal option.[9] Those sums, Crystal opined, would approximate Ovitz's current annual compensation at CAA.
During a telephone conference that same evening, Russell, Watson and Crystal discussed Crystal's memorandum and its assumptions. Their discussion generated additional questions that prompted Russell to ask Crystal to revise his memorandum to resolve certain ambiguities in the current draft of the employment agreement. But, rather than address the points Russell highlighted, Crystal faxed to Russell a new letter that expressed Crystal's concern about the OEA's $50 million option appreciation guarantee. Crystal's concern, based on his understanding of the current draft of the OEA, was that Ovitz could hold the first tranche of options, wait out the five-year term, collect the $50 million guarantee, and then exercise the in-the-money options and receive an additional windfall. Crystal was philosophically opposed to a pay package that would give Ovitz the best of both worlds—low risk and high return.
Addressing Crystal's concerns, Russell made clear that the guarantee would not function as Crystal believed it might. Crystal then revised his original letter, adjusting the value of the OEA (assuming a two year renewal) to $24.1 million per year. Up to that point, only three Disney directors—Eisner, Russell and Watson— [39] knew the status of the negotiations with Ovitz and the terms of the draft OEA.
While Russell, Watson and Crystal were finalizing their analysis of the OEA, Eisner and Ovitz reached a separate agreement. Eisner told Ovitz that: (1) the number of options would be reduced from a single grant of five million to two separate grants, the first being three million options for the first five years and the second consisting of two million more options if the contract was renewed; and (2) Ovitz would join Disney only as President, not as a co-CEO with Eisner. After deliberating, Ovitz accepted those terms, and that evening Ovitz, Eisner, Sid Bass[10] and their families celebrated Ovitz's decision to join Disney.
Unfortunately, the celebratory mood was premature. The next day, August 13, Eisner met with Ovitz, Russell, Sanford Litvack (an Executive Vice President and Disney's General Counsel), and Stephen Bollenbach (Disney's Chief Financial Officer) to discuss the decision to hire Ovitz. Litvack and Bollenbach were unhappy with that decision, and voiced concerns that Ovitz would disrupt the cohesion that existed between Eisner, Litvack and Bollenbach. Litvack and Bollenbach were emphatic that they would not report to Ovitz, but would continue to report to Eisner.[11] Despite Ovitz's concern about his "shrinking authority" as Disney's future President, Eisner was able to provide sufficient reassurance so that ultimately Ovitz acceded to Litvack's and Bollenbach's terms.
On August 14, Eisner and Ovitz signed a letter agreement (the "OLA"), which outlined the basic terms of Ovitz's employment, and stated that the agreement (which would ultimately be embodied in a formal contract) was subject to approval by Disney's compensation committee and board of directors. Russell called Sidney Poitier, a Disney director and compensation committee member, to inform Poitier of the OLA and its terms. Poitier believed that hiring Ovitz was a good idea because of Ovitz's reputation and experience. Watson called Ignacio Lozano, another Disney director and compensation committee member, who felt that Ovitz would successfully adapt from a private company environment to Disney's public company culture. Eisner also contacted each of the other board members by phone to inform them of the impending new hire, and to explain his friendship with Ovitz and Ovitz's qualifications.[12]
[40] That same day, a press release made the news of Ovitz's hiring public. The reaction was extremely positive: Disney was applauded for the decision, and Disney's stock price rose 4.4 % in a single day, thereby increasing Disney's market capitalization by over $1 billion.
Once the OLA was signed, Joseph Santaniello, a Vice President and counsel in Disney's legal department, began to embody in a draft OEA the terms that Russell and Goldman had agreed upon and had been memorialized in the OLA. In the process, Santaniello concluded that the $50 million guarantee created negative tax implications for Disney, because it might not be deductible. Concluding that the guarantee should be eliminated, Russell initiated discussions on how to compensate Ovitz for this change. What resulted were several amendments to the OEA to replace the back-end guarantee. The (to-be-eliminated) $50 million guarantee would be replaced by: (i) a reduction in the option strike price from 115% to 100% of the Company's stock price on the day of the grant for the two million options that would become exercisable in the sixth and seventh year of Ovitz's employment; (ii) a $10 million severance payment if the Company did not renew Ovitz's contract; and (iii) an alteration of the renewal option to provide for a five-year extension, a $1.25 million annual salary, the same bonus structure as the first five years of the contract, and a grant of three million additional options. To assess the potential consequences of the proposed changes, Watson worked with Russell and Crystal, who applied the Black-Scholes method to evaluate the extended exercisability features of the options. Watson also generated his own separate analysis.
On September 26, 1995, the Disney compensation committee (which consisted of Messrs. Russell, Watson, Poitier and Lozano) met for one hour to consider, among other agenda items, the proposed terms of the OEA. A term sheet was distributed at the meeting, although a draft of the OEA was not. The topics discussed were historical comparables, such as Eisner's and Wells' option grants, and also the factors that Russell, Watson and Crystal had considered in setting the size of the option grants and the termination provisions of the contract. Watson testified that he provided the compensation committee with the spreadsheet analysis that he had performed in August, and discussed his findings with the committee.[13] Crystal did not attend the meeting, although he was available by telephone to respond to questions if needed, but no one from the committee called. After Russell's and Watson's presentations, Litvack also responded to substantive questions. At trial Poitier and Lozano testified that they believed they had received sufficient information from Russell's and Watson's presentations to exercise their judgment in the best interests of the Company. The committee voted unanimously to approve the OEA terms, subject to "reasonable further negotiations within the framework of the terms and conditions" described in the OEA.
[41] Immediately after the compensation committee meeting, the Disney board met in executive session. The board was told about the reporting structure to which Ovitz had agreed, but the initial negative reaction of Litvack and Bollenbach to the hiring was not recounted. Eisner led the discussion relating to Ovitz, and Watson then explained his analysis, and both Watson and Russell responded to questions from the board. After further deliberation, the board voted unanimously to elect Ovitz as President.
At its September 26, 1995 meeting, the compensation committee determined that it would delay the formal grant of Ovitz's stock options until further issues between Ovitz and the Company were resolved. That was done, and the committee met again, on October 16, 1995, to discuss stock option-related issues. The committee approved amendments to the Walt Disney Company 1990 Stock Incentive Plan (the "1990 Plan"), and also approved a new plan, known as the Walt Disney 1995 Stock Incentive Plan (the "1995 Plan"). Both plans were subject to further approval by the full board of directors and the shareholders. Both the amendment to the 1990 Plan and the Stock Option Agreement provided that in the event of a non-fault termination ("NFT"), Ovitz's options would be exercisable until the later of September 30, 2002 or twenty-four months after termination, but in no event later than October 16, 2005. After approving those Plans, the committee unanimously approved the terms of the OEA and the award of Ovitz's options under the 1990 Plan.
B. Ovitz's Performance As President of Disney
Ovitz's tenure as President of the Walt Disney Company officially began on October 1, 1995, the date that the OEA was executed.[14] When Ovitz took office, the initial reaction was optimistic, and Ovitz did make some positive contributions while serving as President of the Company.[15] [42] By the fall of 1996, however, it had become clear that Ovitz was "a poor fit with his fellow executives."[16] By then the Disney directors were discussing that the disconnect between Ovitz and the Company was likely irreparable and that Ovitz would have to be terminated.
The Court of Chancery identified three competing theories as to why Ovitz did not succeed:
First, plaintiffs argue that Ovitz failed to follow Eisner's directives, especially in regard to acquisitions, and that generally, Ovitz did very little. Second, Ovitz contends Eisner's micromanaging prevented Ovitz from having the authority necessary to make the changes that Ovitz thought were appropriate. In addition, Ovitz believes he was not given enough time for his efforts to bear fruit. Third, the remaining defendants simply posit that Ovitz failed to transition from a private to a public company, from the "sell side to the buy side," and otherwise did not adapt to the Company culture or fit in with other executives. In the end, however, it makes no difference why Ovitz was not as successful as his reputation would have led many to expect, so long as he was not grossly negligent or malfeasant.[17]
Although the plaintiffs attempted to show that Ovitz acted improperly (i.e., with gross negligence or malfeasance) while in office, the Chancellor found that the trial record did not support those accusations.[18] Rejecting the plaintiffs' first factual claim that Ovitz was insubordinate, the Court found that although many of Ovitz's efforts failed to produce results, that was because his efforts often reflected a philosophy opposite to "that held by Eisner, Iger, and Roth."[19] That difference did not mean, however, "that Ovitz intentionally failed to follow Eisner's directives or that [Ovitz] was insubordinate."[20]
The Chancellor also rejected the appellants' second claim—that Ovitz was a habitual liar. The Court found no evidence that Ovitz ever told a material falsehood or made any false or misleading disclosures during his tenure at Disney.[21] Lastly, the Chancellor found that the record did not support, and often contradicted, the appellants' third claim—that Ovitz had violated the Company's policies relating to expenses and to reporting gifts he received while President of Disney.[22]
Nonetheless, Ovitz's relationship with the Disney executives did continue to deteriorate through September 1996. In mid-September, Litvack, with Eisner's approval, told Ovitz that he was not working out at Disney and that he should start looking for a graceful exit from Disney and a new job. Litvack reported this conversation to Eisner, who sent Litvack back to Ovitz to make it clear that Eisner no longer wanted Ovitz at Disney and that Ovitz should seriously consider other opportunities, including one then developing at Sony. Ovitz responded by telling Litvack that he was not leaving and that if Eisner wanted him [43] to leave Disney, Eisner could tell him that to his face.
On September 30, 1996, the Disney board met. During an executive session of that meeting, and in small group discussions where Ovitz was not present, Eisner told the other board members of the continuing problems with Ovitz's performance. On October 1, Eisner wrote a letter to Russell and Watson detailing Eisner's mounting difficulties with Ovitz, including Eisner's lack of trust of Ovitz and Ovitz's failures to adapt to Disney's culture and to alleviate Eisner's workload. Eisner's goal in writing this letter was to prevent Ovitz from succeeding him at Disney. Because of that purpose, the Chancellor found that the letter contained "a good deal of hyperbole to help Eisner `unsell' Ovitz as his successor."[23] Neither that letter nor its contents were shared with other members of the board.
Those interchanges set the stage for Ovitz's eventual termination as Disney's President.
C. Ovitz's Termination At Disney
After the discussions between Litvack and Ovitz, Eisner and Ovitz met several times. During those meetings they discussed Ovitz's future, including Ovitz's employment prospects at Sony. Eisner believed that because Ovitz had a good, longstanding relationship with many Sony senior executives, Sony would be willing to take Ovitz in "trade" from Disney. Eisner favored such a trade, which would not only remove Ovitz from Disney, but also would relieve Disney of any obligation to pay Ovitz under the OEA. Thereafter, in October 1996, Ovitz, with Eisner's permission, entered into negotiations with Sony. Those negotiations did not prove fruitful, however. On November 1, Ovitz wrote a letter to Eisner notifying him that the Sony negotiations had ended, and that Ovitz had decided to recommit himself to Disney with a greater dedication of his own energies and an increased appreciation of the Disney organization.
In response to this unwelcome news, Eisner wrote (but never sent) a letter to Ovitz on November 11, in which Eisner attempted to make it clear that Ovitz was no longer welcome at Disney.[24] Instead of sending that letter, Eisner met with Ovitz personally on November 13, and discussed much of what the letter contained. Eisner left that meeting believing that "Ovitz just would not listen to what he was trying to tell him and instead, Ovitz insisted that he would stay at Disney, going so far as to state that he would chain himself to his desk."[25]
During this period Eisner was also working with Litvack to explore whether they could terminate Ovitz under the OEA for cause. If so, Disney would not owe Ovitz the NFT payment. From the very beginning, Litvack advised Eisner that he did not believe there was cause to terminate Ovitz under the OEA. Litvack's advice never changed.
At the end of November 1996, Eisner again asked Litvack if Disney had cause to fire Ovitz and thereby avoid the costly NFT payment. Litvack proceeded to examine that issue more carefully. He studied the OEA, refreshed himself on the meaning of "gross negligence" and "malfeasance," and reviewed all the facts [44] concerning Ovitz's performance of which he was aware. Litvack also consulted Val Cohen, co-head of Disney's litigation department and Joseph Santaniello, in Disney's legal department. Cohen and Santaniello both concurred in Litvack's conclusion that no basis existed to terminate Ovitz for cause. Litvack did not personally conduct any legal research or request an outside opinion on the issue, because he believed that it "was not a close question, and in fact, Litvack described it as `a no brainer.'"[26] Eisner testified that after Litvack notified Eisner that he did not believe cause existed, Eisner "checked with almost anybody that [he] could find that had a legal degree, and there was just no light in that possibility. It was a total dead end from day one."[27] Although the Chancellor was critical of Litvack and Eisner for lacking sufficient documentation to support his conclusion and the work they did to arrive at that conclusion, the Court found that Eisner and Litvack "did in fact make a concerted effort to determine if Ovitz could be terminated for cause, and that despite these efforts, they were unable to manufacture the desired result."[28]
Litvack also believed that it would be inappropriate, unethical and a bad idea to attempt to coerce Ovitz (by threatening a for-cause termination) into negotiating for a smaller NFT package than the OEA provided. The reason was that when pressed by Ovitz's attorneys, Disney would have to admit that in fact there was no cause, which could subject Disney to a wrongful termination lawsuit. Litvack believed that attempting to avoid legitimate contractual obligations would harm Disney's reputation as an honest business partner and would affect its future business dealings.
The Disney board next met on November 25. By then the board knew Ovitz was going to be fired, yet the only action recorded in the minutes concerning Ovitz was his renomination to a new three-year term on the board. Although that action was somewhat bizarre given the circumstances, Stanley Gold, a Disney director, testified that because Ovitz was present at that meeting, it would have been a "public hanging" not to renominate him.[29] An executive session took place after the board meeting, from which Ovitz was excluded. At that session, Eisner informed the directors who were present that he intended to fire Ovitz by year's end, and that he had asked Gary Wilson, a board member and friend of Ovitz, to speak with Ovitz while Wilson and Ovitz were together on vacation during the upcoming Thanksgiving holiday.[30]
Shortly after the November 25 board meeting and executive session, the Ovitz and Wilson families left on their yacht for a Thanksgiving trip to the British Virgin Islands. Ovitz hoped that if he could manage [45] to survive at Disney until Christmas, he could fix everything with Disney and make his problems go away. Wilson quickly dispelled that illusion, informing Ovitz that Eisner wanted Ovitz out of the Company. At that point Ovitz first began to realize how serious his situation at Disney had become. Reporting back his conversation with Ovitz, Wilson told Eisner that Ovitz was a "loyal friend and devastating enemy,"[31] and he advised Eisner to "be reasonable and magnanimous, both financially and publicly, so Ovitz could save face."[32]
After returning from the Thanksgiving trip, Ovitz met with Eisner on December 3, to discuss his termination. Ovitz asked for several concessions, all of which Eisner ultimately rejected. Eisner told Ovitz that all he would receive was what he had contracted for in the OEA.
On December 10, the Executive Performance Plan Committee met to consider annual bonuses for Disney's most highly compensated executive officers. At that meeting, Russell informed those in attendance[33] that Ovitz was going to be terminated, but without cause.[34]
On December 11, Eisner met with Ovitz to agree on the wording of a press release to announce the termination, and to inform Ovitz that he would not receive any of the additional items that he requested. By that time it had already been decided that Ovitz would be terminated without cause and that he would receive his contractual NFT payment, but nothing more. Eisner and Ovitz agreed that neither Ovitz nor Disney would disparage each other in the press, and that the separation was to be undertaken with dignity and respect for both sides. After his December 11 meeting with Eisner, Ovitz never returned to Disney.
Ovitz's termination was memorialized in a letter, dated December 12, 1996, that Litvack signed on Eisner's instruction. The board was not shown the letter, nor did it meet to approve its terms. A press release announcing Ovitz's termination was issued that same day. Before the press release was issued, Eisner attempted to contact each of the board members by telephone to notify them that Ovitz had been officially terminated. None of the board members at that time, or at any other time, objected to Ovitz's termination, and most, if not all, of them thought it was the appropriate step for Eisner to take.[35] Although the board did not meet to vote on the termination, the Chancellor found that most, if not all, of the Disney directors trusted Eisner's and Litvack's conclusion that there was no cause to terminate Ovitz, and that Ovitz should be terminated without cause even though that involved making the costly NFT payment.[36]
[46] A December 27, 1996 letter from Litvack to Ovitz, which Ovitz signed, memorialized the termination, accelerated Ovitz's departure date from January 31, 1997 to December 31, 1996, and informed Ovitz that he would receive roughly $38 million in cash and that the first tranche of three million options would vest immediately. By the terms of that letter agreement, Ovitz's tenure as an executive and a director of Disney officially ended on December 27, 1996. Shortly thereafter, Disney paid Ovitz what was owed under the OEA for an NFT, minus a holdback of $1 million pending final settlement of Ovitz's accounts. One month after Disney paid Ovitz, the plaintiffs filed this action.
II. SUMMARY OF APPELLANTS' CLAIMS OF ERROR
As noted earlier, the Court of Chancery rejected all of the plaintiff-appellants' claims on the merits and entered judgment in favor of the defendant-appellees on all counts. On appeal, the appellants claim that the adverse judgment rests upon multiple erroneous rulings and should be reversed, because the 1995 decision to approve the OEA and the 1996 decision to terminate Ovitz on a non-fault basis, resulted from various breaches of fiduciary duty by Ovitz and the Disney directors.
The appellants' claims of error are most easily analyzed in two separate groupings: (1) the claims against the Disney defendants and (2) the claims against Ovitz. The first category encompasses the claims that the Disney defendants breached their fiduciary duties to act with due care and in good faith by (1) approving the OEA, and specifically, its NFT provisions; and (2) approving the NFT severance payment to Ovitz upon his termination—a payment that is also claimed to constitute corporate waste. It is notable that the appellants do not contend that the Disney defendants are directly liable as a consequence of those fiduciary duty breaches. Rather, appellants' core argument is indirect, i.e., that those breaches of fiduciary duty deprive the Disney defendants of the protection of business judgment review, and require them to shoulder the burden of establishing that their acts were entirely fair to Disney. That burden, the appellants contend, the Disney defendants failed to carry.[37] The appellants claim that by ruling that the Disney defendants did not breach their fiduciary duty to act with due care or in good faith, the Court of Chancery committed reversible error in numerous respects.[38] Alternatively, the [47] appellants claim that even if the business judgment presumptions apply, the Disney defendants are nonetheless liable, because the NFT payout constituted corporate waste and the Court of Chancery erred in concluding otherwise.[39]
Falling into the second category are the claims being advanced against Ovitz. Appellants claim that Ovitz breached his fiduciary duties of care and loyalty to Disney by (i) negotiating for and accepting the NFT severance provisions of the OEA, and (ii) negotiating a full NFT payout in connection with his termination.[40] The appellants' position is that by concluding that Ovitz breached no fiduciary duty owed to Disney, the Court of Chancery reversibly erred in several respects.
In this Opinion we address these two groups of claims in reverse order. In Part III, we analyze the claims relating to Ovitz. In Part IV, we address the claims asserted against the Disney defendants.
III. THE CLAIMS AGAINST OVITZ
The appellants argue that the Chancellor erroneously rejected their claims against Ovitz on two distinct grounds. We analyze them separately.
A. Claims Based Upon Ovitz's Conduct Before Assuming Office At Disney
First, appellants contend that the Court of Chancery erred by dismissing their claim, as a summary judgment matter, that Ovitz had breached his fiduciary duties to Disney by negotiating and entering into the OEA. On summary judgment the Chancellor determined that Ovitz had breached no fiduciary duty to Disney, because Ovitz did not become a fiduciary until he formally assumed office on October 1, 1995, by which time the essential terms of the NFT provision had been negotiated. Therefore, the Court of Chancery held, Ovitz's pre-October 1 conduct was not constrained by any fiduciary duty standard.
That ruling was erroneous, appellants argue, because even though Ovitz did not formally assume the title of President until October 1, 1995, he became a de facto fiduciary before then. As a result, the entire OEA negotiation process became subject to a fiduciary review standard. [48] That conclusion is compelled, appellants urge, because Ovitz's substantial contacts with third parties, and his receipt of confidential Disney information and request for reimbursement of expenses before October 1, prove that Eisner and Disney had already vested Ovitz with at least apparent authority before his formal investiture in office. Therefore, summary judgment was inappropriate, not only for those reasons but also because before summary judgment was granted, Ovitz failed to produce his work files that would have established his de facto status. Lastly, appellants contend that even if Ovitz was not a fiduciary until October 1, he is still liable for negotiating the NFT provisions because the OEA was considerably revised after October 1 and did not become final until December 1995. At the very least, issues of fact concerning those revisions should have precluded summary judgment.
On appeal from a decision granting summary judgment, this Court reviews the entire record to determine whether the Chancellor's findings are clearly supported by the record and whether the conclusions drawn from those findings are the product of an orderly and logical reasoning process.[41] This Court does not draw its own conclusions with respect to those facts unless the record shows that the trial court's findings are clearly wrong and justice so requires.[42] Whether the Chancellor correctly formulated the legal standard for determining if Ovitz owed a fiduciary duty to Disney during the OEA negotiations presents a question of law that this Court reviews de novo.[43] Under any and all of these standards of review, the appellants have failed to persuade us that the Chancellor committed any error of fact or law.
As a threshold matter, the appellants' de facto fiduciary argument is procedurally barred, because it was never fairly presented to the Court of Chancery. Only questions fairly presented to the trial court are properly before this Court for review.[44] In the Court of Chancery the appellants, as plaintiffs, never opposed the Ovitz motion for summary judgment on the ground that Ovitz was a de facto officer, nor did they move for reconsideration of the summary judgment motion after they received (post-summary judgment) the documents they contend should have been produced to them earlier.[45]
In any event, the de facto officer argument lacks merit, both legally and factually. A de facto officer is one who actually assumes possession of an office under the claim and color of an election or appointment and who is actually discharging the duties of that office, but for some legal reason lacks de jure legal title to that office.[46] Here, Ovitz did not assume, or [49] purport to assume, the duties of the Disney presidency before October 1, 1995. In his post-trial Opinion, the Chancellor found as fact that all of Ovitz's pre-October 1 conduct upon which appellants rely to establish de facto officer status, represented Ovitz's preparations to assume the duties of President after he was formally in office.[47] The record amply supports those findings.
Similarly unavailing is the appellants' alternative argument that even if Ovitz did not become a fiduciary until October 1, his negotiation of the OEA must nonetheless be measured by fiduciary standards, because the OEA did not become final until December 1995, and because between October 1 and December 1995, substantial redrafting of the OEA had occurred. This argument lacks merit because the critical terms of Ovitz's employment that are at issue in this lawsuit were found to have been agreed to before Ovitz assumed office on October 1. The Chancellor further found that any changes negotiated after October 1 were not material. The appellants have not shown that those findings are clearly wrong.[48]
B. Claims Based Upon Ovitz's Conduct During His Termination As President
The appellants' second claim is that the Court of Chancery erroneously concluded that Ovitz breached no fiduciary duty, including his duty of loyalty, by receiving the NFT payment upon his termination as President of Disney. The Chancellor found:
Ovitz did not breach his fiduciary duty of loyalty by receiving the NFT payment because he played no part in the decisions: (1) to be terminated and (2) that the termination would not be for cause under the OEA. Ovitz did possess fiduciary duties as a director and officer while these decisions were made, but by not improperly interjecting himself into the corporation's decisionmaking process nor manipulating that process, he did not breach the fiduciary duties he possessed in that unique circumstance. Furthermore, Ovitz did not "engage" in a transaction with the corporation—rather, the corporation imposed an unwanted transaction upon him.
Once Ovitz was terminated without cause (as a result of decisions made entirely without input or influence from Ovitz), he was contractually entitled, without any negotiation or action on his part, to receive the benefits provided by the OEA for a termination without cause, benefits for which he negotiated at arm's length before becoming a fiduciary.[49]
The appellants claim that these findings are reversible error, because the contemporaneous evidence shows that Ovitz was not fired but, rather, acted to "settle out his contract."[50] In those circumstances, appellants urge, Ovitz had a fiduciary duty [50] to convene a board meeting to consider terminating him for cause—a duty that he failed to observe.
These arguments amount essentially to an attack upon the trial court's factual findings. To the extent those findings turn on determinations of the credibility of live witness testimony and the acceptance or rejection of particular items of testimony, those findings will be upheld.[51] To the extent the challenged factual findings do not turn on the credibility of live witnesses, this Court will accept those findings if they are supported by the evidence and are the product of an orderly and logical reasoning process.[52] And, insofar as this claim of error challenges the Chancellor's legal rulings, we review those rulings de novo.[53] The appellants' arguments fail to pass muster under any of these standards.
The record establishes overwhelmingly that Ovitz did not leave Disney voluntarily. Nor did Ovitz arrange beforehand with Eisner to structure his departure as a termination without cause. To be sure, the evidence upon which the appellants rely does show that Ovitz fought being forced out every step of the way, but in the end, Ovitz had no choice but to accept the inevitable. As the trial court found, "Ovitz did not `engage' in a transaction with the corporation—rather, the corporation imposed an unwanted transaction upon him."[54] Every witness with personal knowledge of the events confirmed the unilateral, involuntary nature of Ovitz's termination in credible and colorful detail. The Chancellor credited the testimony of those witnesses, and the appellants have not shown that the Court exercised its fact finding powers inappropriately.
Nor is there any basis to overturn the Court of Chancery's finding that Ovitz played no role in the directors' decision to terminate him without cause. At trial the plaintiff-appellants attempted to prove that Ovitz had colluded with Eisner and others to obtain an NFT payment to which he was not entitled. The Chancellor found the facts to be otherwise, and ample evidence supports that finding. The record shows that the discussions between Eisner and Litvack as to the nature of the termination took place outside of Ovitz's presence and knowledge. At no point before this litigation was Ovitz ever told that Disney had even considered a for-cause termination a possibility. And, it is undisputed that Ovitz made no attempt to influence the board during that process.[55]
That brings us to the appellants' final Ovitz-related claim, which is that Ovitz breached a fiduciary duty to Disney by not convening a meeting of the Disney board to consider terminating him for cause. That argument is defective both legally and factually. The appellants cite no authority recognizing such a duty in these circumstances. That comes as no surprise, given the Chancellor's affirmation of Litvack's legal conclusion that no [51] board action was required to terminate Ovitz and that no basis existed to terminate him for cause.[56] The argument also fails factually because Ovitz never knew that a termination for cause was being considered. As the Court of Chancery stated:
No reasonably prudent fiduciary in Ovitz's position would have unilaterally determined to call a board meeting to force the corporation's chief executive officer to reconsider his termination and the terms thereof, with that reconsideration for the benefit of shareholders and potentially to Ovitz's detriment.
Furthermore, having just been terminated, no reasonably prudent fiduciary in Ovitz's shoes would have insisted on a board meeting to discuss and ratify his termination after being terminated by the corporation's chief executive officer (with guidance and assistance from the Company's general counsel). Just as Delaware law does not require directors-to-be to comply with their fiduciary duties, former directors owe no fiduciary duties, and after December 27, 1996, Ovitz could not breach a duty he no longer had.[57]
The Court of Chancery determined that Ovitz did not breach any fiduciary duty that he owed to Disney when negotiating for, or when receiving severance payments under, the non-fault termination clause of the OEA. The Court made no error in arriving at that determination and we uphold it.[58]
IV. THE CLAIMS AGAINST THE DISNEY DEFENDANTS
We next turn to the claims of error that relate to the Disney defendants. Those claims are subdivisible into two groups: (A) claims arising out of the approval of the OEA and of Ovitz's election as President; and (B) claims arising out of the NFT severance payment to Ovitz upon his termination. We address separately those two categories and the issues that they generate.
A. Claims Arising From The Approval Of The OEA And Ovitz's Election As President
As earlier noted, the appellants' core argument in the trial court was that the Disney defendants' approval of the OEA and election of Ovitz as President were not entitled to business judgment rule protection, because those actions were either grossly negligent or not performed in good faith. The Court of Chancery rejected these arguments, and held that the appellants had failed to prove that the Disney defendants had breached any fiduciary duty.
For clarity of presentation we address the claimed errors relating to the fiduciary duty of care rulings separately from those that relate to the directors' fiduciary duty to act in good faith.
[52] 1. The Due Care Determinations
The plaintiff-appellants advance five contentions to support their claim that the Chancellor reversibly erred by concluding that the plaintiffs had failed to establish a violation of the Disney defendants' duty of care. The appellants claim that the Chancellor erred by: (1) treating as distinct questions whether the plaintiffs had established by a preponderance of the evidence either gross negligence or a lack of good faith; (2) ruling that the old board was not required to approve the OEA; (3) determining whether the old board had breached its duty of care on a director-by-director basis rather than collectively; (4) concluding that the compensation committee members did not breach their duty of care in approving the NFT provisions of the OEA; and (5) holding that the remaining members of the old board (i.e., the directors who were not members of the compensation committee) had not breached their duty of care in electing Ovitz as Disney's President.
To the extent that these claims attack legal rulings of the Court of Chancery we review them de novo.[59] To the extent they attack the Court's factual findings, those findings will be upheld where they are based on the Chancellor's assessment of live testimony.[60] The issue these claims present is whether the Court of Chancery legally (and reversibly) erred in one or more of the foregoing respects. We conclude that the Chancellor committed no error.
(a) TREATING DUE CARE AND BAD FAITH AS SEPARATE GROUNDS FOR DENYING BUSINESS JUDGMENT RULE REVIEW
This argument is best understood against the backdrop of the presumptions that cloak director action being reviewed under the business judgment standard. Our law presumes that "in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company."[61] Those presumptions can be rebutted if the plaintiff shows that the directors breached their fiduciary duty of care or of loyalty or acted in bad faith. If that is shown, the burden then shifts to the director defendants to demonstrate that the challenged act or transaction was entirely fair to the corporation and its shareholders.[62]
Because no duty of loyalty claim was asserted against the Disney defendants, the only way to rebut the business judgment rule presumptions would be to show that the Disney defendants had either breached their duty of care or had not acted in good faith. At trial, the plaintiff-appellants attempted to establish both grounds, but the Chancellor determined that the plaintiffs had failed to prove either.
The appellants' first claim is that the Chancellor erroneously (i) failed to make a "threshold determination" of gross negligence, and (ii) "conflated" the appellants' [53] burden to rebut the business judgment presumptions, with an analysis of whether the directors' conduct fell within the 8 Del. C. § 102(b)(7) provision that precludes exculpation of directors from monetary liability "for acts or omissions not in good faith." The argument runs as follows: Emerald Partners v. Berlin[63] required the Chancellor first to determine whether the business judgment rule presumptions were rebutted based upon a showing that the board violated its duty of care, i.e., acted with gross negligence. If gross negligence were established, the burden would shift to the directors to establish that the OEA was entirely fair. Only if the directors failed to meet that burden could the trial court then address the directors' Section 102(b)(7) exculpation defense, including the statutory exception for acts not in good faith.
This argument lacks merit. To make the argument the appellants must ignore the distinction between (i) a determination of bad faith for the threshold purpose of rebutting the business judgment rule presumptions, and (ii) a bad faith determination for purposes of evaluating the availability of charter-authorized exculpation from monetary damage liability after liability has been established. Our law clearly permits a judicial assessment of director good faith for that former purpose.[64] Nothing in Emerald Partners requires the Court of Chancery to consider only evidence of lack of due care (i.e. gross negligence) in determining whether the business judgment rule presumptions have been rebutted.
Even if the trial court's analytical approach were improper, the appellants have failed to demonstrate any prejudice. The Chancellor's determinations of due care and good faith were analytically distinct and were separately conducted, even though both were done for the purpose of deciding whether to apply the business judgment standard of review. Nowhere have the appellants shown that the result would have been any different had the Chancellor proceeded in the manner that they now advocate.
(b) RULING THAT THE FULL DISNEY BOARD WAS NOT REQUIRED TO CONSIDER AND APPROVE THE OEA
The appellants next challenge the Court of Chancery's determination that the full Disney board was not required to consider and approve the OEA, because the Company's governing instruments allocated that decision to the compensation committee.[65] This challenge also cannot survive scrutiny.
As the Chancellor found, under the Company's governing documents the board of directors was responsible for selecting the corporation's officers, but under the compensation committee charter, the committee was responsible for establishing and approving the salaries, together with benefits and stock options, of the Company's CEO and President.[66] The compensation committee also had the charter-imposed duty to "approve employment contracts, or contracts at will" for "all corporate officers who are members of the Board of Directors regardless of salary."[67] That is exactly what occurred here. The full board ultimately selected Ovitz as President, [54] [68] and the compensation committee considered and ultimately approved the OEA, which embodied the terms of Ovitz's employment, including his compensation.
The Delaware General Corporation Law (DGCL) expressly empowers a board of directors to appoint committees and to delegate to them a broad range of responsibilities,[69] which may include setting executive compensation. Nothing in the DGCL mandates that the entire board must make those decisions. At Disney, the responsibility to consider and approve executive compensation was allocated to the compensation committee, as distinguished from the full board. The Chancellor's ruling—that executive compensation was to be fixed by the compensation committee—is legally correct.
The appellants base their contrary argument upon their reading of this Court's opinion in Brehm v. Eisner.[70] A "central holding" of Brehm, which the appellants claim is the "law of the case," is that the Disney board had a duty to approve the OEA because of its materiality. The appellants misread Brehm. There, in upholding a dismissal of the complaint in a procedural setting where the complaint's well-pled allegations must be taken as true, we observed that "in this case the economic exposure of the corporation to the payout scenarios of the Ovitz contract was material, particularly given its large size, for purposes of the directors' decision-making process."[71] Contrary to the appellant's position, that observation is not the law of the case, because in Brehm this Court was not addressing, and did not have before it, the question of whether it was the exclusive province of the full board (as distinguished from a committee of the board) to approve the terms of the contract. That issue did not arise until the trial, during which a complete record was made. Therefore, in deciding the issue of which body—the full board or the compensation committee—was empowered to approve the OEA, the Chancellor was not constrained by any pronouncement made in Brehm.[72]
[55] (c) WHETHER THE BOARD MEMBERS' OBSERVANCE OF THEIR DUTY OF CARE SHOULD HAVE BEEN DETERMINED ON A DIRECTOR-BY-DIRECTOR BASIS OR COLLECTIVELY
In the Court of Chancery the appellants argued that the board had failed to exercise due care, using a director-by-director, rather than a collective analysis. In this Court, however, the appellants argue that the Chancellor erred in following that very approach. An about-face, the appellants now claim that in determining whether the board breached its duty of care, the Chancellor was legally required to evaluate the actions of the old board collectively.
We reject this argument, without reaching its merits, for two separate reasons. To begin with, the argument is precluded by Rule 8 of this Court, which provides that arguments not fairly presented to the trial court will not be considered by this Court.[73] The appellants' "individual vs. collective" argument goes beyond being not fairly presented. It borders on being unfairly presented, since the appellants are taking the trial court to task for adopting the very analytical approach that they themselves used in presenting their position.
The argument also fails because nowhere do appellants identify how this supposed error caused them any prejudice. The Chancellor viewed the conduct of each director individually, and found that no director had breached his or her fiduciary duty of care (as members of the full board) in electing Ovitz as President or (as members of the compensation committee) in determining Ovitz's compensation. If, as appellants now argue, a due care analysis of the board's conduct must be made collectively, it is incumbent upon them to show how such a collective analysis would yield a different result. The appellants' failure to do that dooms their argument on this basis as well.
(d) HOLDING THAT THE COMPENSATION COMMITTEE MEMBERS DID NOT FAIL TO EXERCISE DUE CARE IN APPROVING THE OEA
The appellants next challenge the Chancellor's determination that although the compensation committee's decision-making process fell far short of corporate governance "best practices," the committee members breached no duty of care in considering and approving the NFT terms of the OEA. That conclusion is reversible error, the appellants claim, because the record establishes that the compensation committee members did not properly inform themselves of the material facts and, hence, were grossly negligent in approving the NFT provisions of the OEA.
The appellants advance five reasons why a reversal is compelled: (i) not all committee members reviewed a draft of the OEA; (ii) the minutes of the September 26, 1995 compensation committee meeting do not recite any discussion of the grounds for which Ovitz could receive a non-fault termination; (iii) the committee members did not consider any comparable employment agreements or the economic impact of extending the exercisability of the options being granted to Ovitz; (iv) Crystal did not attend the September 26, 1995 committee meeting, nor was his letter distributed to or discussed with Poitier and Lozano; and (v) Poitier and Lozano did not review the spreadsheets generated by Watson. These contentions amount essentially to an [56] attack upon underlying factual findings that will be upheld where they result from the Chancellor's assessment of live testimony.[74]
Although the appellants have balkanized their due care claim into several fragmented parts, the overall thrust of that claim is that the compensation committee approved the OEA with NFT provisions that could potentially result in an enormous payout, without informing themselves of what the full magnitude of that payout could be. Rejecting that claim, the Court of Chancery found that the compensation committee members were adequately informed. The issue thus becomes whether that finding is supported by the evidence of record.[75] We conclude that it is.
In our view, a helpful approach is to compare what actually happened here to what would have occurred had the committee followed a "best practices" (or "best case") scenario, from a process standpoint. In a "best case" scenario, all committee members would have received, before or at the committee's first meeting on September 26, 1995, a spreadsheet or similar document prepared by (or with the assistance of) a compensation expert (in this case, Graef Crystal). Making different, alternative assumptions, the spreadsheet would disclose the amounts that Ovitz could receive under the OEA in each circumstance that might foreseeably arise. One variable in that matrix of possibilities would be the cost to Disney of a non-fault termination for each of the five years of the initial term of the OEA. The contents of the spreadsheet would be explained to the committee members, either by the expert who prepared it or by a fellow committee member similarly knowledgeable about the subject. That spreadsheet, which ultimately would become an exhibit to the minutes of the compensation committee meeting, would form the basis of the committee's deliberations and decision.
Had that scenario been followed, there would be no dispute (and no basis for litigation) over what information was furnished to the committee members or when it was furnished. Regrettably, the committee's informational and decisionmaking process used here was not so tidy. That is one reason why the Chancellor found that although the committee's process did not fall below the level required for a proper exercise of due care, it did fall short of what best practices would have counseled.
The Disney compensation committee met twice: on September 26 and October 16, 1995. The minutes of the September 26 meeting reflect that the committee approved the terms of the OEA (at that time embodied in the form of a letter agreement), except for the option grants, which were not approved until October 16—after the Disney stock incentive plan had been amended to provide for those options. At the September 26 meeting, the compensation committee considered a "term sheet"[76] which, in summarizing the material terms of the OEA, relevantly disclosed that in the event of a non-fault termination, Ovitz would receive: (i) the present value of his salary ($1 million per year) for the balance of the contract term, (ii) the present value of his annual bonus payments (computed at $7.5 million) for the balance of the contract term, (iii) a $10 million termination fee, and (iv) the acceleration of his options for 3 million shares, [57] which would become immediately exercisable at market price.
Thus, the compensation committee knew that in the event of an NFT, Ovitz's severance payment alone could be in the range of $40 million cash,[77] plus the value of the accelerated options. Because the actual payout to Ovitz was approximately $130 million, of which roughly $38.5 million was cash, the value of the options at the time of the NFT payout would have been about $91.5 million.[78] Thus, the issue may be framed as whether the compensation committee members knew, at the time they approved the OEA, that the value of the option component of the severance package could reach the $92 million order of magnitude if they terminated Ovitz without cause after one year. The evidentiary record shows that the committee members were so informed.
On this question the documentation is far less than what best practices would have dictated. There is no exhibit to the minutes that discloses, in a single document, the estimated value of the accelerated options in the event of an NFT termination after one year. The information imparted to the committee members on that subject is, however, supported by other evidence, most notably the trial testimony of various witnesses about spreadsheets that were prepared for the compensation committee meetings.
The compensation committee members derived their information about the potential magnitude of an NFT payout from two sources. The first was the value of the "benchmark" options previously granted to Eisner and Wells and the valuations by Watson of the proposed Ovitz options. Ovitz's options were set at 75% of parity with the options previously granted to Eisner and to Frank Wells. Because the compensation committee had established those earlier benchmark option grants to Eisner and Wells and were aware of their value, a simple mathematical calculation would have informed them of the potential value range of Ovitz's options. Also, in August and September 1995, Watson and Russell met with Graef Crystal to determine (among other things) the value of the potential Ovitz options, assuming different scenarios. Crystal valued the options under the Black-Scholes method, while Watson used a different valuation metric. Watson recorded his calculations and the resulting values on a set of spreadsheets that reflected what option profits Ovitz might receive, based upon a range of different assumptions about stock market price increases. Those spreadsheets were shared with, and explained to, the committee members at the September meeting.
The committee's second source of information was the amount of "downside protection" that Ovitz was demanding. Ovitz required financial protection from the risk of leaving a very lucrative and secure position at CAA, of which he was a controlling partner, to join a publicly held corporation [58] to which Ovitz was a stranger, and that had a very different culture and an environment which prevented him from completely controlling his destiny. The committee members knew that by leaving CAA and coming to Disney, Ovitz would be sacrificing "booked" CAA commissions of $150 to $200 million—an amount that Ovitz demanded as protection against the risk that his employment relationship with Disney might not work out. Ovitz wanted at least $50 million of that compensation to take the form of an "up-front" signing bonus. Had the $50 million bonus been paid, the size of the option grant would have been lower. Because it was contrary to Disney policy, the compensation committee rejected the up-front signing bonus demand, and elected instead to compensate Ovitz at the "back end," by awarding him options that would be phased in over the five-year term of the OEA.
It is on this record that the Chancellor found that the compensation committee was informed of the material facts relating to an NFT payout. If measured in terms of the documentation that would have been generated if "best practices" had been followed, that record leaves much to be desired. The Chancellor acknowledged that, and so do we. But, the Chancellor also found that despite its imperfections, the evidentiary record was sufficient to support the conclusion that the compensation committee had adequately informed itself of the potential magnitude of the entire severance package, including the options, that Ovitz would receive in the event of an early NFT.
The OEA was specifically structured to compensate Ovitz for walking away from $150 million to $200 million of anticipated commissions from CAA over the five-year OEA contract term. This meant that if Ovitz was terminated without cause, the earlier in the contract term the termination occurred the larger the severance amount would be to replace the lost commissions. Indeed, because Ovitz was terminated after only one year, the total amount of his severance payment (about $130 million) closely approximated the lower end of the range of Ovitz's forfeited commissions ($150 million), less the compensation Ovitz received during his first and only year as Disney's President. Accordingly, the Court of Chancery had a sufficient evidentiary basis in the record from which to find that, at the time they approved the OEA, the compensation committee members were adequately informed of the potential magnitude of an early.NFT severance payout.
Exposing the lack of merit in appellants' core due care claim enables us to address more cogently (and expeditiously) the appellants' fragmented subsidiary arguments. First, the appellants argue that not all members of the compensation committee reviewed the then-existing draft of the OEA. The Chancellor properly found that that was not required, because in this case the compensation committee was informed of the substance of the OEA.[79]
Second, appellants point out that the minutes of the September 26 compensation committee meeting recite no discussion of the grounds for which Ovitz could receive a non-fault termination. But the term sheet did include a description of the consequences of a not-for-cause termination, and the Chancellor found that although "no one on the committee recalled any discussion concerning the meaning of gross [59] negligence or malfeasance," those terms "were not foreign to the board of directors, as the language was standard, and could be found, for example, in Eisner's, Wells', Katzenberg's and Roth's employment contracts."[80]
Third, contrary to the appellants' position, the compensation committee members did consider comparable employment agreements. The Chancellor found, as Russell's extensive notes demonstrated, that the comparable historical option grants that Russell analyzed at the September 26 meeting were the grants to Eisner and Wells. The evidence also lays to rest the claim that the compensation committee members did not consider the economic impact of the extended exercisability of the options being granted to Ovitz. Russell and Crystal had assessed the value of those options using the Black-Scholes and other valuation methods during the two weeks preceding the September 26 compensation committee meeting. Russell summarized those analyses at that meeting, and (as earlier discussed) at the time the compensation committee members approved the OEA, they were informed of the magnitude of those values in the event of an NFT.
Fourth, the appellants stress that Crystal did not make a report in person to the compensation committee at its September 26 meeting. Although that is true, it is undisputed that Crystal was available by phone if the committee members had questions that could not be answered by those who were present. Moreover, Russell and Watson related the substance of Crystal's analysis and information to the committee. The Court of Chancery noted (and we agree) that although it might have been the better course of action, it was "not necessary for an expert to make a formal presentation at the committee meeting in order for the board to rely on that expert's analysis. . . ."[81] Nor did the Chancellor find merit to the appellants' related argument that two committee members, Poitier and Lozano, were not entitled to rely upon the work performed by Russell, Watson and Crystal in August and September 1995, without having first seen all of the written materials generated during that process or having participated in the discussions held during that time. In reaching a contrary conclusion, the Chancellor found:
The compensation committee reasonably believed that the analysis of the terms of the OEA was within Crystal's professional or expert competence, and together with Russell and Watson's professional competence in those same areas, the committee relied on the information, opinions, reports and statements made by Crystal, even if Crystal did not relay the information, opinions, reports and statements in person to the committee as a whole. Crystal's analysis was not so deficient that the compensation committee would have reason to question it. Furthermore, Crystal appears to have been selected with reasonable care, especially in light of his previous engagements with the Company in connection with past executive compensation contracts that were structurally, at least, similar to the OEA. For all these reasons, the compensation committee also is entitled to the protections of 8 Del. C. § 141(e) in relying upon Crystal.[82]
The Chancellor correctly applied Section 141(e) in upholding the reliance of Lozano and Poitier upon the information that Crystal, Russell and Watson furnished to [60] them. To accept the appellants' narrow reading of that statute would eviscerate its purpose, which is to protect directors who rely in good faith upon information presented to them from various sources, including "any other person as to matters the member reasonably believes are within such person's professional or expert competence and who has been selected with reasonable care by and on behalf of the corporation."[83]
Finally, the appellants contend that Poitier and Lozano did not review the spreadsheets generated by Watson at the September 26 meeting. The short answer is that even if Poitier and Lozano did not review the spreadsheets themselves, Russell and Watson adequately informed them of the spreadsheets' contents. The Court of Chancery explicitly found, and the record supports, that Poitier and Lozano "were informed by Russell and Watson of all material information reasonably available, even though they were not privy to every conversation or document exchanged amongst Russell, Watson, Crystal, and Ovitz's representatives."[84]
For these reasons, we uphold the Chancellor's determination that the compensation committee members did not breach their fiduciary duty of care in approving the OEA.
(e) HOLDING THAT THE REMAINING DISNEY DIRECTORS DID NOT FAIL TO EXERCISE DUE CARE IN APPROVING THE HIRING OF OVITZ AS THE PRESIDENT OF DISNEY
The appellants' final claim in this category is that the Court of Chancery erroneously held that the remaining members of the old Disney board[85] had not breached their duty of care in electing Ovitz as President of Disney. This claim lacks merit, because the arguments appellants advance in this context relate to a different subject—the approval of the OEA, which was the responsibility delegated to the compensation committee, not the full board.
The appellants argue that the Disney directors breached their duty of care by failing to inform themselves of all material information reasonably available with respect to Ovitz's employment agreement. We need not dwell on the specifics of this argument, because in substance they repeat the gross negligence claims previously leveled at the compensation committee—claims that were rejected by the Chancellor and now also by this Court.[86] [61] The only properly reviewable action of the entire board was its decision to elect Ovitz as Disney's President. In that context the sole issue, as the Chancellor properly held, is "whether [the remaining members of the old board] properly exercised their business judgment and acted in accordance with their fiduciary duties when they elected Ovitz to the Company's presidency."[87] The Chancellor determined that in electing Ovitz, the directors were informed of all information reasonably available and, thus, were not grossly negligent. We agree.
