Business Judgment – Page 5

Chancery Court Holds that Compensation Paid to Non-Employee Directors Pursuant to Shareholder-Approved Plan Must Be Reviewed Under Entire Fairness Standard

May 12 2015

In Calma v. Templeton, C.A. No. 9579-CB (Del. Ch. April 30, 2015) (Bouchard, C.), the Delaware Chancery Court held that Citrix System, Inc’s (“Citrix”) payment of compensation to non-employee directors under a shareholder-approved compensation plan must be reviewed under the entire fairness standard because the shareholders’ omnibus approval of a plan covering several different types of beneficiaries did not constitute ratification of the amount of compensation to be paid to non-employee directors.

In 2005, Citrix shareholders approved an equity compensation plan (the “Plan”) for beneficiaries such as directors, officers, employees, consultants, and advisors. The plan did not specify the amount of compensation that non-employee directors could receive, instead only providing a limit of 1 million restricted stock units (“RSUs”) for any beneficiary’s annual compensation. Based on the company’s share price at the time the suit was filed, 1 million RSUs would be worth over $55 million.

Sound the Alarm? Not so Fast as Chancery Court Dismisses Derivative Suit Alleging Self-Interested “Pump-And-Dump” Scheme Arising Out of Alarm Company’s Repurchase of $450 Million in Stock from Hedge Fund Investor

May 05 2015

By Lauren Garraux and Phillip Kardis

In his April 28, 2015 Memorandum Opinion, Vice Chancellor Parsons dismissed a derivative suit brought by ADT Corp. stockholder Walter E. Ryan, Jr. (“Plaintiff”) against the Company’s board of directors, Corvex Management LP (“Corvex”), a hedge fund investor, and Corvex’s principal arising out of the Company’s repurchase of $450 million in stock held by Corvex, a move that led to a drop in the Company’s stock price. Citing Chancery Court Rule 23.1, Vice Chancellor Parsons dismissed the suit because Plaintiff had neither made a pre-suit demand on the Company’s board nor met his burden of proving that demand should be excused as futile under Aronson.

Plaintiff commenced this derivative action on August 1, 2014 and filed an amended complaint on October 3, 2014, asserting claims of breach of fiduciary duties of care and loyalty against ADT’s board of directors, aiding and abetting those breaches against Corvex and unjust enrichment against Corvex and Corvex principal Keith Meister (“Meister”) who, during the time period relevant to the complaint, held a seat on ADT’s board and audit committee. Plaintiff’s claims arose out of what Plaintiff characterized as a self-interested “pump-and-dump” scheme pursuant to which Meister managed to “pump up” the price of ADT’s stock and then convinced his fellow board members to repurchase most of Corvex’s ADT stock in November 2013 at $44.01 per share for an approximate total of $450 million, the alleged “dump.” Following the repurchase, ADT was left in a “far-worse-than forecasted financial condition,” with “diminished future prospects” and a slipping stock price that ultimately settled around $28 per share in the first few days of February 2014.

Holders of Preferred Stock Beware: Delaware Chancery Court Holds that Preferred Stock Is Subject to the Issuer’s Need as a Going Concern, Not Just DGCL §160

Apr 08 2015

By David Bernstein and B. Ashby Hardesty, Jr.

TCV v. TradingScreen, Inc. concerns the interplay between a charter provision providing for the mandatory redemption of preferred stock, Section 160 of the Delaware General Corporation Law (the “DGCL”), and Delaware common law. The Chancery Court held that despite an adequate surplus under Section 160, common law restrictions prohibited a corporation from redeeming preferred stock as required by its charter.

In TCV, TradingScreen’s charter required that if after a specified date holders of a majority of TradingScreen’s Series D preferred stock asked for assistance in selling their preferred stock, TradingScreen would give that assistance. If no third-party buyer were found, TradingScreen would repurchase its preferred stock at its fair value as agreed upon or determined by an expert. In June 2012, the holders of a majority of the preferred stock requested assistance in selling their shares. When no suitable third-party buyer was found, an expert selected by Trading Screen and the majority owners of the preferred stock made a valuation and determined the sale price. After receiving the valuation, TradingScreen refused to repurchase more than a small portion of the preferred stock, stating that its board had determined, based on a study it had had prepared by an outside expert, that doing so would impair TradingScreen’s ability to continue as a going concern. The preferred stockholders brought suit, alleging, among other claims, that TradingScreen breached the Charter by failing to honor the charter’s redemption provision and, as a result, triggered interest payments at 13% on the unpaid amounts.

