CHANCERY COURT VALIDATES A DEFECTIVE MERGER AND REAFFIRMS RELIANCE ON OUTSIDE LEGAL COUNSEL UNDER DELAWARE LAW
By Holly Hatfield and Dean Brazier
In The Cirillo Family Trust v. Aram Moezinia, Lewis Tepper, Mark Walter, and DAVA Pharmaceuticals, Inc., C.A. No. 10116-CB (Del. Ch. Jul. 11, 2018), the Delaware Chancery Court granted the defendants’ motion dismissing certain claims arising from the 2014 merger between DAVA Pharmaceuticals, Inc. (“DAVA”) and an affiliate of Endo Pharmaceuticals, Inc. (such affiliate, “Endo”). The Court held that Section 205 of the Delaware General Corporation Law (the “DGCL”) validated deficiencies in the written consents to the merger (the “Written Consents”) and a director’s reasonable, good faith reliance on the advice of legal counsel hired for specific expertise can exculpate the director for a fiduciary duty breach. The Court also granted part of the plaintiff’s motion to amend the complaint to add a claim against certain directors in their capacities as officers of DAVA.
DAVA was once a closely-held, pharmaceutical manufacturer. At the time of the merger, the Cirillo Family Trust (the “Trust”) was one of 31 stockholders and held 0.27% of DAVA’s outstanding shares. At this time, Aram Moezinia, Lewis Tepper, and Mark Walter (the “Director Defendants”) constituted DAVA’s board of directors. In 2014, the Director Defendants approved DAVA’s merger agreement with Endo. Subsequent to the approval, DAVA’s outside legal counsel, Dechert LLP (“Dechert”), advised DAVA to obtain the Written Consents approving the merger from a majority of DAVA’s stockholders. Using the Written Consents, DAVA initially obtained approval from the nine largest stockholders, representing more than 95% of the outstanding shares. Under the DGCL, stockholders that do not approve of the merger must be given notice of their options to sell their shares at the merger price or to seek appraisal of the value of their shares (“Notice”).
The current complaint makes two claims. First, the Written Consents were invalid, which rendered the stockholder approval of the merger defective. Second, the Defendant Directors breached their fiduciary duties by sending a deficient Notice to the Trust, which was the lone stockholder that did not approve of the merger.
With respect to the first claim, the Court recognized that seven of these nine initial Written Consents were undated or contained a typewritten date added by Dechert after obtaining signed Written Consents. Here, “Dechert was responsible for preparing copies of the Written Consents for the stockholders to sign.” Because these Written Consents were not dated when signed, they were per se invalid under Section 228(c) of the DGCL. The Court states, “[b]ecause Section 228 permits immediate action without prior notice to minority stockholders, the statute involves great potential for mischief and its requirements must be strictly complied with . . . even [] the ministerial requirements of Section 228, such as the dating of consents by each consenting stockholder when the statute contained such a requirement.” These seven invalid Written Consents represented 92.7% of the outstanding shares and, thus, the merger technically failed to obtain approval from a majority of the stockholders.
In response to this claim, the defendants sought validation under Section 205 of the DGCL for the otherwise invalid Written Consents. Section 205 provided a mechanism for courts to remedy a defective corporate act, such as the stockholder approval in this case. Where the court grants such a remedy, the defective act is treated as valid as of the time it was initially conducted. Here, the Court noted, “no one has questioned the authenticity of the signatures on the Written Consents or the intent and desire of all stockholders other than the Trust–holding 99.7% of DAVA’s stock–to approve the [m]erger.” Furthermore, the Section 228 requirement for all signatures to be dated was removed in 2017, which the Court viewed as “suggest[ing] that this requirement was technical in nature and a superfluous condition to the use of written consents.”
The Court granted the defendants’ request for validation, which rendered the merger approved by a majority of the stockholders as of the time the signatures were obtained. This relief mooted the Trust’s first claim, so the Court granted the defendants’ motion for summary judgment and dismissed this claim.
With respect to the second claim, only part of the Trust’s claim survived after the Court validated the stockholder approval: “the Director Defendants breached their fiduciary duty . . . by failing to include ‘any information that would enable those stockholders to determine whether to accept the [m]erger consideration or seek appraisal of their stock.” The Trust argued that the Director Defendants either breached their duty of loyalty and were self-interested, having received certain warrants for DAVA stock in the years prior to the merger, or they breached their duty of care and acted in bad faith by sending the incomplete notice to the Trust.
Addressing the Director Defendants’ independence, the Court concluded and the Trust conceded that the grant of warrants and the merger were “not part of a unitary transaction.” The Court continues, “”the undisputed facts of record are that the [m]erger was an arm’s-length transaction between unaffiliated parties, each represented by separate counsel.” Additionally, the Director Defendants’ holding of the warrants at issue incentivized them to maximize the price all stockholders would receive from Endo, which aligned the Director Defendants’ interests with all stockholders, including the Trust.
After determining that the Director Defendants did not breach their duty of loyalty, the Court turned to the incomplete notice. Such a claim requires that the directors act intentionally or recklessly with respect to the accuracy and completeness of their communications with the stockholders. The Court agreed that the notice was “legally deficient” but also noted that “the unrebutted record shows that the Director Defendants reasonably relied upon DAVA’s longtime outside corporate counsel to prepare the [n]otice.” This reliance becomes the critical element for the Court’s analysis here and the defendants’ second motion for summary judgment.
To assess the defendants’ second motion, the Court had to determine the extent, if any, to which directors could rely on outside counsel for the preparation of merger documents, such as the notice at issue here. Reaffirming Delaware law and legal precedent, the Court states, “[j]ustifiable reliance on outside counsel evinces good faith, not an improper dereliction of duty” and “Delaware law statutorily encourages directors to rely on experts, including legal counsel, to inform themselves and properly discharge their fiduciary duties.” None of the Director Defendants were experts in Delaware mergers and reliance on outside expertise in such circumstances should be encouraged as a matter of good policy. Here, the Court determined that the Director Defendants’ reliance on Dechert to prepare a valid and complete notice was reasonable. Accordingly, the Court granted the defendants’ second motion and dismissed the complaint’s second claim.
In effect, the Court dismissed the claims in the existing complaint but this does not settle the matter between the parties because the Court also granted the Trust’s motion to amend the complaint. The Trust advances four new claims, all but one of which the Court rejects as futile or moot based on the merger’s validation under Section 205 or the factual record of events preceding the motion. The surviving claim argues that Moezinia and Tepper, as officers of DAVA, breached their fiduciary duties. The Court recognizes that the analysis of the DGCL, with respect to the Director Defendants above, would be different in the context of Moezinia and Tepper as officers rather than directors. While skeptical about this claim’s potential for success, the Court concedes that “[a]llegations that were sufficient to state a claim that the Director Defendants acted in bad faith by failing to include material information in the [n]otice logically also would be sufficient to state a claim that Moezinia and Tepper were grossly negligent” and there were no briefings on the officers’ fiduciary duties. For these reasons, the Court granted the Trust’s motion to amend and add a claim for a fiduciary duty breach against the two officers.