The Chancellor found and the record shows the following: well in advance of the September 26, 1995 board meeting the directors were fully aware that the Company needed—especially in light of Wells' death and Eisner's medical problems—to hire a "number two" executive and potential successor to Eisner. There had been many discussions about that need and about potential candidates who could fill that role even before Eisner decided to try to recruit Ovitz. Before the September 26 board meeting Eisner had individually discussed with each director the possibility of hiring Ovitz, and Ovitz's background and qualifications. The directors thus knew of Ovitz's skills, reputation and experience, all of which they believed would be highly valuable to the Company. The directors also knew that to accept a position at Disney, Ovitz would have to walk away from a very successful business—a reality that would lead a reasonable person to believe that Ovitz would likely succeed in similar pursuits elsewhere in the industry. The directors also knew of the public's highly positive reaction to the Ovitz announcement, and that Eisner and senior management had supported the Ovitz hiring.[88] Indeed, Eisner, who had long desired to bring Ovitz within the Disney fold, consistently vouched for Ovitz's qualifications and told the directors that he could work well with Ovitz.
The board was also informed of the key terms of the OEA (including Ovitz's salary, bonus and options). Russell reported this information to them at the September 26, 1995 executive session, which was attended by Eisner and all non-executive directors. Russell also reported on the compensation committee meeting that had immediately preceded the executive session. And, both Russell and Watson responded to questions from the board. Relying upon the compensation committee's approval of the OEA[89] and the other information furnished to them, the Disney directors, after further deliberating, unanimously elected Ovitz as President.
Based upon this record, we uphold the Chancellor's conclusion that, when electing Ovitz to the Disney presidency the remaining Disney directors were fully informed of all material facts, and that the appellants [62] failed to establish any lack of due care on the directors' part.
2. The Good Faith Determinations
The Court of Chancery held that the business judgment rule presumptions protected the decisions of the compensation committee and the remaining Disney directors, not only because they had acted with due care but also because they had not acted in bad faith. That latter ruling, the appellants claim, was reversible error because the Chancellor formulated and then applied an incorrect definition of bad faith.
In its Opinion the Court of Chancery defined bad faith as follows:
Upon long and careful consideration, I am of the opinion that the concept of intentional dereliction of duty, a conscious disregard for one's responsibilities, is an appropriate (although not the only) standard for determining whether fiduciaries have acted in good faith. Deliberate indifference and inaction in the face of a duty to act is, in my mind, conduct that is clearly disloyal to the corporation. It is the epitome of faithless conduct.[90]
The appellants contend that definition is erroneous for two reasons. First they claim that the trial court had adopted a different definition in its 2003 decision denying the motion to dismiss the complaint, and the Court's post-trial (2005) definition materially altered the 2003 definition to appellants' prejudice. Their argument runs as follows: under the Chancellor's 2003 definition of bad faith, the directors must have "consciously and intentionally disregarded their responsibilities, adopting a `we don't care about the risks' attitude concerning a material corporate decision."[91] Under the 2003 formulation, appellants say, "directors violate their duty of good faith if they are making material decisions without adequate information and without adequate deliberation[,]"[92] but under the 2005 post-trial definition, bad faith requires proof of a subjective bad motive or intent. This definitional change, it is claimed, was procedurally prejudicial because appellants relied on the 2003 definition in presenting their evidence of bad faith at the trial. Without any intervening change in the law, the Court of Chancery could not unilaterally alter its definition and then hold the appellants to a higher, more stringent standard.
Second, the appellants claim that the Chancellor's post-trial definition of bad faith is erroneous substantively. They argue that the 2003 formulation was (and is) the correct definition, because it is "logically tied to board decision-making under the duty of care."[93] The post-trial formulation, on the other hand, "wrongly incorporated substantive elements regarding the rationality of the decisions under review rather than being constrained, as in a due care analysis, to strictly procedural criteria."[94] We conclude that both arguments must fail.[95]
[63] The appellants' first argument—that there is a real, significant difference between the Chancellor's pre-trial and post-trial definitions of bad faith—is plainly wrong. We perceive no substantive difference between the Court of Chancery's 2003 definition of bad faith—a "conscious[] and intentional[] disregard[] [of] responsibilities, adopting a `we don't care about the risks' attitude..."—and its 2005 post-trial definition—an "intentional dereliction of duty, a conscious disregard for one's responsibilities." Both formulations express the same concept, although in slightly different language.
The most telling evidence that there is no substantive difference between the two formulations is that the appellants are forced to contrive a difference. Appellants assert that under the 2003 formulation, "directors violate their duty of good faith if they are making material decisions without adequate information and without adequate deliberation."[96] For that ipse dixit they cite no legal authority.[97] That comes as no surprise because their verbal effort to collapse the duty to act in good faith into the duty to act with due care, is not unlike putting a rabbit into the proverbial hat and then blaming the trial judge for making the insertion.
The appellants essentially concede that their proof of bad faith is insufficient to satisfy the standard articulated by the Court of Chancery. That is why they ask this Court to treat a failure to exercise due care as a failure to act in good faith. Unfortunately for appellants, that "rule," even if it were accepted, would not help their case. If we were to conflate these two duties and declare that a breach of the duty to be properly informed violates the duty to act in good faith, the outcome would be no different, because, as the Chancellor and we now have held, the appellants failed to establish any breach of the duty of care. To say it differently, even if the Chancellor's definition of bad faith were erroneous, the error would not be reversible because the appellants cannot satisfy the very test they urge us to adopt.
For that reason, our analysis of the appellants' bad faith claim could end at this point. In other circumstances it would. This case, however, is one in which the duty to act in good faith has played a prominent role, yet to date is not a well-developed area of our corporate fiduciary law.[98] Although the good faith concept has recently been the subject of considerable scholarly writing,[99] which includes articles [64] focused on this specific case,[100] the duty to act in good faith is, up to this point relatively uncharted. Because of the increased recognition of the importance of good faith, some conceptual guidance to the corporate community may be helpful. For that reason we proceed to address the merits of the appellants' second argument.
The precise question is whether the Chancellor's articulated standard for bad faith corporate fiduciary conduct—intentional dereliction of duty, a conscious disregard for one's responsibilities—is legally correct. In approaching that question, we note that the Chancellor characterized that definition as "an appropriate (although not the only) standard for determining whether fiduciaries have acted in good faith."[101] That observation is accurate and helpful, because as a matter of simple logic, at least three different categories of fiduciary behavior are candidates for the "bad faith" pejorative label.
The first category involves so-called "subjective bad faith," that is, fiduciary conduct motivated by an actual intent to do harm. That such conduct constitutes classic, quintessential bad faith is a proposition so well accepted in the liturgy of fiduciary law that it borders on axiomatic.[102] We need not dwell further on this category, because no such conduct is claimed to have occurred, or did occur, in this case.
The second category of conduct, which is at the opposite end of the spectrum, involves lack of due care—that is, fiduciary action taken solely by reason of gross negligence and without any malevolent intent. In this case, appellants assert claims of gross negligence to establish breaches not only of director due care but also of the directors' duty to act in good faith. Although the Chancellor found, and we agree, that the appellants failed to establish gross negligence, to afford guidance we address the issue of whether gross negligence (including a failure to [65] inform one's self of available material facts), without more, can also constitute bad faith. The answer is clearly no.
From a broad philosophical standpoint, that question is more complex than would appear, if only because (as the Chancellor and others have observed) "issues of good faith are (to a certain degree) inseparably and necessarily intertwined with the duties of care and loyalty...."[103] But, in the pragmatic, conduct-regulating legal realm which calls for more precise conceptual line drawing, the answer is that grossly negligent conduct, without more, does not and cannot constitute a breach of the fiduciary duty to act in good faith. The conduct that is the subject of due care may overlap with the conduct that comes within the rubric of good faith in a psychological sense,[104] but from a legal standpoint those duties are and must remain quite distinct. Both our legislative history and our common law jurisprudence distinguish sharply between the duties to exercise due care and to act in good faith, and highly significant consequences flow from that distinction.
The Delaware General Assembly has addressed the distinction between bad faith and a failure to exercise due care (i.e., gross negligence) in two separate contexts. The first is Section 102(b)(7) of the DGCL, which authorizes Delaware corporations, by a provision in the certificate of incorporation, to exculpate their directors from monetary damage liability for a breach of the duty of care.[105] That exculpatory provision affords significant protection to directors of Delaware corporations. The statute carves out several exceptions, however, including most relevantly, "for acts or omissions not in good faith...."[106] Thus, a corporation can exculpate its directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith. To adopt a definition of bad faith that would cause a violation of the duty of care automatically to become an act or omission "not in good faith," would eviscerate the protections accorded to directors by the General Assembly's adoption of Section 102(b)(7).
A second legislative recognition of the distinction between fiduciary conduct that is grossly negligent and conduct that is not in good faith, is Delaware's indemnification statute, found at 8 Del. C. § 145. To oversimplify, subsections (a) and (b) of that statute permit a corporation to indemnify (inter alia) any person who is or was a director, officer, employee or agent of the corporation against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement of specified actions, suits or proceedings, where (among other things): (i) that person is, was, or is threatened to be made a party to that action, suit or proceeding, and (ii) that person "acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the [66] corporation...."[107] Thus, under Delaware statutory law a director or officer of a corporation can be indemnified for liability (and litigation expenses) incurred by reason of a violation of the duty of care, but not for a violation of the duty to act in good faith.
Section 145, like Section 102(b)(7), evidences the intent of the Delaware General Assembly to afford significant protections to directors (and, in the case of Section 145, other fiduciaries) of Delaware corporations.[108] To adopt a definition that conflates the duty of care with the duty to act in good faith by making a violation of the former an automatic violation of the latter, would nullify those legislative protections and defeat the General Assembly's intent. There is no basis in policy, precedent or common sense that would justify dismantling the distinction between gross negligence and bad faith.[109]
That leaves the third category of fiduciary conduct, which falls in between the first two categories of (1) conduct motivated by subjective bad intent and (2) conduct resulting from gross negligence. This third category is what the Chancellor's definition of bad faith—intentional dereliction of duty, a conscious disregard for one's responsibilities—is intended to capture. The question is whether such misconduct is properly treated as a non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith. In our view it must be, for at least two reasons.
First, the universe of fiduciary misconduct is not limited to either disloyalty in the classic sense (i.e., preferring the adverse self-interest of the fiduciary or of a related person to the interest of the corporation) or gross negligence. Cases have arisen where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed of all facts material to the decision. To protect the interests of the corporation and its shareholders, fiduciary conduct of this kind, which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed. A vehicle is needed to address such violations doctrinally, and that doctrinal vehicle is the duty to act in good faith. The Chancellor implicitly so recognized in his Opinion, where he identified different examples of bad faith as follows:
[67] The good faith required of a corporate fiduciary includes not simply the duties of care and loyalty, in the narrow sense that I have discussed them above, but all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.[110]
Those articulated examples of bad faith are not new to our jurisprudence. Indeed, they echo pronouncements our courts have made throughout the decades.[111]
Second, the legislature has also recognized this intermediate category of fiduciary misconduct, which ranks between conduct involving subjective bad faith and gross negligence. Section 102(b)(7)(ii) of the DGCL expressly denies money damage exculpation for "acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law." By its very terms that provision distinguishes between "intentional misconduct" and a "knowing violation of law" (both examples of subjective bad faith) on the one hand, and "acts...not in good faith," on the other. Because the statute exculpates directors only for conduct amounting to gross negligence, the statutory denial of exculpation for "acts...not in good faith" must encompass the intermediate category of misconduct captured by the Chancellor's definition of bad faith.
For these reasons, we uphold the Court of Chancery's definition as a legally appropriate, although not the exclusive, definition of fiduciary bad faith. We need go no further. To engage in an effort to craft (in the Court's words) "a definitive and categorical definition of the universe of acts that would constitute bad faith"[112] would be unwise and is unnecessary to dispose of the issues presented on this appeal.
Having sustained the Chancellor's finding that the Disney directors acted in good [68] faith when approving the OEA and electing Ovitz as President, we next address the claims arising out of the decision to pay Ovitz the amount called for by the NFT provisions of the OEA.
B. Claims Arising From The Payment Of The NFT Severance Payout To Ovitz
The appellants advance three alternative claims (each accompanied by assorted subsidiary arguments) whose overall thrust is that even if the OEA approval was legally valid, the NFT severance payout to Ovitz pursuant to the OEA was not. Specifically, the appellants contend that: (1) only the full Disney board with the concurrence of the compensation committee—but not Eisner alone—was authorized to terminate Ovitz; (2) because Ovitz could have been terminated for cause, Litvack and Eisner acted without due care and in bad faith in reaching the contrary conclusion; and (3) the business judgment rule presumptions did not protect the new Disney board's acquiescence in the NFT payout, because the new board was not entitled to rely upon Eisner's and Litvack's contrary advice. Appellants urge that in rejecting these claims the Court of Chancery committed reversible error. We disagree.
1. Was Action By The New Board Required To Terminate Ovitz As The President of Disney?
The Chancellor determined that although the board as constituted upon Ovitz's termination (the "new board") had the authority to terminate Ovitz, neither that board nor the compensation committee was required to act, because Eisner also had, and properly exercised, that authority. The new board, the Chancellor found, was not required to terminate Ovitz under the company's internal documents. Without such a duty to act, the new board's failure to vote on the termination could not give rise to a breach of the duty of care or the duty to act in good faith. Because those are conclusions of law that rest upon the Chancellor's legal construction of Disney's governing instruments, our review of them is plenary.[113]
Article Tenth of the Company's certificate of incorporation in effect at the termination plainly states that:
The officers of the Corporation shall be chosen in such a manner, shall hold their offices for such terms and shall carry out such duties as are determined solely by the Board of Directors, subject to the right of the Board of Directors to remove any officer or officers at any time with or without cause.[114]
Article IV of Disney's bylaws provided that the Board Chairman/CEO "shall, subject to the provisions of the Bylaws and the control of the Board of Directors, have general and active management, direction, and supervision over the business of the Corporation and over its officers...."[115] From these documents the Court of Chancery concluded (inter alia) that:
1) the board of directors has the sole power to elect the officers of the Company;...3) the Chairman/CEO has "general and active management, direction and supervision over the business of the Corporation and over its officers," and that such management, direction and supervision is subject to the control of the board of directors; 4) the Chairman/CEO has the power to manage, direct and supervise the lesser officers and employees of the Company; 5) the [69] board has the right, but not the duty to remove the officers of the Company with or without cause, and that right is non-exclusive; and 6) because that right is non-exclusive, and because the Chairman/CEO is affirmatively charged with the management, direction and supervision of the officers of the Company, together with the powers and duties incident to the office of chief executive, the Chairman/CEO, subject to the control of the board of directors, also possesses the right to remove the inferior officers and employees of the corporation.[116]
The issue is whether the Chancellor's interpretation of these instruments, as giving the board and the Chairman/CEO concurrent power to terminate a lesser officer, is legally permissible. In two hypothetical cases there would be a clear answer. If the certificate of incorporation vested the power of removal exclusively in the board, then absent an express delegation of authority from the board, the presiding officer would have not have a concurrent removal power. If, on the other hand, the governing instruments expressly placed the power of removal in both the board and specified officers, then there would be concurrent removal power.[117] This case does not fall within either hypothetical fact pattern, because Disney's governing instruments do not vest the removal power exclusively in the board, nor do they expressly give the Board Chairman/CEO a concurrent power to remove officers. Read together, the governing instruments do not yield a single, indisputably clear answer, and could reasonably be interpreted either way. For that reason, with respect to this specific issue, the governing instruments are ambiguous.[118]
Where corporate governing instruments are ambiguous, our case law permits a court to determine their meaning by resorting to well-established legal rules of construction,[119] which include the rules governing the interpretation of contracts.[120] One such rule is that where a contract is ambiguous, the court must look to extrinsic evidence to determine which of the reasonable readings the parties intended.[121]
Here, the extrinsic evidence clearly supports the conclusion that the board and Eisner understood that Eisner, as Board Chairman/CEO had concurrent power with the board to terminate Ovitz as President. In that regard, the Chancellor credited the testimony of new board members that Eisner, as Chairman and CEO, was empowered to terminate Ovitz without board approval or intervention; and also Litvack's testimony that during his tenure as general counsel, many Company officers were terminated and the board never once took action in connection with their terminations. [70] [122] Because Eisner possessed, and exercised, the power to terminate Ovitz unilaterally, we find that the Chancellor correctly concluded that the new board was not required to act in connection with that termination, and, therefore, the board did not violate any fiduciary duty to act with due care or in good faith.
As the Chancellor correctly held, the same conclusion is equally applicable to the compensation committee. The only role delegated to the compensation committee was "to establish and approve compensation for Eisner, Ovitz and other applicable Company executives and high paid employees."[123] The committee's September 26, 1995 approval of Ovitz's compensation arrangements "included approval for the termination provisions of the OEA, obviating any need to meet and approve the payment of the NFT upon Ovitz's termination."[124]
Because neither the new board nor the compensation committee was required to take any action that was subject to fiduciary standards, that leaves only the actions of Eisner and Litvack for our consideration. The appellants claim that in concluding that Ovitz could not be terminated "for cause," these defendants did not act with due care or in good faith. We next address that claim.
2. In Concluding That Ovitz Could Not Be Terminated For Cause, Did Litvack or Eisner Breach Any Fiduciary Duty?
It is undisputed that Litvack and Eisner (based on Litvack's advice) both concluded that if Ovitz was to be terminated, it could only be without cause, because no basis existed to terminate Ovitz for cause. The appellants argued in the Court of Chancery that the business judgment presumptions do not protect that conclusion, because by permitting Ovitz to be terminated without cause, Litvack and Eisner acted in bad faith and without exercising due care. Rejecting that claim, the Chancellor determined independently, as a matter of fact and law, that (1) Ovitz had not engaged in any conduct as President that constituted gross negligence or malfeasance—the standard for an NFT under the OEA; and (2) in arriving at that same conclusion in 1996, Litvack and Eisner did not breach their fiduciary duty of care or their duty to act in good faith.
The appellants now urge that those rulings constitute reversible error. To the extent the trial court's rulings are legal, [71] we review them de novo, to the extent they involve factual findings based upon determinations of witness credibility, we will uphold them;[125] and to the extent a factual finding is based on an expert opinion, it "may be overturned only if arbitrary or lacking any evidentiary support."[126] Measured by these standards of review, the appellants have failed to establish error of any kind.
In determining independently that Ovitz could not have been fired for cause, the Chancellor held:
...I conclude that given his performance, Ovitz could not have been fired for cause under the OEA. Any early termination of his employment, therefore, had to be in the form of an NFT. In reaching this conclusion, ] rely on the expert reports of both [Larry] Feldman and [John] Fox, whose factual assumptions are generally consonant with my factual findings above. Nevertheless, by applying the myriad of definitions for gross negligence and malfeasance discussed by [John] Donohue, Feldman and Fox, I also independently conclude, based upon the facts as I have found them, that Ovitz did not commit gross negligence or malfeasance while serving as the Company's President.[127]
The appellants challenge this conclusion on two grounds: (1) that the trial court did not articulate its understanding of the good cause determination; and (2) the court did not cite any facts to support its findings. Neither argument is correct.
The Court of Chancery considered (even though it did not accept all of) the definitions of gross negligence and malfeasance advanced by trial experts Feldman, Donohue and Fox. Based upon the facts as found by the Court, the Chancellor concluded that under all the myriad definitions discussed by those experts, Ovitz did not commit gross negligence. The appellants have not shown that the Court of Chancery relied arbitrarily upon the definitions advanced by these experts. Nor could they, because the appellants' true quarrel is with the factual findings that underlie the Court's legal conclusion. The appellants are unable, however, to show that those findings, all of which are based on extensive trial testimony, witness credibility determinations, and highly textured treatment in the Post-trial Opinion, are in any way wrong.
At the trial level, the appellants attempted to show, as a factual matter, that Ovitz's conduct as President met the standard for a termination for cause, because (i) Ovitz intentionally failed to follow Eisner's directives and was insubordinate, (ii) Ovitz was a habitual liar, and (iii) Ovitz violated Company policies relating to expenses and to reporting gifts he gave while President of Disney. The Court found the facts contrary to appellants' position. As to the first accusation, the Court found that many of Ovitz's efforts failed to produce results "often because his efforts reflected an opposite philosophy than that held by Eisner, Iger, and Roth. This does not mean that Ovitz intentionally failed to follow Eisner's directives or that he was insubordinate."[128] As to the second, the Court found that:
In the absence of any concrete evidence that Ovitz told a material falsehood during his tenure at Disney, plaintiffs fall back on alleging that Ovitz's disclosures regarding his earn-out with, and past [72] income from, CAA, were false or materially misleading. As a neutral fact-finder, I find that the evidence simply does not support either of those assertions.[129]
And, as to the third accusation, the Court found "that Ovitz was not in violation of The Walt Disney Company's policies relating to expenses or giving and receiving gifts."[130] Accordingly, the appellants' claim that the Chancellor incorrectly determined that Ovitz could not legally be terminated for cause lacks any factual foundation.
Despite their inability to show factual or legal error in the Chancellor's determination that Ovitz could not be terminated for cause, appellants contend that Litvack and Eisner breached their fiduciary duty to exercise due care and to act in good faith in reaching that same conclusion. The Court of Chancery scrutinized the record to determine independently whether, in reaching their conclusion, Litvack and Eisner had separately exercised due care and acted in good faith. The Court determined that they had properly discharged both duties. Appellants' attack upon that determination lacks merit, because it is also without basis in the factual record.
After considering the OEA and Ovitz's conduct, Litvack concluded, and advised Eisner, that Disney had no basis to terminate Ovitz for cause and that Disney should comply with its contractual obligations. Even though Litvack personally did not want to grant a NFT to Ovitz, he concluded that for Disney to assert falsely that there was cause would be both unethical and harmful to Disney's reputation. As to Litvack, the Court of Chancery held:
I do not intend to imply by these conclusions that Litvack was an infallible source of legal knowledge. Nevertheless, Litvack's less astute moments as a legal counsel do not impugn his good faith or preparedness in reaching his conclusions with respect to whether Ovitz could have been terminated for cause....
* * *
In conclusion, Litvack gave the proper advice and came to the proper conclusions when it was necessary. He was adequately informed in his decisions, and he acted in good faith for what he believed were the best interests of the Company.[131]
With respect to Eisner, the Chancellor found that faced with a situation where he was unable to work well with Ovitz, who required close and constant supervision, Eisner had three options: 1) keep Ovitz as President and continue trying to make things work; 2) keep Ovitz at Disney, but in a role other than as President; or 3) terminate Ovitz. The first option was unacceptable, and the second would have entitled Ovitz to the NFT, or at the very least would have resulted in a costly lawsuit to determine whether Ovitz was so entitled. After an unsuccessful effort to "trade" Ovitz to Sony, that left only the third option, which was to terminate Ovitz and pay the NFT. The Chancellor found that in choosing this alternative, Eisner had breached no duty and had exercised his business judgment:
...I conclude that Eisner's actions in connection with the termination are, for the most part, consistent with what is expected of a faithful fiduciary. Eisner unexpectedly found himself confronted with a situation that did not have an easy solution. He weighed the alternatives, [73] received advice from counsel and then exercised his business judgment in the manner he thought best for the corporation. Eisner knew all the material information reasonably available when making the decision, he did not neglect an affirmative duty to act (or fail to cause the board to act) and he acted in what he believed were the best interests of the Company, taking into account the cost to the Company of the decision and the potential alternatives. Eisner was not personally interested in the transaction in any way that would make him incapable of exercising business judgment, and I conclude that the plaintiffs have not demonstrated by a preponderance of the evidence that Eisner breached his fiduciary duties or acted in bad faith in connection with Ovitz's termination and receipt of the NFT.[132]
These determinations rest squarely on factual findings that, in turn, are based upon the Chancellor's assessment of the credibility of Eisner and other witnesses. Even though the Chancellor found much to criticize in Eisner's "imperial CEO" style of governance, nothing has been shown to overturn the factual basis for the Court's conclusion that, in the end, Eisner's conduct satisfied the standards required of him as a fiduciary.[133]
3. Were The Remaining Directors Entitled To Rely Upon Eisner's And Litvack's Advice That Ovitz Could Not Be Fired For Cause?
The appellants' third claim of error challenges the Chancellor's conclusion that the remaining new board members could rely upon Litvack's and Eisner's advice that Ovitz could be terminated only without cause. The short answer to that challenge is that, for the reasons previously discussed, the advice the remaining directors received and relied upon was accurate. Moreover, the directors' reliance on that advice was found to be in good faith. Although formal board action was not necessary, the remaining directors all supported the decision to terminate Ovitz based on the information given by Eisner and Litvack. The Chancellor found credible the directors' testimony that they believed that Disney would be better off without Ovitz, and the appellants offer no basis to overturn that finding.
* * * *
To summarize, the Court of Chancery correctly determined that the decisions of the Disney defendants to approve the OEA, to hire Ovitz as President, and then to terminate him on an NFT basis, were protected business judgments, made without any violations of fiduciary duty. Having so concluded, it is unnecessary for the Court to reach the appellants' contention that the Disney defendants were required to prove that the payment of the NFT severance to Ovitz was entirely fair.
V. THE WASTE CLAIM
The appellants' final claim is that even if the approval of the OEA was protected by the business judgment rule presumptions, the payment of the severance amount to Ovitz constituted waste. This claim is rooted in the doctrine that a plaintiff who [74] fails to rebut the business judgment rule presumptions is not entitled to any remedy unless the transaction constitutes waste.[134] The Court of Chancery rejected the appellants' waste claim, and the appellants claim that in so doing the Court committed error.
To recover on a claim of corporate waste, the plaintiffs must shoulder the burden of proving that the exchange was "so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration."[135] A claim of waste will arise only in the rare, "unconscionable case where directors irrationally squander or give away corporate assets."[136] This onerous standard for waste is a corollary of the proposition that where business judgment presumptions are applicable, the board's decision will be upheld unless it cannot be "attributed to any rational business purpose."[137]
The claim that the payment of the NFT amount to Ovitz, without more, constituted waste is meritless on its face, because at the time the NFT amounts were paid, Disney was contractually obligated to pay them. The payment of a contractually obligated amount cannot constitute waste, unless the contractual obligation is itself wasteful. Accordingly, the proper focus of a waste analysis must be whether the amounts required to be paid in the event of an NFT were wasteful ex ante.
Appellants claim that the NFT provisions of the OEA were wasteful because they incentivized Ovitz to perform poorly in order to obtain payment of the NFT provisions. The Chancellor found that the record did not support that contention:
[T]erminating Ovitz and paying the NFT did not constitute waste because he could not be terminated for cause and because many of the defendants gave credible testimony that the Company would be better off without Ovitz, meaning that would be impossible for me to conclude that the termination and receipt of NFT benefits result in "an exchange that is so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration," or a situation where the defendants have "irrationally squandered or given away corporate assets." In other words, defendants did not commit waste.[138]
That ruling is erroneous, the appellants argue, because the NFT provisions of the OEA were wasteful in their very design. Specifically, the OEA gave Ovitz every incentive to leave the Company before serving out the full term of his contract. The appellants urge that although the OEA may have induced Ovitz to join Disney as President, no contractual safeguards were in place to retain him in that position. In essence, appellants claim that the NFT provisions of the OEA created an irrational incentive for Ovitz to get himself fired.[139]
[75] That claim does not come close to satisfying the high hurdle required to establish waste. The approval of the NFT provisions in the OEA had a rational business purpose: to induce Ovitz to leave CAA, at what would otherwise be a considerable cost to him, in order to join Disney.[140] The Chancellor found that the evidence does not support any notion that the OEA irrationally incentivized Ovitz to get himself fired.[141] Ovitz had no control over whether or not he would be fired, either with or without cause. To suggest that at the time he entered into the OEA Ovitz would engineer an early departure at the cost of his extraordinary reputation in the entertainment industry and his historical friendship with Eisner, is not only fanciful but also without proof in the record. Indeed, the Chancellor found that it was "patently unreasonable to assume that Ovitz intended to perform just poorly enough to be fired quickly, but not so poorly that he could be terminated for cause."[142]
We agree. Because the appellants have failed to show that the approval of the NFT terms of the OEA was not a rational business decision, their waste claim must fail.
VI. CONCLUSION
For the reasons stated above, the judgment of the Court of Chancery is affirmed.
[1] The Court of Chancery dismissed the original complaint in 2000. In re The Walt Disney Co. Derivative Litig., 731 A.2d 342 (Del. Ch.1998). On appeal, this Court affirmed the dismissal in part and reversed it in part, remanding the case to the Court of Chancery and granting the plaintiffs leave to replead. Brehm v. Eisner, 746 A.2d 244 (Del.2000). The plaintiffs filed their second amended complaint in January 2002, and in May 2003, the Court of Chancery denied the defendants' motion to dismiss that complaint, ruling that a complete factual record was needed to determine whether the defendant directors had breached their fiduciary duties. In re The Walt Disney Co. Derivative Litig., 825 A.2d 275 (Del.Ch.2003). After extensive discovery Ovitz moved for summary judgment. That motion was granted in part and denied in part in September 2004. In re Walt Disney Co. Derivative Litig., 2004 WL 2050138 (Del.Ch. Sept.10, 2004). Thereafter, the case was scheduled for trial.
[2] In re The Walt Disney Company Derivative Litig., 2005 WL 2056651, at * 1 (Del. Ch. Aug. 9, 2005); ___ A.2d ___ (Del.2005) (cited throughout this Opinion as "Post-trial Op.").
[3] The facts recited herein are a skeletal summary of over 100 pages of factual findings contained in the Court of Chancery's Post-trial Opinion, supra at note 2. Except where noted, those findings are uncontroverted.
[4] The Disney board of directors at that time and at the time the Ovitz Employment Agreement was approved (the "old board") consisted of Eisner, Roy E. Disney, Stanley P. Gold, Sanford M. Litvack, Richard A. Nunis, Sidney Poitier, Irwin E. Russell, Robert A.M. Stern, E. Cardon Walker, Raymond L. Watson, Gary L. Wilson, Reveta F. Bowers, Ignacio E. Lozano, Jr., George J. Mitchell, and Stephen F. Bollenbach. The board of directors at the time Ovitz was terminated as President of Disney (the "new board") consisted of the persons listed above (other than Bollenbach), plus Leo J. O'Donovan and Thomas S. Murphy. Neither O'Donovan nor Murphy served on the old board.
[5] Post-trial Op. at ___, *6 (footnote omitted).
[6] Id.
[7] Id.
[8] The Black-Scholes method is a formula for option valuation that is widely used and accepted in the industry and by regulators.
[9] In a later, revised memorandum, Crystal estimated that the two additional years would increase the value of the entire OEA to $24.1 million per year.
[10] Sid Bass was one of Disney's largest individual shareholders.
[11] In its Opinion, the Court of Chancery was skeptical of Litvack's and Bollenbach's stated reasons for not wanting to report to Ovitz. The Court perceived that Litvack's resistance to Ovitz stemmed in part from his resentment at not being selected to be Disney's President, a post he coveted; and that Bollenbach's emphasis on the importance of being part of a cohesive trio was "disingenuous," since Bollenbach had been with the Company for only three months before learning of the Ovitz negotiations. Post-trial Op. at ___, *8.
[12] The appellants contend the trial court erred in finding that Eisner had made phone calls to the remaining board members, because there was no evidence that Eisner discussed the details of the OEA with those directors, and there was no contemporaneous documentary evidence of the content or the subject of those calls. The Court of Chancery, however, had sufficient evidence from which to make that finding. Directors Eisner, Gold, Bollenbach, Mitchell, Nunis, Lozano, and Stern testified that those conversations took place, and Eisner's telephone log corroborated that testimony. Post-Trial Op. at n. 72. At bottom, the appellants are claiming that the Chancellor should have disbelieved Eisner's testimony. That is a credibility determination based on testimony that the Chancellor, as the finder of fact, was entitled to make and that this Court will approve on review. Levitt v. Bouvier, 287 A.2d 671, 673 (Del. 1972); Alabama By-Products v. Neal, 588 A.2d 255, 259 (Del.1991).
[13] In their Opening Brief, the appellants emphasize that during their trial testimony, neither Poitier nor Lozano could recall seeing Watson's spreadsheets at the September 26th meeting, and the meeting minutes did not indicate any discussion about the cost of a NFT payout. The Court of Chancery found that Poitier's and Lozano's lack of recollection on that point was more likely the result of the nine years that had passed since the meeting, and credited Watson's testimony that he had distributed the spreadsheets. Post-trial Op. at ___, *9, n. 82.
[14] The appellants contend, as a factual matter, that Ovitz became the "de facto" President of Disney before October 1, 1995, and as a result, owed fiduciary duties to Ovitz before his official start date. The appellants assert that "Ovitz's substantial contacts with third parties and his receipt of confidential Disney information before October 1st show that Eisner and Disney had already vested him with at least apparent authority prior to his formal investiture in office." (Appellants' Opening Br. at 46-47). Appellants base this contention upon (i) Ovitz having played a role in the design and construction of his new office at Disney in August 1995; (ii) Ovitz being furnished internal documents during that summer; (iii) Ovitz having met with third parties on Disney's behalf in relation to a deal Disney was considering with the NFL; and (iv) Ovitz having submitted requests for reimbursement for business related expenses during the pre-October 1 period. The Court of Chancery's findings undermine that contention. The Chancellor found that Ovitz's authority over the construction project was "minimal at best" (Post-trial Op. at ___, *12); that the pre-October 1 work that he performed at Disney was in preparation for his tenure there and made his request for reimbursement of expenses related to Disney "appropriate and reasonable" (Id. at n. 133); and that any work Ovitz did on Disney's behalf with respect to the NFL was evidence of "Ovitz's good faith efforts to benefit the Company and bring himself up to speed...." (Id. at ___, *12).
[15] As the Chancellor found, Ovitz made the successful recommendation to construct the gate to Disney's California Adventure Park across from the main gate to Disneyland. He was also able to recruit Geraldine Laybourne, founder of the children's cable channel, Nickelodeon, as well as overhaul ABC's Saturday morning lineup. Ovitz brought Tim Allen back to work after Allen walked off the set of Home Improvement following a disagreement; he also helped retain several animators that Jeffrey Katzenberg was trying to recruit to his new company, Dreamworks; and Ovitz also helped in handling relationships with talent.
[16] Post-trial Op. at ___, *11.
[17] Post-trial Op. at ___, *14 (footnotes omitted).
[18] Id. at ___, *12.
[19] Id. at ___, *14 (The surname references are to Robert Iger, President of ABC, and Joe Roth, head of the Disney Studio).
[20] Id. ("But different does not mean wrong. Total agreement within an organization is often a far greater threat than diversity of opinion. Unfortunately, the philosophical divide between Eisner and Ovitz was greater than both believed....").
[21] Id. at ___ _ ___, *14-15.
[22] Id. at ___, *16.
[23] Post-trial Op. at ___, *19.
[24] As with his October 1 letter, Eisner did not share this letter or its contents with the board. The only director to receive the November 11 letter was Russell, who also did not share it with the other board members.
[25] Post-trial Op. at ___, *19 (footnote omitted).
[26] Id. at 20.
[27] Id.
[28] Id. The Chancellor found Litvack's testimony on this issue especially persuasive because "[i]n light of the hostile relationship between Litvack and Ovitz, I believe that if Litvack thought it were possible to avoid paying Ovitz the NFT payment, that out of pure ill-will, Litvack would have tried almost anything to avoid the payment." Id. at ___, *20, n. 269.
[29] Id. at ___, *21.
[30] The Court of Chancery found that at least Eisner, Gold, Bowers, Watson, and Stern were present at that executive session. The Court also found that the record was in conflict as to whether any details of the NFT and the termination for cause question were discussed.
[31] Id. at ___, 22.
[32] Id.
[33] In attendance at that meeting were its members, Gold, Lozano, Poitier and Russell, although Poitier and Lozano attended by phone. Also in attendance were Eisner, Watson, Litvack, Santaniello, and another staff member, Marsha Reed.
[34] The committee members also awarded a $7.5 million bonus to Ovitz for his services performed during fiscal year 1996, despite Ovitz's poor performance and the fact that the bonuses were discretionary. That bonus was later rescinded after more deliberate consideration, following Ovitz's termination.
[35] Post-trial Op. at ___, *24 & n. 325, 326.
[36] Id. at ___, *25 & n. 332. Although neither the board nor the compensation committee voted on the matter, many directors believed that Eisner had the power to fire Ovitz on his own, and that he did not need to convene a board meeting to do so. Other directors believed that if a meeting was required to terminate Ovitz, then Litvack, as corporate counsel, would have so advised them and would have made sure that a meeting was called. Litvack believed that Eisner had the power to fire Ovitz on his own accord, and that no meeting was called, because it was unnecessary and because all the directors were up to speed and in agreement that Ovitz should be terminated.
[37] The plaintiff-appellants appear to have structured their liability claim in this indirect way because Article Eleventh of the Disney Certificate of Incorporation contains an exculpatory provision modeled upon 8 Del. C. § 102(b)(7). That provision precludes a money damages remedy against the Disney directors for adjudicated breaches of their duty of care. For that reason the plaintiffs are asserting their due care claim as the basis for shifting the standard of review from business judgment to entire fairness, rather than as a basis for direct liability. Presumably for the sake of consistency the appellants are utilizing their good faith fiduciary claim in a like manner.
[38] These claims are asserted against the Disney defendants in their capacity as directors. The appellants also advance, as an alternative claim, an argument that Disney defendants Eisner, Litvack and Russell, are liable in their separate capacity as officers who, unlike directors, are not protected by the business judgment rule or the exculpatory provision of the Disney charter. That alternative argument is procedurally barred, because it was not fairly presented to the Court of Chancery. SUP.CT. R. 8. Indeed, the Chancellor noted in his Post-trial Opinion that the application of the business judgment to Eisner and Litvack was not contested, and that the "parties essentially treat both officers and directors as comparable fiduciaries, that is, subject to the same fiduciary duties and standards of substantive review." Post-trial Op. at ___, *50, n. 588. To the extent the argument is advanced against Russell, it also is not grounded in fact, because Russell was not an officer of Disney.
[39] "When a plaintiff fails to rebut the presumption of the business judgment rule, she is not entitled to any remedy, be it legal or equitable, unless the transaction constitutes waste." Post-trial Op. at ___, *31 (citing In re J.P. Stevens & Co., Inc. S'holders Litig., 542 A.2d 770, 780 (Del.Ch.1988)).
[40] The claims against Ovitz, unlike those asserted against the Disney defendants, appear to be advanced as the basis for holding Ovitz liable directly, as distinguished from being used indirectly as a vehicle to shift the standard of review from business judgment to entire fairness. We use the qualifying term "appear," because we cannot ascertain with clarity, either from the appellants' briefs in this Court or in the Court of Chancery, the precise character of their liability argument. In the end, however, it does not matter, because our affirmance of the Chancellor's rulings render irrelevant the issue of whether appellants are asserting a claim of liability directly as a consequence of a breach of Ovitz's duty of loyalty and/or good faith, or indirectly as a consequence of his failure to prove the entire fairness of his actions.
[41] Dutra De Amorim v. Norment, 460 A.2d 511, 514 (Del.1983) (citing Levitt v. Bouvier, 287 A.2d 671, 673 (Del.1972)).
[42] Fiduciary Trust Co. v. Fiduciary Trust Co., 445 A.2d 927, 930 (Del.1982).
[43] Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360 (Del.1993).
[44] SUP.CT. R. 8.
[45] Four months elapsed between the summary judgment decision and the end of trial, yet the plaintiffs never sought reconsideration of the summary judgment motion on the basis of the evidence produced after the motion was decided.
[46] WILLIAM MEADE FLETCHER, FLETCHER CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS § 374 (perm.ed., rev.vol.1998) ("FLETCHER"); see also State ex rel. James v. Schorr, 65 A.2d 810, 817 (Del.1948); Rudnitsky v. Rudnitsky, 2000 WL 1724234, *6, 2000 Del. Ch. LEXIS 165, *21 (Nov. 14, 2000) ("It is an established principle of Delaware law that apparent authority cannot be asserted by a party who knew, at the time of the transaction, that the agent lacked actual authority.")
[47] See discussion supra at p. 41, note 14.
[48] The only evidence the appellants cite to support the claimed material change to the OEA is the assertion that after October 1, a "major rewrite of Section 10" occurred. (Appellants' Opening Br. at 47.) The rewrite of that section was not material, however. It only changed the terms that Disney must meet to make a "qualifying offer" to renew the OEA for a second term—from specific thresholds to a general requirement that Disney must make a "reasonable" offer. That change was not material to the issues presented in this lawsuit, and was not a critical term of the OEA.
[49] Post-trial Op. at ___, *37-38 (italics in original, footnotes omitted).
[50] Appellants' Opening Br. at 47.
[51] Levitt v. Bouvier, 287 A.2d 671, 673 (Del. 1972).
[52] Id.; see also Hudak v. Procek, 806 A.2d 140, 151 n. 28 (Del.2002) (The Chancellor is "the sole judge of the credibility of live witness testimony.").
[53] Hudak, 806 A.2d at 150.
[54] Post-trial Op. at ___, *37.
[55] The only negotiation in which Ovitz engaged with Disney concerned how the NFT would work and what, if anything, Ovitz would receive in addition to the NFT. The trial court found, however, and the appellants do not contest, that Disney rejected all of Ovitz's requests and gave him only what he was entitled to receive under his contract.
[56] Post-trial Op. at ___, ___, *38-39, 48-49. For the reasons more fully set forth in Section V, infra, of this Opinion, we uphold these determinations.
[57] Id. at 52, *38 (italics in original, footnotes omitted).
[58] That determination stands independent of, and without regard to, whether the OEA and the NFT payout were properly approved, constituted a waste of assets or were otherwise the product of a breach of fiduciary duty by the Disney defendants. The appellants claim that the approval of the OEA and the NFT payout to Ovitz were legally improper on all these grounds. Those claims are addressed in Parts IV and V of this Opinion.
[59] Hudak, 806 A.2d at 150.
[60] Levitt, 287 A.2d at 673.
[61] Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).
[62] Emerald Partners v. Berlin, 787 A.2d 85, 91 (Del.2001); Brehm v. Eisner, 746 A.2d 244, 264 n. 66 (Del.2000) ("Thus, directors' decisions will be respected by courts unless the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.").
[63] 787 A.2d 85, 93 (Del.2001).
[64] Id. at 91.
[65] Post-trial Op. at ___, ___, *42, 47.
[66] Id. at ___, ___, *42, 44.
[67] Id. at ___, *42.
[68] Id. at ___, *47.
[69] 8 Del. C. § 141(c).
[70] 746 A.2d 244, 259 (Del.2000).
[71] Id.
[72] The only arguably tenable "law of the case" contention might read Brehm to hold that the size of the NFT payout would be material to a decision maker, whether the decision maker is the full board or the compensation committee. Indeed, the appellants appear to suggest that argument in attacking as erroneous the Chancellor's determination that, even though the amount of the NFT payout was quite large, it was immaterial given the Company's size ($19 billion in revenues and over $3 billion in operating revenues) and the large amounts budgeted for a single feature film. See Post-trial Op. at *44, n. 532. If that is appellants' argument, it also reads too much into the Brehm decision, because our observation was based upon the facts as alleged in the complaint, not the facts as found by the Chancellor based upon a complete trial record. This argument also ignores our admonition therein that "[o]ne must also keep in mind that the size of executive compensation for a large public company in the current environment often involves huge numbers. This is particularly true in the entertainment industry where the enormous revenues from one `hit' movie or enormous losses from a `flop' place in perspective the compensation of executives whose genius or misjudgment, as the case may be, have contributed to the `hit' or `flop.'" 746 A.2d at 259, n. 49 (internal citations omitted). In any event, the materiality or immateriality of the NFT payout, whether viewed from an ex ante or ex post perspective, is not legally germane to our analysis of the claims presented on this appeal, or to the result we reach here. For that reason we do not decide the issue of the materiality of the NFT payout.
[73] SUP. CT. R. 8.
[74] Levitt v. Bouvier, 287 A.2d 671, 673 (Del. 1972).
[75] Id.
[76] The term sheet was attached as an exhibit to the September 26 minutes.
[77] The cash portion of the NFT payout after one year would be the sum of: (i) the present value of Ovitz's remaining salary over the life of the contract (4 years × $1 million/yr = $4 million, reduced to present value), plus (ii) the present value of his unpaid annual bonus payments ($7.5 million/yr × 4 years = $30 million, discounted to present value), plus (iii) $10 million cash for the second tranche of options. These amounts total $44 million before discounting the $34 million of annual salaries and bonuses to present value. The actual cash payment to Ovitz was $38.5 million, which, it would appear, reflects the then-present value of the $34 million of salaries and bonuses.
[78] Or, if it is assumed that the compensation committee would have estimated the cash portion of an NFT payout after one year at $40 million, then the value of the option portion would have been $90 million.
[79] As the Court found, "the compensation committee was provided with a term sheet of the key terms of the OEA and a presentation was made by Russell (assisted by Watson), who had personal knowledge of the relevant information by virtue of his negotiations with Ovitz and discussions with Crystal." Post-trial Op. at ___, *45.
[80] Id. at ___, *9, n. 81.
[81] Id. at ___, *45.
[82] Id. at ___, *46.
[83] 8 Del. C. § 141(e).
[84] Id. at ___, *46 (emphasis in original). The appellants underscore that neither Poitier or Lozano could recall in their respective testimony, whether they had actually received or reviewed Watson's spreadsheets. The Court of Chancery, however, attributed that lack of recollection to the length of time that had passed since the meeting and credited Watson's testimony that he had shared his spreadsheets with the committee. We will not disturb that credibility determination.
The appellants also contend, in this connection, that Poitier and Lozano were not properly informed because they were not furnished with Crystal's August 26 letter. That letter, however, was based upon Crystal's misunderstanding about the guarantee originally proposed as a feature of the stock options. Once Russell cleared up that misunderstanding, Crystal revised his original letter to comport with the facts and sent the revised letter to Russell and Watson, who then described the revised letter's contents to Poitier and Lozano at the September 26, 1995 meeting.
[85] The remaining old board members were Bollenbach, Litvack, Roy Disney, Nunis, Stern, Walker, O'Donovan, Murphy, Gold, Bowers, Wilson and Mitchell.
[86] Specifically, the appellants contend that the entire board: (1) did not review or discuss a spreadsheet showing the possible payouts to Ovitz in the event of an NFT; (2) were not given any written materials to review; (3) did not have any report, written or given in person, by a compensation expert; (4) had no idea that the OEA was then the richest pay package ever offered to a corporate officer; and (5) did not discuss the gross negligence or malfeasance standards that would control Ovitz's receipt of an NFT payout.
[87] Post-trial Op. at, *47.
[88] The directors were informed of the reporting structure to which Ovitz had agreed. That reporting structure resolved Litvack's and Bollenbach's initial personal reaction to being told that Ovitz would be coming to Disney.
[89] Contrary to the appellants' assertion (made with no citation of authority), the remaining board members were entitled to rely upon the compensation committee's approval of the OEA, and upon Russell's report of the discussions that occurred at the compensation committee meeting, when considering whether to elect Ovitz as President of Disney. 8 Del. C. § 141(e).
[90] Post-trial Op. at —, *36 (italics in original, footnotes omitted).