The preferred stockholders argued that because TradingScreen had a surplus that far exceeded the amount it would need to redeem the preferred stock without violating Section 160, its charter required it to repurchase the preferred stock. TradingScreen argued that under Delaware common law, funds would not be “legally available” for repurchase of preferred stock if doing so threatened the corporation’s ability to continue operating as a going concern. The Chancery Court agreed with TradingScreen. It held that even though redemption of the preferred stock would not violate Section 160, “outside the DGCL, a wide range of statutes and legal doctrines restrict a corporation’s ability to use funds.” It held that the common law restricted TradingScreen’s ability to redeem its shares when doing so would damage its ability to continue as a going concern, and that to challenge the Board’s judgment regarding the effect of redemption on TradingScreen’s ability to continue as a going concern, the preferred stockholders would have to show that the Board’s decision was made in bad faith or was so far off the mark as to constitute actual or constructive fraud. The Court rejected the argument that the charter provisions regarding the preferred stock were a contract between the corporation and the holders of the preferred stock, saying the preferred stockholders “fail to appreciate the hybrid nature of preferred stock” and that the preferred stockholders “are holders of equity, not debt.” It is likely many holders of preferred stock will be surprised to learn that their rights with regard to their preferred stock are subject to the issuers’ needs as going concerns.

TCV v. TradingScreen, Inc., C.A. No. 10164-VCN (Del. Ch. March 27, 2015) (Noble, V.C.)

In re Sanchez Energy Derivative Litig., C.A. No. 9132-VCG (November 25, 2014) (Glasscock, V.C.)

Dec 03 2014

By Priya Chadha and David Bernstein

In In re Sanchez Energy, Vice Chancellor Glasscock granted a motion to dismiss in a shareholder derivative action because the plaintiffs had failed to make a demand on the Board, holding that the plaintiffs failed to meet Rule 23.1’s particularized pleading standards for demand futility. The case centered around a transaction in which Sanchez Energy Corporation (“Sanchez Energy”), a publicly held corporation, purchased property at $2500/acre from Sanchez Resources, LLC (“Sanchez Resources”), a privately held, company, which Sanchez Resources had purchased for $184/acre. Two members of the Sanchez family—A.R. Sanchez Jr. and A.R. Sanchez III—owned a combined 21.5% of the shares of Sanchez Energy and served on its board of directors, which had three other members. Those three members comprised Sanchez Energy’s audit committee, which approved the transaction.

The court rejected the plaintiff’s claim that demand would have been futile because the three members of the Audit Committee were not independent. The Vice Chancellor said the plaintiffs had failed to show the audit committee members’ social and business relationships with the Sanchezes were such that “the non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.” He also rejected Plaintiffs’ arguments that the Sanchezes should be treated as controlling shareholders because they failed to show that the Sanchezes controlled the board or the negotiation process for the transaction. Vice Chancellor Glasscock pointed to the fact that transaction was approved by the Audit Committee and that the Sanchezes owned at most a combined 21.5% stake in Sanchez Energy as evidence that the Sanchezes were not controlling shareholders. Lastly, VC Glasscock rejected the idea that because of the huge disparity between what Sanchez Resources paid to acquire the property and what Sanchez Energy paid to acquire the property from Sanchez Resources, the transaction was so facially unfair that it could not have been the product of valid business judgment, noting, among other things, that between Sanchez Resources’ initial purchase and its sale to Sanchez Energy, half of the property had been developed and found to contain proven oil reserves.

Thus, because the Complaint failed to specifically please facts excusing demand, the Court dismissed the Complaint.

In Re Sanchez

Higher Education Management Group, Inc. v. Matthews, C.A. No. 911-VCP (November 3, 2014) (Parsons, V.C.)

Nov 06 2014

By David Bernstein and Max Kaplan

On November 3, 2014, the Delaware Chancery Court granted defendants’ motion to dismiss derivative claims in Higher Education Management Group, Inc. v. Mathews, C.A. No. 911-VCP (Del. Ch. Nov. 3, 2014) (Parsons, V.C.), after finding, among other things, that plaintiffs failed to plead with particularity facts showing demand upon nominal defendant’s board would have been futile. In this case, defendant corporation’s subsidiary, Aspen University, paid out nearly $2.2 million in what were apparently expense reimbursements between 2003 and 2011. These outlays were never recorded in the firm’s accounts—a fact discovered by management through a November 2011 audit. Apparently, rather than recording the expense, which would have required Aspen to restate previous years’ financial statements, management chose to treat the $2.2 million as a secured loan receivable owed by Aspen University’s former CEO—plaintiff Patrick Spada—with the intention of taking a write-off in the future. Spada denied there ever was a loan and alleged that defendant officers and directors materially misrepresented the corporation’s finances by knowingly mischaracterizing the $2.2 million as a loan.

