CHANCERY COURT DISMISSES COMPLAINT FOR FAILURE TO STATE A CLAIM, HOLDING THAT REVIEW OF SALE UNDER ENTIRE FAIRNESS IS NOT WARRANTED
By: Joanna Diakos and Adam Heyd
In Aron English and Richard Peppe v. Charles K. Narang, et al., C.A. No. 2018-0221-AGB (Del. Ch. March 20, 2019), the Delaware Court of Chancery (the “Court”) dismissed a stockholder suit against the board members of NCI, Inc., a publicly-traded company (the “Company”), for failure to state a claims for relief in connection with allegations of breach of fiduciary duty, and against H.I.G. Capital, LLC (“HIG”) for aiding and abetting such breach during a sale of the Company to HIG. The Court held that the controlling stockholder’s alleged need for liquidity was not sufficient to compel review of the Company sale under an “entire fairness” standard, and that the vote of stockholders approving the sale was fully informed.
The Company was founded by Charles Narang, who retired as CEO in 2015 but continued to serve as Chairman of the Company’s board of directors (the “Board”) and to hold a substantial majority of the Company’s voting stock. In January 2016, the Board began discussions about a possible Company sale. Over the following months, Company representatives had discussions with various potential buyers, including HIG. By April 2017 the Company had received offers of as much as $20 per share for a sale transaction. By May 2017, however, HIG was the sole remaining bidder. In July 2017, HIG and the Company agreed to a sale of all Company stock to HIG for $20 per share, to be carried out by way of an all-cash tender offer and subsequent merger. A recommendation statement describing the tender offer and merger (the “Recommendation Statement”) was delivered to stockholders. By August 2017, stockholders representing approximately 82% of Company shares agreed to sell their stock (approximately 73.6% excluding Charles Narang’s shares). The merger closed on August 15, 2017.
In March 2018, the plaintiffs (two former stockholders of NCI) filed their complaint over seven months after the transaction closed) asserting two causes of action: (1) a claim against NCI directors for breach of fiduciary duty, contending that they agreed to a price for the Company that was not “entirely fair” and failed to disclose certain material information; and (2) a claim that members of HIG and its affiliates for aiding and abetting those breaches. The defendants moved to dismiss the claims under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief.
The main assertion of the defendants is that the complaint should be dismissed under Corwin v. KKR Financial Holdings decision (125 A.3d 304 (2015)) because a majority of the NCI stockholders tendered their shares in an uncoerced and fully informed tender office and that the transaction should be judged according to the business judgment standard of review. When a transaction is not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, courts must apply the business judgment rule and defer to the judgment of a company’s board and executives. The Court first addressed the applicability of the entire fairness standard to the Company sale. Entire fairness requires the defendants to establish to the court’s satisfaction that the transaction was the product of both fair dealing and fair price. Where a controlled corporation effects a transaction, the controlling stockholder must engage in a conflicted transaction for entire fairness to apply, which may include a transaction where the controller extracts a “unique benefit” to address their need for liquidity. The plaintiffs argued that at the age of 73 and with nearly all of his net worth tied up in Company stock, Charles Narang had an immediate need to liquidate his controlling stake through a sale. However the Court noted there are only very narrow circumstances in which a need for liquidity might compel an entire fairness review, such as a “fire sale” of a company driven by a controller’s imminent default on a large loan or investment. The plaintiffs made no such allegations in this case. The Court also noted that the plaintiffs made no allegations of any imprudent wealth management strategy by Narang, and the Court emphasized that Narang was a wealthy man when he retired with no apparent incentive to sell quickly at less than full value. Since the plaintiffs failed to show evidence of a conflict caused by Narang’s supposed need for liquidity, the Court found no basis existed to apply an entire fairness review.
The Court also rejected plaintiffs’ arguments that the Recommendation Statement was misleading or omitted material information, and the Court addressed the plaintiffs’ various arguments that Company stockholders were not fully informed during the tender offer process. The plaintiffs first claimed that the Company CEO’s optimism about the Company’s prospects during several investor calls demonstrated that the Company’s financial projections in the Recommendation Statement had been understated. The Court found that the Company’s projections included in the Recommendation Statement were generally positive, and the plaintiffs did not provide “quantifiable support” for the amount by which the projections understated the Company’s value compared with the Company CEO’s statements. The plaintiffs then asserted that the Recommendation Statement failed to disclose any information concerning HIG’s plans to retain certain of the Company’s management, despite the Company’s disclosure on the merger closing date that certain Company management would continue their employment. While the Court conceded that HIG and Company officials must have discussed employment of certain the Company’s management prior to disclosing relevant information on the merger closing date, the Court found no allegation that the Company and HIG had discussed such matters before the Board agreed to a deal with HIG. Finally, the plaintiffs argued that the Recommendation Statement failed to disclose all material information concerning work the Company’s financial advisors had done for HIG in the past, and any conflicts of interest that might have resulted. The Court countered with examples from the Recommendation Statement disclosing that the Company’s financial advisors had previously provided services to HIG.
The Court concluded that based on Delaware court precedents and the plaintiffs did not plead facts sufficient for either an entire fairness review or to show that the Company’s stockholders were not fully informed about the merger, the Court applied the business judgment rule and dismissed the plaintiffs’ complaint against both the Board members and HIG for failure to state a claim for relief.