[91] In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 289 (Del.Ch.2003) (italics in original).
[92] Appellants' Opening Br. at 23.
[93] Id.
[94] Id. at 4.
[95] The appellants also assert that the Chancellor erred by imposing upon them the burden of proving that the Disney directors acted in bad faith. That argument fails because our decisions clearly hold that for purposes of rebutting the business judgment presumptions, the plaintiffs have the burden of proving bad faith. Emerald Partners, 787 A.2d at 91; Brehm, 746 A.2d at 264.
[96] Appellants' Opening Br. at 23.
[97] The appellants cite only the Chancellor's 2003 pre-trial Opinion (825 A.2d at 289). But nowhere on the cited page does the Court suggest, let alone rule, that making material decisions without adequate information and without adequate deliberation, without more, constitutes bad faith. To the contrary, immediately after identifying the good faith standard, the Court states that "[k]nowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct that, in my opinion, that may not have been taken honestly and in good faith to advance the best interests of the company." Id.
[98] The Chancellor observed, after surveying the sparse case law on the subject, that both the meaning and the contours of the duty to act in good faith were "[s]hrouded in the fog of...hazy jurisprudence." Post-Trial Op. at, *35.
[99] See, e.g., Hillary A. Sale, Delaware's Good Faith, 89 CORNELL L.REv. 456 (2004); Matthew R. Berry, Does Delaware's Section 102(b)(7) Protect Reckless Directors From Personal Liability? Only if Delaware Courts Act in Good Faith, 79 WASH. L.REV. 1125 (2004); John L. Reed and Matt Neiderman, Good Faith and the Ability of Directors to Assert § 102(b)(7) of the Delaware Corporation Law as a Defense to Claims Alleging Abdication, Lack of Oversight, and Similar Breaches of Fiduciary Duty, 29 DEL. J. CORP. L. 111 (2004); David Rosenberg, Making Sense of Good Faith in Delaware Corporate Fiduciary Law: A Contractarian Approach, 29 DEL. J. CORP. L. 491 (2004); Sean J. Griffith, Good Faith Business Judgment: A Theory of Rhetoric in Corporate Law Jurisprudence, 55 DUKE L.J. 1 (2005) ("Griffith"); Melvin A. Eisenberg, The Duty of Good Faith in Corporate Law, 31 DEL. J. CORP. L. 1 (2005); Filippo Rossi, Making Sense of the Delaware Supreme Court's Triad of Fiduciary Duties (June 22, 2005), available at http://ssrn.com/abstract=755784; Christopher M. Bruner, "Good Faith," State of Mind, and the Outer Boundaries of Director Liability in Corporate Law (Boston Univ. Sch. of Law Working Paper No. 05-19), available at http://ssrn.com/abstract=832944; Sean J. Griffith & Myron T. Steele, On Corporate Law Federalism Threatening the Thaumatrope, 61 Bus. LAW. 1 (2005)
[100] See, e.g., Robert Baker, In Re Walt Disney: What It Means To The Definition Of Good Faith, Exculpatory Clauses, and the Nature of Executive Compensation, 4 FLA. ST. U. Bus. REV. 261 (2004-2005); Tara L. Dunn, The Developing Theory of Good Faith In Director Conduct: Are Delaware Courts Ready To Force Corporate Directors To Go Out-Of-Pocket After Disney IV?, 83 DENV. U.L.REV. 531 (2005).
[101] Post-Trial Op. at —, *36 (italics added, italics in original omitted).
[102] The Chancellor so recognized. Id. at, *35 ("[A]n action taken with the intent to harm the corporation is a disloyal act in bad faith."). See McGowan v. Ferro, 859 A.2d 1012, 1036 (Del.Ch.2004) ("Bad faith is `not simply bad judgment or negligence,' but rather 'implies the conscious doing of a wrong because of dishonest purpose or moral obliquity...it contemplates a state of mind affirmatively operating with furtive design or ill will.'") (quoting Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1208, n. 16 (Del.1993)).
[103] Post-trial Op. at —, *31 (citing Griffith, supra note 99, at 15).
[104] An example of such overlap might be the hypothetical case where a director, because of subjective hostility to the corporation on whose board he serves, fails to inform himself of, or to devote sufficient attention to, the matters on which he is making decisions as a fiduciary. In such a case, two states of mind coexist in the same person: subjective bad intent (which would lead to a finding of bad faith) and gross negligence (which would lead to a finding of a breach of the duty of care). Although the coexistence of both states of mind may make them indistinguishable from a psychological standpoint, the fiduciary duties that they cause the director to violate—care and good faith—are legally separate and distinct.
[105] 8 Del. C. § 102(b)(7).
[106] 8 Del. C. § 102(b)(7)(ii).
[107] 8 Del. C. §§ 145(a) & (b).
[108] As we recently stated in Stifel Financial Corp. v. Cochran, 809 A.2d 555, 561 (Del. 2002):
The invariant policy of Delaware legislation on indemnification is to "promote the desirable end that corporate officials will resist what they consider unjustified suits and claims, secure in the knowledge that their reasonable expenses will be borne by the corporation they have served if they are vindicated" Folk, on Delaware General Corporation Law sec. 145 (2001). Beyond that, its larger purpose is "to encourage capable men to serve as corporate directors, secure in the knowledge that expenses incurred by them in upholding their honesty and integrity as directors will be borne by the directors they serve." Id.
[109] Basic to the common law of torts is the distinction between conduct that is negligent (or grossly negligent) and conduct that is intentional. And in the narrower area of corporation law, our jurisprudence has recognized the distinction between the fiduciary duties to act with due care, with loyalty, and in good faith, as well as the consequences that flow from that distinction. Recent Delaware case law precludes a recovery of rescissory (as distinguished from out-of-pocket) damages for a breach of the duty of care, but permits such a recovery for a breach of the duty of loyalty. See Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1147-1150 (Del.Ch.1994), aff'd, 663 A.2d 1156 (Del.1995).
[110] Post-trial Op. at —, *36 (footnotes omitted).
[111] See, e.g., Allaun v. Consol. Oil Co., 147 A. 257, 261 (Del.Ch.1929) (further judicial scrutiny is warranted if the transaction results from the directors' "reckless indifference to or a deliberate disregard of the interests of the whole body of stockholders"); Gimbel v. Signal Cos., Inc., 316 A.2d 599, 604 (Del.Ch.1974), aff'd, 316 A.2d 619 (Del.1974) (injunction denied because, inter alia, there was "[n]othing in the record [that] would justify a finding...that the directors acted for any personal advantage or out of improper motive or intentional disregard of shareholder interests"); In re Caremark Int'l Derivative Litig., 698 A.2d 959, 971 (Del.Ch.1996) ("only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability."); Nagy v. Bistricer, 770 A.2d 43, 48, n.2 (Del.Ch.2000) (observing that the utility of the duty of good faith "may rest in its constant reminder...that, regardless of his motive, a director who consciously disregards his duties to the corporation and its stockholders may suffer a personal judgment for monetary damages for any harm he causes," even if for a reason "other than personal pecuniary interest").
[112] Post-trial Op. at —, *36. For the same reason, we do not reach or otherwise address the issue of whether the fiduciary duty to act in good faith is a duty that, like the duties of care and loyalty, can serve as an independent basis for imposing liability upon corporate officers and directors. That issue is not before us on this appeal.
[113] Kahn v. Lynch Commc'ns Sys., 669 A.2d 79, 84 (Del.1995).
[114] Post-trial Op. at —, *48.
[115] Id.
[116] Id. at —, *49 (emphasis in original) (footnotes omitted).
[117] See FLETCHER, supra note 46, at § 357.
[118] Rhone-Poulenc Basic Chem. Co. v. Am. Motorists Ins. Co., 616 A.2d 1192, 1196 (Del. 1992) (ambiguity exists "when the provisions in controversy are reasonably or fairly susceptible of different interpretations or may have two or more different meanings").
[119] Investment Assoc. v. Standard Power & Light Corp., 48 A.2d 501 (Del.Ch.1946); aff'd, 51 A.2d 572 (Del.1947).
[120] Ellingwood v. Wolf's Head Oil Ref. Co., 38 A.2d 743 (Del.1944).
[121] Eagle Industries, Inc. v. DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del.1997); Pellaton v. The Bank of New York, 592 A.2d 473, 478 (Del.1991); Harrah's Entertainment, Inc. v. JCC Holding Company, 802 A.2d 294, 309 (Del. Ch.2002) (applying rule of construction to ambiguous corporate instruments).
[122] Post-trial Op. at ,*49, n. 571, 572. Nonetheless, the board was informed of, and supported, Eisner's decision.
[123] Id. at , *49.
[124] Id. To support their argument that the compensation committee's approval of the Ovitz termination was required, appellants point to a provision of the Option Plan giving the compensation committee "the sole power to make determinations regarding the termination of any participant's employment," including "the cause[s] therefor and the consequences thereof." That provision, however, is expressly limited by the language "or as otherwise may be provided by the [Compensation] Committee." Here, the compensation committee approved the OEA, which contained its own termination provisions and standards. Section 11 of the OEA provided that "the Company" shall determine if cause exists for a termination. The OEA does not purport to delegate any authority to the compensation committee to make such a determination. The Chancellor recognized that although the foregoing reasoning might not be dispositive, the limiting language of the Option Plan was "sufficiently ambiguous—as to whether action by the compensation committee is required in all terminations...of employees who possess options—to, in my opinion, absolve...the compensation committee for not acting with respect to Ovitz's termination." Id. at , *50.
[125] Hudak, 806 A.2d at 151, n. 28.
[126] Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1146 (Del.1989).
[127] Post-trial Op. at , *39.
[128] Id. at , *14.
[129] Id. at , *15.
[130] Id. at , *16.
[131] Id. at , *50.
[132] Id. at , *51
[133] Although the appellants continue to argue as fact that Eisner allowed Ovitz to receive an NFT as an act of friendship, the Chancellor found that Eisner did not want Ovitz to receive that payment. Id. at, *20 ("Despite the paucity of evidence, it is clear to the Court that both Eisner and Litvack wanted to fire Ovitz for cause to avoid the costly NFT payment, and perhaps out of personal motivations."). Appellants offer no tenable basis to overturn that finding.
[134] In re J.P. Stevens & Co., Inc. S'holders Litig., 542 A.2d 770, 780 (Del.Ch.1988).
[135] Brehm, 746 A.2d at 263.
[136] Id.
[137] Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del.1971); see also Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del.1985).
[138] Post-trial Op. at , *39.
[139] The appellants also claim, because the Disney defendants had a rational basis to fire Ovitz for cause, the NFT payment to Ovitz constituted an unnecessary gift of corporate assets to Eisner's friend. Because we affirm the Court of Chancery's legal determination that no cause existed to terminate Ovitz, that claim lacks merit on its face.
[140] See Kerbs v. California Eastern Airways, 90 A.2d 652, 656 (Del.1952) ("Sufficient consideration to the corporation may be, inter alia, the retention of the services of an employee, or the gaining of the services of a new employee, provided there is a reasonable relationship between the value of the services to be rendered by the employee and the value of the options granted as an inducement or compensation.").
[141] Indeed, all the credible evidence supports the Chancellor's conclusion that Ovitz resisted, at every turn, all suggestions, communicated directly or indirectly by Eisner, that Ovitz leave Disney.
[142] Post-trial Op. at —, *38.
1.2.2.3 Stone v. Ritter 1.2.2.3 Stone v. Ritter
The business judgment rule, as authoritatively stated in Aronson and applied in Disney, should provide comfort to directors and officers even in the absence of a 102(b)(7) waiver (which does not cover officers). For a long time, however, directors and officers might have been worried by the following passage from Aronson:“However, it should be noted that the business judgment rule operates only in the context of director action. Technically speaking, it has no role where directors have either abdicated their functions, or absent a conscious decision, failed to act.”Aronson v. Lewis, 473 A.2d 805, at 813 (Del. 1984).To be sure, Aronson continued that “a conscious decision to refrain from acting may nonetheless be a valid exercise of business judgment and enjoy the protections of the rule” and acknowledged in a footnote to the quoted paragraph that “questions of director liability in such cases have [nevertheless] been adjudicated upon concepts of business judgment” (emphasis added). Doubts remained, however, and were only amplified by Chancellor Allen’s famous 1996 Caremark decision, which mused that the absence of a reporting system could give rise to liability. Stone addressed this question.1. What is the rule of Stone: what is the liability standard for oversight failures?2. How does the rule compare to the business judgment rule – is it more or less lenient for defendants, doctrinally speaking?3. Do you think the doctrinal difference matters in practice?4. What is the role of DGCL 102(b)(7) in this case?
William STONE and Sandra Stone, derivatively on Behalf of Nominal Defendant AmSOUTH BANCORPORATION, Plaintiffs Below, Appellants,
v.
C. Dowd RITTER, Ronald L. Kuehn, Jr., Claude B. Nielsen, James R. Malone, Earnest W. Davenport, Jr., Martha R. Ingram, Charles D. McCrary, Cleophus Thomas, Jr., Rodney C. Gilbert, Victoria B. Jackson, J. Harold Chandler, James E. Dalton, Elmer B. Harris, Benjamin F. Payton, and John N. Palmer, Defendants Below, Appellees, and
AmSouth Bancorporation, Nominal Defendant Below, Appellee.
Supreme Court of Delaware.
Brian D. Long (argued) and Seth D. Rigrodsky, of Rigrodsky & Long, P.A., Wilmington, DE, for appellants.
Jesse A. Finkelstein, Raymond J. DiCamillo, and Lisa Zwally Brown, of Richards, Layton & Finger, Wilmington, DE, David B. Tulchin (argued), L. Wiesel, and Jacob F.M. Oslick, of Sullivan & Cromwell, L.L.P., New York City, for appellees.
Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS, and RIDGELY, Justices (constituting the Court en Banc).
HOLLAND, Justice:
This is an appeal from a final judgment of the Court of Chancery dismissing a derivative complaint against fifteen present and former directors of AmSouth Bancorporation ("AmSouth"), a Delaware corporation. The plaintiffs-appellants, William and Sandra Stone, are AmSouth shareholders and filed their derivative complaint without making a pre-suit demand on AmSouth's board of directors (the "Board"). The Court of Chancery held that the plaintiffs had failed to adequately plead that such a demand would have been futile. The Court, therefore, dismissed the derivative complaint under Court of Chancery Rule 23.1.
The Court of Chancery characterized the allegations in the derivative complaint as a "classic Caremark claim," a claim that derives its name from In re Caremark Int'l Deriv. Litig.[1] In Caremark, the Court of Chancery recognized that: "[g]enerally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation . . . only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability."[2]
In this appeal, the plaintiffs acknowledge that the directors neither "knew [n]or should have known that violations of law were occurring," i.e., that there were no "red flags" before the directors. Nevertheless, the plaintiffs argue that the Court of Chancery erred by dismissing the derivative complaint which alleged that "the defendants had utterly failed to implement any sort of statutorily required monitoring, reporting or information controls that would have enabled them to learn of problems requiring their attention." The defendants argue that the plaintiffs' assertions are contradicted by the derivative complaint itself and by the documents incorporated therein by reference.
[365] Consistent with our opinion in In re Walt Disney Co. Deriv Litig, we hold that Caremark articulates the necessary conditions for assessing director oversight liability.[3] We also conclude that the Caremark standard was properly applied to evaluate the derivative complaint in this case. Accordingly, the judgment of the Court of Chancery must be affirmed.
Facts
This derivative action is brought on AmSouth's behalf by William and Sandra Stone, who allege that they owned AmSouth common stock "at all relevant times." The nominal defendant, AmSouth, is a Delaware corporation with its principal executive offices in Birmingham, Alabama. During the relevant period, AmSouth's wholly-owned subsidiary, AmSouth Bank, operated about 600 commercial banking branches in six states throughout the southeastern United States and employed more than 11,600 people.
In 2004, AmSouth and AmSouth Bank paid $40 million in fines and $10 million in civil penalties to resolve government and regulatory investigations pertaining principally to the failure by bank employees to file "Suspicious Activity Reports" ("SARs"), as required by the federal Bank Secrecy Act ("BSA")[4] and various anti-money-laundering ("AML") regulations.[5] Those investigations were conducted by the United States Attorney's Office for the Southern District of Mississippi ("USAO"), the Federal Reserve, FinCEN and the Alabama Banking Department. No fines or penalties were imposed on AmSouth's directors, and no other regulatory action was taken against them.
The government investigations arose originally from an unlawful "Ponzi" scheme operated by Louis D. Hamric, II and Victor G. Nance. In August 2000, Hamric, then a licensed attorney, and Nance, then a registered investment advisor with Mutual of New York, contacted an AmSouth branch bank in Tennessee to arrange for custodial trust accounts to be created for "investors" in a "business venture." That venture (Hamric and Nance represented) involved the construction of medical clinics overseas. In reality, Nance had convinced more than forty of his clients to invest in promissory notes bearing high rates of return, by misrepresenting the nature and the risk of that investment. Relying on similar misrepresentations by Hamric and Nance, the AmSouth branch employees in Tennessee agreed to provide custodial accounts for the investors and to distribute monthly interest payments to each account upon receipt of a check from Hamric and instructions from Nance.
The Hamric-Nance scheme was discovered in March 2002, when the investors did not receive their monthly interest payments. Thereafter, Hamric and Nance became the subject of several civil actions brought by the defrauded investors in Tennessee and Mississippi (and in which AmSouth [366] also was named as a defendant), and also the subject of a federal grand jury investigation in the Southern District of Mississippi. Hamric and Nance were indicted on federal money-laundering charges, and both pled guilty.
The authorities examined AmSouth's compliance with its reporting and other obligations under the BSA. On November 17, 2003, the USAO advised AmSouth that it was the subject of a criminal investigation. On October 12, 2004, AmSouth and the USAO entered into a Deferred Prosecution Agreement ("DPA") in which AmSouth agreed: first, to the filing by USAO of a one-count Information in the United States District Court for the Southern District of Mississippi, charging AmSouth with failing to file SARs; and second, to pay a $40 million fine. In conjunction with the DPA, the USAO issued a "Statement of Facts," which noted that although in 2000 "at least one" AmSouth employee suspected that Hamric was involved in a possibly illegal scheme, AmSouth failed to file SARs in a timely manner. In neither the Statement of Facts nor anywhere else did the USAO ascribe any blame to the Board or to any individual director.
On October 12, 2004, the Federal Reserve and the Alabama Banking Department concurrently issued a Cease and Desist Order against AmSouth, requiring it, for the first time, to improve its BSA/AML program. That Cease and Desist Order required AmSouth to (among other things) engage an independent consultant "to conduct a comprehensive review of the Bank's AML Compliance program and make recommendations, as appropriate, for new policies and procedures to be implemented by the Bank." KPMG Forensic Services ("KPMG") performed the role of independent consultant and issued its report on December 10, 2004 (the "KPMG Report").
Also on October 12, 2004, FinCEN and the Federal Reserve jointly assessed a $10 million civil penalty against AmSouth for operating an inadequate anti-money-laundering program and for failing to file SARs. In connection with that assessment, FinCEN issued a written Assessment of Civil Money Penalty (the "Assessment"), which included detailed "determinations" regarding AmSouth's BSA compliance procedures. FinCEN found that "AmSouth violated the suspicious activity reporting requirements of the Bank Secrecy Act," and that "[s]ince April 24, 2002, AmSouth has been in violation of the anti-money-laundering program requirements of the Bank Secrecy Act." Among FinCEN's specific determinations were its conclusions that "AmSouth's [AML compliance] program lacked adequate board and management oversight," and that "reporting to management for the purposes of monitoring and oversight of compliance activities was materially deficient." AmSouth neither admitted nor denied FinCEN's determinations in this or any other forum.
Demand Futility and Director Independence
It is a fundamental principle of the Delaware General Corporation Law that "[t]he business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors. . . ."[6] Thus, "by its very nature [a] derivative action impinges on the managerial freedom of directors."[7] Therefore, the right of a stockholder to prosecute a derivative suit is limited to situations where either the stockholder has [367] demanded the directors pursue a corporate claim and the directors have wrongfully refused to do so, or where demand is excused because the directors are incapable of making an impartial decision regarding whether to institute such litigation.[8] Court of Chancery Rule 23.1, accordingly, requires that the complaint in a derivative action "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors [or] the reasons for the plaintiff's failure to obtain the action or for not making the effort."[9]
In this appeal, the plaintiffs concede that "[t]he standards for determining demand futility in the absence of a business decision" are set forth in Rales v. Blasband.[10] To excuse demand under Rales, "a court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint is filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand."[11] The plaintiffs attempt to satisfy the Rales test in this proceeding by asserting that the incumbent defendant directors "face a substantial likelihood of liability" that renders them "personally interested in the outcome of the decision on whether to pursue the claims asserted in the complaint," and are therefore not disinterested or independent.[12]
Critical to this demand excused argument is the fact that the directors' potential personal liability depends upon whether or not their conduct can be exculpated by the section 102(b)(7) provision contained in the AmSouth certificate of incorporation.[13] Such a provision can exculpate directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty.[14] The standard for assessing a director's potential personal liability for failing to act in good faith in discharging his or her oversight responsibilities has evolved beginning with our decision in Graham v. Allis-Chalmers Manufacturing Company,[15] through the Court of Chancery's Caremark decision to our most recent decision in Disney.[16] A brief discussion of that evolution will help illuminate the standard that we adopt in this case.
Graham and Caremark
Graham was a derivative action brought against the directors of Allis-Chalmers for [368] failure to prevent violations of federal anti-trust laws by Allis-Chalmers employees. There was no claim that the Allis-Chalmers directors knew of the employees' conduct that resulted in the corporation's liability. Rather, the plaintiffs claimed that the Allis-Chalmers directors should have known of the illegal conduct by the corporation's employees. In Graham, this Court held that "absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists."[17]
In Caremark, the Court of Chancery reassessed the applicability of our holding in Graham when called upon to approve a settlement of a derivative lawsuit brought against the directors of Caremark International, Inc. The plaintiffs claimed that the Caremark directors should have known that certain officers and employees of Caremark were involved in violations of the federal Anti-Referral Payments Law. That law prohibits health care providers from paying any form of remuneration to induce the referral of Medicare or Medicaid patients. The plaintiffs claimed that the Caremark directors breached their fiduciary duty for having "allowed a situation to develop and continue which exposed the corporation to enormous legal liability and that in so doing they violated a duty to be active monitors of corporate performance."[18]
In evaluating whether to approve the proposed settlement agreement in Caremark, the Court of Chancery narrowly construed our holding in Graham "as standing for the proposition that, absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's behalf."[19] The Caremark Court opined it would be a "mistake" to interpret this Court's decision in Graham to mean that:
corporate boards may satisfy their obligation to be reasonably informed concerning the corporation, without assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation's compliance with law and its business performance.[20]
To the contrary, the Caremark Court stated, "it is important that the board exercise a good faith judgment that the corporation's information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations, so that it may satisfy its responsibility."[21] The Caremark Court recognized, however, that "the duty to act in good faith to be informed cannot be thought to require directors to possess detailed information about all aspects of the operation of the enterprise."[22] The Court of Chancery then formulated the following standard for assessing the liability of directors where the directors are unaware of employee [369] misconduct that results in the corporation being held liable:
Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, as in Graham or in this case, . . . only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability.[23]
Caremark Standard Approved
As evidenced by the language quoted above, the Caremark standard for so-called "oversight" liability draws heavily upon the concept of director failure to act in good faith. That is consistent with the definition(s) of bad faith recently approved by this Court in its recent Disney[24] decision, where we held that a failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence).[25] In Disney, we identified the following examples of conduct that would establish a failure to act in good faith:
A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.[26]
The third of these examples describes, and is fully consistent with, the lack of good faith conduct that the Caremark court held was a "necessary condition" for director oversight liability, i.e., "a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists. . . ."[27] Indeed, our opinion in Disney cited Caremark with approval for that proposition.[28] Accordingly, the Court of Chancery applied the correct standard in assessing whether demand was excused in this case where failure to exercise oversight was the basis or theory of the plaintiffs' claim for relief.
It is important, in this context, to clarify a doctrinal issue that is critical to understanding fiduciary liability under Caremark as we construe that case. The phraseology used in Caremark and that we employ here—describing the lack of good faith as a "necessary condition to liability"—is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability.[29] The failure to act in [370] good faith may result in liability because the requirement to act in good faith "is a subsidiary element[,]" i.e., a condition, "of the fundamental duty of loyalty."[30] It follows that because a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.
This view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a "triad" of fiduciary duties that includes the duties of care and loyalty,[31] the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, "[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest."[32]
We hold that Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.[33] Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities,[34] they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.[35]
Chancery Court Decision
The plaintiffs contend that demand is excused under Rule 23.1 because AmSouth's directors breached their oversight duty and, as a result, face a "substantial likelihood of liability" as a result of their "utter failure" to act in good faith to put into place policies and procedures to ensure compliance with BSA and AML obligations. The Court of Chancery found that the plaintiffs did not plead the existence of "red flags"—"facts showing that the board ever was aware that AmSouth's internal controls were inadequate, that these inadequacies would result in illegal activity, and that the board chose to do nothing about problems it allegedly knew existed." In dismissing the derivative complaint in this action, the Court of Chancery concluded:
This case is not about a board's failure to carefully consider a material corporate decision that was presented to the [371] board. This is a case where information was not reaching the board because of ineffective internal controls. . . . With the benefit of hindsight, it is beyond question that AmSouth's internal controls with respect to the Bank Secrecy Act and anti-money laundering regulations compliance were inadequate. Neither party disputes that the lack of internal controls resulted in a huge fine—$50 million, alleged to be the largest ever of its kind. The fact of those losses, however, is not alone enough for a court to conclude that a majority of the corporation's board of directors is disqualified from considering demand that AmSouth bring suit against those responsible.[36]
This Court reviews de novo a Court of Chancery's decision to dismiss a derivative suit under Rule 23.1.[37]
Reasonable Reporting System Existed
The KPMG Report evaluated the various components of AmSouth's longstanding BSA/AML compliance program. The KPMG Report reflects that AmSouth's Board dedicated considerable resources to the BSA/AML compliance program and put into place numerous procedures and systems to attempt to ensure compliance. According to KPMG, the program's various components exhibited between a low and high degree of compliance with applicable laws and regulations.
The KPMG Report describes the numerous AmSouth employees, departments and committees established by the Board to oversee AmSouth's compliance with the BSA and to report violations to management and the Board:
BSA Officer. Since 1998, AmSouth has had a "BSA Officer" "responsible for all BSA/AML-related matters including employee training, general communications, CTR reporting and SAR reporting," and "presenting AML policy and program changes to the Board of Directors, the managers at the various lines of business, and participants in the annual training of security and audit personnel[;]"
BSA/AML Compliance Department. AmSouth has had for years a BSA/AML Compliance Department, headed by the BSA Officer and comprised of nineteen professionals, including a BSA/AML Compliance Manager and a Compliance Reporting Manager;
Corporate Security Department. AmSouth's Corporate Security Department has been at all relevant times responsible for the detection and reporting of suspicious activity as it relates to fraudulent activity, and William Burch, the head of Corporate Security, has been with AmSouth since 1998 and served in the U.S. Secret Service from 1969 to 1998; and
Suspicious Activity Oversight Committee. Since 2001, the "Suspicious Activity Oversight Committee" and its predecessor, the "AML Committee," have actively overseen AmSouth's BSA/AML compliance program. The Suspicious Activity Oversight Committee's mission has for years been to "oversee the policy, procedure, and process issues affecting the Corporate Security and BSA/ AML Compliance Programs, to ensure that an effective program exists at AmSouth to deter, detect, and report money laundering, suspicious activity and other fraudulent activity."
The KPMG Report reflects that the directors not only discharged their oversight [372] responsibility to establish an information and reporting system, but also proved that the system was designed to permit the directors to periodically monitor AmSouth's compliance with BSA and AML regulations. For example, as KPMG noted in 2004, AmSouth's designated BSA Officer "has made annual high-level presentations to the Board of Directors in each of the last five years." Further, the Board's Audit and Community Responsibility Committee (the "Audit Committee") oversaw AmSouth's BSA/AML compliance program on a quarterly basis. The KPMG Report states that "the BSA Officer presents BSA/AML training to the Board of Directors annually," and the "Corporate Security training is also presented to the Board of Directors."
The KPMG Report shows that AmSouth's Board at various times enacted written policies and procedures designed to ensure compliance with the BSA and AML regulations. For example, the Board adopted an amended bank-wide "BSA/AML Policy" on July 17, 2003—four months before AmSouth became aware that it was the target of a government investigation. That policy was produced to plaintiffs in response to their demand to inspect AmSouth's books and records pursuant to section 220[38] and is included in plaintiffs' appendix. Among other things, the July 17, 2003, BSA/AML Policy directs all AmSouth employees to immediately report suspicious transactions or activity to the BSA/AML Compliance Department or Corporate Security.
Complaint Properly Dismissed
In this case, the adequacy of the plaintiffs' assertion that demand is excused depends on whether the complaint alleges facts sufficient to show that the defendant directors are potentially personally liable for the failure of non-director bank employees to file SARs. Delaware courts have recognized that "[m]ost of the decisions that a corporation, acting through its human agents, makes are, of course, not the subject of director attention."[39] Consequently, a claim that directors are subject to personal liability for employee failures is "possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment."[40]
For the plaintiffs' derivative complaint to withstand a motion to dismiss, "only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability."[41] As the Caremark decision noted:
Such a test of liability—lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight—is quite high. But, a demanding test of liability in the oversight context is probably beneficial to corporate shareholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.[42]
The KPMG Report—which the plaintiffs explicitly incorporated by reference into their derivative complaint—refutes the assertion that the directors "never took the necessary steps . . . to ensure that a reasonable BSA compliance and reporting system existed." KPMG's findings reflect [373] that the Board received and approved relevant policies and procedures, delegated to certain employees and departments the responsibility for filing SARs and monitoring compliance, and exercised oversight by relying on periodic reports from them. Although there ultimately may have been failures by employees to report deficiencies to the Board, there is no basis for an oversight claim seeking to hold the directors personally liable for such failures by the employees.
With the benefit of hindsight, the plaintiffs' complaint seeks to equate a bad outcome with bad faith. The lacuna in the plaintiffs' argument is a failure to recognize that the directors' good faith exercise of oversight responsibility may not invariably prevent employees from violating criminal laws, or from causing the corporation to incur significant financial liability, or both, as occurred in Graham, Caremark and this very case. In the absence of red flags, good faith in the context of oversight must be measured by the directors' actions "to assure a reasonable information and reporting system exists" and not by second-guessing after the occurrence of employee conduct that results in an unintended adverse outcome.[43] Accordingly, we hold that the Court of Chancery properly applied Caremark and dismissed the plaintiffs' derivative complaint for failure to excuse demand by alleging particularized facts that created reason to doubt whether the directors had acted in good faith in exercising their oversight responsibilities.
Conclusion
The judgment of the Court of Chancery is affirmed.
[1] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959 (Del.Ch.1996).
[2] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d at 971; see also David B. Shaev Profit Sharing Acct. v. Armstrong, 2006 WL 391931, at *5 (Del.Ch.); Guttman v. Huang, 823 A.2d 492, 506 (Del.Ch.2003).
[3] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).
[4] 31 U.S.C. § 5318 (2006) et seq. The Bank Secrecy Act and the regulations promulgated thereunder require banks to file with the Financial Crimes Enforcement Network, a bureau of the U.S. Department of the Treasury known as "FinCEN," a written "Suspicious Activity Report" (known as a "SAR") whenever, inter alia, a banking transaction involves at least $5,000 "and the bank knows, suspects, or has reason to suspect" that, among other possibilities, the "transaction involves funds derived from illegal activities or is intended or conducted in order to hide or disguise funds or assets derived from illegal activities. . . ." 31 U.S.C. § 5318(g) (2006); 31 C.F.R. § 103.18(a)(2) (2006).
[5] See, e.g., 31 C.F.R. § 103.18(a)(2) (2006).
[6] Del.Code Ann. tit. 8, § 141(a) (2006). See Rales v. Blasband, 634 A.2d 927, 932 (Del. 1993).
[7] Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984).
[8] Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del.2000).
[9] Ch. Ct. R. 23.1. Allegations of demand futility under Rule 23.1 "must comply with stringent requirements of factual particularity that differ substantially from the permissive notice pleadings governed solely by Chancery Rule 8(a)." Brehm v. Eisner, 746 A.2d at 254.
[10] Rales v. Blasband, 634 A.2d 927 (Del. 1993).
[11] Id. at 934.
[12] The fifteen defendants include eight current and seven former directors. The complaint concedes that seven of the eight current directors are outside directors who have never been employed by AmSouth. One board member, C. Dowd Ritter, the Chairman, is an officer or employee of AmSouth.
[13] Del.Code Ann. tit. 8, § 102(b)(7) (2006).
[14] Id.; see In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).
[15] Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125 (Del.1963).
[16] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).
[17] Graham v. Allis-Chalmers Mfg. Co., 188 A.2d at 130 (emphasis added).
[18] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 967 (Del.Ch.1996).
[19] Id. at 969.
[20] Id. at 970.
[21] Id.
[22] Id. at 971.
[23] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d at 971.
[24] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27 (Del.2006).
[25] Id. at 66.
[26] Id. at 67.
[27] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 971 (Del.Ch.1996).
[28] In re Walt Disney Co. Deriv. Litig., 906 A.2d at 67 n. 111.
[29] That issue, whether a violation of the duty to act in good faith is a basis for the direct imposition of liability, was expressly left open in Disney. 906 A.2d at 67 n. 112. We address that issue here.
[30] Guttman v. Huang, 823 A.2d 492, 506 n. 34 (Del.Ch.2003).
[31] See Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993).
[32] Guttman v. Huang, 823 A.2d 492, 506 n. 34 (Del.Ch.2003).
[33] Id. at 506.
[34] In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 67 (Del.2006).
[35] See Guttman v. Huang, 823 A.2d at 506.
[36] Stone v. Ritter, C.A. No. 1570-N, 2006 WL 302558, at *2 (Del.Ch.2006) (Letter Opinion).
[37] Beam ex rel. Martha Stewart Living Omnimedia Inc. v. Stewart, 845 A.2d 1040, 1048 (Del.2004).
[38] Del.Code Ann. tit. 8, § 220 (2006).
[39] In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d at 968.
[40] Id. at 967.
[41] Id. at 971.
[42] Id. (emphasis in original).
[43] Id. at 967-68, 971.
1.2.3 Shareholder Litigation etc. 1.2.3 Shareholder Litigation etc.
It is often said that corporate fiduciary duties are a U.S. specialty. It would be more accurate to say that shareholder litigation is the U.S. specialty. Fiduciary duties or something resembling them exist in all corporate laws that I know of. Most jurisdictions, however, severely limit shareholder litigation that could enforce these duties, relying instead on prohibitions, shareholder approval requirements, or perhaps even criminal law enforcement. Not so the U.S., particularly Delaware.Like most litigation, shareholder litigation presents an obvious dilemma. On the one hand, fiduciary duties are toothless without shareholder litigation to enforce them. That is why courts encourage it with generous fee awards(see Americas Mining below). On the other hand, litigation is extremely expensive, especially the corporate sort. In particular, defendants can incur substantial costs in discovery even if the case never goes to trial, let alone results in a verdict for the plaintiff. In fiduciary duty suits, the main cost is the disruption caused by depositions of directors and managers and, more generally, their distraction from ordinary business. Opportunistic plaintiffs may threaten such litigation costs to extract a meritless settlement.In other words, Delaware’s reliance on fiduciary duties creates a conundrum: how to encourage meritorious suits while discouraging deleterious nuisance suits. Meritorious suits are necessary to enforce fiduciary duties and allow the courts to flesh out their content, whereas nuisance suits can be a costly drag on the system. Do the procedural peculiarities introduced in this section succeed in sorting the good shareholder litigation from the bad?
1.2.3.1 Aronson v. Lewis 1.2.3.1 Aronson v. Lewis
Having learned the substantive law of fiduciary duties, you are prepared to finally read Aronson itself. As you know by now, the case contains Delaware’s canonical statement of the business judgment rule. What Aronson is really about, however, is a procedural overlay to the business judgment rule (and other substantive fiduciary law): the so-called demand futility test.The demand requirement is Delaware’s main procedural filter to address the danger of nuisance suits described above. The complaint must provide some initial reason for why a shareholder should be allowed to prosecute the suit instead of the board. In essence, courts will allow the case to proceed to discovery only if the derivative complaint alleges particularized facts that, if true, would create a reasonable doubt that a majority of the directors can impartially assess the expeditiousness of the suit. Directors can be partial either because they themselves are interested in the underlying transaction (not: the lawsuit!) or violated their fiduciary duties in dealing with it, or because they are beholden to others who are or did. In the case of a suit against the entire board for violation of their duties, this is simply a heightened pleading standard: In particular, it is not sufficient simply to name all directors as defendants; the complaint must allege particularized facts that suggest they may actually be liable. Courts address this question on a motion to dismiss. Even if they do not grant that motion, courts may dismiss the suit at any later time during discovery if a “special litigation committee” so recommends (see Zapata as reported by Aronson).Reading Aronson is complicated by arcane and even misleading terminology. Some signposts may be helpful. Formally, the case arises under Delaware Chancery Rule 23.1(a), which states:“The [derivative] complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors [i.e., the plaintiff’s demand to the board to direct the corporation to sue] and the reasons for the plaintiff's failure to obtain the action or for not making the effort.” [emphasis added]For this rule to make any sense, it must be read to require dismissal if the board rightfully rejected the plaintiff’s demand, or, if no demand was made, the plaintiff’s reasons for failing to make a demand were not legally compelling (why else insist that the reasons be stated?). In practice, serious derivative plaintiffs never make a formal demand — the directors will hardly agree to sue themselves, and the Delaware Supreme Court has ruled that making a demand waives the right to contest the independence of the board (such that challenging the demand refusal as “wrongful” is virtually impossible if the board does its homework and considers the demand with reasonable information – business judgment rule!). Hence the relevant question in Aronson and other cases is: when is demand “futile”? To answer that question, the Delaware courts have developed the test summarized in the preceding paragraph, and further explained in Aronson.Both the demand requirement and the powers of the special litigation committee only apply to derivative suits; they do not apply to direct suits (which are usually filed as class actions). The test for distinguishing direct from derivative actions is “(1) who suffered the alleged harm (the corporation or the suing stock-holders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stock-holders, individually)?” Tooley v. Donaldson, Lufkin & Jenrette, 845 A. 2d 1031, at 1033 (Del. 2004). In practice, this means that shareholders can sue directly over mergers and other transactions that affect their status as shareholders, but not over transactions such as executive compensation that affect shareholders merely financially. For example, of the shareholder suit cases you have read so far, Weinberger and Van Gorkom were direct (class) actions, while Sinclair, Disney, and Stone were derivative actions.1. Does it make sense to treat direct and derivative actions differently, erecting special procedural hurdles only for the latter?2. The Aronson court ultimately rules that "demand was not futile" in this case, i.e., the shareholder-plaintiff was not entitled to prosecute this suit. What should the shareholder have done to achieve a different outcome, and was this feasible? In light of this, do you think Aronson's hurdle for derivative suits is appropriate, too high, or too low?
Senior ARONSON, et al., Defendants Below, Appellants,
v.
Harry LEWIS, Plaintiff Below, Appellee.
Supreme Court of Delaware.
Submitted: November 14, 1983.
Decided: March 1, 1984.
William T. Quillen (argued), Robert K. Payson, Peter M. Sieglaff, Potter, Anderson & Corroon, Wilmington; and Allan M. Pepper, Michael D. Braff, Kaye, Scholer, Fierman, Hays & Handler, New York City, for appellants.
Joseph A. Rosenthal (argued), Morris & Rosenthal, P.A., Wilmington; and Irving Bizar, Pincus, Ohrenstein, Bizar, D'Alessandro & Solomon, New York City, for appellee.
Before McNEILLY, MOORE and CHRISTIE, JJ.
[807] MOORE, Justice:
In the wake of Zapata Corp. v. Maldonado, Del.Supr., 430 A.2d 779 (1981), this Court left a crucial issue unanswered: when is a stockholder's demand upon a board of directors, to redress an alleged wrong to the corporation, excused as futile prior to the filing of a derivative suit? We granted this interlocutory appeal to the defendants, Meyers Parking System, Inc. (Meyers), a Delaware corporation, and its directors, to review the Court of Chancery's denial of their motion to dismiss this action, pursuant to Chancery Rule 23.1, for the [808] plaintiff's failure to make such a demand or otherwise demonstrate its futility.[1] The Vice Chancellor ruled that plaintiff's allegations raised a "reasonable inference" that the directors' action was unprotected by the business judgment rule. Thus, the board could not have impartially considered and acted upon the demand. See Lewis v. Aronson, Del.Ch., 466 A.2d 375, 381 (1983).
We cannot agree with this formulation of the concept of demand futility. In our view demand can only be excused where facts are alleged with particularity which create a reasonable doubt that the directors' action was entitled to the protections of the business judgment rule. Because the plaintiff failed to make a demand, and to allege facts with particularity indicating that such demand would be futile, we reverse the Court of Chancery and remand with instructions that plaintiff be granted leave to amend the complaint.
I.
The issues of demand futility rest upon the allegations of the complaint. The plaintiff, Harry Lewis, is a stockholder of Meyers. The defendants are Meyers and its ten directors, some of whom are also company officers.
In 1979, Prudential Building Maintenance Corp. (Prudential) spun off its shares of Meyers to Prudential's stockholders. Prior thereto Meyers was a wholly owned subsidiary of Prudential. Meyers provides parking lot facilities and related services throughout the country. Its stock is actively traded over-the-counter.
This suit challenges certain transactions between Meyers and one of its directors, Leo Fink, who owns 47% of its outstanding stock. Plaintiff claims that these transactions were approved only because Fink personally selected each director and officer of Meyers.[2]
Prior to January 1, 1981, Fink had an employment agreement with Prudential which provided that upon retirement he was to become a consultant to that company for ten years. This provision became operable when Fink retired in April 1980.[3] Thereafter, Meyers agreed with Prudential to share Fink's consulting services and reimburse Prudential for 25% of the fees paid Fink. Under this arrangement Meyers paid Prudential $48,332 in 1980 and $45,832 in 1981.
On January 1, 1981, the defendants approved an employment agreement between Meyers and Fink for a five year term with provision for automatic renewal each year thereafter, indefinitely. Meyers agreed to pay Fink $150,000 per year, plus a bonus of 5% of its pre-tax profits over $2,400,000. Fink could terminate the contract at any time, but Meyers could do so only upon six months' notice. At termination, Fink was to become a consultant to Meyers and be paid $150,000 per year for the first three years, $125,000 for the next three years, and $100,000 thereafter for life. Death benefits were also included. Fink agreed to devote his best efforts and substantially his entire business time to advancing Meyers' interests. The agreement also provided [809] that Fink's compensation was not to be affected by any inability to perform services on Meyers' behalf. Fink was 75 years old when his employment agreement with Meyers was approved by the directors. There is no claim that he was, or is, in poor health.
Additionally, the Meyers board approved and made interest-free loans to Fink totalling $225,000. These loans were unpaid and outstanding as of August 1982 when the complaint was filed. At oral argument defendants' counsel represented that these loans had been repaid in full.
The complaint charges that these transactions had "no valid business purpose", and were a "waste of corporate assets" because the amounts to be paid are "grossly excessive", that Fink performs "no or little services", and because of his "advanced age" cannot be "expected to perform any such services". The plaintiff also charges that the existence of the Prudential consulting agreement with Fink prevents him from providing his "best efforts" on Meyers' behalf. Finally, it is alleged that the loans to Fink were in reality "additional compensation" without any "consideration" or "benefit" to Meyers.
The complaint alleged that no demand had been made on the Meyers board because:
13. ... such attempt would be futile for the following reasons:
(a) All of the directors in office are named as defendants herein and they have participated in, expressly approved and/or acquiesced in, and are personally liable for, the wrongs complained of herein.
(b) Defendant Fink, having selected each director, controls and dominates every member of the Board and every officer of Meyers.
(c) Institution of this action by present directors would require the defendant-directors to sue themselves, thereby placing the conduct of this action in hostile hands and preventing its effective prosecution.
Complaint, at ¶ 13.
The relief sought included the cancellation of the Meyers-Fink employment contract and an accounting by the directors, including Fink, for all damage sustained by Meyers and for all profits derived by the directors and Fink.
II.
Defendants moved to dismiss for plaintiff's failure to make demand on the Meyers board prior to suit, or to allege with factual particularity why demand is excused. See Del.Ch.Ct.R. 23.1, supra.
After recounting the allegations, the trial judge noted that the demand requirement of Rule 23.1 is a rule of substantive right designed to give a corporation the opportunity to rectify an alleged wrong without litigation, and to control any litigation which does arise. Lewis, 466 A.2d at 380. According to the Vice Chancellor, the test of futility is "whether the Board, at the time of the filing of the suit, could have impartially considered and acted upon the demand". Id. at 381.
As part of this formulation, the trial judge stated that interestedness is one factor affecting impartiality, and indicated that the business judgment rule is a potential defense to allegations of director interest, and hence, demand futility. Id. However, the court observed that to establish demand futility, a plaintiff need not allege that the challenged transaction could never be deemed a product of business judgment. Id. Rather, the Vice Chancellor maintained that a plaintiff "must only allege facts which, if true, show that there is a reasonable inference that the business judgment rule is not applicable for purposes of considering a pre-suit demand pursuant to Rule 23.1". Id. The court concluded that this transaction permitted such an inference. Id. at 384-86.
Upon these formulations, the Court of Chancery addressed the plaintiff's arguments [810] as to the futility of demand. Id. at 381-84. The trial judge correctly noted that futility is gauged by the circumstances existing at the commencement of a derivative suit. This disposed of plaintiff's argument that defendants' motion to dismiss established board hostility and the futility of demand. Id. at 381.
The Vice Chancellor then dealt with plaintiff's contention that Fink, as a 47% shareholder of Meyers, dominated and controlled each director, thereby making demand futile. Id. at 381-83. Plaintiff also argued that Fink's interest, when combined with the shareholdings of four other defendants, amounted to 57.5% of Meyers' outstanding shares. Id. at 381. After noting the presumptions under the business judgment rule that a board's actions are taken in good faith and in the best interests of the corporation, the Court of Chancery ruled that mere board approval of a transaction benefiting a substantial, but non-majority, shareholder will not overcome the presumption of propriety. Id. at 382. Specifically, the court observed that:
A plaintiff, to properly allege domination of the Board, particularly domination based on ownership of less than a majority of the corporation's stock, in order to excuse a pre-suit demand, must allege ownership plus other facts evidencing control to demonstrate that the Board could not have exercised its independent business judgment.
Id.
As to the combined 57.5% control claim, the court stated that there were no factual allegations regarding the alignment of the four directors with Fink, such as a claim that they were beneficiaries of the Meyers-Fink agreement. Id. at 382, 383. Because it was not alleged in the complaint, the court rejected plaintiff's argument that, as evidence of alignment with Fink, two of the directors have "similar" compensation agreements with Meyers. Id. at 383.
Turning to plaintiff's allegations of board approval, participation in, and/or acquiescence in the wrong, the trial court focused on the underlying transaction to determine whether the board's action was wrongful and not protected by the business judgment rule. Id. [citing Dann v. Chrysler, Del.Ch., 174 A.2d 696 (1961)]. The Vice Chancellor indicated that if the underlying transaction supported a reasonable inference that the business judgment rule did not apply, then the directors who approved the transaction were potentially liable for a breach of their fiduciary duty, and thus, could not impartially consider a stockholder's demand. Id.
