Undisclosed Post-Merger Compensation Plan for CEO Also Serving as Lead Merger Negotiator Found Insufficient to Rebut Business Judgment Rule and Insufficient to Show Board Acted in Bad Faith

By: Scott E. Waxman and Serena M. Hamann

In the class action, In re Towers Watson & Co. Stockholders Litigation, C.A. no. 2018-0132-KSJM (Del. Ch. July 25, 2019), the Delaware Court of Chancery dismissed the complaint in its entirety under Rule 12(b)(6) because the Plaintiffs failed to plead facts sufficient to rebut the application of the business judgment rule and failed to show the Towers Board acted in bad faith.

When Towers Watson & Co. (“Towers”) announced a “merger of equals” between itself and Willis Group Holdings plc (“Willis”), Towers stockholders reacted negatively, disparaging the deal as a windfall for Willis. Analysts discussed the ongoing financial woes of Willis and growing financial success of Towers. Fearing a negative outcome, the Towers Board postponed the stockholder vote. Towers’s CEO, who was also Towers’s lead negotiator, then renegotiated the transaction, securing a stockholder dividend more than double the amount initially agreed upon between the merging entities. Shortly thereafter, Towers stockholders approved transaction and the merger closed.

The Towers stockholders (“Plaintiffs”) argued that their CEO and lead negotiator suffered a material conflict, which he failed to disclose to the Towers Board and which a reasonable board member would have regarded as significant in evaluating the proposed transaction. The Plaintiffs pointed to a compensation proposal made to the CEO by a major Willis stockholder after the announcement of the merger but before the final agreement was reached. Allegedly, the proposal guaranteed that the CEO would receive much greater compensation post-merger than he had received pre-merger. The Plaintiffs argued the CEO was thus incentivized to ask for no more of a dividend than necessary to secure the approval of the Towers stockholders. Had the CEO not been so incentivized, he would have pressed Willis for more money.

The stockholder complaint asserted three causes of action. In Count I, the Plaintiffs claimed the CEO breached his fiduciary duties by failing to disclose the proposed compensation plan to the Towers Board. In Count II, the Plaintiffs claimed that the Towers Board members breached their fiduciary duties by allowing the CEO to serve as lead negotiator. Lastly, in Count III, the Plaintiffs claimed the Willis stockholder (and its CEO) aided and abetted in the director defendants’ breach of fiduciary duties. The defendants moved to dismissed the complaint pursuant to Court of Chancery Rule 12(b)(6).

The Court held that the transaction was presumptively subject to the business judgment rule and that the fact of the allegedly undisclosed compensation proposal failed to rebut the business judgment rule. The Court noted that to rebut the business judgment rule based solely on the material conflicts of a minority of the directors of a multi-director board, a plaintiff must allege that the conflicts impacted the majority of the board either by demonstrating that the conflicted director dominated the board or by showing that the director failed to disclose his material interest in the transaction, and a reasonable board member would have considered the interest a significant fact in the evaluation of the proposed transaction.

Here, the Court found the Towers Board members would not have deemed the undisclosed compensation proposal significant in evaluating the transaction because the Board was already fully aware of the CEO’s post-merger employment and knew the CEO would receive a higher salary because the combined entities would be larger. The compensation proposal was also only that, a proposal. It offered the possibility of a great upside to the CEO based on performance but no agreement was formalized between the CEO and Willis until after the merger. The Board was also generally apprised of the negotiations regarding the size of the stockholder dividend. According to the Court, the facts alleged did not support a finding of deceptive silence or fraud on the board, and thus the Plaintiffs failed to rebut the business judgment rule.

The business judgment rule insulates a merger from all attacks other than on grounds of gift or waste. To prevail on a waste claim, the plaintiff must overcome the presumption of good faith by showing that the board’s decision was so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests. Here, the Plaintiffs alleged that the Board members acted in bad faith because they intentionally failed to act in the face of a known duty to act. The Plaintiffs argued that the Board “abdicated” its fiduciary duties by failing to oversee the CEO’s actions during the period between the merger announcement and final closing. However, the Court found the Plaintiffs failed to show the “extreme facts” necessary to demonstrate that disinterested directors acted disloyally because Board members were aware of the CEO’s conflict when they selected him as negotiator, attended meetings between the CEO and Willis, and met to discuss and approve the initial and renegotiated terms of the transaction. The Court found the Plaintiffs did not plead facts sufficient to establish a bad-faith claim against the majority of the Towers Board and thus failed to state a claim under the exacting test for waste.