The trial court then stated that board approval of the Meyers-Fink agreement, allowing Fink's consultant compensation to remain unaffected by his ability to perform any services, may have been a transaction wasteful on its face. Id. [citing Fidanque v. American Maracaibo Co., Del.Ch., 92 A.2d 311 (1952)]. Consequently, demand was excused as futile, because the Meyers' directors faced potential liability for waste and could not have impartially considered the demand. Id. at 384.
III.
The defendants make two arguments, one policy-oriented and the other, factual. First, they assert that the demand requirement embraces the policy that directors, rather than stockholders, manage the affairs of the corporation. They contend that this fundamental principle requires the strict construction and enforcement of Chancery Rule 23.1. Second, the defendants point to four of plaintiff's basic allegations and argue that they lack the factual particularity necessary to excuse demand. Concerning the allegation that Fink dominated and controlled the Meyers board, the defendants point to the absence of any facts explaining how he "selected each director". With respect to Fink's 47% stock interest, the defendants say that absent other facts this is insufficient to indicate domination and control. Regarding the claim of hostility to the plaintiff's suit, because defendants would have to sue themselves, the latter assert that this bootstrap argument ignores the possibility that the directors have other [811] alternatives, such as cancelling the challenged agreement. As for the allegation that directorial approval of the agreement excused demand, the defendants reply that such a claim is insufficient, because it would obviate the demand requirement in almost every case. The effect would be to subvert the managerial power of a board of directors. Finally, as to the provision guaranteeing Fink's compensation, even if he is unable to perform any services, the defendants contend that the trial court read this out of context. Based upon the foregoing, the defendants conclude that the plaintiff's allegations fall far short of the factual particularity required by Rule 23.1.
IV.
A.
A cardinal precept of the General Corporation Law of the State of Delaware is that directors, rather than shareholders, manage the business and affairs of the corporation. 8 Del.C. § 141(a). Section 141(a) states in pertinent part:
"The business and affairs of a corporation organized under this chapter shall be managed by or under the direction of a board of directors except as may be otherwise provided in this chapter or in its certificate of incorporation."
8 Del.C. § 141(a) (Emphasis added). The existence and exercise of this power carries with it certain fundamental fiduciary obligations to the corporation and its shareholders.[4]Loft, Inc. v. Guth, Del.Ch., 2 A.2d 225 (1938), aff'd, Del.Supr., 5 A.2d 503 (1939). Moreover, a stockholder is not powerless to challenge director action which results in harm to the corporation. The machinery of corporate democracy and the derivative suit are potent tools to redress the conduct of a torpid or unfaithful management. The derivative action developed in equity to enable shareholders to sue in the corporation's name where those in control of the company refused to assert a claim belonging to it. The nature of the action is two-fold. First, it is the equivalent of a suit by the shareholders to compel the corporation to sue. Second, it is a suit by the corporation, asserted by the shareholders on its behalf, against those liable to it.
By its very nature the derivative action impinges on the managerial freedom of directors.[5] Hence, the demand requirement of Chancery Rule 23.1 exists at the threshold, first to insure that a stockholder exhausts his intracorporate remedies, and [812] then to provide a safeguard against strike suits. Thus, by promoting this form of alternate dispute resolution, rather than immediate recourse to litigation, the demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of corporations.
In our view the entire question of demand futility is inextricably bound to issues of business judgment and the standards of that doctrine's applicability. The business judgment rule is an acknowledgment of the managerial prerogatives of Delaware directors under Section 141(a). See Zapata Corp. v. Maldonado, 430 A.2d at 782. It is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Kaplan v. Centex Corp., Del.Ch., 284 A.2d 119, 124 (1971); Robinson v. Pittsburgh Oil Refinery Corp., Del.Ch., 126 A. 46 (1924). Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption. See Puma v. Marriott, Del.Ch., 283 A.2d 693, 695 (1971).
The function of the business judgment rule is of paramount significance in the context of a derivative action. It comes into play in several ways — in addressing a demand, in the determination of demand futility, in efforts by independent disinterested directors to dismiss the action as inimical to the corporation's best interests, and generally, as a defense to the merits of the suit. However, in each of these circumstances there are certain common principles governing the application and operation of the rule.
First, its protections can only be claimed by disinterested directors whose conduct otherwise meets the tests of business judgment. From the standpoint of interest, this means that directors can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally. Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 720 (1971); Cheff v. Mathes, Del.Supr., 199 A.2d 548, 554 (1964); David J. Greene & Co. v. Dunhill International, Inc., Del.Ch., 249 A.2d 427, 430 (1968). See also 8 Del.C. § 144. Thus, if such director interest is present, and the transaction is not approved by a majority consisting of the disinterested directors, then the business judgment rule has no application whatever in determining demand futility. See 8 Del.C. § 144(a)(1).
Second, to invoke the rule's protection directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed, they must then act with requisite care in the discharge of their duties. While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence.[6] See Veasey & Manning, Codified Standard [813] — Safe Harbor or Uncharted Reef? 35 Bus.Law. 919, 928 (1980).
However, it should be noted that the business judgment rule operates only in the context of director action. Technically speaking, it has no role where directors have either abdicated their functions, or absent a conscious decision, failed to act.[7] But it also follows that under applicable principles, a conscious decision to refrain from acting may nonetheless be a valid exercise of business judgment and enjoy the protections of the rule.
The gap in our law, which we address today, arises from this Court's decision in Zapata Corp. v. Maldonado. There, the Court defined the limits of a board's managerial power granted by Section 141(a) and restricted application of the business judgment rule in a factual context similar to this action. Zapata Corp. v. Maldonado, 430 A.2d at 782-86, rev'g, Maldonado v. Flynn, Del.Ch., 413 A.2d 1251 (1980).
By way of background, this Court's review in Zapata was limited to whether an independent investigation committee of disinterested directors had the power to cause the derivative action to be dismissed. Preliminarily, it was noted in Zapata that "[d]irectors of Delaware corporations derive their managerial decision making power, which encompasses decisions whether to initiate, or refrain from entering, litigation, from 8 Del.C. § 141(a)". Zapata, 430 A.2d at 782 (footnotes omitted). In that context, this Court observed that the business judgment rule has no relevance to corporate decision making until after a decision has been made. Id. In Zapata, we stated that a shareholder does not possess an independent individual right to continue a derivative action. Moreover, where demand on a board has been made and refused, we apply the business judgment rule in reviewing the board's refusal to act pursuant to a stockholder's demand. Id. at 784 & n. 10. Unless the business judgment rule does not protect the refusal to sue, the shareholder lacks the legal managerial power to continue the derivative action, since that power is terminated by the refusal. Id. at 784. We also concluded that where demand is excused a shareholder possesses the ability to initiate a derivative action, but the right to prosecute it may be terminated upon the exercise of applicable standards of business judgment. Id. The thrust of Zapata is that in either the demand-refused or the demand-excused case, the board still retains its Section 141(a) managerial authority to make decisions regarding corporate litigation. Moreover, the board may delegate its managerial authority to a committee of independent disinterested directors. Id. at 786. See 8 Del.C. § 141(c). Thus, even in a demand-excused case, a board has the power to appoint a committee of one or more independent disinterested directors to determine whether the derivative action should be pursued or dismissal sought. Zapata, 430 A.2d at 786. Under Zapata, the Court of Chancery, in passing on a committee's motion to dismiss a derivative action in a demand excused case, must apply a two-step test. First, the court must inquire into the independence and good faith of the committee and review the reasonableness and good faith of the committee's investigation. Id. at 788. Second, the court must apply its own independent business judgment to decide whether the motion to dismiss should be granted. Id. at 789.
After Zapata numerous derivative suits were filed without prior demand upon boards of directors. The complaints in such actions all alleged that demand was excused because of board interest, approval or acquiescence in the wrongdoing. In any event, the Zapata demand-excused/demand-refused [814] bifurcation, has left a crucial issue unanswered: when is demand futile and, therefore, excused?
Delaware courts have addressed the issue of demand futility on several earlier occasions. See Sohland v. Baker, Del. Supr., 141 A. 277, 281-82 (1927); McKee v. Rogers, Del.Ch., 156 A. 191, 193 (1931); Miller v. Loft, Del.Ch., 153 A. 861, 862 (1931); Fleer v. Frank H. Fleer Corp., Del.Ch., 125 A. 411, 414 (1924); Harden v. Eastern States Public Service Co., Del.Ch., 122 A. 705, 707 (1923); Ellis v. Penn Beef Co., Del.Ch., 80 A. 666, 668 (1911). Cf. Mayer v. Adams, Del.Supr., 141 A.2d 458, 461 (1958) (minority demand on majority shareholders). The rule emerging from these decisions is that where officers and directors are under an influence which sterilizes their discretion, they cannot be considered proper persons to conduct litigation on behalf of the corporation. Thus, demand would be futile. See, e.g., McKee v. Rogers, Del.Ch., 156 A. 191, 192 (1931) (holding that where a defendant controlled the board of directors, "[i]t is manifest then that there can be no expectation that the corporation would sue him, and if it did, it can hardly be said that the prosecution of the suit would be entrusted to proper hands"). But see, e.g., Fleer v. Frank H. Fleer Corp., Del.Ch., 125 A. 411, 415 (1924) ("[w]here the demand if made would be directed to the particular individuals who themselves are the alleged wrongdoers and who therefore would be invited to sue themselves, the rule is settled that a demand and refusal is not requisite"); Miller v. Loft, Inc., Del.Ch., 153 A. 861, 862 (1931) ("if by reason of hostile interest or guilty participation in the wrongs complained of, the directors cannot be expected to institute suit, ... no demand upon them to institute suit is requisite").
However, those cases cannot be taken to mean that any board approval of a challenged transaction automatically connotes "hostile interest" and "guilty participation" by directors, or some other form of sterilizing influence upon them. Were that so, the demand requirements of our law would be meaningless, leaving the clear mandate of Chancery Rule 23.1 devoid of its purpose and substance.
The trial court correctly recognized that demand futility is inextricably bound to issues of business judgment, but stated the test to be based on allegations of fact, which, if true, "show that there is a reasonable inference" the business judgment rule is not applicable for purposes of a pre-suit demand. Lewis, 466 A.2d at 381.
The problem with this formulation is the concept of reasonable inferences to be drawn against a board of directors based on allegations in a complaint. As is clear from this case, and the conclusory allegations upon which the Vice Chancellor relied, demand futility becomes virtually automatic under such a test. Bearing in mind the presumptions with which director action is cloaked, we believe that the matter must be approached in a more balanced way.
Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof. As to the latter inquiry the court does not assume that the transaction is a wrong to the corporation requiring corrective steps by the board. Rather, the alleged wrong is substantively reviewed against the factual background alleged in the complaint. As to the former inquiry, directorial independence and disinterestedness, the court reviews the factual allegations to decide whether they raise a reasonable doubt, as a threshold matter, that the protections of the business judgment rule are available to the board. [815] Certainly, if this is an "interested" director transaction, such that the business judgment rule is inapplicable to the board majority approving the transaction, then the inquiry ceases. In that event futility of demand has been established by any objective or subjective standard.[8]See, e.g., Bergstein v. Texas Internat'l Co., Del.Ch., 453 A.2d 467, 471 (1982) (because five of nine directors approved stock appreciation rights plan likely to benefit them, board was interested for demand purposes and demand held futile). This includes situations involving self-dealing directors. See Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717 (1971); Sterling v. Mayflower, Del.Supr., 93 A.2d 107 (1952); Trans World Airlines, Inc. v. Summa Corp., Del.Ch., 374 A.2d 5 (1977); David J. Greene & Co. v. Dunhill International, Inc., Del.Ch., 249 A.2d 427 (1968).
However, the mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors, although in rare cases a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability therefore exists. See Gimbel v. Signal Cos., Inc., Del.Ch., 316 A.2d 599, aff'd, Del.Supr., 316 A.2d 619 (1974); Cottrell v. Pawcatuck Co., Del.Supr., 128 A.2d 225 (1956). In sum the entire review is factual in nature. The Court of Chancery in the exercise of its sound discretion must be satisfied that a plaintiff has alleged facts with particularity which, taken as true, support a reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment. Only in that context is demand excused.
B.
Having outlined the legal framework within which these issues are to be determined, we consider plaintiff's claims of futility here: Fink's domination and control of the directors, board approval of the Fink-Meyers employment agreement, and board hostility to the plaintiff's derivative action due to the directors' status as defendants.
Plaintiff's claim that Fink dominates and controls the Meyers' board is based on: (1) Fink's 47% ownership of Meyers' outstanding stock, and (2) that he "personally selected" each Meyers director. Plaintiff also alleges that mere approval of the employment agreement illustrates Fink's domination and control of the board. In addition, plaintiff argued on appeal that 47% stock ownership, though less than a majority, constituted control given the large number of shares outstanding, 1,245,745.
Such contentions do not support any claim under Delaware law that these directors lack independence. In Kaplan v. Centex Corp., Del.Ch., 284 A.2d 119 (1971), the Court of Chancery stated that "[s]tock ownership alone, at least when it amounts to less than a majority, is not sufficient proof of domination or control". Id. at 123. Moreover, in the demand context even proof of majority ownership of a company does not strip the directors of the presumptions of independence, and that their acts have been taken in good faith and in the best interests of the corporation. There must be coupled with the allegation of control such facts as would demonstrate that through personal or other relationships the directors are beholden to the controlling person. See Mayer v. Adams, Del.Ch., 167 A.2d 729, 732, aff'd, Del.Supr., 174 A.2d 313 (1961). To date the principal decisions dealing [816] with the issue of control or domination arose only after a full trial on the merits. Thus, they are distinguishable in the demand context unless similar particularized facts are alleged to meet the test of Chancery Rule 23.1. See e.g., Kaplan, 284 A.2d at 123; Chasin v. Gluck, Del.Ch., 282 A.2d 188 (1971); Greene v. Allen, Del.Ch., 114 A.2d 916 (1955); Loft, Inc. v. Guth, Del.Ch., 2 A.2d 225, 237 (1938), aff'd, Del.Supr., 5 A.2d 503 (1939).
The requirement of director independence inhers in the conception and rationale of the business judgment rule. The presumption of propriety that flows from an exercise of business judgment is based in part on this unyielding precept. Independence means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences. While directors may confer, debate, and resolve their differences through compromise, or by reasonable reliance upon the expertise of their colleagues and other qualified persons, the end result, nonetheless, must be that each director has brought his or her own informed business judgment to bear with specificity upon the corporate merits of the issues without regard for or succumbing to influences which convert an otherwise valid business decision into a faithless act.
Thus, it is not enough to charge that a director was nominated by or elected at the behest of those controlling the outcome of a corporate election. That is the usual way a person becomes a corporate director. It is the care, attention and sense of individual responsibility to the performance of one's duties, not the method of election, that generally touches on independence.
We conclude that in the demand-futile context a plaintiff charging domination and control of one or more directors must allege particularized facts manifesting "a direction of corporate conduct in such a way as to comport with the wishes or interests of the corporation (or persons) doing the controlling". Kaplan, 284 A.2d at 123. The shorthand shibboleth of "dominated and controlled directors" is insufficient. In recognizing that Kaplan was decided after trial and full discovery, we stress that the plaintiff need only allege specific facts; he need not plead evidence. Otherwise, he would be forced to make allegations which may not comport with his duties under Chancery Rule 11.[9]
Here, plaintiff has not alleged any facts sufficient to support a claim of control. The personal-selection-of-directors allegation stands alone, unsupported. At best it is a conclusion devoid of factual support. The causal link between Fink's control and approval of the employment agreement is alluded to, but nowhere specified. The director's approval, alone, does not establish control, even in the face of Fink's 47% stock ownership. See Kaplan v. Centex Corp., 284 A.2d at 122, 123. The claim that Fink is unlikely to perform any services under the agreement, because of his age, and his conflicting consultant work with Prudential, adds nothing to the control claim.[10] Therefore, we cannot conclude that the [817] complaint factually particularizes any circumstances of control and domination to overcome the presumption of board independence, and thus render the demand futile.
C.
Turning to the board's approval of the Meyers-Fink employment agreement, plaintiff's argument is simple: all of the Meyers directors are named defendants, because they approved the wasteful agreement; if plaintiff prevails on the merits all the directors will be jointly and severally liable; therefore, the directors' interest in avoiding personal liability automatically and absolutely disqualifies them from passing on a shareholder's demand.
Such allegations are conclusory at best. In Delaware mere directorial approval of a transaction, absent particularized facts supporting a breach of fiduciary duty claim, or otherwise establishing the lack of independence or disinterestedness of a majority of the directors, is insufficient to excuse demand.[11] Here, plaintiff's suit is premised on the notion that the Meyers-Fink employment agreement was a waste of corporate assets. So, the argument goes, by approving such waste the directors now face potential personal liability, thereby rendering futile any demand on them to bring suit. Unfortunately, plaintiff's claim falls in its initial premise. The complaint does not allege particularized facts indicating that the agreement is a waste of corporate assets. Indeed, the complaint as now drafted may not even state a cause of action, given the directors' broad corporate power to fix the compensation of officers.[12]
In essence, the plaintiff alleged a lack of consideration flowing from Fink to Meyers, since the employment agreement provided that compensation was not contingent on Fink's ability to perform any services. The bare assertion that Fink performed "little or no services" was plaintiff's conclusion based solely on Fink's age and the existence of the Fink-Prudential employment agreement. As for Meyers' loans to Fink, beyond the bare allegation that they were made, the complaint does not allege facts indicating the wastefulness of such arrangements. Again, the mere existence of such loans, given the broad corporate powers conferred by Delaware law, does not even state a claim.[13]
In sustaining plaintiff's claim of demand futility the trial court relied on Fidanque v. American Maracaibo Co., Del. Ch., 92 A.2d 311, 321 (1952), which held that a contract providing for payment of consulting fees to a retired president/director was a waste of corporate assets. Id. In Fidanque, the court found after trial that the contract and payments were in reality compensation for past services. Id. at 320. This was based upon facts not present here: the former president/director was a 70 year old stroke victim, neither the agreement nor the record spelled out his consulting duties at all, the consulting salary equalled the individual's salary when he was president and general manager of the corporation, and the contract was silent as to continued employment in the event that the retired president/director again became incapacitated and unable to perform his duties. Id. at 320-21. Contrasting the facts of Fidanque with the complaint here, it is apparent that plaintiff has not alleged [818] facts sufficient to render demand futile on a charge of corporate waste, and thus create a reasonable doubt that the board's action is protected by the business judgment rule. Cf. Beard v. Elster, Del.Supr., 160 A.2d 731 (1960); Lieberman v. Koppers Company Line, Inc., Del.Ch., 149 A.2d 756, aff'd, Lieberman v. Becker, Del.Supr., 155 A.2d 596 (1959).
D.
Plaintiff's final argument is the incantation that demand is excused because the directors otherwise would have to sue themselves, thereby placing the conduct of the litigation in hostile hands and preventing its effective prosecution. This bootstrap argument has been made to and dismissed by other courts. See, e.g., Lewis v. Graves, 701 F.2d 245, 248-49 (2d Cir.1983); Heit v. Baird, 567 F.2d 1157, 1162 (1st Cir. 1977); Lewis v. Anselmi, 564 F.Supp., 768, 772 (S.D.N.Y.1983). Its acceptance would effectively abrogate Rule 23.1 and weaken the managerial power of directors. Unless facts are alleged with particularity to overcome the presumptions of independence and a proper exercise of business judgment, in which case the directors could not be expected to sue themselves, a bare claim of this sort raises no legally cognizable issue under Delaware corporate law.
V.
In sum, we conclude that the plaintiff has failed to allege facts with particularity indicating that the Meyers directors were tainted by interest, lacked independence, or took action contrary to Meyers' best interests in order to create a reasonable doubt as to the applicability of the business judgment rule. Only in the presence of such a reasonable doubt may a demand be deemed futile. Hence, we reverse the Court of Chancery's denial of the motion to dismiss, and remand with instructions that plaintiff be granted leave to amend his complaint to bring it into compliance with Rule 23.1 based on the principles we have announced today.
* * *
REVERSED AND REMANDED.
[1] Chancery Rule 23.1, similar to Fed.R.Civ.P. 23.1, provides in pertinent part:
In a derivative action brought by 1 or more shareholders or members to enforce a right of a corporation or of an unincorporated association, the corporation or association having failed to enforce a right which may properly be asserted by it, the complaint shall allege that the plaintiff was a shareholder or member at the time of the transaction of which he complains or that his share of membership thereafter devolved on him by operation of law. The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and the reasons for his failure to obtain the action or for not making the effort. Del.Ch.Ct.R. 23.1 (Emphasis added).
[2] The Court of Chancery stated that Fink had been chief executive officer of Prudential prior to the spin-off and thereafter became chairman of Meyers' board. This was not alleged in the complaint. Lewis, 466 A.2d at 379.
[3] The trial court stated that Fink "changed his status with Prudential building from employee to consultant". Lewis, 466 A.2d at 379.
[4] The broad question of structuring the modern corporation in order to satisfy the twin objectives of managerial freedom of action and responsibility to shareholders has been extensively debated by commentators. See, e.g., Fischel, The Corporate Governance Movement, 35 Vand.L.Rev. 1259 (1982); Dickstein, Corporate Governance and the Shareholders' Derivative Action: Rules and Remedies for Implementing the Monitoring Model, 3 Cardozo L.Rev. 627 (1982); Haft, Business Decisions by the New Board: Behavioral Science and Corporate Law, 80 Mich.L.Rev. 1 (1981); Dent, The Revolution in Corporate Governance, The Monitoring Board, and The Director's Duty of Care, 61 B.U.L.Rev. 623 (1981); Moore, Corporate Officer & Director Liability: Is Corporate Behavior Beyond the Control of Our Legal System? 16 Capital U.L.Rev. 69 (1980); Jones, Corporate Governance: Who Controls the Large Corporation? 30 Hastings L.J. 1261 (1979); Small, The Evolving Role of the Director in Corporate Governance, 30 Hastings L.J. 1353 (1979).
[5] Like the broader question of corporate governance, the derivative suit, its value, and the methods employed by corporate boards to deal with it have received much attention by commentators. See, e.g., Brown, Shareholder Derivative Litigation and the Special Litigation Committee, 43 U.Pitt.L.Rev. 601 (1982); Coffee and Schwartz, The Survival of the Derivative Suit: An Evaluation and a Proposal for Legislative Reform, 81 Colum.L.Rev. 261 (1981); Shnell, A Procedural Treatment of Derivative Suit Dismissals by Minority Directors, 609 Calif.L.Rev. 885 (1981); Dent, The Power of Directors to Terminate Shareholder Litigation: The Death of the Derivative Suit? 75 N.W.U.L. Rev. 96 (1980); Jones, An Empirical Examination of the Incidence of Shareholder Derivative and Class Action Lawsuits, 1971-1978, 60 B.U. L.Rev. 306 (1980); Comment, The Demand and Standing Requirements in Stockholder Derivative Actions, 44 U.Chi.L.Rev. 168 (1976); Dykstra, The Revival of the Derivative Suit, 116 U.Pa.L.Rev. 74 (1967); Note, Demand on Directors and Shareholders as a Prerequisite to a Derivative Suit, 73 Harv.L.Rev. 729 (1960).
[6] While the Delaware cases have not been precise in articulating the standard by which the exercise of business judgment is governed, a long line of Delaware cases holds that director liability is predicated on a standard which is less exacting than simple negligence. Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 722 (1971), rev'g, Del.Ch., 261 A.2d 911 (1969) ("fraud or gross overreaching"); Getty Oil Co. v. Skelly Oil Co., Del.Supr., 267 A.2d 883, 887 (1970), rev'g, Del.Ch., 255 A.2d 717 (1969) ("gross and palpable overreaching"); Warshaw v. Calhoun, Del.Supr., 221 A.2d 487, 492-93 (1966) ("bad faith ... or a gross abuse of discretion"); Moskowitz v. Bantrell, Del.Supr., 190 A.2d 749, 750 (1963) ("fraud or gross abuse of discretion"); Penn Mart Realty Co. v. Becker, Del.Ch., 298 A.2d 349, 351 (1972) ("directors may breach their fiduciary duty ... by being grossly negligent"); Kors v. Carey, Del.Ch., 158 A.2d 136, 140 (1960) ("fraud, misconduct or abuse of discretion"); Allaun v. Consolidated Oil Co., Del.Ch., 147 A. 257, 261 (1929) ("reckless indifference to or a deliberate disregard of the stockholders").
[7] Although questions of director liability in such cases have been adjudicated upon concepts of business judgment, they do not in actuality present issues of business judgment. See Graham v. Allis-Chalmers Manufacturing Co., Del.Supr., 188 A.2d 125 (1963); Kelly v. Bell, Del.Ch., 254 A.2d 62 (1969), aff'd, Del. Supr., 266 A.2d 878 (1970); Lutz v. Boas, Del. Ch., 171 A.2d 381 (1961). See also Arsht, Fiduciary Responsibilities of Directors, Officers & Key Employees, 4 Del.J.Corp.L. 652, 659 (1979).
[8] We recognize that drawing the line at a majority of the board may be an arguably arbitrary dividing point. Critics will charge that we are ignoring the structural bias common to corporate boards throughout America, as well as the other unseen socialization processes cutting against independent discussion and decisionmaking in the boardroom. The difficulty with structural bias in a demand futile case is simply one of establishing it in the complaint for purposes of Rule 23.1. We are satisfied that discretionary review by the Court of Chancery of complaints alleging specific facts pointing to bias on a particular board will be sufficient for determining demand futility.
[9] Chancery Rule 11 provides:
Every pleading of a party represented by an attorney shall be signed by at least 1 attorney of record in his individual name, whose address shall be stated. A party who is not represented by an attorney shall sign his pleading and state his address. Except when otherwise specifically provided by statute or rule, pleadings need not be verified or accompanied by affidavit. The signature of an attorney constitutes a certificate by him that he has read the pleading; that to the best of his knowledge, information, and belief there is good ground to support it; and that it is not interposed for delay. If a pleading is not signed or is signed with intent to defeat the purpose of this rule, it may be stricken as sham and false and the action may proceed as though the pleading had not been served. For a willful violation of this rule an attorney may be subjected to appropriate disciplinary action. Similar action may be taken if scandalous or indecent matter is inserted.
Del.Ch.Ct.R. 11.
[10] Plaintiff made no legal argument that the "best efforts" provision of the agreement prohibited dual consultant duties, thereby demonstrating that the contract's approval evidenced control or was otherwise wrongful.
[11] See also In re Kauffman Mutual Fund Actions, 479 F.2d 257, 265 (1st Cir.1973); Greenspun v. Del E. Webb, 634 F.2d 1204, 1210 (9th Cir.1980); Grossman v. Johnson, 674 F.2d 115, 124 (1st Cir.1982); Lewis v. Curtis, 671 F.2d 779, 785 (3d Cir.1982); Lewis v. Graves, 701 F.2d 245, 248 (2d Cir.1983).
[12] 8 Del.C. § 122(5) provides that "[e]very corporation created under this chapter shall have the power to appoint such officers and agents as the business of the corporation requires and to pay or otherwise provide for them suitable compensation". 8 Del.C. § 122(5).
[13] Plaintiff's allegation ignores 8 Del.C. § 143 which expressly authorizes interest-free loans to "any officer or employee of the corporation... whenever, in the judgment of the directors, such loan ... may reasonably be expected to benefit the corporation." 8 Del.C. § 143.
1.2.3.2 Indemnification and Insurance 1.2.3.2 Indemnification and Insurance
Disney and Stone made it quite clear that the risk of liability for unconflicted directors is now modest at best even under the default rules: the business judgment rule provides robust protection to directors (and arguably officers). If the corporation’s charter has a 102(b)(7) waiver, as most do, the risk of liability for directors (but not officers) is even less. And under Aronson and the demand requirement, very few shareholders suits will advance to discovery if brought derivatively.
Nevertheless, directors and officers still face residual risk, in particular from litigation costs. Moreover, directors and officers may be the target of third-party litigation in relation to their corporate office: For example, the directors might be the target of an SEC enforcement action or an employee lawsuit as a result of their board service, whether or not such actions have a legally sound basis. For this reason, directors and officers should and do require that corporations indemnify and insure them extensively, even in advance of the final disposition of proceedings, which can take years (and generate hefty expenses in the interim). Please (re-)read Article VI of the model charter, and the law firm advice to prospective directors at perma.cc/4QGU-M4FL. Under DGCL 145, corporations are allowed (subsections a-b, e-f) and sometimes required (subsection c) to provide such indemnification and insurance. As a result, outside directors virtually never have to pay anything out of their own pockets in corporate lawsuits, see Black, Cheffins, & Klausner, Outside Director Liability, 58 Stan. L. Rev. 1055 (2006).
Please answer the following questions:
1. Which liabilities and expenses are indemnifiable under DGCL 145? Which are insurable?
2. What does your answer to the preceding question imply for directors' and officers' incentives to settle a derivative action?
3. Why do directors and officers insist on insurance, i.e., why are they still worried in spite of the business judgment rule, 102(b)(7) waivers, and generous indemnification promises?
4. What is the point of liability, if any, if all of the foregoing neutralizes it?
1.2.3.3 Americas Mining Corp. v. Theriault 1.2.3.3 Americas Mining Corp. v. Theriault
To generate a substantial amount of shareholder litigation, merely allowing shareholders suits, direct or derivative, is not sufficient. Somebody needs to have an incentive to bring the suit. If shareholder-plaintiffs only recovered their pro rata share of the recovery (indirectly in the case of a derivative suit), incentives to bring suit would be very low and, in light of substantial litigation costs, usually insufficient. Litigation would be hamstrung by the same collective action problem as proxy fights. Under the common fund doctrine, however, U.S. courts award a substantial part of the recovery to the plaintiff or, in the standard case, to the plaintiff lawyer. As Americas Mining shows, that award can be very substantial indeed.The litigation incentives generated by such awards strike some as excessive. For a while, virtually every M&A deal attracted shareholder litigation, albeit mostly with much lower or no recovery. Corporations tried various tactics to limit the amount of litigation they face, prompting recent amendments of the DGCL (sections 102(f) and 115 – read!).1. How does the court determine the right amount of the fee award? What criteria does it use, and what purposes does it aim to achieve? Are the criteria well calibrated to the purposes?2. Who is opposing the fee award, and why?3. Are the damage and fee awards sufficient to deter fiduciary duty violations similar to those at issue in this case?Note: I excerpt here only the passages relevant to the attorney fee award. The case below was In re Southern Peru (Del. Ch. 2011).
AMERICAS MINING CORPORATION, et al., Defendants Below, Appellants,
v.
Michael THERIAULT, as Trustee for the Theriault Trust, Plaintiff Below, Appellee.
Southern Copper Corporation, formerly known as Southern Peru Copper Corporation, Nominal Defendant Below, Appellant,
v.
Michael Theriault, as Trustee for the Theriault Trust, Plaintiff Below, Appellee.
Supreme Court of Delaware.
[1218] S. Mark Hurd, Esquire and Kevin M. Coen, Esquire, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware, and Bruce D. Angiolillo, Esquire (argued), Jonathan K. Youngwood, Esquire, Craig S. Waldman, Esquire, and Daniel J. Stujenske, Esquire, Simpson, Thacher & Bartlett LLP, New York, New York, for appellants, Americas Mining Corporation, Germán Larrea Mota-Velasco, Genaro Larrea Mota-Velasco, Oscar Gonzalez Rocha, Emilio Carrillo Gamboa, Jaime Fernando Collazo Gonzalez, Xavier Garcia de Quevedo Topete, Armando Ortega Gómez, and Juan Rebolledo Gout.
Stephen E. Jenkins, Esquire (argued), Richard L. Renck, Esquire, Andrew D. Cordo, Esquire and F. Troupe Mickler, IV, Esquire, Ashby & Geddes, Wilmington, Delaware, for appellant, Nominal Defendant Southern Copper Corporation, formerly known as Southern Peru Copper Corporation.
Ronald A. Brown, Jr., Esquire (argued) and Marcus E. Montejo, Esquire, Prickett, Jones & Elliott, P.A., Wilmington, Delaware, and Kessler Topaz Meltzer & Check, LLP, Radnor, Pennsylvania, for appellee.
Before STEELE, Chief Justice, HOLLAND, BERGER and RIDGELY, Justices and VAUGHN, President Judge,[1] constituting the Court en Banc.
HOLLAND, Justice, for the majority:
This is an appeal from a post-trial decision and final judgment of the Court of Chancery awarding more than $2 billion in damages and more than $304 million in attorneys' fees. The Court of Chancery held that the defendants-appellants, Americas Mining Corporation ("AMC"), the subsidiary of Southern Copper Corporation's ("Southern Peru") controlling shareholder, and affiliate directors of Southern Peru (collectively, the "Defendants"), breached their fiduciary duty of loyalty to Southern Peru and its minority stockholders by causing Southern Peru to acquire the controller's 99.15% interest in a Mexican mining company, Minera México, S.A. de C.V. ("Minera"), for much more than it was worth, i.e., at an unfair price.
The Plaintiff challenged the transaction derivatively on behalf of Southern Peru. The Court of Chancery found the trial evidence established that the controlling shareholder, Grupo México, S.A.B. de C.V. ("Grupo Mexico"), through AMC, "extracted a deal that was far better than market" from Southern Peru due to the ineffective operation of a special committee (the "Special Committee"). To remedy the Defendants' breaches of loyalty, the Court of Chancery awarded the difference between the value Southern Peru paid for Minera ($3.7 billion) and the amount the Court of Chancery determined Minera was worth ($2.4 billion). The Court of Chancery awarded damages in the amount of $1.347 billion plus pre- and post-judgment interest, for a total judgment of $2.0316 billion. The Court of Chancery also awarded the Plaintiff's counsel attorneys' fees and expenses in the amount of 15% of the total judgment, which amounts to more than $304 million.
Issues on Appeal
The Defendants have raised five issues on appeal. First, they argue that the Court of Chancery impermissibly denied the Defendants the opportunity to present a witness from Goldman, Sachs & Co. ("Goldman") at trial to explain its valuation process, on the grounds that the witness constituted an "unfair surprise." Second, they contend that the Court of Chancery committed reversible error by failing to [1219] determine which party bore the burden of proof before trial. They further claim the Court of Chancery erred by ultimately allocating the burden to the Defendants, because, they submit, the Special Committee was independent, well-functioning, and did not rely on the controlling shareholder for the information that formed the basis for its recommendation. Third, they argue that the Court of Chancery's determination about the "fair" price for the transaction was arbitrary and capricious. Fourth, they assert that the Court of Chancery's award of damages is not supported by evidence in the record, but rather by impermissible speculation and conjecture. Finally, the Defendants' allege that the Court of Chancery's award of attorneys' fees of more than $304 million is an abuse of discretion. Southern Peru also appeals from the award of attorneys' fees to the Plaintiff's counsel.
We have determined that all of the Defendants' arguments are without merit. Therefore, the judgment of the Court of Chancery is affirmed.
FACTUAL BACKGROUND[2]
The controlling stockholder in this case is Grupo México, S.A.B. de C.V. The NYSE-listed mining company is Southern Peru Copper Corporation.[3] The Mexican mining company is Minera México, S.A. de C.V.[4]
In February 2004, Grupo Mexico proposed that Southern Peru buy its 99.15% stake in Minera. At the time, Grupo Mexico owned 54.17% of Southern Peru's outstanding capital stock and could exercise 63.08% of the voting power of Southern Peru, making it Southern Peru's majority stockholder.
Grupo Mexico initially proposed that Southern Peru purchase its equity interest in Minera with 72.3 million shares of newly-issued Southern Peru stock. This "indicative" number assumed that Minera's equity was worth $3.05 billion, because that is what 72.3 million shares of Southern Peru stock were worth then in cash. By stark contrast with Southern Peru, Minera was almost wholly owned by Grupo Mexico and therefore had no market-tested value.
Because of Grupo Mexico's self-interest in the merger proposal, Southern Peru formed a "Special Committee" of disinterested directors to "evaluate" the transaction with Grupo Mexico. The Special Committee spent eight months in an awkward back and forth with Grupo Mexico over the terms of the deal before approving Southern Peru's acquisition of 99.15% of Minera's stock in exchange for 67.2 million newly-issued shares of Southern Peru stock (the "Merger") on October 21, 2004. That same day, Southern Peru's board of directors (the "Board") unanimously approved the Merger and Southern Peru and Grupo Mexico entered into a definitive agreement (the "Merger Agreement"). On October 21, 2004, the market value of 67.2 million shares of Southern Peru stock was $3.1 billion. When the Merger closed on April 1, 2005, the value [1220] of 67.2 million shares of Southern Peru had grown to $3.75 billion.
This derivative suit was then brought against the Grupo Mexico subsidiary that owned Minera, the Grupo Mexico-affiliated directors of Southern Peru, and the members of the Special Committee, alleging that the Merger was entirely unfair to Southern Peru and its minority stockholders.
The crux of the Plaintiff's argument is that Grupo Mexico received something demonstrably worth more than $3 billion (67.2 million shares of Southern Peru stock) in exchange for something that was not worth nearly that much (99.15% of Minera).[5] The Plaintiff points to the fact that Goldman, which served as the Special Committee's financial advisor, never derived a value for Minera that justified paying Grupo Mexico's asking price, but instead relied on a "relative" valuation analysis that involved comparing the discounted cash flow ("DCF") values of Southern Peru and Minera, and a contribution analysis that improperly applied Southern Peru's own market EBITDA multiple (and even higher multiples) to Minera's EBITDA projections, to determine an appropriate exchange ratio to use in the Merger. The Plaintiff claims that, because the Special Committee and Goldman abandoned the company's market price as a measure of the true value of the give, Southern Peru substantially overpaid in the Merger.
The Defendants remaining in the case are Grupo Mexico and its affiliate directors who were on the Southern Peru Board at the time of the Merger.[6] These Defendants assert that Southern Peru and Minera are similar companies and were properly valued on a relative basis. In other words, the defendants argue that the appropriate way to determine the price to be paid by Southern Peru in the Merger was to compare both companies' values using the same set of assumptions and methodologies, rather than comparing Southern Peru's market capitalization to Minera's DCF value. The Defendants do not dispute that shares of Southern Peru stock could have been sold for their market price at the time of the Merger, but they contend that Southern Peru's market price did not reflect the fundamental value of Southern Peru and thus could not appropriately be compared to the DCF value of Minera.
After this brief overview of the basic events and the parties' core arguments, the Court of Chancery provided the following more detailed recitation of the facts as it found them after trial.
The Key Players
Southern Peru operates mining, smelting, and refining facilities in Peru, producing copper and molybdenum as well as silver and small amounts of other metals. Before the Merger, Southern Peru had two classes of stock: common shares that were traded on the New York Stock Exchange; and "Founders Shares" that were owned by Grupo Mexico, Cerro Trading Company, Inc., and Phelps Dodge Corporation (the "Founding Stockholders"). Each Founders Share had five votes per share versus one vote per share for ordinary common stock. Grupo Mexico owned 43.3 million Founders Shares, which translated [1221] to 54.17% of Southern Peru's outstanding stock and 63.08% of the voting power.
Southern Peru's certificate of incorporation and a stockholders' agreement also gave Grupo Mexico the right to nominate a majority of the Southern Peru Board. The Grupo Mexico-affiliated directors who are defendants in this case held seven of the thirteen Board seats at the time of the Merger. Cerro owned 11.4 million Founders Shares (14.2% of the outstanding common stock) and Phelps Dodge owned 11.2 million Founders Shares (13.95% of the outstanding common stock). Among them, therefore, Grupo Mexico, Cerro, and Phelps Dodge owned over 82% of Southern Peru.
Grupo Mexico is a Mexican holding company listed on the Mexican stock exchange. Grupo Mexico is controlled by the Larrea family, and at the time of the Merger defendant Germán Larrea was the Chairman and CEO of Grupo Mexico, as well as the Chairman and CEO of Southern Peru. Before the Merger, Grupo Mexico owned 99.15% of Minera's stock and thus essentially was Minera's sole owner. Minera is a company engaged in the mining and processing of copper, molybdenum, zinc, silver, gold, and lead through its Mexico-based mines. At the time of the Merger, Minera was emerging from — if not still mired in — a period of financial difficulties, and its ability to exploit its assets had been compromised by these financial constraints. By contrast, Southern Peru was in good financial condition and virtually debt-free.
Grupo Mexico Proposes That Southern Peru Acquire Minera
In 2003, Grupo Mexico began considering combining its Peruvian mining interests with its Mexican mining interests. In September 2003, Grupo Mexico engaged UBS Investment Bank to provide advice with respect to a potential strategic transaction involving Southern Peru and Minera.
Grupo Mexico and UBS made a formal presentation to Southern Peru's Board on February 3, 2004, proposing that Southern Peru acquire Grupo Mexico's interest in Minera from AMC in exchange for newly-issued shares of Southern Peru stock. In that presentation, Grupo Mexico characterized the transaction as "[Southern Peru] to acquire Minera [] from AMC in a stock for stock deal financed through the issuance of common shares; initial proposal to issue 72.3 million shares." A footnote to that presentation explained that the 72.3 million shares was "an indicative number" of Southern Peru shares to be issued, assuming an equity value of Minera of $3.05 billion and a Southern Peru share price of $42.20 as of January 29, 2004.
In other words, the consideration of 72.3 million shares was indicative in the sense that Grupo Mexico wanted $3.05 billion in dollar value of Southern Peru stock for its stake in Minera, and the number of shares that Southern Peru would have to issue in exchange for Minera would be determined based on Southern Peru's market price. As a result of the proposed merger, Minera would become a virtually wholly-owned subsidiary of Southern Peru. The proposal also contemplated the conversion of all Founders Shares into a single class of common shares.
Southern Peru Forms A Special Committee
In response to Grupo Mexico's presentation, the Board met on February 12, 2004 and created a Special Committee to evaluate the proposal. The resolution creating the Special Committee provided that the "duty and sole purpose" of the Special Committee was "to evaluate the [Merger] [1222] in such manner as the Special Committee deems to be desirable and in the best interests of the stockholders of [Southern Peru]," and authorized the Special Committee to retain legal and financial advisors at Southern Peru's expense on such terms as the Special Committee deemed appropriate. The resolution did not give the Special Committee express power to negotiate, nor did it authorize the Special Committee to explore other strategic alternatives.
The Special Committee's makeup as it was finally settled on March 12, 2004 was as follows:
• Harold S. Handelsman: Handelsman graduated from Columbia Law School and worked at Wachtell, Lipton, Rosen & Katz as an M & A lawyer before becoming an attorney for the Pritzker family interests in 1978. The Pritzker family is a wealthy family based in Chicago that owns, through trusts, a myriad of businesses. Handelsman was appointed to the Board in 2002 by Cerro, which was one of those Pritzker-owned businesses.
• Luis Miguel Palomino Bonilla: Palomino has a Ph.D in finance from the Wharton School at the University of Pennsylvania and worked as an economist, analyst and consultant for various banks and financial institutions. Palomino was nominated to the Board by Grupo Mexico upon the recommendation of certain Peruvian pension funds that held a large portion of Southern Peru's publicly traded stock.
• Gilberto Perezalonso Cifuentes: Perezalonso has both a law degree and an MBA and has managed multi-billion dollar companies such as Grupo Televisa and AeroMexico Airlines. Perezalonso was nominated to the Board by Grupo Mexico.
• Carlos Ruiz Sacristán: Ruiz, who served as the Special Committee's Chairman, worked as a Mexican government official for 25 years before co-founding an investment bank, where he advises on M & A and financing transactions. Ruiz was nominated to the Board by Grupo Mexico.
The Special Committee Hires Advisors And Seeks A Definitive Proposal From Grupo Mexico
The Special Committee began its work by hiring U.S. counsel and a financial advisor. After considering various options, the Special Committee chose Latham & Watkins LLP and Goldman. The Special Committee also hired a specialized mining consultant to help Goldman with certain technical aspects of mining valuation. Goldman suggested consultants that the Special Committee might hire to aid in the process; after considering these options, the Special Committee retained Anderson & Schwab ("A & S").
After hiring its advisors, the Special Committee set out to acquire a "proper" term sheet from Grupo Mexico. The Special Committee did not view the most recent term sheet that Grupo Mexico had sent on March 25, 2004 as containing a price term that would allow the Special Committee to properly evaluate the proposal. For some reason the Special Committee did not get the rather clear message that Grupo Mexico thought Minera was worth $3.05 billion.
Thus, in response to that term sheet, on April 2, 2004, Ruiz sent a letter to Grupo Mexico on behalf of the Special Committee in which he asked for clarification about, among other things, the pricing of the proposed transaction. On May 7, 2004, Grupo Mexico sent to the Special Committee [1223] what the Special Committee considered to be the first "proper" term sheet, making even more potent its ask.
The May 7 Term Sheet
Grupo Mexico's May 7 term sheet contained more specific details about the proposed consideration to be paid in the Merger. It echoed the original proposal, but increased Grupo Mexico's ask from $3.05 billion worth of Southern Peru stock to $3.147 billion. Specifically, the term sheet provided that:
The proposed value of Minera [] is US$4,3 billion, comprised of an equity value of US$3,147 million [sic] and US$1,153 million [sic] of net debt as of April 2004. The number of [Southern Peru] shares to be issued in respect to the acquisition of Minera [] would be calculated by dividing 98.84% of the equity value of Minera [] by the 20-day average closing share price of [Southern Peru] beginning 5 days prior to closing of the [Merger].[7]
In other words, Grupo Mexico wanted $3.147 billion in market-tested Southern Peru stock in exchange for its stake in Minera. The structure of the proposal, like the previous Grupo Mexico ask, shows that Grupo Mexico was focused on the dollar value of the stock it would receive.
Throughout May 2004, the Special Committee's advisors conducted due diligence to aid their analysis of Grupo Mexico's proposal. As part of this process, A & S visited Minera's mines and adjusted the financial projections of Minera management (i.e., of Grupo Mexico) based on the outcome of their due diligence.
Goldman Begins To Analyze Grupo Mexico's Proposal
On June 11, 2004, Goldman made its first presentation to the Special Committee addressing the May 7 term sheet. Although Goldman noted that due diligence was still ongoing, it had already done a great deal of work and was able to provide preliminary valuation analyses of the standalone equity value of Minera, including a DCF analysis, a contribution analysis, and a look-through analysis.
Goldman performed a DCF analysis of Minera based on long-term copper prices ranging from $0.80 to $1.00 per pound and discount rates ranging from 7.5% to 9.5%, utilizing both unadjusted Minera management projections and Minera management projections as adjusted by A & S. The only way that Goldman could derive a value for Minera close to Grupo Mexico's asking price was by applying its most aggressive assumptions (a modest 7.5% discount rate and its high-end $1.00/lb long-term copper price) to the unadjusted Minera management projections, which yielded an equity value for Minera of $3.05 billion. By applying the same aggressive assumptions to the projections as adjusted by A & S, Goldman's DCF analysis yielded a lower equity value for Minera of $2.41 billion. Goldman's mid-range assumptions (an 8.5% discount rate and $0.90/lb long-term copper price) only generated a $1.7 billion equity value for Minera when applied to the A & S-adjusted projections. That is, the mid-range of the Goldman analysis generated a value for Minera (the "get") a full $1.4 billion less than Grupo Mexico's ask for the give.
It made sense for Goldman to use the $0.90 per pound long term copper price as a mid-range assumption, because this price [1224] was being used at the time by both Southern Peru and Minera for purposes of internal planning. The median long-term copper price forecast based on Wall Street research at the time of the Merger was also $0.90 per pound.
Goldman's contribution analysis applied Southern Peru's market-based sales, EBITDA, and copper sales multiples to Minera. This analysis yielded an equity value for Minera ranging only between $1.1 and $1.7 billion. Goldman's look-through analysis, which was a sum-of-the-parts analysis of Grupo Mexico's market capitalization, generated a maximum equity value for Minera of $1.3 billion and a minimum equity value of only $227 million.
Goldman summed up the import of these various analyses in an "Illustrative Give/Get Analysis," which made patent the stark disparity between Grupo Mexico's asking price and Goldman's valuation of Minera: Southern Peru would "give" stock with a market price of $3.1 billion to Grupo Mexico and would "get" in return an asset worth no more than $1.7 billion.
The important assumption reflected in Goldman's June 11 presentation was that a bloc of shares of Southern Peru could yield a cash value equal to Southern Peru's actual stock market price and was thus worth its market value was emphasized by the Court of Chancery. At trial, the Defendants disclaimed any reliance upon a claim that Southern Peru's stock market price was not a reliable indication of the cash value that a very large bloc of shares — such as the 67.2 million paid to Grupo Mexico — could yield in the market. Thus, the price of the "give" was always easy to discern. The question thus becomes what was the value of the "get." Unlike Southern Peru, Minera's value was not the subject of a regular market test. Minera shares were not publicly traded and thus the company was embedded in the overall value of Grupo Mexico.
The June 11 presentation clearly demonstrates that Goldman, in its evaluation of the May 7 term sheet, could not get the get anywhere near the give. Notably, that presentation marked the first and last time that a give-get analysis appeared in Goldman's presentations to the Special Committee.
The Court of Chancery described what happened next as curious. The Special Committee began to devalue the "give" in order to make the "get" look closer in value. The DCF analysis of the value of Minera that Goldman presented initially caused concern. As Handelsman stated at trial, "when [the Special Committee] thought that the value of Southern Peru was its market value and the value of Minera [] was its discounted cash flow value ... those were very different numbers."
But, the Special Committee's view changed when Goldman presented it with a DCF analysis of the value of Southern Peru on June 23, 2004. In this June 23 presentation, Goldman provided the Special Committee with a preliminary DCF analysis for Southern Peru analogous to the one that it had provided for Minera in the June 11 presentation. But, the discount rates that Goldman applied to Southern Peru's cash flows ranged from 8% to 10% instead of 7.5% to 9.5%. Based on Southern Peru management's projections, the DCF value generated for Southern Peru using mid-range assumptions (a 9% discount rate and $0.90/lb long-term copper price) was $2.06 billion. This was about $1.1 billion shy of Southern Peru's market capitalization as of June 21, 2004 ($3.19 billion). Those values "comforted" the [1225] Special Committee.[8]
The Court of Chancery found that "comfort" was an odd word for the Special Committee to use in this context. What Goldman was basically telling the Special Committee was that Southern Peru was being overvalued by the stock market. That is, Goldman told the Special Committee that even though Southern Peru's stock was worth an obtainable amount in cash, it really was not worth that much in fundamental terms. Thus, although Southern Peru had an actual cash value of $3.19 billion, its "real," "intrinsic," or "fundamental" value was only $2.06 billion, and giving $2.06 billion in fundamental value for $1.7 billion in fundamental value was something more reasonable to consider.
The Court of Chancery concluded that the more logical reaction of someone not in the confined mindset of directors of a controlled company may have been that it was a good time to capitalize on the market multiple the company was getting and monetize the asset. The Court of Chancery opined that a third party in the Special Committee's position might have sold at the top of the market, or returned cash to the Southern Peru stockholders by declaring a special dividend. For example, if it made long-term strategic sense for Grupo Mexico to consolidate Southern Peru and Minera, there was a logical alternative for the Special Committee: ask Grupo Mexico to make a premium to market offer for Southern Peru. Let Grupo Mexico be the buyer, not the seller.
In other words, the Court of Chancery found that by acting like a third-party negotiator with its own money at stake and with the full range of options, the Special Committee would have put Grupo Mexico back on its heels. Doing so would have been consistent with the financial advice it was getting and seemed to accept as correct. The Special Committee could have also looked to use its market-proven stock to buy a company at a good price (a lower multiple to earnings than Southern Peru's) and then have its value rolled into Southern Peru's higher market multiple to earnings. That could have included buying Minera at a price equal to its fundamental value using Southern Peru's market-proven currency.
The Court of Chancery was chagrined that instead of doing any of these things, the Special Committee was "comforted" by the fact that they could devalue that currency and justify paying more for Minera than they originally thought they should.
Special Committee Moves Toward Relative Valuation
After the June 23, 2004 presentation, the Special Committee and Goldman began to embrace the idea that the companies should be valued on a relative basis. In a July 8, 2004 presentation to the Special Committee, Goldman included both a revised standalone DCF analysis of Minera and a "Relative Discounted Cash Flow Analysis" in the form of matrices presenting the "indicative number" of Southern Peru shares that should be issued to acquire Minera based on various assumptions. The relative DCF analysis generated a vast range of Southern Peru shares to be issued in the Merger of 28.9 million to 71.3 million. Based on Southern Peru's July 8, 2004 market value of $40.30 per share, 28.9 million shares of Southern Peru stock had a market value of $1.16 billion, and 71.3 million shares were worth $2.87 [1226] billion. In other words, even the highest equity value yielded for Minera by this analysis was short of Grupo Mexico's actual cash value asking price.
The revised standalone DCF analysis applied the same discount rate and long-term copper price assumptions that Goldman had used in its June 11 presentation to updated projections. This time, by applying a 7.5% discount rate and $1.00 per pound long-term copper price to Minera management's projections, Goldman was only able to yield an equity value of $2.8 billion for Minera. Applying the same aggressive assumptions to the projections as adjusted by A & S generated a standalone equity value for Minera of only $2.085 billion. Applying mid-range assumptions (a discount rate of 8.5% and $0.90/lb long-term copper price) to the A & S-adjusted projections yielded an equity value for Minera of only $1.358 billion.
The Special Committee Makes A Counterproposal Suggests A Fixed-Exchange Ratio
After Goldman's July 8 presentation, the Special Committee made a counterproposal to Grupo Mexico. The Court of Chancery noted it was "oddly" not mentioned in Southern Peru's proxy statement describing the Merger (the "Proxy Statement"). In this counterproposal, the Special Committee offered that Southern Peru would acquire Minera by issuing 52 million shares of Southern Peru stock with a then-current market value of $2.095 billion. The Special Committee also proposed implementation of a fixed, rather than a floating, exchange ratio that would set the number of Southern Peru shares issued in the Merger.
From the inception of the Merger, Grupo Mexico had contemplated that the dollar value of the price to be paid by Southern Peru would be fixed (at a number that was always north of $3 billion), while the number of Southern Peru shares to be issued as consideration would float up or down based on Southern Peru's trading price around the time of closing. But, the Special Committee was uncomfortable with having to issue a variable amount of shares in the Merger. Handelsman testified that, in its evaluation of Grupo Mexico's May 7 term sheet, "it was the consensus of the [Special Committee] that a floating exchange rate was a nonstarter" because "no one could predict the number of shares that [Southern Peru] would have to issue in order to come up with the consideration requested."
The Special Committee wanted a fixed exchange ratio, which would set the number of shares that Southern Peru would issue in the Merger at the time of signing. The dollar value of the Merger consideration at the time of closing would vary with the fluctuations of Southern Peru's market price. According to the testimony of the Special Committee members, their reasoning was that both Southern Peru's stock and the copper market had been historically volatile, and a fixed exchange ratio would protect Southern Peru's stockholders from a situation in which Southern Peru's stock price went down and Southern Peru would be forced to issue a greater number of shares for Minera in order to meet a fixed dollar value. The Court of Chancery found that position was hard to reconcile with the Special Committee and Southern Peru's purported bullishness about the copper market in 2004.
Grupo Mexico Sticks To Its Demand
In late July or early August, Grupo Mexico responded to the Special Committee's counterproposal by suggesting that Southern Peru should issue in excess of 80 million shares of common stock to purchase Minera. It is not clear on the record [1227] exactly when Grupo Mexico asked for 80 million shares, but given Southern Peru's trading history at that time, the market value of that consideration would have been close to $3.1 billion, basically the same place where Grupo Mexico had started. The Special Committee viewed Grupo Mexico's ask as too high, which is not surprising given that the parties were apparently a full billion dollars in value apart, and negotiations almost broke down.
But, on August 21, 2004, after what is described as "an extraordinary effort" in Southern Peru's Proxy Statement, Grupo Mexico proposed a new asking price of 67 million shares. On August 20, 2004, Southern Peru was trading at $41.20 per share, so 67 million shares were worth about $2.76 billion on the market, a drop in Grupo Mexico's ask. Grupo Mexico's new offer brought the Special Committee back to the negotiating table.
After receiving two term sheets from Grupo Mexico that reflected the 67 million share asking price, the second of which was received on September 8, 2004, when 67 million shares had risen to be worth $3.06 billion on the market, Goldman made another presentation to the Special Committee on September 15, 2004. In addition to updated relative DCF analyses of Southern Peru and Minera (presented only in terms of the number of shares of Southern Peru stock to be issued in the Merger), this presentation contained a "Multiple Approach at Different EBITDA Scenarios," which was essentially a comparison of Southern Peru and Minera's market-based equity values, as derived from multiples of Southern Peru's 2004 and 2005 estimated (or "E") EBITDA.
Goldman also presented these analyses in terms of the number of Southern Peru shares to be issued to Grupo Mexico, rather than generating standalone values for Minera. The range of shares to be issued at the 2004E EBITDA multiple (5.0x) was 44 to 54 million; at the 2005E multiple (6.3x) Goldman's analyses yielded a range of 61 to 72 million shares of Southern Peru stock. Based on Southern Peru's $45.34 share price as of September 15, 2004, 61 to 72 million shares had a cash value of $2.765 billion to $3.26 billion.
The Special Committee sent a new proposed term sheet to Grupo Mexico on September 23, 2004. That term sheet provided for a fixed purchase price of 64 million shares of Southern Peru (translating to a $2.95 billion market value based on Southern Peru's then-current closing price). The Special Committee's proposal contained two terms that would protect the minority stockholders of Southern Peru: (1) a 20% collar around the purchase price, which gave both the Special Committee and Grupo Mexico the right to walk away from the Merger if Southern Peru's stock price went outside of the collar before the stockholder vote; and (2) a voting provision requiring that a majority of the minority stockholders of Southern Peru vote in favor of the Merger. Additionally, the proposal called for Minera's net debt, which Southern Peru was going to absorb in the Merger, to be capped at $1.105 billion at closing, and contained various corporate governance provisions.
The Special Committee's Proposed Terms Rejected But The Parties Work Out A Deal
On September 30, 2004, Grupo Mexico sent a counterproposal to the Special Committee, in which Grupo Mexico rejected the Special Committee's offer of 64 million shares and held firm to its demand for 67 million shares. Grupo Mexico's counterproposal also rejected the collar and the majority of the minority vote provision, proposing instead that the Merger be conditioned [1228] on the vote of two-thirds of the outstanding stock. Grupo Mexico noted that conditioning the Merger on a two-thirds shareholder vote obviated the need for the walk-away right requested by the Special Committee, because Grupo Mexico would be prevented from approving the Merger unilaterally in the event the stock price was materially higher at the time of the stockholder vote than at the time of Board approval. Grupo Mexico did accept the Special Committee's proposed $1.05 billion debt cap at closing. The Court of Chancery found that was not much of a concession in light of the fact that Minera was already contractually obligated to pay down its debt and was in the process of doing so.
After the Special Committee received Grupo Mexico's September 30 counterproposal, the parties reached agreement on certain corporate governance provisions to be included in the Merger Agreement, some of which were originally suggested by Grupo Mexico and some of which were first suggested by the Special Committee. Without saying these provisions were of no benefit at all to Southern Peru and its outside investors, the Court of Chancery did say that they did not factor more importantly in its decision because they do not provide any benefit above the protections of default law that were economically meaningful enough to close the material dollar value gap that existed.
On October 5, 2004, members of the Special Committee met with Grupo Mexico to iron out a final deal. At that meeting, the Special Committee agreed to pay 67 million shares, dropped their demand for the collar, and acceded to most of Grupo Mexico's demands. The Special Committee justified paying a higher price through what the Court of Chancery described as a series of economic contortions. The Special Committee was able to "bridge the gap" between the 64 million and the 67 million figures by decreasing Minera's debt cap by another $105 million, and by getting Grupo Mexico to cause Southern Peru to issue a special dividend of $100 million, which had the effect of decreasing the value of Southern Peru's stock. According to Special Committee member Handelsman, these "bells and whistles" made it so that "the value of what was being ... acquired in the merger went up, and the value of the specie that was being used in the merger went down...," giving the Special Committee reason to accept a higher Merger price.
The closing share price of Southern Peru was $53.16 on October 5, 2004, so a purchase price of 67 million shares had a market value of $3.56 billion, which was higher than the dollar value requested by Grupo Mexico in its February 2004 proposal or its original May 7 term sheet.
At that point, the main unresolved issue was the stockholder vote that would be required to approve the Merger. After further negotiations, on October 8, 2004, the Special Committee gave up on its proposed majority of the minority vote provision and agreed to Grupo Mexico's suggestion that the Merger require only the approval of two-thirds of the outstanding common stock of Southern Peru. Given the size of the holdings of Cerro and Phelps Dodge, Grupo Mexico could achieve a two-thirds vote if either Cerro or Phelps Dodge voted in favor of the Merger.
Multi-Faceted Dimensions Of Controlling Power: Large Stockholders Who Want To Get Out Support A Strategic, Long-Term Acquisition As A Prelude To Their Own Exit As Stockholders
One of the members of the Special Committee, Handelsman, represented a large [1229] Founding Stockholder, Cerro. The Court of Chancery noted that this might be seen in some ways to have ideally positioned Handelsman to be a very aggressive negotiator. But Handelsman had a problem to deal with, which did not involve Cerro having any self-dealing interest in the sense that Grupo Mexico had. Rather, Grupo Mexico had control over Southern Peru and thus over whether Southern Peru would take the steps necessary to make the Founding Stockholders' shares marketable under applicable securities regulations. Cerro and Phelps Dodge wanted to monetize their investment in Southern Peru and get out.
Thus, while the Special Committee was negotiating the terms of the Merger, Handelsman was engaged in negotiations of his own with Grupo Mexico. Cerro and Phelps Dodge had been seeking registration rights from Grupo Mexico (in its capacity as Southern Peru's controller) for their shares of Southern Peru stock, which they needed because of the volume restrictions imposed on affiliates of an issuer by SEC Rule 144.
The Court of Chancery found that it is not clear which party first proposed liquidity and support for the Founding Stockholders in connection with the Merger. But it is plain that the concept appears throughout the term sheets exchanged between Grupo Mexico and the Special Committee, and it is clear that Handelsman knew that registration rights would be part of the deal from the beginning of the Merger negotiations and that thus the deal would enable Cerro to sell as it desired. The Special Committee did not take the lead in negotiating the specific terms of the registration rights provisions — rather, it took the position that it wanted to leave the back-and-forth over the agreement details to Cerro and Grupo Mexico. Handelsman, however, played a key role in the negotiations with Grupo Mexico on Cerro's behalf.
At trial, Handelsman explained that there were two justifications for pursuing registration rights — one offered benefits exclusive to the Founding Stockholders, and the other offered benefits that would inure to Southern Peru's entire stockholder base. The first justification was that Cerro needed the registration rights in order to sell its shares quickly, and Cerro wanted "to get out" of its investment in Southern Peru. The second justification concerned the public market for Southern Peru stock.
Granting registration rights to the Founding Stockholders would allow Cerro and Phelps Dodge to sell their shares, increasing the amount of stock traded on the market and thus increasing Southern Peru's somewhat thin public float. This would in turn improve stockholder liquidity, generate more analyst exposure, and create a more efficient market for Southern Peru shares, all of which would benefit the minority stockholders. Handelsman thus characterized the registration rights situation as a "win-win," because "it permitted us to sell our stock" and "it was good for [Southern Peru] because they had a better float and they had a more organized sale of shares."
Handelsman's tandem negotiations with Grupo Mexico culminated in Southern Peru giving Cerro registration rights for its shares on October 21, 2004, the same day that the Special Committee approved the Merger. In exchange for registration rights, Cerro expressed its intent to vote its shares in favor of the Merger if the Special Committee recommended it. If the Special Committee made a recommendation against the Merger, or withdrew its recommendation in favor of it, Cerro was bound by the agreement to vote against the Merger.
[1230] Grupo Mexico's initial proposal, which Handelsman received on October 18, 2004 — a mere three days before the Special Committee was to vote on the Merger — was that it would grant Cerro registration rights in exchange for Cerro's agreement to vote in favor of the Merger. The Special Committee and Handelsman suggested instead that Cerro's vote on the Merger be tied to whether or not the Special Committee recommended the Merger. After discussing the matter with the Special Committee, Grupo Mexico agreed.
On December 22, 2004, after the Special Committee approved the Merger but well before the stockholder vote, Phelps Dodge entered into an agreement with Grupo Mexico that was similar to Cerro's, but did not contain a provision requiring Phelps Dodge to vote against the Merger if the Special Committee did. By contrast, Phelps Dodge's agreement only provided that, [t]aking into account that the Special Committee ... did recommend ... the approval of the [Merger], Phelps Dodge "express[es] [its] current intent, to [] submit its proxies to vote in favor of the [Merger]...." Thus, in the event that the Special Committee later withdrew its recommendation to approve the Merger, Cerro would be contractually bound to vote against it, but Grupo Mexico could still achieve the two-thirds vote required to approve the Merger solely with Phelps Dodge's cooperation. Under the terms of the Merger Agreement, the Special Committee was free to change its recommendation of the Merger, but it was not able to terminate the Merger Agreement on the basis of such a change. Rather, a change in the Special Committee's recommendation only gave Grupo Mexico the power to terminate the Merger Agreement.
This issue caused the Court of Chancery concern. Although it was not prepared on this record to find that Handelsman consciously agreed to a suboptimal deal for Southern Peru simply to achieve liquidity for Cerro from Grupo Mexico, it had little doubt that Cerro's own predicament as a stockholder dependent on Grupo Mexico's whim as a controller for registration rights influenced how Handelsman approached the situation. The Court of Chancery found that did not mean Handelsman consciously gave in, but it did mean that he was less than ideally situated to press hard. Put simply, Cerro was even more subject to the dominion of Grupo Mexico than smaller holders because Grupo Mexico had additional power over it because of the unregistered nature of its shares.
Most important to the Court of Chancery was that Cerro's desires, when considered alongside the Special Committee's actions, illustrate the tendency of control to result in odd behavior. During the negotiations of the Merger, Cerro had no interest in the long-term benefits to Southern Peru of acquiring Minera, nor did Phelps Dodge. Certainly, Cerro did not want any deal so disastrous that it would tank the value of Southern Peru completely, but nor did it have a rational incentive to say no to a suboptimal deal if that risked being locked into its investments.
The Court of Chancery found that Cerro wanted to sell and sell then and there. But as a Special Committee member, Handelsman did not act consistently with that impulse for all stockholders. He did not suggest that Grupo Mexico make an offer for Southern Peru, but instead pursued a long-term strategic transaction in which Southern Peru was the buyer. Accordingly, the Court of Chancery concluded that a short-term seller of a company's shares caused that company to be a long-term buyer.
[1231] After One Last Price Adjustment, Goldman Makes Its Final Presentation
On October 13, 2004, Grupo Mexico realized that it owned 99.15% of Minera rather than 98.84%, and the purchase price was adjusted to 67.2 million shares instead of 67 million shares to reflect the change in size of the interest being sold. On October 13, 2004, Southern Peru was trading at $45.90 per share, which meant that 67.2 million shares had a dollar worth of $3.08 billion.
On October 21, 2004, the Special Committee met to consider whether to recommend that the Board approve the Merger. At that meeting, Goldman made a final presentation to the Special Committee. The October 21, 2004 presentation stated that Southern Peru's implied equity value was $3.69 billion based on its then current market capitalization at a stock price of $46.41 and adjusting for debt. Minera's implied equity value is stated as $3.146 billion, which was derived entirely from multiplying 67.2 million shares by Southern Peru's $46.41 stock price and adjusting for the fact that Southern Peru was only buying 99.15% of Minera.
No standalone equity value of Minera was included in the Goldman October 21 presentation.[9] Instead, the presentation included a series of relative DCF analyses and a "Contribution Analysis at Different EBITDA Scenarios," both of which were presented in terms of a hypothetical number of Southern Peru shares to be issued to Grupo Mexico for Minera. Goldman's relative DCF analyses provided various matrices showing the number of shares of Southern Peru that should be issued in exchange for Minera under various assumptions regarding the discount rate, the long-term copper price, the allocation of tax benefits, and the amount of royalties that Southern Peru would need to pay to the Peruvian government.
As it had in all of its previous presentations, Goldman used a range of long-term copper prices from $0.80 to $1.00 per pound. The DCF analyses generated a range of the number of shares to be issued in the Merger from 47.2 million to 87.8 million. Based on the then-current stock price of $45.92, this translated to $2.17 billion to $4.03 billion in cash value. Assuming the mid-range figures of a discount rate of 8.5% and a long-term copper price of $0.90 per pound, the analyses yielded a range of shares from 60.7 to 78.7 million.
Goldman's contribution analysis generated a range of 42 million to 56 million shares of Southern Peru to be issued based on an annualized 2004E EBITDA multiple (4.6x) and forecasted 2004E EBITDA multiple (5.0x), and a range of 53 million to 73 million shares based on an updated range of estimated 2005E EBITDA multiples (5.6x to 6.5x). Notably, the 2004E EBITDA multiples did not support the issuance of 67.2 million shares of Southern Peru stock in the Merger. But, [1232] 67.2 million shares falls at the higher end of the range of shares calculated using Southern Peru's 2005E EBITDA multiples.
As notable, these multiples were not the product of the median of the 2005E EBITDA multiples of comparable companies identified by Goldman (4.8x). Instead, the multiples used were even higher than Southern Peru's own higher 2005E EBITDA Wall Street consensus (5.5x) — an adjusted version of which was used as the bottom end of the range. These higher multiples were then attributed to Minera, a non-publicly traded company suffering from a variety of financial and operational problems.
Goldman opined that the Merger was fair from a financial perspective to the stockholders of Southern Peru, and provided a written fairness opinion.
Special Committee And Board Approve The Merger
After Goldman made its presentation, the Special Committee voted 3-0 to recommend the Merger to the Board. At the last-minute suggestion of Goldman, Handelsman decided not to vote in order to remove any appearance of conflict based on his participation in the negotiation of Cerro's registration rights, despite the fact that he had been heavily involved in the negotiations from the beginning and his hands had been deep in the dough of the now fully baked deal. The Board then unanimously approved the Merger and Southern Peru entered into the Merger Agreement.
Market Reacts To The Merger
The market reaction to the Merger was mixed and the parties have not presented any reliable evidence about it. That is, neither party had an expert perform an event study analyzing the market reaction to the Merger. Southern Peru's stock price traded down by 4.6% when the Merger was announced. When the preliminary proxy statement, which provided more financial information regarding the Merger terms, became public on November 22, 2004, Southern Peru's stock price again declined by 1.45%. But the stock price increased for two days after the final Proxy Statement was filed.
The Court of Chancery found that determining what effect the Merger itself had on this rise is difficult because, as the Plaintiff pointed out, this was not, as the Defendants contended, the first time that Southern Peru and Minera's financials were presented together. Rather, the same financial statements were in the preliminary Proxy Statement and the stock price fell. However, the Court of Chancery noted that the Plaintiff offered no evidence that these stock market fluctuations provided a reliable basis for assessing the fairness of the deal because it did not conduct a reliable event study.
The Court of Chancery found, in fact, against a backdrop of strong copper prices, the trading price of Southern Peru stock increased substantially by the time the Merger closed. By April 1, 2005, Southern Peru's stock price had a market value of $55.89 per share, an increase of approximately 21.7% over the October 21, 2004 closing price. The Court of Chancery found this increase could not be attributed to the Merger because other factors were in play. That included the general direction of copper prices, which lifted the market price of not just Southern Peru, but those of its publicly traded competitors. Furthermore, Southern Peru's own financial performance was very strong.
Goldman Does Not Update Its Fairness Analysis
Despite rising Southern Peru share prices and performance, the Special Committee [1233] did not ask Goldman to update its fairness analysis at the time of the stockholder vote on the Merger and closing — nearly five months after the Special Committee had voted to recommend it. At trial, Handelsman testified that he called a representative at Goldman to ask whether the transaction was still fair, but the Court of Chancery found that Handelsman's phone call hardly constitutes a request for an updated fairness analysis. The Court of Chancery also found that the Special Committee's failure to determine whether the Merger was still fair at the time of the Merger vote and closing was curious for two reasons.
First, for whatever the reason, Southern Peru's stock price had gone up substantially since the Merger was announced in October 2004. In March 2005, Southern Peru stock was trading at an average price of $58.56 a share. The Special Committee had agreed to a collarless fixed exchange ratio and did not have a walk-away right. The Court of Chancery noted an adroit Special Committee would have recognized the need to re-evaluate the Merger in light of Southern Peru's then-current stock price.
Second, Southern Peru's actual 2004 EBITDA became available before the stockholder vote on the Merger took place, and Southern Peru had smashed through the projections that the Special Committee had used for it. In the October 21 presentation, Goldman used a 2004E EBITDA for Southern Peru of $733 million and a 2004E EBITDA for Minera of $687 million. Southern Peru's actual 2004 EBITDA was $1.005 billion, 37% more and almost $300 million more than the projections used by Goldman. Minera's actual 2004 EBITDA, by contrast, was $681 million, 0.8% less than the projections used by Goldman.
The Court of Chancery noted that earlier, in Goldman's contribution analysis it relied on the values (measured in Southern Peru shares) generated by applying an aggressive range of Southern Peru's 2005E EBITDA multiples to Minera's A & S-adjusted and unadjusted projections, not the 2004E EBITDA multiple, and that the inaccuracy of Southern Peru's estimated 2004 EBITDA should have given the Special Committee serious pause. If the 2004 EBITDA projections of Southern Peru — which were not optimized and had been prepared by Grupo Mexico-controlled management — were so grossly low, it provided reason to suspect that the 2005 EBITDA projections, which were even lower than the 2004 EBITDA projections, were also materially inaccurate, and that the assumptions forming the basis of Goldman's contribution analysis should be reconsidered.
Moreover, Southern Peru made $303.4 million in EBITDA in the first quarter of 2005, over 52% of the estimate in Goldman's fairness presentation for Southern Peru's 2005 full year performance. Although the first-quarter 2005 financial statements, which covered the period from January 1, 2005 to March 31, 2005, would not have been complete by the time of the stockholder vote, the Court of Chancery reasonably assumed that, as directors of Southern Peru, the Special Committee had access to nonpublic information about Southern Peru's monthly profit and loss statements. Southern Peru later beat its EBITDA projections for 2005 by a very large margin, 135%, a rate well ahead of Minera's 2005 performance, which beat the deal estimates by a much lower 45%.
The Special Committee's failure to get a fairness update was even more of a concern to the Court of Chancery because Cerro had agreed to vote against the Merger if the Special Committee changed [1234] its recommendation. The Special Committee failed to obtain a majority of the minority vote requirement, but it supposedly agreed to a two-thirds vote requirement instead because a two-thirds vote still prevented Grupo Mexico from unilaterally approving the Merger. This out was only meaningful, however, if the Special Committee took the recommendation process seriously. If the Special Committee maintained its recommendation, Cerro had to vote for the Merger, and its vote combined with Grupo Mexico's vote would ensure passage. By contrast, if the Special Committee changed its recommendation, Cerro was obligated to vote against the Merger.
The Court of Chancery found the tying of Cerro's voting agreement to the Special Committee's recommendation was somewhat odd, in another respect. In a situation involving a third-party merger sale of a company without a controlling stockholder, the third party will often want to lock up some votes in support of a deal. A large blocholder and the target board might therefore negotiate a compromise, whereby the blocholder agrees to vote yes if the target board or special committee maintains a recommendation in favor of the transaction. In this situation, however, there is a factor not present here. In an arm's-length deal, the target usually has the flexibility to change its recommendation or terminate the original merger upon certain conditions, including if a superior proposal is available, or an intervening event makes the transaction impossible to recommend in compliance with the target's fiduciary duties.
Here, by contrast, Grupo Mexico faced no such risk of a competing superior proposal because it controlled Southern Peru. Furthermore, the fiduciary out that the Special Committee negotiated for in the Merger agreement provided only that the Special Committee could change its recommendation in favor of the Merger, not that it could terminate the Merger altogether or avoid a vote on the Merger. The only utility therefore of the recommendation provision was if the Special Committee seriously considered the events between the time of signing and the stockholder vote and made a renewed determination of whether the deal was fair. The Court of Chancery found there is no evidence of such a serious examination, despite important emerging evidence that the transaction's terms were skewed in favor of Grupo Mexico.
Southern Peru's Stockholders Approve The Merger
On March 28, 2005, the stockholders of Southern Peru voted to approve the Merger. More than 90% of the stockholders voted in favor of the Merger. The Merger then closed on April 1, 2005. At the time of closing, 67.2 million shares of Southern Peru had a market value of $3.75 billion.
Cerro Sells Its Shares
On June 15, 2005, Cerro, which had a basis in its stock of only $1.32 per share, sold its entire interest in Southern Peru in an underwritten offering at $40.635 per share. Cerro sold its stock at a discount to the then-current market price, as the low-high trading prices for one day before the sale were $43.08 to $44.10 per share. The Court of Chancery found that this illustrated Cerro's problematic incentives.
Plaintiff Sues Defendants and Special Committee
This derivative suit challenging the Merger, first filed in late 2004, moved too slowly, and it was not until June 30, 2010 that the Plaintiff moved for summary judgment. On August 10, 2010, the Defendants filed a cross-motion for summary judgment, or in the alternative, to shift the burden of proof to the Plaintiff under the [1235] entire fairness standard. On August 11, 2010, the individual Special Committee defendants cross-moved for summary judgment on all claims under Southern Peru's exculpatory provision adopted under title 8, section 102(b)(7) of the Delaware Code.
At a hearing held on December 21, 2010, the Court of Chancery dismissed the Special Committee defendants from the case because the plaintiff had failed to present evidence supporting a non-exculpated breach of their fiduciary duty of loyalty. It denied all other motions for summary judgment. The Court of Chancery noted that this, of course, did not mean that the Special Committee had acted adroitly or that the remaining defendants, Grupo Mexico and its affiliates, were immune from liability.
In contrast to the Special Committee defendants, precisely because the remaining directors were employed by Grupo Mexico, which had a self-dealing interest directly in conflict with Southern Peru, the exculpatory charter provision was of no benefit to them at that stage, given the factual question regarding their motivations. At trial, these individual Grupo Mexico-affiliated director defendants made no effort to show that they acted in good faith and were entitled to exculpation despite their lack of independence. In other words, the Grupo Mexico-affiliated directors did nothing to distinguish each other and none of them argued that he should not bear liability for breach of the duty of loyalty if the transaction was unfairly advantageous to Grupo Mexico, which had a direct self-dealing interest in the Merger. Accordingly, the Court of Chancery concluded that their liability would rise or fall with the issue of fairness.
In dismissing the Special Committee members on the summary judgment record, the Court of Chancery necessarily treated the predicament faced by Cerro and Handelsman, which involved facing additional economic pressures as a minority stockholder as a result of Grupo Mexico's control, differently than a classic self-dealing interest. The Court of Chancery continued to hold that view. Although it believed that Cerro, and therefore Handelsman, were influenced by Cerro's desire for liquidity as a stockholder, it seemed counterproductive to the Court of Chancery to equate a legitimate concern of a stockholder for liquidity from a controller into a self-dealing interest.
Therefore, the Court of Chancery concluded that there had to be a triable issue regarding whether Handelsman acted in subjective bad faith to force him to trial. The Court of Chancery concluded then on that record that no such issue of fact existed and even on the fuller trial record (where the Plaintiff actually made much more of an effort to pursue this angle), it still could not find that Handelsman acted in bad faith to purposely accept an unfair deal.
Nevertheless, the Court of Chancery found that Cerro, and therefore Handelsman, did have the sort of economic concern that ideally should have been addressed upfront and forthrightly in terms of whether the stockholder's interest well positioned its representative to serve on a special committee. Thus, although the Court of Chancery continued to be unpersuaded that it could label Handelsman as having acted with the state of mind required to expose him to liability, given the exculpatory charter protection to which he is entitled, it was persuaded that Cerro's desire to sell influenced how Handelsman approached his duties and compromised his effectiveness.
TRIAL SCHEDULE PROPERLY MAINTAINED
The Defendants' first argument is that the Court of Chancery erred by excluding [1236] the testimony of James Del Favero regarding the advice given to the Special Committee by its financial advisor, Goldman, on the ground that Del Favero was identified too late and allowing him to testify would be unfair to the Plaintiff. The Plaintiff contends that the Court of Chancery exercised sound discretion by refusing to modify the stipulated trial schedule in order to permit a new Goldman witness (Del Favero) to be deposed and testify weeks after the trial was scheduled to have concluded, when a video-taped deposition of the Special Committee's actual Goldman advisor was already in the record. Both parties agree, however, that whether the trial judge's ruling is characterized as an exclusion of evidence or a refusal to change the trial scheduling order, either action is reviewed on appeal for an abuse of discretion.[10]
The record reflects that the Plaintiff obtained commissions for deposing three of the six members of the Goldman team identified in Goldman's pitch book to the Special Committee. By agreement of the parties, the Plaintiff deposed Martin Sanchez ("Sanchez") who was the head member of the Goldman team that advised the Special Committee. Sanchez was apparently the Goldman person to whom the Special Committee spoke most often.
Sanchez was deposed on October 21, 2009. He had not worked at Goldman since 2006. Accordingly, at the time of Sanchez's 2009 deposition, the Defendants were aware that neither they nor Goldman could control whether Sanchez would appear at trial. Sanchez's deposition was videotaped. Therefore, it was not simply a cold transcript.
The June 20, 2011 trial date was stipulated to by the parties and set by order of the Court of Chancery on February 10, 2011. On May 31, 2011, the Defendants notified the Plaintiff that Sanchez may not appear to testify at trial. The Defendants assert that they immediately began a search — three weeks before trial — for an alternative Goldman witness who would be available to testify. Their initial choice, however, was not Del Favero.
On June 9, 2011, when the Defendants informed the Plaintiff that Sanchez was "definitely not showing up" for trial, they identified Martin Werner ("Werner"), another Goldman member of the Special Committee advisory team, as their witness for trial. The Plaintiff did not object to the late identification of Werner but did seek to confirm that he would be able to depose Werner before trial. The Defendants' attorney responded, "Of course. I am not optimistic that we will get him to trial, in which case we will have no live Goldman witness."
On Monday, June 13, 2011, just twenty-four hours before the pretrial stipulation was due and one week before trial was scheduled to commence, the Defendants proposed for the first time that they call Del Favero as their live Goldman witness at trial. Unlike Sanchez or Werner, Del Favero was not offered to testify about the advice Goldman provided to the Special Committee, but rather about Goldman's internal processes relating to issuing fairness opinions. In proposing to call Del Favero as a witness, the Defendants stated: "We know that Your Honor had commented on[,] at the summary judgment hearing[,] the fairness opinion review process at Goldman Sachs and had some questions about that. We believe that he [1237] would be in a position to answer those questions."
Del Favero was not available to either testify during the long-established June trial dates or to be deposed before trial began on June 20. The Defendants suggested that Del Favero be deposed after every other trial witness had testified, and that the trial schedule be modified to reconvene sometime in July to allow Del Favero to testify several weeks after the trial was scheduled to conclude.
At the pretrial conference, the Plaintiff objected to the Defendants' proposal regarding Del Favero for several reasons. First, the Plaintiff argued that allowing Del Favero to be deposed and then testify after every other trial witness had testified, and the trial was otherwise concluded, would be unfair. Second, the Plaintiff objected to Del Favero's testimony because it was not directly relevant to the issues to be presented at trial since Del Favero was not a member of the Goldman team that advised the Special Committee, and had only attended one Special Committee meeting, during which Goldman only pitched its services. Third, the Plaintiff objected to the subject matter to which Del Favero would testify because it was the same subject matter on which counsel for Goldman and the Special Committee had precluded the Plaintiff from inquiring about at Sanchez's deposition.
The Court of Chancery held that Del Favero's inability to testify during the scheduled trial dates, or even to be deposed before the trial began, would unfairly prejudice the Plaintiff. In the Court of Chancery and on appeal, the Defendants assert that a live Goldman witness was central to their defense in light of the trial judge's comments made at the December 2010 summary judgment argument. In denying the Defendants' request to depose and to call Del Favero as a witness several weeks after the trial was scheduled to end, the trial judge noted that if his comments six months earlier at the summary judgment argument had caused the Defendants to reconsider their witness selection,
[T]hen I expect that you would have promptly identified this gentleman as a relevant witness and made him available for deposition. It's simply not fair to the plaintiffs.
Because the other thing about people who want to be witnesses is they get deposed, and when they get deposed, you learn things, and you might ask other people or shape your trial strategy differently. It just adds an unfair element of surprise. And in the 1930s, we decided with the Rules of Civil Procedure to eliminate surprise, at least insofar as your opponent was diligent and asked questions.
It's regrettable that the lead banker [Sanchez] for a client, even with the passage of time, would decline coming to testify. I understand he may be at a different institution, but, you know, he was the lead banker.
So I'll watch the [Sanchez] video and we'll deal with it then. Otherwise, we have a fairly truncated set-up of live witnesses; correct?
On appeal, the Defendants assert that "[i]t is difficult to see any harm — let alone unfair harm" if the bench trial had to be reconvened after several weeks to permit Del Favero to be deposed and to testify because the Plaintiff "allowed this case to languish unprosecuted for many years." The Defendants also argue, for the first time on appeal, that if deposing Del Favero after all "other trial testimony would have been problematic, the only fair solution would have been to postpone [commencement] of the trial for a short period to avoid prejudicing the Defendants."
[1238] Accordingly, the Defendants contend that the Court of Chancery's refusal to either postpone the commencement of the trial or to reconvene the trial should be reversed because "[a]llowing a proposed trial schedule to dictate which testimony can and cannot be presented by the parties would be the `tail wagging the dog.'" That argument reflects a fundamental misunderstanding of both fact and law. First, as a matter of fact, the June 20 start date for the trial was not proposed. It had been fixed by court order months earlier in February, with the agreement of the parties. Second, as a matter of law, to use the Defendants' analogy, a trial scheduling order is the dog and not the tail.
This Court has stated that "[p]arties must be mindful that scheduling orders are not merely guidelines but have [the same] full force and effect" as any other court order.[11] Once the trial dates are set, the trial judge (the dog's handler) determines whether there is a manifest necessity for amending the trial scheduling order (changing the pace or direction of the dog). That determination is entrusted to the trial judge's discretion.[12]
The record reflects that the trial judge refused to change the trial scheduling order to accommodate Del Favero's availability. The trial judge did not exclude Del Favero's testimony. Nor did the trial judge exclude trial testimony from any other Goldman witness. Sanchez was deposed, and the trial judge specifically stated he would "watch the video" of Sanchez's deposition. Because the trial judge excluded no testimony, this case is significantly different from the facts in the two cases relied upon by the Defendants, Drejka v. Hitchens Tire Service, Inc.,[13] and Sheehan v. Oblates of St. Francis de Sales.[14]
The Defendants' contention that the Court of Chancery committed reversible error because Del Favero's availability "could easily be accommodated during a bench trial" continues its misconception of the judicial process. Trial judges are vested with the discretion to resolve scheduling matters and to control their own docket.[15] When an act of judicial discretion is at issue on appeal, this Court cannot substitute its opinion of what is right for that of the trial judge, if the trial judge's opinion was based upon conscience and reason, as opposed to arbitrariness or capriciousness.[16]
The Court of Chancery's decision was neither arbitrary nor capricious. The Defendants sought to modify the stipulated trial schedule at the eleventh hour by requesting that the trial proceed on June 20, as scheduled, but then be continued until "sometime" in July, and that Del Favero be deposed and testify after every other trial witness had testified. The Court of Chancery ruled this was "simply not fair to the plaintiffs." The Court of Chancery noted that when witnesses "get deposed, you learn things, and you might ask other people or shape your trial strategy differently." The Court of Chancery also noted that if the Defendants had truly been concerned about having a live Goldman witness testify at trial, they could "have [1239] promptly identified this gentleman as a relevant witness and made him available for deposition."
The Defendants' assertion that they were prejudiced by not being able to present Del Favero's live testimony at trial is undermined by the record. First, several days before the trial was scheduled to commence, the Defendants acknowledged that they might not have a live Goldman witness to present at trial. Therefore, they would have to rely on the videotaped deposition of Sanchez. Second, in making their post-trial entire fairness arguments to the Court of Chancery, the Defendants stated "the record here is replete with evidence showing what Goldman Sachs did and why."
Del Favero was not available to be deposed, let alone to offer trial testimony, until weeks after the testimony of every other trial witness concluded. The Court of Chancery found the nature of the Defendants' eleventh-hour request to modify the long-standing trial dates would have been unfair to the Plaintiff. That finding is supported by the record and the product of a logical deductive reasoning process. We hold that the Court of Chancery properly exercised its discretion by refusing to modify the stipulated trial scheduling order to accommodate Del Favero's availability.
BURDEN SHIFTING ANALYSIS
The Defendants' second argument on appeal is that the Court of Chancery committed reversible error by failing to determine which party bore the burden of proof before trial. The Defendants submit that the Court of Chancery further erred by ultimately allocating the burden to the Defendants, because the Special Committee was independent, was well-functioning, and did not rely on the controlling shareholder for the information that formed the basis for its recommendation.
When a transaction involving self-dealing by a controlling shareholder is challenged, the applicable standard of judicial review is entire fairness, with the defendants having the burden of persuasion.[17] In other words, the defendants bear the burden of proving that the transaction with the controlling stockholder was entirely fair to the minority stockholders. In the Court of Chancery and on appeal, both the Plaintiff and the Defendants agree that entire fairness is the appropriate standard of judicial review for the Merger.[18]
The entire fairness standard has two parts: fair dealing and fair price.[19] Fair dealing "embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained."[20] Fair price "relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock."[21]
[1240] In Kahn v. Lynch Communication Systems, Inc.,[22] this Court held that when the entire fairness standard applies, the defendants may shift the burden of persuasion by one of two means: first, they may show that the transaction was approved by a well-functioning committee of independent directors; or second, they may show that the transaction was approved by an informed vote of a majority of the minority shareholders.[23] Nevertheless, even when an interested cash-out merger transaction receives the informed approval of a majority of minority stockholders or a well-functioning committee of independent directors, an entire fairness analysis is the only proper standard of review.[24] Accordingly, "[r]egardless of where the burden lies, when a controlling shareholder stands on both sides of the transaction the conduct of the parties will be viewed under the more exacting standard of entire fairness as opposed to the more deferential business judgment standard."[25]
In Emerald Partners v. Berlin,[26] we noted that "[w]hen the standard of review is entire fairness, ab initio, director defendants can move for summary judgment on either the issue of entire fairness or the issue of burden shifting."[27] In this case, the Defendants filed a summary judgment motion, arguing that the Special Committee process shifted the burden of persuasion under the preponderance standard to the Plaintiff. The Court of Chancery found the summary judgment record was insufficient to determine that question of burden shifting prior to trial.
Lynch and its progeny[28] set forth what is required of an independent committee for the defendants to obtain a burden shift. In this case, the Court of Chancery recognized that, in Kahn v. Tremont Corp.,[29] this Court held that "[t]o obtain the benefit of a burden shifting, the controlling shareholder must do more than establish a perfunctory special committee of outside directors."[30] Rather, the special committee must "function in a manner which indicates that the controlling shareholder did not dictate the terms of the transaction and that the committee exercised real bargaining power `at an arms-length.'"[31] In this case, the Court of Chancery properly concluded that:
A close look at Tremont suggests that the [burden shifting] inquiry must focus on how the special committee actually negotiated the deal — was it "well functioning"[32] — rather than just how the committee was set up. The test, therefore, [1241] seems to contemplate a look back at the substance, and efficacy, of the special committee's negotiations, rather than just a look at the composition and mandate of the special committee.[33]
The Court of Chancery expressed its concern about the practical implications of such a factually intensive burden shifting inquiry because it is "deeply enmeshed" in the ultimate entire fairness analysis.
Subsuming within the burden shift analysis questions of whether the special committee was substantively effective in its negotiations with the controlling stockholder — questions fraught with factual complexity — will, absent unique circumstances, guarantee that the burden shift will rarely be determinable on the basis of the pretrial record alone.[34] If we take seriously the notion, as I do, that a standard of review is meant to serve as the framework through which the court evaluates the parties' evidence and trial testimony in reaching a decision, and, as important, the framework through which the litigants determine how best to prepare their cases for trial,[35] it is problematic to adopt an analytical approach whereby the burden allocation can only be determined in a post-trial opinion, after all the evidence and all the arguments have been presented to the court.
We agree with these thoughtful comments. However, the general inability to decide burden shifting prior to trial is directly related to the reason why entire fairness remains the applicable standard of review even when an independent committee is utilized, i.e., "because the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny."[36]
This case is a perfect example. The Court of Chancery could not decide whether to shift the burden based upon the pretrial record. After hearing all of the evidence presented at trial, the Court of Chancery found that, although the independence of the Special Committee was not challenged, "from inception, the Special Committee fell victim to a controlled mindset and allowed Grupo Mexico to dictate the terms and structure of the merger." The Court of Chancery concluded that "although the Special Committee members were competent businessmen and may have had the best of intentions, they allowed themselves to be hemmed in by the controlling stockholder's demands."
We recognize that there are practical problems for litigants when the issue of [1242] burden shifting is not decided until after the trial.[37] For example, "in order to prove that a burden shift occurred because of an effective special committee, the defendants must present evidence of a fair process. Because they must present this evidence affirmatively, they have to act like they have the burden of persuasion throughout the entire trial court process."[38] That is exactly what happened in this case.
Delaware has long adhered to the principle that the controlling shareholders have the burden of proving an interested transaction was entirely fair.[39] However, in order to encourage the use of procedural devices that foster fair pricing, such as special committees and minority stockholder approval conditions, this Court has provided transactional proponents with what has been described as a "modest procedural benefit — the shifting of the burden of persuasion on the ultimate issue of entire fairness to the plaintiffs — if the transaction proponents proved, in a factually intensive way, that the procedural devices had, in fact, operated with integrity."[40] We emphasize that in Cox, the procedural benefit of burden shifting was characterized as "modest."
Once again, in this case, the Court of Chancery expressed uncertainty about whether "there is much, if any, practical implication of a burden shift." According to the Court of Chancery, "[t]he practical effect of the Lynch doctrine's burden shift is slight. One reason why this is so is that shifting the burden of persuasion under a preponderance standard is not a major move, if one assumes ... that the outcome of very few cases hinges on what happens if ... the evidence is in equipoise."[41]
In its post-trial opinion, the Court of Chancery found that the burden of persuasion remained with the Defendants, because the Special Committee was not "well functioning."[42] The trial judge also found, "however, that this determination matters little because I am not stuck in equipoise about the issue of fairness. Regardless of who bears the burden, I conclude that the Merger was unfair to Southern Peru and its stockholders."
Nothing in the record reflects that a different outcome would have resulted if either the burden of proof had been shifted to the Plaintiff, or the Defendants had been advised prior to trial that the burden had not shifted. The record reflects that, by agreement of the parties, each witness other than the Plaintiff's expert was called in direct examination by the Defendants, and then was cross-examined by the Plaintiff. The Defendants have not identified any decision they might have made differently, if they had been advised prior to trial that the burden of proof had not shifted.
The Court of Chancery concluded that this is not a case where the evidence of fairness or unfairness stood in equipoise. It found that the evidence of unfairness was so overwhelming that the question of who had the burden of proof at trial was [1243] irrelevant to the outcome. That determination is supported by the record. The Court of Chancery committed no error by not allocating the burden of proof before trial, in accordance with our prior precedents. In the absence of a renewed request by the Defendants during trial that the burden be shifted to the Plaintiff, the burden of proving entire fairness remained with the Defendants throughout the trial.[43] The record reflects that is how the trial in this case was conducted.
Nevertheless, we recognize that the purpose of providing defendants with the opportunity to seek a burden shift is not only to encourage the use of special committees,[44] but also to provide a reliable pretrial guide for the parties regarding who has the burden of persuasion.[45] Therefore, which party bears the burden of proof must be determined, if possible, before the trial begins. The Court of Chancery has noted that, in the interest of having certainty, "it is unsurprising that few defendants have sought a pretrial hearing to determine who bears the burden of persuasion on fairness" given "the factually intense nature of the burden-shifting inquiry" and the "modest benefit" gained from the shift.[46]
The failure to shift the burden is not outcome determinative under the entire fairness standard of review. We have concluded that, because the only "modest" effect of the burden shift is to make the plaintiff prove unfairness under a preponderance of the evidence standard, the benefits of clarity in terms of trial presentation outweigh the costs of continuing to decide either during or after trial whether the burden has shifted. Accordingly, we hold prospectively that, if the record does not permit a pretrial determination that the defendants are entitled to a burden shift, the burden of persuasion will remain with the defendants throughout the trial to demonstrate the entire fairness of the interested transaction.
The Defendants argue that if the Court of Chancery rarely determines the issue of burden shifting on the basis of a pretrial record, corporations will be dissuaded from forming special committees of independent directors and from seeking approval of an interested transaction by an informed vote of a majority of the minority shareholders. That argument underestimates the importance of either or both actions to the process component — fair dealing — of the entire fairness standard. This Court has repeatedly held that any board process is materially enhanced when the decision is attributable to independent directors.[47] Accordingly, judicial review for entire fairness of how the transaction [1244] was structured, negotiated, disclosed to the directors, and approved by the directors will be significantly influenced by the work product of a properly functioning special committee of independent directors.[48] Similarly, the issue of how stockholder approval was obtained will be significantly influenced by the affirmative vote of a majority of the minority stockholders.[49]
A fair process usually results in a fair price. Therefore, the proponents of an interested transaction will continue to be incentivized to put a fair dealing process in place that promotes judicial confidence in the entire fairness of the transaction price. Accordingly, we have no doubt that the effective use of a properly functioning special committee of independent directors and the informed conditional approval of a majority of minority stockholders will continue to be integral parts of the best practices that are used to establish a fair dealing process.
UNFAIR DEALING PRODUCES UNFAIR PRICE
Although the entire fairness standard has two components, the entire fairness analysis is "not a bifurcated one as between fair dealing and fair price. All aspects of the issue must be examined as a whole since the question is one of entire fairness."[50] In a non-fraudulent transaction, "price may be the preponderant consideration outweighing other features of the merger."[51] Evidence of fair dealing has significant probative value to demonstrate the fairness of the price obtained. The paramount consideration, however, is whether the price was a fair one.[52]
The Court of Chancery found that the process by which the Merger was negotiated and approved was not fair and did not result in the payment of a fair price. Because the issues relating to fair dealing and fair price were so intertwined, the Court of Chancery did not separate its analysis, but rather treated them together in an integrated examination. That approach is consistent with the inherent non-bifurcated nature of the entire fairness standard of review.[53]
The independence of the members of the Special Committee was not challenged by the Plaintiff. The Court of Chancery found that the Special Committee members were competent, well-qualified individuals with business experience. The Court of Chancery also found that the Special Committee was "given the resources to hire outside advisors, and it hired not only respected, top tier of the market financial and legal counsel, but also a mining consultant and Mexican counsel." Nevertheless, the Court of Chancery found that, although the Special Committee members had their "hands ... on the oars[,]" the boat went "if anywhere, backward[.]"
The Special Committee began its work with a narrow mandate, to "evaluate a transaction suggested by the majority stockholder." The Court of Chancery found that "the Special Committee members' understanding of their mandate ... evidenced their lack of certainty about whether the Special Committee could do more than just evaluate the Merger." The [1245] Court of Chancery concluded that, although the Special Committee went beyond its limited mandate and engaged in negotiations, "its approach to negotiations was stilted and influenced by its uncertainty about whether it was actually empowered to negotiate."
Accordingly, the Court of Chancery determined that "from inception, the Special Committee fell victim to a controlled mindset and allowed Grupo Mexico to dictate the terms and structure of the Merger." The Special Committee did not ask for an expansion of its mandate to look at alternatives. Instead, the Court of Chancery found that the Special Committee "accepted that only one type of transaction was on the table, a purchase of Minera by Southern Peru."
In its post-trial opinion, the Court of Chancery stated that this "acceptance" influenced the ultimate determination of unfairness, because "it took off the table other options that would have generated a real market check and also deprived the Special Committee of negotiating leverage to extract better terms." The Court of Chancery summarized these dynamics as follows:
In sum, although the Special Committee members were competent businessmen and may have had the best of intentions, they allowed themselves to be hemmed in by the controlling stockholder's demands. Throughout the negotiation process, the Special Committee's and Goldman's focus was on finding a way to get the terms of the Merger structure proposed by Grupo Mexico to make sense, rather than aggressively testing the assumption that the Merger was a good idea in the first place.
Goldman made its first presentation to the Special Committee on June 11, 2004. Goldman's conclusions were summarized in an "Illustrative Give/Get Analysis." The Court of Chancery found this analysis "made patent the stark disparity between Grupo Mexico's asking price and Goldman's valuation of Minera: Southern Peru would `give' stock with a market price of $3.1 billion to Grupo Mexico and would `get' in return an asset worth no more than $1.7 billion."
According to the Court of Chancery, the Special Committee's controlled mindset was illustrated by what happened after Goldman's initial analysis could not value the "get" — Minera — anywhere near Grupo Mexico's asking price, the "give":
From a negotiating perspective, that should have signaled that a strong response to Grupo Mexico was necessary and incited some effort to broaden, not narrow, the lens. Instead, Goldman and the Special Committee went to strenuous lengths to equalize the values of Southern Peru and Minera. The onus should have been on Grupo Mexico to prove Minera was worth $3.1 billion, but instead of pushing back on Grupo Mexico's analysis, the Special Committee and Goldman devalued Southern Peru and topped up the value of Minera. The actions of the Special Committee and Goldman undermine the defendants' argument that the process leading up to the Merger was fair and lend credence to the plaintiff's contention that the process leading up to the Merger was an exercise in rationalization.
The Court of Chancery found that, following Goldman's first presentation, the Special Committee abandoned a focus on whether Southern Peru would get $3.1 billion in value in an exchange. Instead, the Special Committee moved to a "relative valuation" methodology that involved comparing the values of Southern Peru and Minera. On June 23, 2004, Goldman advised the Special Committee that Southern Peru's DCF value was $2.06 billion and, [1246] thus, approximately $1.1 billion below Southern Peru's actual NYSE market price at that time.
The Court of Chancery was troubled by the fact that the Special Committee did not use this valuation gap to question the relative valuation methodology. Instead, the Special Committee was "comforted" by the analysis, which allowed them to conclude that DCF value of Southern Peru's stock (the "give") was not really worth its market value of $3.1 billion. The Court of Chancery found that:
A reasonable special committee would not have taken the results of those analyses by Goldman and blithely moved on to relative valuation, without any continuing and relentless focus on the actual give-get involved in real cash terms. But, this Special Committee was in the altered state of a controlled mindset. Instead of pushing Grupo Mexico into the range suggested by Goldman's analysis of Minera's fundamental value, the Special Committee went backwards to accommodate Grupo Mexico's asking price — an asking price that never really changed.
The Court of Chancery concluded "[a] reasonable third-party buyer free from a controlled mindset would not have ignored a fundamental economic fact that is not in dispute here — in 2004, Southern Peru stock could have been sold for [the] price at which it was trading on the New York Stock Exchange."
In this appeal, the Defendants contend that the Court of Chancery did not understand Goldman's analysis and rejected their relative valuation of Minera without an evidentiary basis. According to the Defendants, a relative valuation analysis is the appropriate way to perform an accurate comparison of the value of Southern Peru, a publicly-traded company, and Minera, a private company. In fact, the Defendants continue to argue that relative valuation is the only way to perform an "apples-to-apples" comparison of Southern Peru and Minera.
Moreover, the Defendants assert that Goldman and the Special Committee did actually believe that Southern Peru's market price accurately reflected the company's value. According to the Defendants, however, there were certain assumptions reflected in Southern Peru's market price that were not reflected in its DCF value, i.e., the market's view of future copper price increases. Therefore, the Defendants submit that:
If the DCF analysis was missing some element of value for [Southern Peru], it would also miss that very same element of value for Minera. In short, at the time that Goldman was evaluating Minera, its analysis of [Southern Peru] demonstrated that mining companies were trading at a premium to their DCF values. The relative valuation method allowed Goldman to account for this information in its analysis and value Minera fairly.
Accordingly, the Defendants argue that the Court of Chancery failed to recognize that the difference between Southern Peru's DCF and market values also implied a difference between Minera's DCF value and its market value.
The Defendants take umbrage at the Court of Chancery's statement that "the relative valuation technique is not alchemy that turns a sub-optimal deal into a fair one." The Court of Chancery's critical comments regarding a relative value methodology were simply a continuation of its criticism about how the Special Committee operated. The record indicates that the Special Committee's controlled mindset was reflected in its assignments to Goldman. According to the Court of Chancery, "Goldman appears to have helped its client [1247] rationalize the one strategic option available within the controlled mindset that pervaded the Special Committee's process."
The Defendants continue to argue that the Court of Chancery would have understood that "relative valuation" was the "appropriate way" to compare the values of Southern Peru and Minera if a Goldman witness (Del Favero) had testified at trial. As noted earlier, that argument is inconsistent with the Defendants' post-trial assertion that the record was replete with evidence of what Goldman did (a relative valuation analysis) and why that was done. That argument also disregards the trial testimony of the Defendants' expert witness, Professor Schwartz, who used the same relative valuation methodology as Goldman.
Prior to trial, the Defendants represented that Professor Schwartz would be called at trial to "explain that the most reliable way to compare the value of [Southern Peru] and Minera for purposes of the Merger was to conduct a relative valuation." In their pretrial proffer, the Defendants also represented that Professor Schwartz's testimony would demonstrate that "based on relative valuations of Minera and [Southern Peru] using a reasonable range of copper prices ... the results uniformly show that the Merger was fair to [Southern Peru] and its stockholders."
At trial, Professor Schwartz attributed the difference between Southern Peru's DCF value and its market value to the fact that the market was valuing Southern Peru's stock "at an implied copper price of $1.30." Professor Schwartz testified, "if I use $1.30, it gives me the market price of [Southern Peru] and it gives me a market price of Minera Mexico which still makes the transaction fair." In other words, it was fair to "give" Grupo Mexico $3.75 billion of Southern Peru stock because Minera's DCF value, using an assumed long-term copper price of $1.30, implied a "get" of more than $3.7 billion.
The Court of Chancery found that Professor Schwartz's conclusion that the market was assuming a long-term copper price of $1.30 in valuing Southern Peru was based entirely on post-hoc speculation, because there was no credible evidence in the record that anyone at the time of the Merger contemplated a $1.30 long-term copper price. In fact, Southern Peru's own public filings referenced $0.90 per pound as the appropriate long-term copper price. The Court of Chancery summarized its findings as follows:
Thus, Schwartz's conclusion that the market was assuming a long-term copper price of $1.30 in valuing Southern Peru appears to be based entirely on post-hoc speculation. Put simply, there is no credible evidence of the Special Committee, in the heat of battle, believing that the long-term copper price was actually $1.30 per pound but using $0.90 instead to give Southern Peru an advantage in the negotiation process.
The Court of Chancery also noted that Professor Schwartz did not produce a standalone equity value for Minera that justified issuing shares of Southern Peru stock worth $3.1 billion at the time the Merger Agreement was signed.
The record reflects that the Court of Chancery did understand the Defendants' argument and that its rejection of the Defendants' "relative valuation" of Minera was the result of an orderly and logical deductive reasoning process that is supported by the record. The Court of Chancery acknowledged that relative valuation is a valid valuation methodology. It also recognized, however, that since "relative valuation" is a comparison of the DCF values of Minera and Southern Peru, the result is only as reliable as the input data [1248] used for each company. The record reflects that the Court of Chancery carefully explained its factual findings that the data inputs Goldman and Professor Schwartz used for Southern Peru in the Defendants' relative valuation model for Minera were unreliable.
The Court of Chancery weighed the evidence presented at trial and set forth in detail why it was not persuaded that "the Special Committee relied on truly equal inputs for its analyses of the two companies." The Court of Chancery found that "Goldman and the Special Committee went to strenuous lengths to equalize the value of Southern Peru and Minera." In particular, the Court of Chancery found that "when performing the relative valuation analysis, the cash flows for Minera were optimized to make Minera an attractive acquisition target, but no such dressing up was done for Southern Peru."
The Court of Chancery also noted that Goldman never advised the Special Committee that Minera was worth $3.1 billion, or that Minera could be acquired at, or would trade at, a premium to its DCF value if it were a public company. Nevertheless, the Court of Chancery found "the Special Committee did not respond to its intuition that Southern Peru was overvalued in a way consistent with its fiduciary duties or the way that a third-party buyer would have." Accordingly, the Court of Chancery concluded:
The Special Committee's cramped perspective resulted in a strange deal dynamic, in which a majority stockholder kept its eye on the ball — actual value benchmarked to cash — and a Special Committee lost sight of market reality in an attempt to rationalize doing a deal of the kind the majority stockholder proposed. After this game of controlled mindset twister and the contortions it involved, the Special Committee agreed to give away over $3 billion worth of actual cash value in exchange for something worth demonstrably less, and to do so on terms that by consummation made the value gap even worse, without using any of its contractual leverage to stop the deal or renegotiate its terms. Because the deal was unfair, the defendants breached their fiduciary duty of loyalty.
Entire fairness is a standard by which the Court of Chancery must carefully analyze the factual circumstances, apply a disciplined balancing test to its findings, and articulate the bases upon which it decides the ultimate question of entire fairness.[54] The record reflects that the Court of Chancery applied a "disciplined balancing test," taking into account all relevant factors.[55] The Court of Chancery considered the issues of fair dealing and fair price in a comprehensive and complete manner. The Court of Chancery found the process by which the Merger was negotiated and approved constituted unfair dealing and that resulted in the payment of an unfair price.
The Court of Chancery's post-trial determination of entire fairness must be accorded substantial deference on appeal.[56] The Court of Chancery's factual findings are supported by the record and its conclusions are the product of an orderly and [1249] logical deductive reasoning process.[57] Accordingly, the Court of Chancery's judgment, that the Merger consideration was not entirely fair, is affirmed.[58]
DAMAGE AWARD PROPER
In the Court of Chancery, the Plaintiff sought an equitable remedy that cancelled or required the Defendants to return to Southern Peru the shares that Southern Peru issued in excess of Minera's fair value. In the alternative, the Plaintiff asked for rescissory damages in the amount of the then present market value of the excess number of shares that Grupo Mexico held as a result of Southern Peru paying an unfair price in the Merger.
In the Court of Chancery and on appeal, the Defendants argue that no damages are due because the Merger consideration was more than fair. In support of that argument, the Defendants rely on the fact that Southern Peru stockholders should be grateful, because the market value of Southern Peru's stock continued on a generally upward trajectory in the years after the Merger. Alternatively, the Defendants argue that any damage award should be at most a fraction of the amount sought by the Plaintiff, and, in particular, that the Plaintiff has waived the right to seek rescissory damages because of "his lethargic approach to litigating the case."
The Court of Chancery rejected the Defendants' argument that the post-Merger performance of Southern Peru's stock eliminates the need for damages. It noted that the Defendants did not "present a reliable event study about the market's reaction to the Merger, and there is evidence that the market did not view the Merger as fair in spite of material gaps in disclosure about the fairness of the Merger." The trial judge was of the opinion that a "transaction like the Merger can be unfair, in the sense that it is below what a real arms-length deal would have been priced at, while not tanking a strong company with sound fundamentals in a rising market, such as the one in which Southern Peru was a participant. That remains my firm sense here...." The Court of Chancery's decision to award some amount of damages is supported by the record and the product of a logical deductive reasoning process.
Nevertheless, the Court of Chancery did agree with the Defendants' argument that the Plaintiff's delay in litigating the case rendered it inequitable to use a rescission-based approach in awarding damages.[59] The Court of Chancery reached that determination because "[r]escissory damages are the economic equivalent of rescission and[,] therefore[,] if rescission itself is unwarranted because of the plaintiff's delay, so are rescissory damages."[60] Instead of entering a rescission-based remedy, the Court of Chancery decided to craft a damage award, as explained below:
[The award] approximates the difference between the price that the Special Committee would have approved had the Merger been entirely fair (i.e., absent a breach of fiduciary duties) and the price that the Special Committee actually agreed to pay. In other words, I will take the difference between this fair price and the market value of 67.2 million [1250] shares of Southern Peru stock as of the Merger date. That difference, divided by the average closing price of Southern Peru stock in the 20 trading days preceding the issuance of this opinion, will determine the number of shares that the defendants must return to Southern Peru. Furthermore, because of the plaintiff's delay, I will only grant simple interest on that amount, calculated at the statutory rate since the date of the Merger.[61]
After determining the nature of the damage award, the Court of Chancery determined the appropriate valuation for the price that the Special Committee should have paid. To calculate a fair price for remedy purposes, the Court of Chancery balanced three separate values. The first value was a standalone DCF value of Minera. Using defendant-friendly modifications to the Plaintiff's expert's DCF valuation, the Court of Chancery calculated that a standalone equity value for Minera as of October 21, 2004 was $2.452 billion. The second value was the market value of the Special Committee's 52 million share counteroffer made in July 2004, "which was sized based on months of due diligence by Goldman about Minera's standalone value, calculated as of the date on which the Special Committee approved the Merger." Because Grupo Mexico wanted a dollar value of stock, the Court of Chancery fixed the value at what 52 million Southern Peru shares were worth as of October 21, 2004, the date on which the Special Committee approved the Merger, at $2.388 billion, giving Minera credit for the price growth to that date. The third value was the equity value of Minera derived from a comparable companies analysis using the companies identified by Goldman. Using the median premium for merger transactions in 2004, calculated by Mergerstat to be 23.4%, and applying that premium to the value derived from the Court of Chancery's comparable companies analysis yielded a value of $2.45 billion.
The Court of Chancery gave those three separate values equal weight in its damages equation: (($2.452 billion + $2.388 billion + $2.45 billion)/3). The result was a value of $2.43 billion. It then made an adjustment to reflect the fact that Southern Peru bought 99.15%, not 100%, of Minera, which yielded a value of $2.409 billion. The value of 67.2 million Southern Peru shares as of the Merger Date was $3.756 billion.[62] Therefore, the base damage award by the Court of Chancery amounted to $1.347 billion.[63] The Court of Chancery then added interest from the Merger Date, at the statutory rate, without compounding and with that interest to run until time of the judgment and until payment.
The Court of Chancery stated that Grupo Mexico could satisfy the judgment by agreeing to return to Southern Peru such number of its shares as are necessary to satisfy this remedy. The Court of Chancery also ruled that any attorneys' fees would be paid out of the award.
The Defendants' first objection to the Court of Chancery's calculation of damages is that its methodology included the Special Committee's counteroffer of July 2004 as a measure of the true value of Minera. The Defendants assert that the counteroffer was "based only on Goldman's preliminary analyses of the companies before the completion of due diligence. And there was no evidence this was anything [1251] other than what it appears to be — a negotiating position."
The Court of Chancery explained its reason for including the counteroffer in its determination of damages, as follows:
In fact, you know, the formula I used, one of the things that I did to be conservative was actually to use a bargaining position of the special committee. And I used it not because I thought it was an aggressive bargaining position of the special committee, but to give the special committee and its advisors some credit for thinking. It was one of the few indications in the record of something that they thought was actually a responsible value.
And so it was actually not put in there in any way to inflate. It was actually to give some credit to the special committee. If I had thought that it was an absurd ask, I would have never used it. I didn't think it was any, really, aggressive bargaining move. I didn't actually see any aggressive bargaining moves by the special committee. I saw some innovative valuation moves, but I didn't see any aggressive bargaining moves.
The record reflects that the value of Minera pursuant to the counteroffer ($2.388 billion) was very close to the other two values used by the Court of Chancery ($2.452 billion and $2.45 billion). The Court of Chancery properly exercised its discretion — for the reasons it stated — by including the Special Committee's counteroffer as one of the component parts in its calculation of damages. Therefore, the Defendants' argument to the contrary is without merit.
The Defendants also argue that the Court of Chancery "essentially became its own expert witness regarding damages by basing its valuation, at least in part, on its own computer models." In support of that argument, the Defendants rely upon the following statement by the trial judge during oral argument on the fee award: "I'm not going to disclose everything that we got on our computer system, but I can tell you that there are very credible remedial approaches in this case that would have resulted in a much higher award." The Defendants submit that "[i]n the absence of proof from [the] Plaintiff, this speculation and outside-the-record financial modeling is impermissible."
In making a decision on damages, or any other matter, the trial court must set forth its reasons. This provides the parties with a record basis to challenge the decision. It also enables a reviewing court to properly discharge its appellate function.
In this case, the Court of Chancery explained the reasons for its calculation of damages with meticulous detail. That complete transparency of its actual deliberative process provided the Defendants with a comprehensive record to use in challenging the Court of Chancery's damage award on appeal and for this Court to review. Accordingly, any remedial approaches that the Court of Chancery may have considered and rejected are irrelevant.
The Court of Chancery has the historic power "to grant such ... relief as the facts of a particular case may dictate."[64] Both parties agree that an award of damages by the Court of Chancery after trial in an entire fairness proceeding is reviewed on appeal for abuse of discretion.[65] [1252] It is also undisputed that the Court of Chancery has greater discretion when making an award of damages in an action for breach of duty of loyalty than it would when assessing fair value in an appraisal action.[66]
In this case, the Court of Chancery awarded damages based on the difference in value between what was paid (the "give") and the value of what was received (the "get"). In addition to an actual award of monetary relief, the Court of Chancery had the authority to grant pre- and post-judgment interest, and to determine the form of that interest.[67] The record reflects that the Court of Chancery properly exercised its broad historic discretionary powers in fashioning a remedy and making its award of damages. Therefore, the Court of Chancery's judgment awarding damages is affirmed.
ATTORNEYS' FEE AWARD
The Plaintiff petitioned for attorneys' fees and expenses representing 22.5% of the recovery plus post-judgment interest. The Court of Chancery awarded 15% of the $2.031 billion judgment, or $304,742,604.45, plus post-judgment interest until the attorneys' fee and expense award is satisfied ("Fee Award"). The Court of Chancery found that the Fee Award "fairly implements the most important factors our Supreme Court has highlighted under Sugarland,[68] including the importance of benefits," and "creates a healthy incentive for plaintiff's lawyers to actually seek real achievement for the companies that they represent in derivative actions and the classes that they represent in class actions."
On appeal, the Defendants contend "the Court of Chancery abuse[d] its discretion by granting an unreasonable fee award of over $304 million that pays the Plaintiff's counsel over $35,000 per hour worked and 66 times the value of their time and expenses." Specifically, they argue the Court of Chancery gave the first Sugarland factor, i.e. the benefit achieved, "dispositive weight," and that the remaining factors do not support the Fee Award. The Defendants also argue that the Court of Chancery erred by failing to assess the reasonableness of the Fee Award. They submit that the Court of Chancery did not: correctly apply a declining percentage analysis given the size of the judgment; consider whether the resulting hourly rate was reasonable under the circumstances; and evaluate whether the Fee Award conformed to the Delaware Rules of Professional Conduct.[69] The Defendants further contend that the Court of Chancery committed reversible error by "[a]llowing Plaintiff's attorneys to collect fees premised upon the nearly $700 million in prejudgment interest ... even in spite of the fact that the delay impeded a full presentation of the evidence."
Common Fund Doctrine
Under the common fund doctrine, "a litigant or a lawyer who recovers a [1253] common fund for the benefit of persons other than himself or his client is entitled to a reasonable attorney's fee from the fund as a whole."[70] The common fund doctrine is a well-established basis for awarding attorneys' fees in the Court of Chancery.[71] It is founded on the equitable principle that those who have profited from litigation should share its costs.[72]
"Typically, successful derivative or class action suits which result in the recovery of money or property wrongfully diverted from the corporation ... are viewed as fund creating actions."[73] In this case, the record supports the Court of Chancery's finding that Defendants breached their duty of loyalty by exchanging over $3 billion worth of actual cash value for something that was worth much less. The record also supports the Court of Chancery's determination that the $2.031 billion judgment resulted in the creation of a common fund. Accordingly, Plaintiff's counsel, whose efforts resulted in the creation of that common fund, are entitled to receive a reasonable fee and reimbursement for expenses from that fund.[74]
Calculating Common Fund Attorneys' Fees
In the United States, there are two methods of calculating fee awards in common fund cases: the percentage of the fund method and the lodestar method.[75] Under a percentage of the fund method, courts calculate fees based on a reasonable percentage of the common fund.[76] The lodestar method multiplies hours reasonably expended against a reasonable hourly rate to produce a "lodestar," which can then be adjusted through application of a "multiplier," to account for additional factors such as the contingent nature of the case and the quality of an attorney's work.[77]
Beginning in 1881, fees were calculated and awarded from a common fund based on a percentage of that fund.[78] Fees continued to be calculated on a percentage approach for almost 100 years. During the 1970s, however, courts began to use the lodestar method to calculate fee awards in common fund cases.[79]
[1254] In the 1980s, two events led to the reconsideration of the lodestar method. First, in 1984, the United States Supreme Court suggested that an award in a common fund case should be based upon a percentage of the fund.[80] By that time, "the point that `under the common fund doctrine ... a reasonable fee is based on a percentage of the fund bestowed on the class' was so well settled that no more than a footnote was needed to make it."[81] Second, in 1985, a Third Circuit Task Force issued a report concluding that all attorney fee awards in common fund cases should be structured as a percentage of the fund.[82] The report criticized the use of the lodestar method for determining the reasonableness of attorneys' fees in common fund class actions and listed nine deficiencies in the lodestar method.[83] "Ultimately, the Third Circuit allowed district court judges to exercise discretion in employing the percentage of the fund method, the lodestar method, or some combination of both, but the concerns voiced in the 1985 report, as well as in other publications, were not fully answered."[84] Today, after several years of experimentation with the lodestar method, "the vast majority of courts of appeals now permit or direct courts to use the percentage method in common-fund cases."[85]
Delaware's Sugarland Standard
In Sugarland Industries, Inc. v. Thomas, this Court rejected any mechanical approach to determining common fund fee awards.[86] In particular, we explicitly disapproved the Third Circuit's "lodestar method."[87] Therefore, Delaware courts are not required to award fees based on hourly rates that may not be commensurate with the value of the common fund created by the attorneys' efforts. Similarly, in Sugarland, we did not adopt an inflexible percentage of the fund approach.
Instead, we held that the Court of Chancery should consider and weigh the following factors in making an equitable award of attorney fees: 1) the results achieved; 2) the time and effort of counsel; 3) the relative complexities of the litigation; 4) any contingency factor; and 5) the standing and ability of counsel involved.[88] Delaware courts have assigned the greatest weight to the benefit achieved in litigation.[89]
[1255] Sugarland Factors Applied
The determination of any attorney fee award is a matter within the sound judicial discretion of the Court of Chancery.[90] In this case, the Court of Chancery considered and applied each of the Sugarland factors. In rendering its decision on the Fee Award, the Court of Chancery began with the following overview:
When the efforts of a plaintiff on behalf of a corporation result in the creation of a common fund, the Court should award reasonable attorneys' fees and expenses incurred by the plaintiff in achieving the benefit. Typically a-percentage-of-the-benefit approach is used if the benefit achieved is quantifiable.... And determining the percentage of the fund to award is a matter within the Court's discretion.
The aptly-named Sugarland factor[s], perhaps never more aptly-named than today, tell us to look at the benefit achieved, the difficulty and complexity of the litigation, the effort expended, the risk-taking, [and] the standing and ability of counsel. But the most important factor, the cases suggest, is the benefit. In this case it's enormous — a common fund of over 1.3 billion plus interest.
The Court of Chancery then addressed each of the Sugarland factors. The result was its decision to award the Plaintiff's counsel attorneys' fees and expenses equal to 15% of the amount of the common fund.
Benefit Achieved
With regard to the first and most important of the Sugarland factors, the benefit achieved, the Court of Chancery found that "[t]he plaintiffs here indisputably prosecuted this action through trial and secured an immense economic benefit for Southern Peru." The Court of Chancery stated that "this isn't small and this isn't monitoring. This isn't a case where it's rounding, where the plaintiffs share credit."[91] The Court of Chancery concluded that "anything that was achieved ... by this litigation [was] by these plaintiffs." With pre-judgment interest, the benefit achieved through the litigation amounts to more than $2 billion. Post-judgment interest accrues at more than $212,000 per day. The extraordinary benefit that was achieved in this case merits a very substantial award of attorneys' fees.
The Defendants take issue with the fact that the Fee Award was based upon the total damage award, which included pre-judgment interest. They contend that including such interest in the damage award is reversible error because the Plaintiff took too long to litigate this matter. The record reflects that the Court of Chancery considered the slow pace of the litigation in making the Fee Award. In response to the Defendants' [1256] arguments, the trial judge stated: "I'm not going to ... exclude interest altogether. I get that argument.... The interest I awarded is fairly earned by the plaintiffs. It's a lower amount. And, again, I've taken that [pace of litigation] into account by the percentage that I'm awarding." The Court of Chancery's decision to include pre-judgment interest in its determination of the benefit achieved was not arbitrary or capricious, but rather was the product of a logical and deductive reasoning process.
Difficulty and Complexity
The Court of Chancery carefully considered the difficulty and complexity of the case. It noted that the Plaintiff's attorneys had succeeded in presenting complex valuation issues in a persuasive way before a skeptical court:
They advanced a theory of the case that a judge of this court, me, was reluctant to embrace. I denied their motion for summary judgment. I think I gave [Plaintiff's counsel] a good amount of grief that day about the theory. I asked a lot of questions at trial because I was still skeptical of the theory. It faced some of the best lawyers I know and am privileged to have come before me, and they won....
I think when you talk about Sugarland and you talk about the difficulty of the litigation, was this difficult? Yes, it was. Were the defense counsel formidable and among the best that we have in our bar? They were. Did the plaintiffs have to do a lot of good work to get done and have to push back against a judge who was resistant to their approach? They did.
The Plaintiff's attorneys established at trial that Southern Peru had agreed to overpay its controlling shareholder by more than fifty percent ($3.7 billion compared to $2.4 billion). In doing so, the Court of Chancery found that the Plaintiff had to "deal with very complex financial and valuation issues" while being "up against major league, first-rate legal talent." This factor supports a substantial award of attorneys' fees.
Contingent Representation
The Plaintiff's attorneys pursued this case on a contingent fee basis. They invested a significant number of hours and incurred more than one million dollars in expenses. The Defendants litigated vigorously and forced the Plaintiff to go to trial to obtain any monetary recovery. Accordingly, in undertaking this representation, the Plaintiff's counsel incurred all of the classic contingent fee risks, including the ultimate risk — no recovery whatsoever. The Court of Chancery acknowledged that the fee award was "going to be a lot per hour to people who get paid by the hour," but that in this case, the Plaintiff's attorneys' compensation was never based on an hourly rate. Therefore, the Court of Chancery found that an award representing 15% of the common fund was reasonable in light of the absolute risk taken by Plaintiff's counsel in prosecuting the case through trial on a fully contingent fee basis.
Standing and Ability of Counsel
The Court of Chancery acknowledged that it was familiar with Plaintiff's counsel and had respect for their skills and record of success. The Defendants do not contest the skill, ability or reputation of the Plaintiff's counsel. They argue, however, that the Court of Chancery "should have weighed more heavily Plaintiff's counsel's undoubted ability against the causal manner in which this case was litigated." The record does not support that argument.
[1257] First, the Court of Chancery credited the Defendants' arguments that a rescission-based remedy was inappropriate because of the Plaintiff's delay in litigating the case. Second, the Court of Chancery noted that the record could justify a much larger award of attorneys' fees, but it ultimately applied a "conservative metric because of Plaintiff's delay." Accordingly, the record reflects that the Court of Chancery's Fee Award took into account the length of time involved in getting this case to trial.
Time and Effort of Counsel
The effort by the Plaintiff's attorneys was significant. The Plaintiff's attorneys reviewed approximately 282,046 pages in document production and traveled outside the United States to take multiple depositions. They also engaged in vigorously contested pretrial motion practice. They invested their firms' resources by incurring over a million dollars of out-of-pocket expenses. Most significantly, however, the Plaintiff's attorneys took this case to trial and prevailed. We repeat the Court of Chancery's statement: "anything that was achieved ... by this litigation [was] by [the Plaintiff's attorneys]."
The primary focus of the Defendants' challenge to the Court of Chancery's Fee Award is on the hourly rate that it implies, given that Plaintiff's counsel spent 8,597 hours on this case. They argue that the Court of Chancery abused its discretion by failing to consider the hourly rate implied by the Fee Award as a "backstop check" on the reasonableness of the fee. The Court of Chancery recognized the implications of this argument: "I get it. It's approximately — on what I awarded, approximately $35,000 an hour, if you look at it that way." However, the Court of Chancery did not look at it that way.
Sugarland does not require, as the Defendants argue, courts to use the hourly rate implied by a percentage fee award, rather than the benefit conferred, as the benchmark for determining a reasonable fee award. To the contrary, in Sugarland, this Court refused to adopt the Third Circuit's lodestar approach, which primarily focuses on the time spent.[92] There, we summarized that methodology, as follows:
Under Lindy I, the Court's analysis must begin with a calculation of the number of hours to be credited to the attorney seeking compensation. The total hours multiplied by the approved hourly rate is the "lodestar" in the Third Circuit's formulation. It has, indeed, been said that the time approach is virtually the sole consideration in making a fee ruling under Lindy I.[93]
In rejecting the lodestar methodology, we held the Court of Chancery judges "should not be obliged to make the kind of elaborate analyses called for by the several opinions in Lindy I and Lindy II."[94]
Moreover, in Sugarland, this Court rejected an argument that was almost identical to the one the Defendants make in this case. There, the corporation asserted on appeal that in assessing the reasonableness of the fee the Court of Chancery should have given more weight to the plaintiffs' counsel's hours and hourly rate.[95] This Court expressly rejected the use of time expended as the principal basis for determining fees awarded to plaintiff's counsel.[96] Instead, we held that the [1258] benefit achieved by the litigation is the "common yardstick by which a plaintiff's counsel is compensated in a successful derivative action."[97]
In applying that "common yardstick," we affirmed the Court of Chancery's determination that the plaintiffs' attorneys were "entitled to a fair percentage of the benefit inuring to Sugarland and its stockholders...."[98] We also affirmed the Court of Chancery's determination that 20% of the benefit achieved was a reasonable award.[99] Our only disagreement with the Court of Chancery in Sugarland was the "benefit" to which the percentage of 20% should be applied.[100]
In this case, the Court of Chancery properly realized that "[m]ore important than hours is `effort, as in what Plaintiffs' counsel actually did.'"[101] In applying Sugarland, the Court of Chancery understood that it had to look at the hours and effort expended, but recognized the general principle from Sugarland that the hours that counsel worked is of secondary importance to the benefit achieved.[102] In this case, the Court of Chancery was aware of the hourly rate that its Fee Award implied and nonetheless properly concluded that, in accordance with Sugarland, the Plaintiff's attorneys were entitled to a fair percentage of the benefit, i.e., common fund. It then found that "an award of 15 percent of the revised judgment, inclusive of expenses... is appropriate."
The Defendants' alternative to their hourly argument is a challenge to the fairness of the percentage awarded by the Court of Chancery. The Defendants contend that the Court of Chancery erred by failing to apply a declining percentage analysis in its fee determination. According to the Defendants, this Court's decision in Goodrich v. E.F. Hutton Group, Inc.[103] supports the per se use of a declining percentage. We disagree.
In Goodrich, we discussed the declining percentage of the fund concept, noting that the Court of Chancery rightly "acknowledged the merit of the emerging judicial consensus that the percentage of recovery awarded should `decrease as the size of the [common] fund increases.'"[104] We also emphasized, however, that the multiple factor Sugarland approach to determining attorneys' fee awards remained adequate for purposes of applying the equitable common fund doctrine.[105] Therefore, the use of a declining percentage, in applying the Sugarland factors in common fund cases, is a matter of discretion and is not required per se.
In this case, the record does not support the Defendants' argument that the Court of Chancery failed to apply a "declining percentage." In exercising its discretion and explaining the basis for the Fee Award, the Court of Chancery reduced the award from the 22.5% requested by the [1259] Plaintiff to 15% based, at least in part, on its consideration of the Defendants' argument that the percentage should be smaller in light of the size of the judgment:
Now, I gave a percentage of only 15 percent rather than 20 percent, 22 1/2 percent, or even 33 percent because the amount that's requested is large. I did take that into account. Maybe I am embracing what is a declining thing. I've tried to take into account all the factors, the delay, what was at stake, and what was reasonable. And I gave defendants credit for their arguments by going down to 15 percent. The only basis for some further reduction is, again, envy or there's just some level of too much, there's some natural existing limit on what lawyers as a class should get when they do a deal.[106]
Thus, the record reflects that the Court of Chancery did reduce the percentage it awarded due to the large amount of the judgment. The Defendants are really arguing that the Fee Award percentage did not "decline" enough.
Fee Award Percentage Discretionary
In determining the amount of a reasonable fee award, our holding in Sugarland assigns the greatest weight to the benefit achieved in the litigation.[107] When the benefit is quantifiable, as in this case, by the creation of a common fund, Sugarland calls for an award of attorneys' fees based upon a percentage of the benefit. The Sugarland factor that is given the greatest emphasis is the size of the fund created, because a "common fund is itself the measure of success ... [and] represents the benchmark from which a reasonable fee will be awarded."[108]
Delaware case law supports a wide range of reasonable percentages for attorneys' fees, but 33% is "the very top of the range of percentages."[109] The Court of Chancery has a history of awarding lower percentages of the benefit where cases have settled before trial.[110] When a case settles early, the Court of Chancery tends to award 10-15% of the monetary benefit conferred.[111] When a case settles after the plaintiffs have engaged in meaningful litigation efforts, typically including [1260] multiple depositions and some level of motion practice, fee awards in the Court of Chancery range from 15-25% of the monetary benefits conferred.[112] "A study of recent Delaware fee awards finds that the average amount of fees awarded when derivative and class actions settle for both monetary and therapeutic consideration is approximately 23% of the monetary benefit conferred; the median is 25%."[113] Higher percentages are warranted when cases progress to a post-trial adjudication.[114]
The reasonableness of the percentage awarded by the Court of Chancery is reviewed for an abuse of discretion.[115] The question presented in this case is how to properly determine a reasonable percentage for a fee award in a megafund case. A recent study by the economic consulting firm National Economic Research Associates ("NERA") demonstrates that overall as the settlement values increase, the amount of fee percentages and expenses decrease.[116] The study reports that median attorneys' fees awarded from settlements in securities class actions are generally in the range of 22% to 30% of the recovery until the recovery approaches approximately $500 million.[117] Once in the vicinity of over $500 million, the median attorneys' fees falls to 11%.[118]
Appellate courts that have examined a "megafund rule" requiring a fee percentage to be capped at a low figure when the recovery is quite high, have rejected it as a blanket rule. It is now accepted that "[a] mechanical, a per se application of the [1261] `megafund rule' is not necessarily reasonable under the circumstances of a case."[119] For example, although the Third Circuit recognized that its jurisprudence confirms the use of a sliding scale as "appropriate" for percentage fee awards in large recovery cases, it has held that trial judges are not required to use a declining percentage approach in every case involving a large settlement.[120] The Third Circuit reasoned that it has "generally cautioned against overly formulaic approaches in assessing and determining the amounts and reasonableness of attorneys' fees," and that "the declining percentage concept does not trump the fact-intensive [In re] Prudential [Ins. Co. Am. Sales Litigation, 148 F.3d 283 (3d Cir.1998)]/Gunter [v. Ridgewood Energy Corp., 223 F.3d 190 (3d Cir.2000)] [factors,]"[121] which are similar to this Court's Sugarland factors.
Although several courts have recognized the declining percentage principle, none have imposed it as a per se rule.[122] In Goodrich, we held the Court of Chancery did not abuse its discretion by rejecting a "per se rule that awarded attorney's fees as a percentage in relation to the maximum common fund available, without regard to the benefits actually realized by class members."[123] We reasoned that "[t]he adoption of a mandatory methodology or particular mathematical model for determining attorney's fees in common fund cases would be the antithesis of the equitable principles from which the concept of such awards originated."[124] That ratio decidendi equally applies in this case.
Therefore, we decline to impose either a cap or the mandatory use of any particular range of percentages for determining attorneys' fees in megafund cases. As we stated in Goodrich, "[n]ew mechanical guidelines are neither appropriate nor needed for the Court of Chancery."[125] We reaffirm that our holding in Sugarland sets forth the proper factors for determining attorneys' fee awards in all common fund cases.[126]
Fee Award Reasonable Percentage
The percentage awarded as attorneys' fees from a common fund is committed to the sound discretion of the Court of Chancery.[127] In determining the amount of a fee award, the Court of Chancery must consider the unique circumstances of each case. Its reasons for the selection of a given percentage must be stated with particularity.
The Court of Chancery quantified the Fee Award as 15% of the common fund.[128] [1262] The Court of Chancery addressed the Sugarland factors and how those factors caused it to arrive at that percentage, as follows:
The plaintiffs here indisputably prosecuted this action through trial and secured an immense economic benefit for Southern Peru. I've already said — and I'm going to take into account — I already encouraged the plaintiffs to be conservative in their application because they weren't as rapid in moving this as I would have liked. I don't think, though, that you can sort of ignore them, to say because they didn't invest six years on this case on an entirely contingent basis, deal with very complex financial and valuation issues, and ignore the fact that they were up against major league, first-rate legal talent.
. . . .
"[O]ne of the things ... the defendants got credit for in this case is that the plaintiffs were slow.... I also took that into account in how I approach interest in the case.... [I] also ... have to take that into account in the percentage I award for the plaintiffs[,] ... [a]nd I took that into account. I took some cap factors into account, setting the interest in what I did.... I have to take some away from the plaintiff's ... lawyers on that ... frankly, there were grounds for me to award more to the company. And I didn't. And — and so that is going to impel me to reduce the percentage that I'm awarding....[129]
We repeat the Court of Chancery's conclusion:
Now, I gave a percentage of only 15 percent rather than 20 percent, 22 1/2 percent, or even 33 percent because the amount that's requested is large. I did take that into account. Maybe I am embracing what is a declining thing. I've tried to take into account all the factors, the delay, what was at stake, and what was reasonable. And I gave defendants credit for their arguments by going down to 15 percent. The only basis for some further reduction is, again, envy or there's just some level of too much, there's some natural existing limit on what lawyers as a class should get when they do a deal.
We review an award of attorneys' fees for an abuse of discretion.[130] When an act of judicial discretion is under appellate review, this Court may not substitute its notions of what is right for those of the trial judge, if his or her judgment was the product of reason and conscience, as opposed to being either arbitrary or capricious.[131] As we recently stated, the challenge of quantifying fee awards is entrusted to the trial judge and will not be disturbed on appeal in the absence of capriciousness or factual findings that are clearly wrong.[132]
In this case, the Court of Chancery carefully weighed and considered all of the Sugarland factors. The record supports its factual findings and its well-reasoned decision that a reasonable attorneys' fee is 15% of the benefit created. Accordingly, we hold that the Fee Award was a proper exercise of the Court of Chancery's broad discretion in applying the Sugarland factors under the circumstances of this case.
Conclusion
The judgment of the Court of Chancery, awarding more than $2 billion in damages [1263] and more than $304 million in attorneys' fees, is affirmed.
BERGER, Justice, concurring and dissenting:
I concur in the majority's decision on the merits, but I would find that the trial court did not properly apply the law when it awarded attorneys' fees, and respectfully dissent on that issue.
The majority finds no abuse of discretion in the trial court's decision to award more than $304 million in attorneys' fees. The majority says that the trial court applied the settled standards set forth in Sugarland Industries, Inc. v. Thomas,[133] and that this Court may not substitute its notions of what is right for those of the trial court. But the trial court did not apply Sugarland, it applied its own world views on incentives, bankers' compensation, and envy.
To be sure, the trial court recited the Sugarland standards. Its analysis, however, focused on the perceived need to incentivize plaintiffs' lawyers to take cases to trial. The trial court hypothesized that a stockholder plaintiff would be happy with a lawyer who says, "If you get really rich because of me, I want to get rich, too."[134] Then, the trial court talked about how others get big payouts without comment, but that lawyers are not viewed the same way:
[T]here's an idea that when a lawyer or law firms are going to get a big payment, that there's something somehow wrong about that, just because it's a lawyer. I'm sorry, but investment banks have hit it big.... They've hit it big many times. And to me, envy is not an appropriate motivation to take into account when you set an attorney fee.[135]
The trial court opined that a declining percentage for "mega" cases would not create a healthy incentive system, and that the trial court would not embrace such an approach. Rather, the trial court repeatedly pointed out that "plenty of market participants make big fees when their clients win," and that if this were a hedge fund manager or an investment bank, the fee would be okay.[136] In sum, the trial court said that the fundamental test for reasonableness is whether the fee is setting a good incentive, and that the only basis for reducing the fee would be envy.[137] That is not a decision based on Sugarland.
Reargument Unanimously Denied
The appellants, Americas Mining Corporation ("AMC") and nominal defendant, Southern Copper Corporation, have filed a motion for reargument. The issue raised on reargument is the narrow question of whether the relevant "benefit achieved" for calculating attorneys' fees in a derivative case, against a majority stockholder and other defendants, is properly defined as the entire judgment paid to the corporation, or, in this case, 19% of the entire judgment paid to the corporation, because the majority stockholder defendant owns 81% of the corporation that will receive the judgment.
This Court has carefully considered the motion for reargument filed by the Defendants, and the response filed by the Plaintiff. We have determined that the motion for reargument is procedurally barred under [1264] Delaware law, because the issue raised on reargument was not fully and fairly presented in the Defendants' opening briefs;[138] and alternatively, because it is substantively without merit, as a matter of Delaware law.[139]
Waiver Constitutes Procedural Bar
This Court's rules specifically require an appellant to set forth the issues raised on appeal and to fairly present an argument in support of those issues in their opening brief. If an appellant fails to comply with these requirements on a particular issue, the appellant has abandoned that issue on appeal.[140] Supreme Court Rule 14(b)(vi)(A)(3) states that "[t]he merits of any argument that is not raised in the body of the opening brief shall be deemed waived and will not be considered by the Court on appeal."
Neither of the Defendants' opening briefs properly raised the issue set forth in the limited motion for reargument. AMC's opening brief did not mention the issue at all and Southern Copper Corporation's opening brief only mentioned the issue indirectly in a footnote. Arguments in footnotes do not constitute raising an issue in the "body" of the opening brief.[141]
Therefore, the issue raised in the limited motion for reargument is procedurally barred, as a matter of Delaware law, because it has been waived. On that basis alone the motion must be denied.[142]
Argument Without Substantive Merit
Alternatively, and as an independent basis for denying the limited motion for reargument, we conclude that the Court of Chancery properly rejected the "look through" approach to awarding attorneys' fees in a derivative action. The derivative suit has been characterized as "one of the most interesting and ingenious of accountability mechanisms for large formal organizations."[143] It enables a stockholder to bring suit on behalf of the corporation for harm done to the corporation.[144]
Because a derivative suit is being brought on behalf of the corporation, any recovery must go to the corporation.[145] In addition, a stockholder who is directly injured retains the right to bring an individual action for those injuries affecting his or her legal rights as a stockholder.[146] Such an individual injury is distinct from an injury to the corporation alone. "In such individual suits, the recovery or other relief flows directly to the stockholders, not to the corporation."[147]
[1265] In Tooley v. Donaldson, Lufkin, & Jenrette, Inc., this Court held that whether a claim is derivative or direct depends solely upon two questions: "(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?"[148] It is undisputed that this is a derivative proceeding. In this case, the corporation was harmed and the total recovery is awarded to the corporation, Southern Copper Corporation — not "nominally" but actually.
In assessing the "benefit achieved," the Court of Chancery held, and this Court affirmed, that the benefit achieved in a derivative action is the benefit to the corporation. The "look through" approach to awarding attorneys' fees in a derivative case was properly rejected by the Court of Chancery long ago in Wilderman v. Wilderman.[149] Similarly, in rejecting the Defendants' "look-through" argument in this derivative action, the Court of Chancery stated:
There's also this argument that I should only award — I should basically look at it like it's a class action case and that the benefit is only to the minority stockholders. I don't believe that's our law. And this is a corporate right. And, you know, if you look going back to 1974 ... there was Wilderman versus Wilderman, 328 A.2d 456, which talks about not disregarding the corporate form in a derivative action and looking at the benefit to the corporation, to the more recent Carlton — Carlson case, which is now reported, in 925 A.2d 506 does the same.
No stockholder, including the majority stockholder, has a claim to any particular assets of the corporation.[150] Accordingly, Delaware law does not analyze the "benefit achieved" for the corporation in a derivative action, against a majority stockholder and others, as if it were a class action recovery for minority stockholders only. Therefore, the limited motion for reargument is substantively without merit. On that alternative basis alone the motion must also be denied.[151]
Now, therefore, this 21st day of September 2012, it is hereby ordered that the motion for reargument is unanimously denied.
[1] Sitting by designation pursuant to Del. Const. art. IV, § 12 and Supr. Ct. R. 2 and 4.
[2] The facts are taken almost verbatim from the post-trial decision by the Court of Chancery.
[3] On October 11, 2005, Southern Peru changed its name to "Southern Copper Corporation" and is currently traded on the NYSE under the symbol "SCCO."
[4] Grupo Mexico held — and still holds — its interest in Southern Peru through its wholly-owned subsidiary Americas Mining Corporation ("AMC"). Grupo Mexico also held its 99.15% stake in Minera through AMC. AMC, not Grupo Mexico, is a defendant to this action, but I refer to them collectively as Grupo Mexico in this opinion because that more accurately reflects the story as it happened.
[5] The remaining plaintiff in this action is Michael Theriault, as trustee of and for the Theriault Trust.
[6] These individual defendants are Germán Larrea Mota-Velasco, Genaro Larrea Mota-Velasco, Oscar González Rocha, Emilio Carrillo Gamboa, Jaime Fernandez Collazo Gonzalez, Xavier García de Quevedo Topete, Armando Ortega Gómez, and Juan Rebolledo Gout.
[7] At this point in the negotiation process, Grupo Mexico mistakenly believed that it only owned 98.84% of Minera. It later corrects this error, and the final Merger consideration reflected Grupo Mexico's full 99.15% equity ownership stake in Minera.
[8] Tr. at 159 (Handelsman) ("I think the committee was somewhat comforted by the fact that the DCF analysis of Minera [] and the DCF analysis of [Southern Peru] were not as different as the discounted cash flow analysis of Minera [] and the market value of Southern Peru.").
[9] During discovery, two Microsoft Excel worksheets were unearthed that appear to suggest the implied equity values of Minera and Southern Peru that underlie Goldman's October 21 presentation. One worksheet, which contains the Minera model, indicates an implied equity value for Minera of $1.25 billion using a long-term copper price of $0.90/lb and a discount rate of 8.5%. The other worksheet, which contains the Southern Peru model, indicates an implied equity value for Southern Peru of $1.6 billion using a copper price of $0.90 and a discount rate of 9.0%, and assuming a royalty tax of 2%. Both the Plaintiff's expert and the Defendants' expert relied on the projections contained in these worksheets in their reports. The Defendants have also not contested the Plaintiff's expert's contention that these worksheets include Goldman's discounted cash flow estimates as of October 21, 2004.
[10] Barrow v. Abramowicz, 931 A.2d 424, 429 (Del.2007); Sammons v. Doctors for Emergency Servs., P.A., 913 A.2d 519, 528 (Del.2006).
[11] Sammons v. Doctors for Emergency Servs., P.A., 913 A.2d at 528.
[12] Id.
[13] Drejka v. Hitchens Tire Serv., Inc., 15 A.3d 1221, 1223-24 (Del.2010).
[14] Sheehan v. Oblates of St. Francis de Sales, 15 A.3d 1247, 1253 (Del.2011).
[15] Drejka v. Hitchens Tire Serv., Inc., 15 A.3d at 1222-24.
[16] Sammons v. Doctors for Emergency Servs., P.A., 913 A.2d at 528.
[17] Kahn v. Tremont Corp., 694 A.2d 422, 428 (Del. 1997); Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del.1983); see also Rosenblatt v. Getty Oil Co., 493 A.2d 929, 937 (Del.1985).
[18] See Emerald Partners v. Berlin, 726 A.2d 1215, 1221 (Del. 1999); Kahn v. Tremont Corp., 694 A.2d at 428-29.
[19] Weinberger v. UOP, Inc., 457 A.2d at 711.
[20] Id.
[21] Id. (citations omitted).
[22] Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d 1110 (Del.1994).
[23] See id. at 1117 (citation omitted).
[24] Id.
[25] Kahn v. Tremont Corp., 694 A.2d at 428 (citation omitted).
[26] Emerald Partners v. Berlin, 787 A.2d 85 (Del.2001).
[27] Id. at 98-99.
[28] See Emerald Partners v. Berlin, 726 A.2d 1215, 1222-23 (Del. 1999) (describing that the special committee must exert "real bargaining power" in order for defendants to obtain a burden shift); see also Beam v. Stewart, 845 A.2d 1040, 1055 n. 45 (Del.2004) (noting that the test articulated in Tremont requires a determination as to whether the committee members "in fact" functioned independently (citing Kahn v. Tremont Corp., 694 A.2d 422, 429-30 (Del. 1997))).
[29] Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997).
[30] Id. at 429 (citation omitted).
[31] Id. (citation omitted).
[32] Id. at 428.
[33] Accord Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d at 1121 ("[U]nless the controlling or dominating shareholder can demonstrate that it has not only formed an independent committee but also replicated a process `as though each of the contending parties had in fact exerted its bargaining power at arm's length,' the burden of proving entire fairness will not shift." (citing Weinberger v. UOP, Inc., 457 A.2d 701, 709-10 n. 7 (Del.1983))).
[34] Cf. In re Cysive, Inc. S'holders Litig., 836 A.2d 531, 549 (Del.Ch.2003).
[35] See William T. Allen et al., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. L. 1287, 1303-04 n. 63 (2001) (noting the practical problems litigants face when the burden of proof they are forced to bear is not made clear until after the trial); cf. In re Cysive, Inc. S'holders Litig., 836 A.2d at 549.
[36] Kahn v. Tremont Corp., 694 A.2d at 428 (citing Weinberger v. UOP, Inc., 457 A.2d at 710). See also In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d 604, 617 (Del.Ch. 2005) ("All in all, it is perhaps fairest and more sensible to read Lynch as being premised on a sincere concern that mergers with controlling stockholders involve an extraordinary potential for the exploitation by powerful insiders of their informational advantages and their voting clout.").
[37] William T. Allen et al., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. L. 1287, 1303-04 n. 63 (2001).
[38] In re Cysive, Inc. S'holders Litig., 836 A.2d at 549.
[39] Kahn v. Tremont Corp., 694 A.2d at 428-29.
[40] In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d at 617 (emphasis added).
[41] In re Cysive, Inc. S'holders Litig., 836 A.2d at 548.
[42] Kahn v. Tremont Corp., 694 A.2d at 428.
[43] Emerald Partners v. Berlin, 787 A.2d 85, 99 (Del.2001).
[44] See, e.g., In re Cysive, Inc. S'holders Litig., 836 A.2d at 548 ("Because these devices are thought, however, to be useful and to incline transactions towards fairness, the Lynch doctrine encourages them by giving defendants the benefits of a burden shift if either one of the devices is employed.").
[45] See William T. Allen et al., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. L. 1287, 1297 (2001) (explaining that standards of review should be functional, in that they should serve as a "useful tool that aids the court in deciding the fiduciary duty issue" rather than merely "signal the result or outcome").
[46] See In re Cysive, Inc. S'holders Litig., 836 A.2d at 549 (noting that it is inefficient for defendants to seek a pretrial ruling on the burden-shift unless the discovery process has generated a sufficient factual record to make such a determination).
[47] See, e.g., Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985); Weinberger v. UOP, Inc., 457 A.2d at 709 n. 7.
[48] Weinberger v. UOP, Inc., 457 A.2d at 709 n. 7.
[49] Id. at 712, 714.
[50] Id. at 711.
[51] Id.
[52] See, e.g., Valeant Pharms. Int'l v. Jerney, 921 A.2d 732, 746 (Del.Ch.2007).
[53] Weinberger v. UOP, Inc., 457 A.2d at 711.
[54] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1179 (Del. 1995); Nixon v. Blackwell, 626 A.2d 1366, 1373, 1378 (Del. 1993); accord Kahn v. Lynch Commc'n Sys., Inc., 638 A.2d at 1120.
[55] See Nixon v. Blackwell, 626 A.2d at 1373.
[56] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d at 1180; Rosenblatt v. Getty Oil Co., 493 A.2d at 937.
[57] Cinerama, Inc. v. Technicolor, Inc., 663 A.2d at 1180.
[58] Id.
[59] Ryan v. Tad's Enters., Inc., 709 A.2d 682, 699 (Del.Ch.1996).
[60] Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 855 A.2d 1059, 1072 (Del.Ch. 2003).
[61] (citations omitted).
[62] $55.89 closing price × 67,200,000 = $3,755,808,000.
[63] $3.756 billion-$2.409 billion = $1.347 billion.
[64] Weinberger v. UOP, Inc., 457 A.2d at 714; see also Glanding v. Industrial Trust Co., 45 A.2d 553, 555 (Del. 1945) ("[T]he Court of Chancery of the State of Delaware inherited its equity jurisdiction from the English Courts."); 1 Victor B. Woolley, Woolley on Delaware Practice § 56 (1906).
[65] Int'l Telecharge, Inc. v. Bomarko, Inc., 766 A.2d 437, 440 (Del.2000).
[66] Id. at 441.
[67] Summa Corp. v. Trans World Airlines, Inc., 540 A.2d 403, 409 (Del. 1988).
[68] Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del.1980).
[69] This argument is without merit. Rule 1.5(c) of the Rules of Professional Conduct expressly contemplates fees that are based on a percentage. Comment [3] to the Rule provides that the determination of whether a particular contingent fee is reasonable is to be based on the relevant factors and applicable law. In this case, the Court of Chancery made that reasonableness determination based on the relevant factors and applicable law set forth in Sugarland by this Court.
[70] Boeing Co. v. Van Gemert, 444 U.S. 472, 478, 100 S.Ct. 745, 62 L.Ed.2d 676 (1980) (citations omitted). See also Goodrich v. E.F. Hutton Group, Inc., 681 A.2d 1039, 1049 (Del. 1996) ("[T]he condition precedent to invoking the common fund doctrine is a demonstration that a common benefit has been conferred.").
[71] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1044 (citations omitted).
[72] Id. (citing Boeing Co. v. Van Gemert, 444 U.S. at 478, 100 S.Ct. 745; Maurer v. Int'l Re-Insurance Corp., 95 A.2d 827, 830 (Del.1953)).
[73] Tandycrafts, Inc. v. Initio Partners, 562 A.2d 1162, 1164-65 (Del. 1989) (citing CM & M Group, Inc. v. Carroll, 453 A.2d 788, 795 (Del.1982)).
[74] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1045 (citing Weinberger v. UOP, Inc., 517 A.2d 653, 654-55 (Del.Ch.1986); Chrysler Corp. v. Dann, 223 A.2d 384, 386 (Del. 1966)).
[75] See Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046-47; Federal Judicial Center, MANUAL FOR COMPLEX LITIGATION (FOURTH) § 14.121 at 187 (2004).
[76] See Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046.
[77] Id. (citations omitted).
[78] Cent. R.R. & Banking Co. v. Pettus, 113 U.S. 116, 124-25, 5 S.Ct. 387, 28 L.Ed. 915 (1885); Trustees v. Greenough, 105 U.S. 527, 532-33, 26 L.Ed. 1157 (1881). See also Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046-47 (discussing history of common fund fee awards).
[79] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1046-47 (citing Lindy Bros. Builders, Inc. of Phila. v. Am. Radiator & Standard Sanitary Corp., 487 F.2d 161, 167-68 (3d Cir. 1973)).
[80] Blum v. Stenson, 465 U.S. 886, 900 n. 16, 104 S.Ct. 1541, 79 L.Ed.2d 891 (1984).
[81] Shaw v. Toshiba Am. Info. Sys., Inc., 91 F.Supp.2d 942, 962-63 (E.D.Tex.2000) (internal quotation marks omitted).
[82] Report of the Third Circuit Task Force, Court Awarded Attorney Fees, 108 F.R.D. 237, 255 (1985).
[83] Id. at 246-50.
[84] Seinfeld v. Coker, 847 A.2d 330, 335 (Del. Ch.2000) (citing In re General Motors Corp. Pick-Up Truck Fuel Tank Products Liability Litig., 55 F.3d 768, 821 (3d Cir.1995)).
[85] Federal Judicial Center, MANUAL FOR COMPLEX LITIGATION (FOURTH) § 14.121 at 187 (2004); Charles W. "Rocky" Rhodes, Attorneys' Fees in Common-Fund Class Actions: A View from the Federal Circuits, 35 The Advocate (Tex.) 56, 57-58 (2006).
[86] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149-50.
[87] Id. at 150
[88] Id. at 149. See also Loral Space & Commc'ns, Inc. v. Highland Crusader Offshore Partners, L.P., 977 A.2d 867, 870 (Del.2009).
[89] See, e.g., Julian v. E. States Const. Serv., Inc., 2009 WL 154432, at *2 (Del.Ch. Jan. 14, 2009) ("In determining the size of an award, courts assign the greatest weight to the benefit achieved in the litigation.") (citing Franklin Balance Sheet Inv. Fund v. Crowley, 2007 WL 2495018, at *8 (Del.Ch. Aug. 30, 2007)); Seinfeld v. Coker, 847 A.2d 330, 336 (Del.Ch.2000) ("Sugarland's first factor is indeed its most important-the results accomplished for the benefit of the shareholders.") (citations omitted); Dickerson v. Castle, 1992 WL 205796, at *1 (Del.Ch. Aug. 21, 1992) ("Typically, the benefit achieved by the action is accorded the greatest weight.") (citations omitted), aff'd 1993 WL 66586 (Del. Mar. 2, 1993); In re Anderson Clayton S'holders Litig., 1988 WL 97480, at *3 (Del.Ch. Sept. 19, 1988) ("This Court has traditionally placed greatest weight upon the benefits achieved by the litigation."); In re Maxxam Group, Inc., 1987 WL 10016, at *11 (Del.Ch. Apr. 16, 1987) ("The benefits achieved by the litigation constitute the factor generally accorded the greatest weight.").
[90] Johnston v. Arbitrium (Cayman Islands) Handels AG, 720 A.2d 542, 547 (Del.1998).
[91] Cf. In re Cox Commc'ns, Inc. S'holders Litig., 879 A.2d at 609-12 (awarding a "substantially smaller [attorney] fee" than that requested by plaintiffs for settlement of claims challenging a fully negotiable merger proposal where no appreciable risk was taken and credit was "shared" with special committee).
[92] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 150.
[93] Id.
[94] Id.
[95] Id. at 149-50.
[96] Id. at 150.
[97] Id. at 147. See Irving Morris and Kevin Gross, Attorneys' Fee Applications In Common Fund Cases Under Delaware Law: Benefit Achieved as "The Common Yardstick." 324 PLI/Lit 167 (1987).
[98] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 150 (emphasis added).
[99] Id. at 151.
[100] Id. at 150-51.
[101] In re Del Monte Foods Co. S'holders Litig., 2011 WL 2535256, at *13 (Del.Ch. June 27, 2011) (citation omitted).
[102] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 147.
[103] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d 1039 (Del. 1996).
[104] Id. at 1048 (citations omitted).
[105] Id. at 1050.
[106] Emphasis added.
[107] See Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149-50.
[108] 4 Alba Conte & Herbert B. Newberg, Newberg on Class Actions § 14:6, at 547, 550 (4th ed.2001). See Irving Morris & Kevin Gross, Attorneys' Fee Applications In Common-Fund Cases Under Delaware Law: Benefit Achieved as "The Common Yardstick," 324 PLI/Lit 167, 175 (1987).
[109] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 (Del.Ch. Mar. 28, 2011) (citing Thorpe v. CERBCO, 1997 WL 67833 at *6 (Del.Ch. Feb. 6, 1997)).
[110] Franklin Balance Sheet Inv. Fund v. Crowley, 2007 WL 2495018, at *13 (Del.Ch. Aug. 30, 2007).
[111] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 n. 2 (citing Julian v. E. States Constr. Serv., Inc., 2009 WL 154432 (Del.Ch. Jan. 14, 2009) (awarding total of 8% when little time and effort were invested before settlement); Korn v. New Castle Cty., 2007 WL 2981939 (Del.Ch. Oct. 3, 2007) (awarding 10% when "there was limited discovery, no briefing, and no oral argument...."); Seinfeld v. Coker, 847 A.2d 330 (Del.Ch.2000) (awarding 10% when case settled after limited document discovery and no motion practice); In re The Coleman Co. S'holders Litig., 750 A.2d 1202 (Del.Ch.1999) (awarding 10% where counsel did not take a single deposition or file or defend a pretrial motion); In re Josephson Int'l, Inc., 1988 WL 112909 (Del.Ch. Oct. 19, 1988) (awarding 18% when case settled after ten days of document discovery); Schreiber v. Hadson Petroleum Corp., 1986 WL 12169 (Del.Ch. Oct. 29, 1986) (awarding 16% when case settled "[s]hortly after suit was filed")).
[112] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 & n. 3 (citing In re Cablevision/Rainbow Media Gp. Tracking Stock Litig., 2009 WL 1514925 (Del.Ch. May 22, 2009) (awarding 22.5% where plaintiffs' counsel devoted nearly 5,000 hours to the case); Gelobter v. Bressler, 1991 WL 236226 (Del.Ch. Nov. 6, 1991) (awarding 16.67% where counsel pursued extensive discovery, including seventeen depositions); Stepak v. Ross, 1985 WL 21137 (Del.Ch. Sept. 5, 1985) (awarding 20% where plaintiff took extensive discovery)).
[113] See Richard A. Rosen, David C. McBride & Danielle Gibbs, Settlement Agreements in Commercial Disputes: Negotiating, Drafting and Enforcement, § 27.10, at 27-100 (2010).
[114] In re Emerson Radio S'holder Deriv. Litig., 2011 WL 1135006, at *3 & n. 4 (citing Berger v. Pubco Corp., 2010 WL 2573881 (Del.Ch. June 23, 2010) (awarding a total fee of 31.5% where "lengthy and thorough litigation by counsel ... resulted in a final judgment and not a quick settlement"); Gatz v. Ponsoldt, 2009 WL 1743760 (Del.Ch. June 12, 2009) (awarding 33% in case litigated extensively, including through an appeal in the Delaware Supreme Court); Ryan v. Gifford, 2009 WL 18143 (Del.Ch. Jan. 2, 2009) (awarding 33% of cash amount where plaintiffs' counsel engaged in "meaningful discovery," survived "significant, hard fought motion practice" and incurred nearly $400,000 in expenses); Tuckman v. Aerosonic Corp., 1983 WL 20291 (Del.Ch. Apr. 21, 1983) (awarding 29% where litigated through trial and two appeals)).
[115] See Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149.
[116] See Dr. Renzo Comolli et al., Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review, NERA Econ. Consulting, July 2012, at p. 31. For an example, the study finds fee awards in securities class actions amount to 27% in cases where the settlement is between $25 million and $100 million, 22.4% in cases where the settlement is between $100 million and $500 million, and 11.1% in cases where the settlement is above $500 million. Id. Figure 31. See also Federal Judicial Center, MANUAL FOR COMPLEX LITIGATION § 14.121 at 187 (2004) ("Attorney fees awarded under the percentage method are often between 25% and 30% of the fund.").
[117] Dr. Renzo Comolli et al., Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review, NERA Econ. Consulting, July 2012, at p. 31.
[118] Id.
[119] In re Enron Corp. Sec., Deriv. & ERISA Litig., 586 F.Supp.2d 732, 753-54 (S.D.Tex. 2008) (citing cases and concluding that "[a] mechanical, a per se application of the `megafund rule' is not necessarily reasonable under the circumstances of a case.").
[120] In re Rite Aid Corp. Sec. Litig., 396 F.3d 294, 302-03 (3d Cir.2005) ("[T]here is no rule that a district court must apply a declining percentage reduction in every settlement involving a sizable fund.").
[121] Id. at 303.
[122] Id. at 302-03 (3d Cir.2005).
[123] Goodrich v. E.F. Hutton Group, Inc., 681 A.2d at 1049.
[124] Id. at 1050.
[125] Id.
[126] Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del.1980).
[127] Chrysler Corp. v. Dann, 223 A.2d 384, 386 (Del.1966).
[128] See Shaw v. Toshiba Am. Info. Sys., Inc., 91 F.Supp.2d 942 (E.D.Tex.2000) (awarding 15% fee on a common fund of $1 billion); In re NASDAQ Market-Makers Antitrust Litig., 187 F.R.D. 465 (S.D.N.Y.1998) (awarding 14% fee on common fund of $1 billion).
[129] Emphasis added.
[130] Sugarland Indus., Inc. v. Thomas, 420 A.2d at 149.
[131] Chavin v. Cope, 243 A.2d 694, 695 (Del. 1968).
[132] EMAK Worldwide, Inc. v. Kurz, 50 A.3d 429, 432-33, 2012 WL 1319771, at *3 (Del. Ch. Apr. 17, 2012).
[133] Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del.1980).
[134] Appellant Southern Copper Corporation's Opening Brief, Exhibit A at 74.
[135] Id. at 82.
[136] Id. at 81-83.
[137] Id. at 83-84.
[138] Flamer v. State, 953 A.2d 130, 134 (Del. 2008); Roca v. E.I. du Pont de Nemours & Co., 842 A.2d 1238, 1242 (Del.2004).
[139] Wilderman v. Wilderman, 328 A.2d 456, 458 (Del.Ch. 1974). See Gentile v. Rossette, 906 A.2d 91, 102-03 (Del.2006); Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031 (Del.2004).
[140] Roca v. E.I. du Pont de Nemours & Co., 842 A.2d at 1242.
[141] See Supreme Court Rule 14(d) ("Footnotes shall not be used for argument ordinarily included in the body of a brief....").
[142] Michigan v. Long, 463 U.S. 1032, 1044, 103 S.Ct. 3469, 77 L.Ed.2d 1201 (1983).
[143] Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 351 (Del.1988) (quoting R. Clark, Corporate Law 639-40 (1986)).
[144] Kramer v. W. Pac. Indus., Inc., 546 A.2d at 351.
[145] Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d at 1036.
[146] Id.
[147] Id.
[148] Id. at 1033.
[149] Wilderman v. Wilderman, 328 A.2d at 458.
[150] Norte & Co. v. Manor Healthcare Corp., 1985 WL 44684, at *3 (Del.Ch.) ("[T]he corporation is the legal owner of its property and the stockholders do not have any specific interest in the assets of the corporation.").
[151] Michigan v. Long, 463 U.S. at 1044, 103 S.Ct. 3469.
1.2.3.4 In re Trulia Inc. Stockholder Litigation 1.2.3.4 In re Trulia Inc. Stockholder Litigation
Settlements of class and derivative actions require court approval under Del. Ch. Rules 23(e) and 23.1(c), respectively. In Riverbed, Vice-Chancellor Glasscock explained the rationale for this requirement in the context of a class action:"Settlements in class actions present a well-known agency problem: A plaintiff's attorney may favor a quick settlement where the additional effort required to fully develop valuable claims on behalf of the class may not generate an additional fee as lucrative to the plaintiff's attorney as accepting a quick and moderate fee, then pursuing other interests. The interest of the principal—the individual plaintiff/stockholder—is often so small that it serves as scant check on the perverse incentive described above, notwithstanding that the aggregate interest of the class in pursuing litigation may be great—the very problem that makes class litigation appropriate in the first instance."In re Riverbed Tech., Inc. S'holders Litig., 2015 WL 5458041, at *7 (Del. Ch. Sept. 17, 2015).In particular, as class representatives, plaintiff attorneys have the power to forfeit claims on behalf of the entire class in a settlement. Plaintiff attorneys are thus in a position to “sell” shareholder claims—possibly below value but keeping the “price” (fees) for themselves:"In combination, the incentives of the litigants may be inimical to the class: the individual plaintiff may have little actual stake in the outcome, her counsel may rationally believe a quick settlement and modest fee is in his best financial interest, and the defendants may be happy to "purchase," at the bargain price of disclosures of marginal benefit to the class and payment of the plaintiffs' attorney fees, a broad release from liability."Id., at *9.In spite of these concerns, Delaware courts had developed a practice of approving settlements containing broad releases of shareholder claims in return for moderate corporate disclosures and six-figure attorney fees. Starting with Riverbed and culminating with Chancellor Bouchard’s authoritative opinion in Trulia, the Chancery Court announced a change in its practice.Please consider the following questions when reading Chancellor Bouchard’s opinion:1. Chancellor Bouchard’s “opinion further explains that … the Court will be increasingly vigilant in scrutinizing … settlements” (at 888). What precedential value does this language have, formally speaking? What precedential value do you think it has in practice?2. Both Chancellor Bouchard and Vice-Chancellor Glasscock disapprove of settlements for disclosures “of marginal value.” Why are settlements for “plainly material” disclosures less suspicious? Do “plainly material” disclosures guarantee that the settlement is in the class’s best interest?3. Both judges also disapprove of “broad releases from liability.” Can a broad release—including, e.g., antitrust claims—ever be justified?4. Chancellor Bouchard is also concerned that (892) “defendants are incentivized to settle quickly in order to mitigate the considerable expense of litigation and the distraction it entails [and] to achieve closing certainty.” Is this problem specific to class and derivative actions? Is it a problem for the class members? Is it a problem for stockholders? Does blocking settlements solve this problem?5. What settlements should be approved? What litigation should be encouraged, and, once encouraged, under which conditions should it be allowed to terminate?
129 A.3d 884 (2016)
IN RE TRULIA, INC. STOCKHOLDER LITIGATION
CONSOLIDATED C.A. No. 10020-CB.
Court of Chancery of Delaware.
Submitted: October 16, 2015.
Decided: January 22, 2016.
[886] Seth D. Rigrodsky, Brian D. Long, Gina M. Serra and Jeremy J. Riley, Rigrodsky & Long, P.A., Wilmington, Delaware; Peter B. Andrews and Craig J. Springer, Andrews & Springer, LLC, Wilmington, Delaware; James R. Banko, Faruqi & Faruqi, LLP, Wilmington, Delaware; Peter Safirstein, Domenico Minerva and Elizabeth Metcalf, Morgan & Morgan, P.C., New York, New York; Katharine M. Ryan and Richard A. Maniskas, Ryan & Maniskas, LLP, Wayne, Pennsylvania; Kent A. Bronson, Todd Kammerman and Christopher Schuyler, Milberg LLP, New York, New York; Juan E. Monteverde, James Wilson, Jr. and Miles D. Schreiner, Faruqi & Faruqi, LLP, New York, New York; Counsel for Plaintiffs.
Rudolf Koch and Sarah A. Clark, Richards, Layton & Finger, P.A., Wilmington, Delaware; Deborah S. Birnbach, Goodwin Procter LLP, Boston, Massachusetts; Michael T. Jones, Goodwin Procter LLP, Menlo Park, California; Attorneys for Defendants Trulia, Inc., Pete Flint, Robert Moles, Theresia Gouw, Gregory Waldorf, Sami Inkinen, Erik Bardman and Steve Hafner.
William M. Lafferty, Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware; Alan S. Goudiss, Shearman & Sterling, New York, New York; Attorneys for Defendants Zillow, Inc. and Zebra Holdco, Inc.
Joseph Christensen, Joseph Christensen P.A., Wilmington, Delaware; Counsel for Amicus Curiae Sean J. Griffith.
OPINION
BOUCHARD, C.
This opinion concerns the proposed settlement of a stockholder class action challenging Zillow, Inc.'s acquisition of Trulia, Inc. in a stock-for-stock merger that closed in February 2015. Shortly after the public announcement of the proposed transaction, four Trulia stockholders filed essentially identical complaints alleging that Trulia's directors had breached their fiduciary duties in approving the proposed merger [887] at an unfair exchange ratio. Less than four months later, after taking limited discovery, the parties reached an agreement-in-principle to settle.
The proposed settlement is of the type often referred to as a "disclosure settlement." It has become the most common method for quickly resolving stockholder lawsuits that are filed routinely in response to the announcement of virtually every transaction involving the acquisition of a public corporation. In essence, Trulia agreed to supplement the proxy materials disseminated to its stockholders before they voted on the proposed transaction to include some additional information that theoretically would allow the stockholders to be better informed in exercising their franchise rights. In exchange, plaintiffs dropped their motion to preliminarily enjoin the transaction and agreed to provide a release of claims on behalf of a proposed class of Trulia's stockholders. If approved, the settlement will not provide Trulia stockholders with any economic benefits. The only money that would change hands is the payment of a fee to plaintiffs' counsel.
Because a class action impacts the legal rights of absent class members, it is the responsibility of the Court of Chancery to exercise independent judgment to determine whether a proposed class settlement is fair and reasonable to the affected class members. For the reasons explained in this opinion, I conclude that the terms of this proposed settlement are not fair or reasonable because none of the supplemental disclosures were material or even helpful to Trulia's stockholders, and thus the proposed settlement does not afford them any meaningful consideration to warrant providing a release of claims to the defendants. Accordingly, I decline to approve the proposed settlement.
On a broader level, this opinion discusses some of the dynamics that have led to the proliferation of disclosure settlements, noting the concerns that scholars, practitioners and members of the judiciary have expressed that these settlements rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims that have not been investigated with rigor. I also discuss some of the particular challenges the Court faces in evaluating disclosure settlements through a non-adversarial process.
Based on these considerations, this opinion offers the Court's perspective that disclosure claims arising in deal litigation optimally should be adjudicated outside of the context of a proposed settlement so that the Court's consideration of the merits of the disclosure claims can occur in an adversarial process without the defendants' desire to obtain an often overly broad release hanging in the balance. The opinion further explains that, to the extent that litigants continue to pursue disclosure settlements, they can expect that the Court will be increasingly vigilant in scrutinizing the "give" and the "get" of such settlements to ensure that they are genuinely fair and reasonable to the absent class members.
I. BACKGROUND
The facts recited in this opinion are based on the allegations of the Verified Amended Class Action Complaint in C.A. No. 10022-CB, which was designated as the operative complaint in the consolidation action; the brief plaintiffs submitted in support of their motion for a preliminary injunction; and the briefs and affidavits submitted in connection with the proposed settlement. Because of the posture of the litigation, the recited facts do not represent factual findings, but rather the [888] record as it was presented for the Court to evaluate the proposed settlement.
A. The Parties
Defendant Trulia, Inc., a Delaware corporation, is an online provider of information on homes for purchase or for rent in the United States. Individual defendants Pete Flint, Robert Moles, Theresia Gouw, Gregory Waldorf, Sami Inkinen, Erik Bardman, and Steve Hafner were members of Trulia's board of directors when the merger was approved.
Defendant Zillow, Inc., a Washington corporation, is a real estate marketplace that helps home buyers, sellers, landlords and others find and share information about homes. Defendant Zebra Holdco, Inc. ("Holdco"), now known as Zillow Group, Inc., is a Washington corporation that was formed to facilitate the merger at issue and is now the parent company of Zillow and Trulia.
Plaintiffs Christopher Shue, Matthew Sciabacucci, Chaile Steinberg, and Robert Collier were Trulia stockholders at all times relevant to this action.
B. The Announcement of the Merger and the Litigation
On July 28, 2014, Trulia and Zillow announced that they had entered into a definitive merger agreement under which Zillow would acquire Trulia for approximately $3.5 billion in stock.[1] The transaction was structured to include two successive stock-for-stock mergers whereby separate subsidiaries of Holdco would acquire both Trulia and Zillow. After these mergers, Trulia and Zillow would exist as wholly-owned subsidiaries of Holdco, and the former stockholders of Trulia and Zillow would receive, respectively, approximately 33% and 67% of the outstanding shares of Holdco.
After the merger was announced, the four plaintiffs filed class action complaints challenging the Trulia merger and seeking to enjoin it. Each of the complaints alleged essentially identical claims: that the individual defendants had breached their fiduciary duties, and that Zillow, Trulia, and Holdco aided and abetted those breaches.
On September 11, 2014, Holdco filed a registration statement containing Trulia and Zillow's preliminary joint proxy statement with the United States Securities and Exchange Commission. On September 24, 2014, one of the four plaintiffs filed a motion for expedited proceedings and for a preliminary injunction.
On October 13, 2014, the Court granted an unopposed motion to consolidate the four cases into one action and to appoint lead counsel. On October 14, at 10:37 a.m., plaintiffs filed a motion to expedite the proceedings in the newly consolidated case. The Court never heard the motion, however, because the parties promptly agreed on an expedited schedule, which they documented in a stipulated case schedule filed on October 14 at 12:12 p.m., less than two hours after the motion to expedite was filed.
Over the next few weeks, plaintiffs reviewed documents produced by defendants and deposed one director of Trulia (Chairman, CEO, and co-founder Pete Flint) and a banker from J.P. Morgan Securities [889] LLC, Trulia's financial advisor in the transaction.
On November 14, 2014, plaintiffs filed a brief in support of their motion for a preliminary injunction. In that brief, plaintiffs asserted that the individual defendants had breached their fiduciary duties by "failing to obtain the highest exchange ratio available for the Company's stockholders in a single-bidder process, failing to properly value the Company, agreeing to preclusive provisions in the Merger Agreement that impede the Board's ability to consider and accept superior proposals, and disseminating materially false and misleading disclosures to the Company's stockholders. . . ."[2] The discussion of the merits in that brief, however, focused only on disclosure issues. Plaintiffs provided no argument in support of any other aspect of their claims.
On November 17, Trulia and Zillow filed a definitive joint proxy statement regarding the transaction on Schedule 14A (the "Proxy").
C. The Parties Reach a Settlement
On November 19, 2014, the parties entered into a Memorandum of Understanding detailing an agreement-in-principle to settle the litigation for certain disclosures to supplement those contained in the Proxy, subject to confirmatory discovery. The same day, Trulia filed a Form 8-K with the Securities and Exchange Commission containing the disclosures (the "Supplemental Disclosures").
On December 18, 2014, Trulia and Zillow held special meetings of stockholders at which each company's stockholders voted on and approved the transaction. Trulia's stockholders overwhelmingly supported the transaction. Of the Trulia shares that voted, 99.15% voted in favor of the transaction. In absolute terms, 79.52% of Trulia's outstanding shares voted in favor the transaction.[3]
On February 10, 2015, plaintiffs conducted a confirmatory deposition of a second Trulia director, Gregory Waldorf. On February 17, 2015, the transaction closed.
On June 10, 2015, the parties executed a Stipulation and Agreement of Compromise, Settlement, and Release (the "Stipulation") in support of a proposed settlement reiterating the terms of the Memorandum of Understanding. In the Stipulation, the parties agreed to seek certification of a class consisting of all Trulia stockholders from July 28, 2014 (when the transaction was announced) through February 17, 2015 (when the transaction closed). The Stipulation included an extremely broad release encompassing, among other things, "Unknown Claims"[4] and claims "arising under federal, state, foreign, statutory, regulatory, common law or other law or rule" held by any member of the proposed class relating in any conceivable way to the transaction.[5] The Stipulation further provided that plaintiffs' counsel intended to seek an award of attorneys' fees and expenses [890] not to exceed $375,000, which defendants agreed not to oppose.
Beginning on July 17, 2015, Trulia disseminated notices to the proposed class members in accordance with a scheduling order the Court had entered.
D. Procedural Posture
On September 16, 2015, after receiving a brief and an affidavit from plaintiffs advocating for approval of the proposed settlement, I held a hearing to consider the fairness of the terms of the proposed settlement. Defendants made no submissions concerning the proposed settlement before the hearing, and no stockholder filed an objection to it. After the hearing, I took the request to approve the settlement under advisement and asked the parties for supplemental briefing on whether disclosures must meet the legal standard of materiality in order to constitute an adequate benefit to support a settlement, and on the rationale and justification for including "unknown claims" among the claims that would be released by the proposed settlement.
On September 22, 2015, Sean J. Griffith, a professor at Fordham University School of Law who has researched disclosure settlements and objected to them in the past,[6] requested permission to appear as amicus curiae in order to submit a brief on the topics for which I requested supplemental briefing. I approved this request on September 23, and the parties submitted their supplemental briefing on October 16.
Along with their supplemental briefing, plaintiffs submitted an affidavit from Timothy J. Meinhart, a managing director of Willamette Management Associates, which provides business valuation and transaction financial advisory services. The affidavit addresses certain concerns about some (but not all) of the disclosures that I raised at the settlement hearing. Plaintiffs and defendants also informed the Court that, following the hearing, the parties had agreed to a revised stipulation with a narrower release.
Specifically, the parties removed "Unknown Claims" and "foreign" claims from the ambit of the release and added a carve-out so that the release would not cover "any claims that arise under the Hart-Scott-Rodino, Sherman, or Clayton Acts, or any other state or federal antitrust law." As revised, the release still encompasses "any claims arising under federal, state, statutory, regulatory, common law, or other law or rule" held by any member of the proposed class relating in any conceivable way to the transaction, with the exception of the carve-out for claims arising under state and federal antitrust law.[7]
II. LEGAL ANALYSIS
A. Legal Standard
Under Court of Chancery Rule 23, the Court must approve the dismissal or settlement of a class action.[8] Although Delaware has long favored the voluntary settlement of litigation,[9] the fiduciary character of a class action requires the Court to independently examine the fairness of a class action settlement before approving [891] it.[10] "Approval of a class action settlement requires more than a cursory scrutiny by the court of the issues presented."[11] The Court must exercise its own judgment to determine whether the settlement is reasonable and intrinsically fair.[12] In doing so, the Court evaluates not only the claim, possible defenses, and obstacles to its successful prosecution,[13] but also "the reasonableness of the `give' and the `get,'"[14] or what the class members receive in exchange for ending the litigation.
Before turning to that analysis here, I pause to discuss some of the dynamics that have led to the proliferation of disclosure settlements[15] and the concerns that have been expressed about this phenomenon, and to offer the Court's perspective on how disclosure claims in deal litigation should be adjudicated in the future.
B. Considerations Involving Disclosure Claims in Deal Litigation
Over two decades ago, Chancellor Allen famously remarked in Solomon v. Pathe Communications Corporation that "[i]t is a fact evident to all of those who are familiar with shareholder litigation that surviving a motion to dismiss means, as a practical matter, that economical[ly] rational defendants . . . will settle such claims, often for a peppercorn and a fee."[16] The Chancellor's remarks were not made in the context of a settlement, but they touch upon some of the same dynamics that have fueled disclosure settlements of deal litigation.
Today, the public announcement of virtually every transaction involving the acquisition of a public corporation provokes a flurry of class action lawsuits alleging that the target's directors breached their fiduciary duties by agreeing to sell the corporation for an unfair price. On occasion, although it is relatively infrequent, such litigation has generated meaningful economic benefits for stockholders when, for example, the integrity of a sales process has been corrupted by conflicts of interest on the part of corporate fiduciaries or their advisors.[17] But far too often [892] such litigation serves no useful purpose for stockholders. Instead, it serves only to generate fees for certain lawyers who are regular players in the enterprise of routinely filing hastily drafted complaints on behalf of stockholders on the heels of the public announcement of a deal and settling quickly on terms that yield no monetary compensation to the stockholders they represent.
In such lawsuits, plaintiffs' leverage is the threat of an injunction to prevent a transaction from closing. Faced with that threat, defendants are incentivized to settle quickly in order to mitigate the considerable expense of litigation and the distraction it entails, to achieve closing certainty, and to obtain broad releases as a form of "deal insurance." These incentives are so potent that many defendants self-expedite the litigation by volunteering to produce "core documents" to plaintiffs' counsel, obviating the need for plaintiffs to seek the Court's permission to expedite the proceedings in aid of a preliminary injunction application and thereby avoiding the only gating mechanism (albeit one friendly to plaintiffs[18]) the Court has to screen out frivolous cases and to ensure that its limited resources are used wisely.[19]
Once the litigation is on an expedited track and the prospect of an injunction hearing looms, the most common currency used to procure a settlement is the issuance of supplemental disclosures to the target's stockholders before they are asked to vote on the proposed transaction. The theory behind making these disclosures is that, by having the additional information, stockholders will be better informed when exercising their franchise rights.[20] Given the Court's historical practice of approving disclosure settlements when the additional information is not material, and indeed may be of only minor [893] value to the stockholders,[21] providing supplemental disclosures is a particularly easy "give" for defendants to make in exchange for a release.
Once an agreement-in-principle is struck to settle for supplemental disclosures, the litigation takes on an entirely different, non-adversarial character. Both sides of the caption then share the same interest in obtaining the Court's approval of the settlement.[22] The next step, after notice has been provided to the stockholders, is a hearing in which the Court must evaluate the fairness of the proposed settlement. Significantly, in advance of such hearings, the Court receives briefs and affidavits from plaintiffs extolling the value of the supplemental disclosures and advocating for approval of the proposed settlement, but rarely receives any submissions expressing an opposing viewpoint.[23]
Although the Court commonly evaluates the proposed settlement of stockholder class and derivative actions without the benefit of hearing opposing viewpoints, disclosure settlements present some unique challenges. It is one thing for the Court to judge the fairness of a settlement, even in a non-adversarial context, when there has been significant discovery or meaningful motion practice to inform the Court's evaluation. It is quite another to do so when little or no motion practice has occurred and the discovery record is sparse, as is typically the case in an expedited deal litigation leading to an equally expedited resolution based on supplemental disclosures before the transaction closes. In this case, for example, no motions were decided (not even a motion to expedite), and discovery was limited to the production of less than 3,000 pages of documents and the taking of three depositions, two of which were taken before the parties agreed in principle to settle and one of which was a "confirmatory" deposition taken thereafter.[24]
[894] The lack of an adversarial process often requires that the Court become essentially a forensic examiner of proxy materials so that it can play devil's advocate in probing the value of the "get" for stockholders in a proposed disclosure settlement. Consider the following example. During discovery, plaintiffs will typically receive copies of board presentations made by financial advisors who ultimately opine on the fairness of the transaction from a financial point of view. It is all too common for a plaintiff to identify and obtain supplemental disclosure of a laundry list of minutiae in a financial advisor's board presentation that does not appear in the summary of the advisor's analysis in the proxy materials— summaries that commonly run ten or more single-spaced pages in the first instance. Given that the newly added pieces of information were, by definition, missing from the original proxy, it is not difficult for an advocate to make a superficially persuasive argument that it is better for stockholders to have more information rather than less. In an adversarial process, defendants, armed with the help of their financial advisors, would be quick to contextualize the omissions and point out why the missing details are immaterial (and may even be unhelpful) given the summary of the advisor's analysis already disclosed in the proxy. In the settlement context, however, it falls to law-trained judges to attempt to perform this function, however crudely, as best they can.
It is beyond doubt in my view that the dynamics described above, in particular the Court's willingness in the past to approve disclosure settlements of marginal value and to routinely grant broad releases to defendants and six-figure fees to plaintiffs' counsel in the process,[25] have caused deal litigation to explode in the United States beyond the realm of reason. In just the past decade, the percentage of transactions of $100 million or more that have triggered stockholder litigation in this country has more than doubled, from 39.3% in 2005 to a peak of 94.9% in 2014.[26] Only recently has the percentage decreased, falling to 87.7% in 2015 due to a decline near the end of the year.[27] In Delaware, the percentage of such cases settled solely on the basis of supplemental disclosures grew significantly from 45.4% in 2005 to a high of 76.0% in 2012, and only recently has seen some decline.[28] The increased prevalence of deal litigation and [895] disclosure settlements has drawn the attention of academics, practitioners, and the judiciary.
Scholars have criticized disclosure settlements, arguing that non-material supplemental disclosures provide no benefit to stockholders and amount to little more than deal "rents" or "taxes," while the liability releases that accompany settlements threaten the loss of potentially valuable claims related to the transaction in question or other matters falling within the literal scope of overly broad releases.[29] One recent study provides empirical data suggesting that supplemental disclosures make no difference in stockholder voting, and thus provide no benefit that could serve as consideration for a settlement.[30] Another paper, written by a practitioner, provides examples of cases in which unexplored but valuable claims that almost were released through disclosure settlements later yielded significant recoveries for stockholders.[31] A particularly vivid example is the recently concluded Rural/Metro case.[32] In that case, the Court of Chancery initially considered it a "very close call"[33] to reject a disclosure settlement that would have released claims which subsequently yielded stockholders over $100 million, mostly from a post-trial judgment, after new counsel took over the case.[34]
Members of this Court also have voiced their concerns over the deal settlement process, expressing doubts about the value of relief obtained in disclosure settlements, and explaining their reservations over the [896] breadth of the releases sought and the lack of any meaningful investigation of claims proposed to be released.[35] Judges outside of Delaware have expressed similar concerns.[36]
Given the rapid proliferation and current ubiquity of deal litigation, the mounting evidence that supplemental disclosures rarely yield genuine benefits for stockholders, the risk of stockholders losing potentially valuable claims that have not been investigated with rigor, and the challenges of assessing disclosure claims in a non-adversarial settlement process, the Court's historical predisposition toward approving disclosure settlements needs to be reexamined. In the Court's opinion, the optimal means by which disclosure claims in deal litigation should be adjudicated is outside the context of a proposed settlement so that the Court's consideration of the merits of the disclosure claims can occur in an adversarial process where the defendants' desire to obtain a release does not hang in the balance.
Outside the settlement context, disclosure claims may be subjected to judicial review in at least two ways. One is in the context of a preliminary injunction motion, in which case the adversarial process would remain intact and plaintiffs would have the burden to demonstrate on the merits a reasonable likelihood of proving that "the alleged omission or misrepresentation is material."[37] In other words, plaintiffs would bear the burden of showing "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available."[38]
A second way is when plaintiffs' counsel apply to the Court for an award of attorneys' fees after defendants voluntarily decide to supplement their proxy materials by making one or more of the disclosures sought by plaintiffs, thereby mooting some [897] or all of their claims. In that scenario, where securing a release is not at issue, defendants are incentivized to oppose fee requests they view as excessive.[39] Hence, the adversarial process would remain in place and assist the Court in its evaluation of the nature of the benefit conferred (i.e., the value of the supplemental disclosures) for purposes of determining the reasonableness of the requested fee.
In either of these scenarios, to the extent fiduciary duty claims challenging the sales process remain in the case, they may be amenable to dismissal. Harkening back to Chancellor Allen's words in Solomon, the Court would be cognizant of the need to "apply the pleading test under Rule 12 with special care" in stockholder litigation because "the risk of strike suits means that too much turns on the mere survival of the complaint."[40] In that regard, both the litigants and the Court are aided today by thirty years of jurisprudence that now exists interpreting the principles enunciated in Unocal and Revlon that often are central to reviewing fiduciary conduct in deal litigation.[41]
The preferred scenario of a mootness dismissal appears to be catching on. In the wake of the Court's increasing scrutiny of disclosure settlements, the Court has observed an increase in the filing of stipulations in which, after disclosure claims have been mooted by defendants electing to supplement their proxy materials, plaintiffs dismiss their actions without prejudice to the other members of the putative class (which has not yet been certified) and the Court reserves jurisdiction solely to hear a mootness fee application.[42] From the Court's perspective, this arrangement provides a logical and sensible framework for concluding the litigation. After being afforded some discovery to probe the merits of a fiduciary challenge to the substance of the board's decision to approve the transaction in question, plaintiffs can exit the litigation without needing to expend additional resources (or causing the Court and other parties to expend further resources) on dismissal motion practice after the transaction has closed. Although defendants will not have obtained a formal release, the filing of a stipulation of dismissal [898] likely represents the end of fiduciary challenges over the transaction as a practical matter.
In the mootness fee scenario, the parties also have the option to resolve the fee application privately without obtaining Court approval. Twenty years ago, Chancellor Allen acknowledged the right of a corporation's directors to exercise business judgment to expend corporate funds (typically funds of the acquirer, who assumes the expense of defending the litigation after the transaction closes) to resolve an application for attorneys' fees when the litigation has become moot, with the caveat that notice must be provided to the stockholders to protect against "the risk of buy off" of plaintiffs' counsel.[43] As the Court recently stated, "notice is appropriate because it provides the information necessary for an interested person to object to the use of corporate funds, such as by `challeng[ing] the fee payment as waste in a separate litigation,' if the circumstances warrant."[44] In other words, notice to stockholders is designed to guard against potential abuses in the private resolution of fee demands for mooted representative actions. With that protection in place, the Court has accommodated the use of the private resolution procedure on several recent occasions and reiterates here the propriety of proceeding in that fashion.[45]
Returning to the historically trodden but suboptimal path of seeking to resolve disclosure claims in deal litigation through a Court-approved settlement, practitioners should expect that the Court will continue to be increasingly vigilant in applying its independent judgment to its case-by-case assessment of the reasonableness of the "give" and "get" of such settlements in light of the concerns discussed above. To be more specific, practitioners should expect that disclosure settlements are likely to be met with continued disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.[46] In using the term "plainly material," I mean that it should not be a close call that the supplemental information is material as that term is defined under Delaware law. Where the [899] supplemental information is not plainly material, it may be appropriate for the Court to appoint an amicus curiae to assist the Court in its evaluation of the alleged benefits of the supplemental disclosures, given the challenges posed by the non-adversarial nature of the typical disclosure settlement hearing.[47]
Finally, some have expressed concern that enhanced judicial scrutiny of disclosure settlements could lead plaintiffs to sue fiduciaries of Delaware corporations in other jurisdictions in the hope of finding a forum more hospitable to signing off on settlements of no genuine value. It is within the power of a Delaware corporation to enact a forum selection bylaw to address this concern.[48] In any event, it is the Court's opinion, based on its extensive experience in adjudicating cases of this nature, that the historical predisposition that has been shown towards approving disclosure settlements must evolve for the reasons explained above. We hope and trust that our sister courts will reach the same conclusion if confronted with the issue.
With the foregoing considerations in mind, I consider next the "give" and the "get" of the proposed settlement in this case.
C. The Supplemental Disclosures Are not Material and Provided no Meaningful Benefit to Stockholders
Under Delaware law, when directors solicit stockholder action, they must "disclose fully and fairly all material information within the board's control."[49] Delaware has adopted the standard of materiality used under the federal securities laws. Information is material "if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote."[50] In other words, information is material if, from the perspective of a reasonable stockholder, there is a substantial likelihood that it "significantly alter[s] the `total mix' of information made available."[51]
Here, the joint Proxy that Trulia and Zillow stockholders received in advance of their respective stockholders' meetings to consider whether to approve the proposed [900] transaction ran 224 pages in length, excluding annexes. It contained extensive discussion concerning, among other things, the background of the mergers, each board's reasons for recommending approval of the proposed transaction, prospective financial information concerning the companies that had been reviewed by their respective boards and financial advisors, and explanations of the opinions of each company's financial advisor. In the case of Trulia, the opinion of J.P. Morgan was summarized in ten single-spaced pages.
The Supplemental Disclosures plaintiffs obtained in this case solely concern the section of the Proxy summarizing J.P. Morgan's financial analysis, which the Trulia board cited as one of the factors it considered in deciding to recommend approval of the proposed merger.[52] Specifically, these disclosures provided additional details concerning: (1) certain synergy numbers in J.P. Morgan's value creation analysis; (2) selected comparable transaction multiples; (3) selected public trading multiples; and (4) implied terminal EBITDA multiples for a relative discounted cash flow analysis.
Relevant to considering the materiality of information disclosed in this section of the Proxy, then-Vice Chancellor Strine observed in In re Pure Resources, Inc. Shareholders Litigation that there were "conflicting impulses" in Delaware case law about whether, when seeking stockholder action, directors must disclose "investment banker analyses in circumstances in which the bankers' views about value have been cited as justifying the recommendation of the board."[53] The Court held that, under Delaware law, when the board relies on the advice of a financial advisor in making a decision that requires stockholder action, those stockholders are entitled to receive in the proxy statement "a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely."[54] This "fair summary" standard has been a guiding principle for this Court in considering proxy disclosures concerning the work of financial advisors for more than a decade.[55]
A fair summary, however, is a summary. By definition, it need not contain all information underlying the financial advisor's opinion or contained in its report to the board.[56] Indeed, this Court has held [901] that the summary does not need to provide sufficient data to allow the stockholders to perform their own independent valuation.[57] The essence of a fair summary is not a cornucopia of financial data, but rather an accurate description of the advisor's methodology and key assumptions.[58] In my view, disclosures that provide extraneous details do not contribute to a fair summary and do not add value for stockholders.[59]
With the foregoing principles in mind, I consider next whether any of the four specific Supplemental Disclosures that plaintiffs obtained here were material or whether they provided any benefit to Trulia's stockholders at all.
1. Synergy Numbers in the Value Creation Analysis
The Supplemental Disclosures provided some additional details in the sections of J.P. Morgan's analysis entitled "Value Creation Analysis-Intrinsic Value Approach" and "Value Creation Analysis-Market-Based Approach." In the "Intrinsic Value Approach" analysis, J.P. Morgan compared the implied equity value derived [902] from its discounted cash flow analysis of Trulia on a standalone basis to Trulia stockholders' pro forma ownership of the implied equity value of the combined company. In the "Market-Based Approach," J.P. Morgan compared the public market equity value of Trulia on a standalone basis to Trulia stockholders' pro forma ownership of the implied equity value of the combined company.
As supplemented, the disclosure concerning the Intrinsic Value Approach reads in relevant part as follows, with the information that was added to the original disclosure in the Proxy appearing in bolded text:
The pro forma combined company equity value was equal to: (1) the Trulia standalone discounted cash flow value of $2.9 billion, plus (2) the Zillow standalone discounted cash flow value of $6.2 billion, plus (3) $2.2 billion, representing the present value of (a) Trulia's management expected after-tax synergies of $2.4 billion, less (b) Trulia's management estimates of (i) the one-time costs to achieve such synergies of $65.0 million and (ii) transaction expenses of $85 million. The present value of after-tax synergies was based on an estimate of $175.0 million in synergies to be fully realized starting in 2016, extrapolated through 2029 based on assumptions provided by Trulia's management.[60]
Plaintiffs argue that the disclosure of the $175 million synergies figure in the quote above was important because it is substantially different from the $100 million in synergies that J.P. Morgan used in the Market-Based Approach, which figure already was disclosed in the Proxy.[61] According to plaintiffs, "[h]ad [stockholders] initially known that the market-based approach analysis was skewed downward by using lower synergies numbers, their view as to the resulting implied value and reliability of [J.P. Morgan's] analysis may have changed appreciably."[62] There are three fundamental problems with this argument.
First, although plaintiffs question why J.P. Morgan used two different synergies figures in two different analyses, they provide no explanation as to why doing so would be inappropriate. To the contrary, it seems logical that an intrinsic value approach (which is based on a comparison derived from a discounted cash flow analysis) would use synergies based on long-term management projections, while a market-based approach (which is based on a comparison to the public market equity value of Trulia) would use synergies based on what would be publicly announced to investors. Regardless, the Proxy accurately disclosed which synergies assumptions the financial advisor deemed appropriate to use in each analysis.[63]
Second, the $175 million synergies figure that plaintiffs consider so important was not new information. It already was disclosed in the Proxy, which contained the following table providing information about management's synergies expectations:[64]
[903] The following table presents summary estimated synergies that Trulia's management also prepared in respect of the combined company following the completion of the mergers for the calendar years ending 2014 through 2024 in connection with Trulia's evaluation of the mergers.
Trulia Management Estimated synergies (in millions, unaudited)
[Column 1: year, column 2: Total Operating Synergies(1)]
2014E $-
2015E $23
2016E $175
2017E $225
2018E $285
2019E $349
2020E $416
2021E $480
2022E $535
2023E $574
2024E $594
(1) "Total Operating Synergies" means the expected EBIT effect of revenue synergies plus the EBIT effect of cost savings/cost avoidance less one-time costs to achieve and retain such synergies. "EBIT" means earnings before interest and taxes. An assumed tax rate of 40% was applied to Total Operating Synergies to determine estimated after-tax synergies. Projected synergies (including costs to achieve synergies) were prepared by Trulia's management through fiscal year 2016 after discussion with Zillow's management. The management of Trulia provided J.P. Morgan with assumptions relating to projected synergies for fiscal years 2017 through 2024 deemed appropriate by Trulia's management. The management of Trulia then directed J.P. Morgan to use these assumptions in extrapolating such estimated synergies for fiscal years extending beyond those for which the management of Trulia had provided projections. The management of Trulia then reviewed and approved such extrapolation of the synergies.[65]
Because the $175 million figure for 2016 synergies already appeared in this table, inserting it into a methodological paragraph a few pages later is of no benefit to stockholders. In my view, the supplemental disclosure may have added confusion more than anything else, because it lacks explanatory context and does not clearly describe the nature of management's estimate of synergies that was disclosed in the original Proxy.[66]
Third, plaintiffs exaggerate the significance of juxtaposing the synergy figures used in the Intrinsic Value Approach with those used in the Market-Based Approach. In contrast to the Intrinsic Value Approach, the Market-Based Approach was placed in the end of the summary of the financial advisor's analysis in the "Other Information" section, was termed an "illustrative value creation analysis," and "was presented merely for informational purposes."[67] As plaintiffs concede, a "fair reading" of the Proxy indicates that the Market-Based Approach analysis was less important than the Intrinsic Value Approach analysis.[68] Thus, the notion that the disclosure of the $175 million synergies figure used in one analysis (which already was disclosed in the Proxy) was significant because it was higher than the $100 million figure used in a second, different analysis is based on a false equivalence of the relative importance of the two analyses.
In sum, the disclosures in the original Proxy already provided a fair summary of [904] J.P. Morgan's methodology and assumptions in its two "Value Creation" analyses. Inserting additional minutiae underlying some of the assumptions could not reasonably have been expected to significantly alter the total mix of information and thus was not material. Indeed, in my view, the supplemental information was not even helpful to stockholders.
2. Individual Company Multiples in the Selected Transaction Analysis
The Proxy disclosed that J.P. Morgan used publicly available information to analyze certain selected precedent transactions involving companies engaged in businesses that J.P. Morgan considered analogous to Trulia's businesses.[69] The Proxy listed the date, the target, and the acquirer for each of 32 transactions that were considered. It also disclosed the low and high forward EBITDA multiples for the group of transactions. Using a narrower range of multiples falling between the low and the high for the group, J.P. Morgan created an estimated range of equity values per share for Trulia common stock. This methodology was summarized in the Proxy as follows:
J.P. Morgan reviewed the implied firm value for each of the transactions as a multiple of the target company's two-year forward EBITDA immediately preceding the announcement of the transaction. The analysis indicated a range of EBITDA multiples of 8.0x to 69.1x. Based on the result of this analysis and other factors that J.P. Morgan considered appropriate, J.P. Morgan applied an EBITDA multiple range of 10.0x to 23.0x to Trulia's fiscal 2015 Adjusted EBITDA and arrived at an estimated range of equity values per share for Trulia common stock of $17.25-$38.50.[70]
Plaintiffs' grievance is that the Proxy did not provide the relevant multiples for each of the 32 individual transactions. The individual multiples were added in the Supplemental Disclosures for those transactions for which the information was publicly available.[71] The addition of this information made evident that multiples were not publicly available for 15 of the 32 transactions. Plaintiffs argue that, without the Supplemental Disclosures, stockholders would not have realized that J.P. Morgan's analysis did not consider multiples for half of the precedent transactions it listed and was therefore less robust than the Proxy portrayed it to be.
The addition of the individual multiples and the revelation that some were not publicly available could not reasonably have been expected to significantly alter the total mix of information. No argument is made, for example, that having 16 similar transactions was not sufficient to perform the analysis that J.P. Morgan conducted. The discussion in the Proxy, moreover, including the portion quoted above, fairly summarized the methodology and assumptions J.P. Morgan used in conducting that analysis to extrapolate a range of per share values for Trulia stock. A fair summary does not require disclosure of sufficient data to allow stockholders to perform their own valuation.[72]
This conclusion is supported by the Court's decision in In re MONY Group [905] Shareholder Litigation.[73] There, the Court rejected a similar argument that the disclosure of transaction multiples was important because it showed that 25% of the multiples in a set of 71 transactions were unavailable. After noting that the plaintiffs had not argued that the financial advisor did not have sufficient data to perform its analysis, the Court held that the additional information was "immaterial, as a matter of law," and a "triviality [that] could not reasonably be expected to affect the total mix of information."[74] In my view, the addition of similar trivialities was not helpful to Trulia's stockholders here.
3. Individual Company Multiples in the Selected Public Trading Analysis
The Proxy disclosed the names of sixteen publicly traded companies that J.P. Morgan used to construct ranges of forward EBITDA and revenue multiples for Trulia and Zillow.[75] The Proxy provided these multiples for Trulia and Zillow based on their last unaffected trading day before the announcement of the merger, and provided the median multiples for the three groups into which J.P. Morgan categorized the sixteen comparable companies: "Real Estate," "Software as a Service," and "Other." The Proxy did not include individual multiples for the peer companies.
The Supplemental Disclosures added the revenue and EBITDA multiples for each of the sixteen companies. Citing In re Celera Corporation Shareholder Litigation,[76] plaintiffs argue, in essence, that individual company multiples are material per se. That is not a fair reading of the case. In Celera, the Court commented that "as a matter of best practices, a fair summary of a comparable companies or transactions analysis probably should disclose the market multiples derived for the comparable companies or transactions."[77] Although the decision reluctantly concluded that a multiples disclosure was compensable, it found it "questionable whether [the multiples] altered the `total mix' of available information" because that information "already was publicly available."[78] The individual company multiples in the Supplemental Disclosures here also were already publicly available.[79]
[906] More importantly, the original disclosures in Celera simply listed the comparable companies with no summary multiple data at all.[80] Although the supplemental disclosures in that case added summary data for each of three categories of companies, they did not provide any individual company multiples.[81] In other words, the disclosures in Trulia's Proxy, which provided the median multiples for three different categories of companies that J.P. Morgan considered in its judgment to be similar to Trulia, essentially started at the point where Celera ended.[82]
Plaintiffs next argue that the individual multiples are important here because they allow stockholders to compare the selected companies' EBITDA growth rates and EBITDA multiples to Trulia's. This argument is unpersuasive for two reasons. First, basic valuation principles already would suggest to stockholders that higher growth rates should correspond to higher multiples.[83] Second, the Supplemental Disclosures do not contain EBITDA growth rates, so the figures necessary to make that comparison are not present in any event. Thus, plaintiffs have not persuaded me that individual company multiples are material or were even helpful in this case.
4. Implied Terminal EBITDA Multiples in the DCF Analysis
J.P. Morgan performed a relative discounted cash flow analysis to determine the per-share equity values of Trulia and Zillow, using expected cash flows from 2014 through 2028 based on management's projections for each company and the perpetuity growth method to calculate the companies' respective terminal values.[84] The Proxy explained this methodology and provided the assumptions J.P. Morgan used in its analysis. Specifically, the Proxy disclosed management's projections of unlevered free cash flows, the ranges of discount rates (11.0% to 15.0%) and perpetuity growth rates (2.5% to 3.5%) that were used, the terminal period projected cash flows, and other details.[85] In my view, these disclosures already provided a more-than-fair summary of the relative discounted cash flow analysis that J.P. Morgan performed.
The Supplemental Disclosures added to this summary the EBITDA exit multiple ranges for Trulia and Zillow that were [907] implied by the range of terminal values calculated based on J.P. Morgan's chosen inputs. Plaintiffs argue that, although J.P. Morgan used the perpetuity growth method and only derived the implied EBITDA exit multiples to check the strength of its methodology, the implied multiples were important to stockholders, who would be concerned that the exit multiples for Trulia and Zillow are nearly identical despite differences in their current EBITDA growth rates, and that the exit multiples are much lower than the current EBITDA multiples of Trulia and its peers.[86]
The logic of plaintiffs' argument is flawed in two respects. First, because the same range of perpetuity growth rates (2.5% to 3.5%) was used to calculate the terminal values for both companies, it should not have been surprising that the implied exit EBITDA multiples would be similar for both companies: 4.0x to 6.7x for Trulia and 4.1x to 6.8x for Zillow. Second, although Trulia's then-current EBITDA growth rate was high, the exit EBITDA multiples are based on growth assumptions as of 2028, not 2015, and the 2015 growth rate cannot realistically continue through the projection period.[87] Basic principles of valuation suggest that it would be more reasonable to forecast that the growth of both Trulia and Zillow eventually would fall to a market-based rate, making plaintiffs' comparison to the current growth rates of Trulia and its peers inappropriate.[88] Thus, not only is the supplemental disclosure immaterial, it also serves none of the purposes that plaintiffs allege.
* * * * *
For the reasons explained above, none of plaintiffs' Supplemental Disclosures were material or even helpful to Trulia's stockholders. The Proxy already provided a more-than-fair summary of J.P. Morgan's financial analysis in each of the four respects criticized by the plaintiffs. As such, from the perspective of Trulia's stockholders, the "get" in the form of the Supplemental Disclosures does not provide adequate consideration to warrant the "give" of providing a release of claims to defendants and their affiliates, in the form submitted[89] or otherwise. Accordingly, I find that the proposed settlement is not fair or reasonable to Trulia's stockholders.[90]
[908] III. CONCLUSION
For the foregoing reasons, approval of the proposed settlement is DENIED.
IT IS SO ORDERED.
[1] By closing, the transaction value had fallen to $2.5 billion, based on the value of Zillow stock at the time. See Zillow Completes Acquisition of Trulia for $2.5 Billion in Stock; Forms "Zillow Group" Family of Brands, (Feb. 17, 2015), available at http://zillow. mediaroom.com/2015-02-17-Zillow-Completes-Acquisition-of-Trulia-for-2-5-Billion-in-Stock-Forms-Zillow-Group-Family-of-Brands.
[2] Pls.' Op. Br. Supp. Mot. Prelim. Inj. 2.
[3] Trulia, Inc., Current Report (Form 8-K) (Dec. 18, 2014).
[4] "Unknown Claims" were defined as "any claim that a releasing person does not know or suspect exists in his, her or its favor at the time of the release of the Released Claims as against the Released Persons, and at the time of Defendants' release of Plaintiffs, each and all Class Members, and all Plaintiffs' counsel from all claims as set forth in Paragraph 9, including without limitation those claims which, if known, might have affected the decision to enter into the Settlement." Stipulation ¶ 10.
[5] Stipulation ¶ 8.
[6] See In re Riverbed Tech., Inc. S'holders Litig., 2015 WL 5458041, at *2 (Del. Ch. Sept. 17, 2015).
[7] Revised Proposed Order and Final J., Oct. 16, 2015.
[8] See Ct. Ch. R. 23(e). Court of Chancery Rule 23.1(c) similarly requires Court approval of the dismissal or settlement of derivative actions.
[9] Rome v. Archer, 197 A.2d 49, 53 (Del.1964).
[10] Kahn v. Sullivan, 594 A.2d 48, 58 (Del. 1991).
[11] Rome v. Archer, 197 A.2d at 53.
[12] Id.
[13] See id.
[14] In re Activision Blizzard, Inc. S'holder Litig., 124 A.3d 1025, 1043 (Del. Ch.2015).
[15] In this Opinion, I use the term "disclosure settlement" to refer to settlements in which the sole or predominant consideration provided to stockholders in exchange for releasing their claims is the dissemination of one or more disclosures to supplement the proxy materials distributed for the purpose of soliciting stockholder approval for a proposed transaction. An example of a disclosure settlement in which the supplemental disclosures would be the predominant but not sole consideration is one that, in addition to supplemental disclosures, includes an insubstantial component of other non-monetary consideration, such as a minor modification to a deal protection measure.
[16] 1995 WL 250374, at *4 (Del. Ch. Apr. 21, 1995), aff'd, 672 A.2d 35 (Del.1996).
[17] Some examples of adjudicated cases of this type arising from acquisitions of public corporations include: In re Rural/Metro Corp. S'holders Litig., 102 A.3d 205, 263 (Del. Ch.2014) (finding after trial that class suffered damages of $91 million, of which the board's financial advisor was liable for 83%, based on aiding and abetting fiduciary breaches in sale of corporation), aff'd sub nom. RBC Capital Mkts., LLC v. Jervis, 129 A.3d 816, 2015 WL 7721882 (Del. Nov. 30, 2015); In re Dole Food Co., Inc. S'holder Litig., 2015 WL 5052214, at *47 (Del. Ch. Aug. 27, 2015) (finding after trial that certain directors were liable for $148 million in damages, based on fiduciary breaches in going-private transaction); In re Emerging Commc'ns, Inc. S'holders Litig., 2004 WL 1305745, at *43 (Del. Ch. May 3, 2004) (finding after trial that certain defendants were liable to stockholders for damages of $27.80 per share for fiduciary breaches in going-private transaction). See also In re Jefferes Grp., Inc. S'holders Litig., 2015 WL 1414350 (Del. Ch. Mar. 26, 2015) (ORDER) (approving settlement for $70 million (net of attorneys' fees) to resolve allegations involving conflicts of interest in the sale of Jefferies Group to Leucadia National Corporation); In re Del Monte Foods Co. S'holder Litig., Cons.C.A. No. 6027-VCL, 2011 WL 6008590 (Del. Ch. Dec. 1, 2011) (ORDER) (approving $89 million settlement of stockholder suit alleging fiduciary duty violations in connection with leveraged buy-out).
[18] Stockholder plaintiffs who seek expedition benefit from the most favorable standard available under our law for assessing the merits of a claim—"colorability"—and from the sensible policy of this Court to attempt to resolve disclosure claims before stockholders are asked to vote. See Ortsman v. Green, 2007 WL 702475, at *2 (Del. Ch. Feb. 28, 2007) (granting expedited proceedings because disclosure claims were "colorable" and "[o]nly by remedying proxy deficiencies in advance of a vote can irreparable harm be avoided"); Morton v. Am. Mktg. Indus. Hldgs., Inc., 1995 WL 1791090, at *2-4 (Del. Ch. Oct. 5, 1995) (granting expedition because colorability finding did not require a determination of merits or even legal sufficiency of pleadings, and disclosures must be made before stockholder vote rather than after the fact).
[19] Notwithstanding the plaintiff-friendly pleading standard governing a motion to expedite, the Court takes seriously its role to deny expedition in deal litigation when warranted. See, e.g., In re Rite Aid Corp. S'holders Litig., Cons.C.A. No. 11663-CB, at 78-92 (Del. Ch. Jan. 5, 2016) (TRANSCRIPT) (denying motion to expedite); Sheet Metal Workers Local No. 33 Cleveland Dist. Pension Plan v. URS Corp., C.A. No. 9999-CB, at 47-56, 2014 WL 5342671 (Del. Ch. Aug. 28, 2014) (TRANSCRIPT) (same); In re Zalicus Inc. S'holder Litig., Cons.C.A. No. 9602-CB, at 100-11, 2014 WL 3572760 (Del. Ch. Jun. 13, 2014) (TRANSCRIPT) (same).
[20] See In re Riverbed Tech., 2015 WL 5458041, at *4.
[21] See, e.g., id. at *5 (finding that "a positive result of small therapeutic value to the Class. . . can support . . . a settlement, but only where what is given up is of minimal value"); In re Dr. Pepper/Seven Up Cos., Inc. S'holders Litig., 1996 WL 74214, at *4 (Del. Ch. Feb. 9, 1996) ("[E]ven a meager settlement that affords some benefit for stockholders is adequate to support its approval."), aff'd, 683 A.2d 58 (Del.1996) (TABLE).
[22] See Ginsburg v. Phila. Stock Exch., Inc., 2007 WL 2982238, at *1 (Del. Ch. Oct. 9, 2007) ("When parties have reached a negotiated settlement, the litigation enters a new and unusual phase where former adversaries join forces to convince the court that their settlement is fair and appropriate.").
[23] See In re Caremark Int'l Inc. Deriv. Litig., 698 A.2d 959, 961 (Del. Ch.1996) (Allen, C.) ("[I]n most instances, the court is constrained by the absence of a truly adversarial process, since inevitably both sides support the settlement and legally assisted objectors are rare."); Browning Jeffries, The Plaintiffs' Lawyer's Transaction Tax: The New Cost of Doing Business in Public Company Deals, 11 Berkeley Bus. L.J. 55, 59, 89 (2014) ("[D]ue to the agency costs involved in class action litigation and the lack of motivation of any one plaintiff shareholder to monitor class counsel, these fee awards are rarely objected to. . . ."). In the rare case in which objectors are present, the question necessarily becomes whether the objectors represent the interests of the class or instead represent yet another set of interests. See Sean J. Griffith & Alexandra D. Lahav, The Market for Preclusion in Merger Litigation, 66 Vand. L.Rev. 1053, 1084 n.142, 1122 (2013) (noting that in some cases objectors may also be hold-outs demanding a piece of the settlement value).
[24] "Confirmatory" discovery is discovery taken after an agreement-in-principle to settle a case has been reached. Theoretically, it is an opportunity for plaintiffs' counsel to "confirm" that the settlement terms are reasonable—that is, to probe further the strengths and weaknesses of the claims relative to the consideration for the proposed settlement. In reality, given that plaintiffs' counsel already have resigned themselves to settle on certain terms, confirmatory discovery rarely leads to a renunciation of the proposed settlement and, instead, engenders activity more reflective of "going through the motions." See Brinckerhoff v. Tex. E. Prods. Pipeline Co., LLC, 986 A.2d 370, 385 (Del. Ch.2010) (questioning quality of confirmatory discovery process) ("Confirmatory discovery performances ranging from the diffident to the feckless impair, rather than inspire, judicial confidence."); In re Coleman Co., Inc. S'holders Litig., 750 A.2d 1202, 1212 (Del. Ch.1999) ("[C]onfirmatory discovery in settlement situations is hardly the equivalent of adversarial pre-trial discovery.").
[25] See In re Sauer-Danfoss Inc. S'holders Litig., 65 A.3d 1116, 1135-43 (Del. Ch.2011) (discussing disclosure settlements and compiling fee awards in various disclosure-only cases).
[26] Matthew D. Cain & Steven Davidoff Solomon, Takeover Litigation in 2015 2 (Jan. 14, 2016), available at http://ssrn.com/abstract= 2715890. The sample consists of transactions of at least $100 million with publicly traded targets, and includes both Delaware and non-Delaware corporations. Figures for 2015 are preliminary.
[27] See id. at 2-3.
[28] See id. at 6. The percentage of settlements in Delaware based solely on supplemental disclosures was 63.6% in 2013 and 70.6% in 2014. Figures for 2015 appear to be too preliminary to be meaningful.
[29] See generally Jill E. Fisch, Sean J. Griffith & Steven Davidoff Solomon, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93 Tex. L.Rev. 557 (2015) (proposing that state courts reject disclosure settlements and shift disclosure policing to the federal securities laws). See also J. Travis Laster, A Milder Prescription for the Peppercorn Settlement Problem in Merger Litigation, 93 Tex. L.Rev. See Also 129 (2015) (responding to the Fisch, Griffith & Solomon article, acknowledging similar concerns regarding disclosure settlements, and proposing solutions involving greater judicial scrutiny of claims at motion to expedite stage); Matthew D. Cain & Steven Davidoff Solomon, A Great Game: The Dynamics of State Competition and Litigation, 100 Iowa L.Rev. 465 (2015) (examining merger litigation data and theorizing that states seeking to attract corporate litigation award higher fees and dismiss fewer cases); Jeffries, supra note 23 (criticizing disclosure-only settlements and suggesting legislative responses); Griffith & Lahav, supra note 23 (discussing the value for defendants of receiving release through disclosure-only settlements and the potential usefulness of multi-jurisdiction litigation). But see Phillip R. Sumpter, Adjusting Attorneys' Fee Awards: The Delaware Court of Chancery's Answer to Incentivizing Meritorious Disclosure-Only Settlements, 15 U. Pa. J. Bus. L. 669 (2013) (arguing that disclosure-only settlements can have value and discussing the concept of awarding of varying levels of fees to encourage or discourage different types of disclosure settlements).
[30] Fisch, Griffith & Solomon, supra note 29, at 582-87.
[31] See generally Joel Edan Friedlander, How Rural/Metro Exposes the Systemic Problem of Disclosure Settlements (U. Pa. L. Sch. Inst. for L. and Econ. Res. Paper No. 15-40, Draft Dec. 17, 2015), available at http://ssrn.com/ abstract=2689877.
[32] In re Rural/Metro Corp., 102 A.3d 205, aff'd sub nom. RBC Capital Mkts., LLC v. Jervis, 129 A.3d 816, 2015 WL 7721882 (Del. Nov. 30, 2015).
[33] In re Rural/Metro Corp. S'holders Litig., Cons.C.A. 6350-VCL, at 134 (Del. Ch. Jan. 17, 2012) (TRANSCRIPT).
[34] See Friedlander, supra note 31, at 16-22. The paper also examines litigation over the sale of Prime Hospitality Corporation, which settled for $25 million after a disclosure settlement was rejected and new counsel was appointed to litigate the case. See id. at 11-14.
[35] See, e.g., Acevedo v. Aeroflex Hldg. Corp., C.A. No. 9730-VCL, at 60-79, 2015 WL 4127547 (Del. Ch. July 8, 2015) (TRANSCRIPT) (rejecting settlement because relief obtained was insufficient to support a broad release, and giving the option to reapply with a release tailored only to the Delaware disclosure and fiduciary claims investigated by plaintiffs); In re Riverbed Tech., 2015 WL 5458041, at *3-6 (approving settlement, but expressing concerns over agency problems, lack of adversarial presentation, limited benefit conferred by disclosures, and noting that broad releases may not be approved going forward); In re Intermune, Inc. S'holder Litig., C.A. No. 10086-VCN (Del. Ch. July 8, 2015) (TRANSCRIPT) (deferring decision on a disclosure settlement and questioning whether the releases should be limited only to disclosure claims) (settlement later approved in C.A. No. 10086-VCN, 2015 WL 9481182 (Del. Ch. Dec. 29, 2015) (TRANSCRIPT)); In re TW Telecom, Inc. S'holders Litig., C.A. No. 9845-CB (Del. Ch. Aug. 20, 2015) (TRANSCRIPT) (approving a settlement "somewhat reluctantly" while opining that settlements going forward will receive more scrutiny and that all but one disclosure obtained had "no consequential value").
[36] See, e.g., In re Allied Healthcare S'holder Litig., 49 Misc.3d 1210(A), 2015 WL 6499467, at *2 (N.Y.Sup.Ct. Oct. 23, 2015) (rejecting a settlement and expressing concern that "in the area of derivative litigation, a culture has developed that results in cases of relatively worthless settlements (derivative actions are rarely tried to a verdict) that discontinue the action (with releases) resulting in the corporate defendants not opposing an agreed upon legal fee to class counsel"); City Trading Fund v. Nye, 46 Misc.3d 1206(A), 2015 WL 93894 (N.Y.Sup.Ct. Jan. 7, 2015) (rejecting a settlement the court regarded as exceptionally frivolous and noting that the nature of "merger tax suits" incentivizes settlement regardless of a case's frivolity).
[37] Gantler v. Stephens, 965 A.2d 695, 710 (Del.2009).
[38] Id. (quoting Arnold v. Soc'y for Sav. Bancorp, Inc., 650 A.2d 1270, 1277 (Del.1994)).
[39] If defendants do not oppose a mootness fee application, then the Court presumably would not have the benefit of any opposing position when considering the application unless an objector appeared. But, in that case, the Court would have some indication of the reasonableness of the fee request.
[40] 1995 WL 250374, at *4.
[41] That jurisprudence includes the Delaware Supreme Court's recent express confirmation that "the business judgment rule is invoked as the appropriate standard of review for a post-closing damages action 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." Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304, 305-06 (Del.2015).
In this case, because the disputed transaction involved a stock-for-stock merger of widely held, publicly traded corporations, plaintiffs' claims presumably would not benefit from the enhanced scrutiny of Revlon and instead would need to overcome the business judgment presumption. Paramount Commc'ns, Inc. v. QVC Network, Inc., 637 A.2d 34, 46-47 (Del.1994) (quoting Paramount Commc'ns Inc. v. Time Inc., 1989 WL 79880, at *23 (Del. Ch. July 14, 1989), aff'd, 571 A.2d 1140 (Del. 1989)).
[42] See, e.g., In re Family Dollar Stores, Inc. S'holder Litig., C.A. No. 9985-CB, 2015 WL 4642210 (Del. Ch. Aug. 4, 2015) (ORDER) (dismissing case with prejudice to plaintiffs and without prejudice to class, where supplemental disclosures had mooted certain claims, and setting schedule for mootness fee application); In re Zalicus, Inc. S'holder Litig., C.A. No. 9602-CB (Del. Ch. Nov. 12, 2014) (ORDER) (dismissing action without prejudice after defendants had mooted certain disclosure claims, and setting schedule for mootness fee application).
[43] In re Advanced Mammography Sys., Inc. S'holders Litig., 1996 WL 633409, at *1 (Del. Ch. Oct. 30, 1996); see also In re Cellular Commc'ns Int'l, Inc. S'holders Litig., 752 A.2d 1185, 1188 (Del. Ch.2000).
[44] In re Zalicus, Inc. S'holders Litig., 2015 WL 226109, at *2 (Del. Ch. Jan. 16, 2015) (quoting Hack v. Learning Co., 1996 WL 633306, at *2 (Del. Ch. Oct. 29, 1996)).
[45] See, e.g., Swomley v. Schlecht, 2015 WL 1186126, at *1-2 (Del. Ch. Mar. 12, 2015) (setting forth class notice procedure for mootness fee, after defendants mooted certain disclosure claims and successfully moved to dismiss rest of case); In re Zalicus, 2015 WL 226109, at *1-2 (supporting private mootness fee resolution procedure while requiring that adequate notice be provided to stockholders); Astex Pharm., Inc. S'holders Litig., 2014 WL 4180342, at *1-2 (Del. Ch. Aug. 25, 2014) (same).
[46] In contrast to the settlement context, the Court does not need to weigh the "get" of the supplemental disclosures against the "give" of a release when determining whether to grant an award of fees in the mootness fee scenario discussed above. Accordingly, an award of fees in the mootness fee scenario may be appropriate for supplemental disclosures of less significance than would be necessary to sustain approval of a settlement. The amount of the fee in the mootness scenario, however, would be commensurate with the value of the benefit conferred. Thus, for example, a supplemental disclosure of nominal value would warrant only a nominal fee award.
[47] See Hoffman v. Dann, 205 A.2d 343, 345 (Del.1964) (noting that "the Chancellor appointed an amicus curiae to report to him on the relevant issues to be tendered at the hearing on the proposed settlement, and as to proof which would be of assistance to him in passing on the fairness of the settlement."). The costs of the amicus curiae may be taxed to the parties, as appropriate, in the Court's discretion. See 3B C.J.S. Amicus Curiae § 6 ("Where the court appoints an amicus curiae who renders services which prove beneficial to the solution of the question presented, the court may properly award compensation and direct it to be paid by the party responsible for the situation that prompted the court to make the appointment."). Cf. Chapin v. Benwood Found., Inc., 1977 WL 2583, at *1 (Del. Ch. June 28, 1977) (describing appointment of individual trustee defendant as amicus curiae with costs paid by defendant corporation, as agreed by the parties). Scholars have proposed a similar solution in which the Court may "appoint an objector as a kind of guardian ad litem for the class." See Griffith & Lahav, supra note 23, at 1122 n.309 (compiling sources for proposal).
[48] See Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 963 (Del. Ch.2013) (upholding statutory validity of forum selection bylaw).
[49] Stroud v. Grace, 606 A.2d 75, 84 (Del. 1992).
[50] Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del.1985) (adopting materiality standard of TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976)).
[51] Arnold v. Soc'y for Sav. Bancorp, 650 A.2d 1270 at 1277.
[52] Proxy at 118.
[53] 808 A.2d 421, 449 (Del. Ch.2002) (discussing, among other decisions, Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170 (Del.2000) and McMullin v. Beran, 765 A.2d 910 (Del.2000)).
[54] Id.
[55] See, e.g., In re Netsmart Techs., Inc. S'holders Litig., 924 A.2d 171, 203-04 (Del. Ch.2007) ("[W]hen a banker's endorsement of the fairness of a transaction is touted to shareholders, the valuation methods used to arrive at that opinion as well as the key inputs and range of ultimate values generated by those analyses must also be fairly disclosed.").
[56] See, e.g., In re Micromet, Inc. S'holders Litig., 2012 WL 681785, at *11 (Del. Ch. Feb. 29, 2012) (rejecting claim that the board failed to disclose underlying assumptions and bases for probabilities of success of clinical trial drugs) ("Stockholders are entitled to a fair summary of the substantive work performed by the investment bankers, but Delaware courts have repeatedly held that a board need not disclose specific details of the analysis underlying a financial advisor's opinion.") (internal quotation marks omitted); In re Cogent, Inc. S'holder Litig., 7 A.3d 487, 511 (Del. Ch.2010) (holding stockholders are entitled to fair summary, but not to minutiae, and rejecting requests for additional disclosures); Ryan v. Lyondell Chem. Co., 2008 WL 2923427, at *20 & n. 120 (Del. Ch. July 29, 2008) (finding that fair summary did not require disclosure of all projections, as long as it disclosed description of valuation exercises, key assumptions, and range of values generated; but noting that the failure to disclose that the financial advisor used a significantly higher WACC in its calculation than management's WACC estimate, even when it was using management's other financial projections, could constitute a disclosure violation), rev'd on other grounds, 970 A.2d 235 (Del.2009). See also David P. Simonetti Rollover IRA v. Margolis, 2008 WL 5048692, at *9-10 (Del. Ch. June 27, 2008) (distinguishing Pure Resources as a case in which a proxy statement was deficient because it did not disclose "any substantive portions of the bankers' work") (internal quotation marks omitted); In re MONY Grp. Inc. S'holder Litig., 852 A.2d 9, 28 (Del. Ch.2004) ("The plain meaning of `summary' belies the Stockholders' interpretation.").
[57] See Globis P'rs, L.P. v. Plumtree Software, Inc., 2007 WL 4292024, at *12-13 (Del. Ch. Nov. 30, 2007) (rejecting disclosure claims for various details that may have been helpful in determining accuracy of analysis) ("Delaware law does not require disclosure of all the data underlying a fairness opinion such that a shareholder can make an independent determination of value."); In re Gen. Motors (Hughes) S'holder Litig., 2005 WL 1089021, at *16 (Del. Ch. May 4, 2005) (rejecting claim for information that would amount to "the raw data behind the advisors' updated summaries") ("A disclosure that does not include all financial data needed to make an independent determination of fair value is not, however, per se misleading or omitting a material fact. The fact that the financial advisors may have considered certain non-disclosed information does not alter this analysis."), aff'd, 897 A.2d 162 (Del.2006).
One important qualification bears mention. Although management projections and internal forecasts are not per se necessary for a fair summary, this Court has placed special importance on this information because it may contain unique insights into the value of the company that cannot be obtained elsewhere. See In re Netsmart Techs., 924 A.2d at 203 (noting that management projections can be important because management can have "meaningful insight into their firms' futures that the market [does] not").
[58] See In re 3Com S'holders Litig., 2009 WL 5173804, at *2-3 (Del. Ch. Dec. 18, 2009) (rejecting claim for omission of financial projections because "an adequate and fair summary of the work performed by [the advisor] [was] included in the proxy"); In re Check-Free Corp. S'holders Litig., 2007 WL 3262188, at *3 (Del. Ch. Nov. 1, 2007) (distinguishing Netsmart and rejecting disclosure claim based on omission of management financial projections, because proxy statement fairly summarized financial advisor's methods and conclusions); In re Pure Res., 808 A.2d at 449 (noting in fair summary discussion that stockholders would find it material to know the advisor's basic valuation exercises, key assumptions of those exercises, and range of values produced).
[59] See In re PAETEC Hldg. Corp. S'holders Litig., 2013 WL 1110811, at *8 (Del. Ch. Mar. 19, 2013) (citing In re Pure Res., 808 A.2d at 449) (declining to award settlement fees for disclosures that "provide a level of detail beyond what the law of Delaware requires").
[60] Supplemental Disclosures at 5-6.
[61] Pls.' Br. Supp. Proposed Settlement at 23 (citing Proxy at 103 (noting that the synergies "are expected to be at least $100 million in annualized cost savings by 2016")).
[62] Id. at 23-24.
[63] Proxy at 130, 132.
[64] Plaintiffs' counsel was not aware that this information already was disclosed in the Proxy until the Court pointed it out at the settlement hearing. See Hr'g Tr. 12-15, Sept. 16, 2015. If the proposed settlement had been opposed, this fact presumably would have been brought to the attention of plaintiffs and the Court.
[65] Proxy at 123.
[66] For instance, the Supplemental Disclosures refer to the expected synergies after 2016 as extrapolations through 2029 based on management's assumptions. But the table in the Proxy, produced above, notes that management provided assumptions regarding synergies through 2024. Plaintiffs do not address this ambiguity.
[67] Proxy at 131-32.
[68] Hr'g Tr. 15, Sept. 16, 2015.
[69] Proxy at 129-30.
[70] Id. at 130.
[71] In one case, the publicly available multiple was not included because it exceeded 100x and thus was not considered meaningful. Supplemental Disclosures at 5.
[72] In re Gen. Motors (Hughes), 2005 WL 1089021, at *16.
[73] 852 A.2d 9 (Del. Ch.2004).
[74] Id. at 28.
[75] Proxy at 125-26.
[76] 2012 WL 1020471 (Del. Ch. Mar. 23, 2012), aff'd in part, rev'd in part on other grounds, 59 A.3d 418 (Del.2012).
[77] Id. at *32.
[78] Id.
[79] Meinhart, plaintiffs' expert, points out that not all stockholders can access all of this information because some of the forward-looking data are available only from proprietary fee-based services. It may be correct that not all of these data would be freely or easily obtainable. A fair summary, however, does not require disclosure of sufficient data to allow stockholders to perform their own valuation. And it certainly does not require disclosure of underlying data that stockholders could obtain on their own, even if doing so would involve some cost or investment of time. Meinhart also opines that the multiples show a high level of dispersion, but he fails to explain how that information undermines J.P. Morgan's analysis or is otherwise informative considering that J.P. Morgan explicitly stated that its analysis was not strictly quantitative in nature. See Proxy at 126-27 ("J.P. Morgan did not rely solely on the quantitative results. . . . Based on various judgments concerning relative comparability of each of the selected companies to Trulia, as well its experience with the industry . . . J.P. Morgan selected a range of revenue and Adjusted EBITDA multiples that it believed reflected an appropriate range of multiples applicable to Trulia.").
[80] See In re Celera Corp., 2012 WL 1020471, at *32.
[81] See id. The supplemental disclosure in Celera added more categories of summary data, namely the high, low, median, and mean multiples. This distinction is immaterial. The point of a fair summary is to summarize the methodologies and assumptions the financial advisor used in its analysis. Here, the Proxy fairly summarizes J.P. Morgan's use of multiples in its trading multiples analysis.
[82] Plaintiffs also rely on a transcript ruling in Turberg v. ArcSight, C.A. No. 5821-VCL, 2011 WL 9535204 (Del. Ch. Sept. 20, 2011) (TRANSCRIPT). As in Celera, the initial description in ArcSight did not have any multiples at all. The plaintiff obtained a full description of the analysis comparable to the depiction that would appear in a board book. The Court praised that disclosure in the context of a non-adversarial presentation regarding settlement approval. The case is distinguishable because, unlike here, no summary multiples were initially provided to stockholders.
[83] Joshua Rosenbaum & Joshua Pearl, Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions 19 (2009) ("A company's growth profile, as determined by its historical and estimated future financial performance, is an important driver of valuation. Equity investors reward high growth companies with higher trading multiples than slower growing peers.").
[84] See Proxy at 127.
[85] See id. at 108, 122, 127.
[86] Pls.' Br. Supp. Proposed Settlement at 30-31.
[87] Id. at 26 (noting Trulia's expected EBITDA growth rate of 148% and the "decided correlation between higher growth rates and higher valuation multiples"). Were Trulia able to retain this impressive EBITDA growth rate for the entire forecast period, its 2028 EBITDA would amount to nearly $10 trillion, more than half the current GDP of the United States.
[88] See Rosenbaum & Pearl, supra note 83, at 132 ("The perpetuity growth rate is typically chosen on the basis of the company's expected long-term industry growth rate, which generally tends to be within a range of 2% to 4% (i.e., nominal GDP growth).").
[89] As noted above, after the settlement hearing, the parties commendably agreed to narrow the release to exclude "Unknown Claims," foreign claims, and claims arising under state or federal antitrust law. Nevertheless, even if the Supplemental Disclosures had provided sufficient consideration to warrant the "give" of a release of claims, which they did not, the scope of the revised release still would have been too broad to support a fair and reasonable settlement because the revised release was not limited to disclosure claims and fiduciary duty claims concerning the decision to enter the merger.
[90] Because I reject the proposed settlement, I do not address the issue of class certification, although stockholder classes in cases such as this are typically certified.