The court did not reach the merits of plaintiffs’ accusations, and it instead found that plaintiffs failed to either make a demand on the board or sufficiently plead that such a demand would be futile. Plaintiffs had argued that the director defendants had made knowing misrepresentations that exposed them to a “substantial likelihood” of liability, and therefore all the directors were “interested” for purposes of satisfying the demand futility test. However, Plaintiffs pled events that, if taken as true, showed only that two directors knew that there was no loan. With regard to all the other directors, plaintiffs alleged only general knowledge of the loan being fake, attributing identical actions to all of the directors as a group without making specific allegations with regard to individual directors. According to the court, “such broad and identical assertions . . . do not meet the requirements of pleading facts with particularity.” Having found that the facts pled by the plaintiffs were only sufficient to show that a minority of directors were “interested,” the court concluded that a demand had not been shown to be futile and dismissed the claim.

Higher Education Management Group, Inc. v. Mathews

In Re: Crimson Exploration Inc. Stockholder Litigation, C.A. No. 8541-VCP (October 24, 2014) (Parsons, V.C.)

Oct 26 2014

By William Axtman and Ryan Drzemiecki

In Re: Crimson Exploration Inc. Stockholder Litigation involved a consolidated class action claim made by certain minority stockholders (“Plaintiffs”) of Crimson Exploration, Inc. (“Crimson”) challenging the completed acquisition of Crimson by Contango Oil & Gas Co. (“Contango”). The transaction was structured as a stock-for-stock merger (the “Merger”), with the Crimson stockholders holding approximately 20.3 % of the combined entity following the merger and an exchange ratio representing a 7.7% premium based on the April 29, 2013 trading price of Contango common stock and Crimson common stock. Plaintiffs also alleged that the members of Crimson’s Board of Directors (the “Directors”) and various entities affiliated with the investment management firm Oaktree Capital Management, L.P. (“Oaktree”) breached their respective fiduciary duties by selling Crimson below market value for self-serving reasons. In total, Plaintiffs brought claims against Crimson, the Directors, Oaktree, Contango Acquisition, Inc. (the “Merger Sub”) and Contango (“Defendants”).

A major premise of Plaintiffs’ complaint is that Oaktree controlled Crimson and thereby had fiduciary duties to the minority stockholders of Crimson. Oaktree owned roughly 33.7% of Crimson’s pre-Merger outstanding shares and a significant portion of Crimson’s $175 million Second Lien Credit Agreement, which Contango agreed to payoff after the signing of the Merger, including a 1% prepayment fee (the “Prepayment”). Also, in connection with the Merger, Oaktree negotiated to receive a Registration Rights Agreement (the “RRA”) so that it had the option to sell its stock in the post-Merger combined entity through a private placement.

In re KKR Financial Holdings LLC Shareholder Litigation, C.A. No. 9210-CB (October 14, 2014) (Bouchard, C.)

Oct 21 2014

By Kristy Harlan and Eric Taylor

This case involves a challenge to a stock-for-stock merger by a group of stockholders of the target company who alleged breaches of fiduciary duty by both the board of directors of the target (the “Board”) and an alleged controlling stockholder who held less than 1% of the stock of the target. The transaction (the “Merger”) involved the acquisition of KKR Financial Holdings LLC (“KFN”) by KKR & Co. L.P. (“KKR”). KFN was managed by an affiliate of KKR, which was responsible for day-to-day operations of KFN, subject to the oversight of the Board pursuant to a management agreement between the parties. In October 2013, KKR expressed interest in acquiring KFN to a member of the Board. Over the next several months, the Board began to discuss the approach from KKR, set up a transaction committee to review the potential transaction, and met several times with representatives from KKR to negotiate for better terms. In mid-December 2013, the Board approved the Merger and KFN and KKR executed a merger agreement. The transaction was valued at approximately $2.6 billion.

This case is the consolidated result of nine separate actions that were filed challenging the Merger in December 2013 and January 2014. KFN and KKR moved for summary judgment, which the plaintiffs sought to overcome by arguing that the Merger should be subject to “entire fairness” review, instead of the presumed business judgment review. The Court held that the business judgment rule applied, granted summary judgment to KFN and KKR and dismissed the suit with prejudice.

Zutrau v. Jansing, C.A. No. 7457-VCP (Del. Ch. July 31, 2014) (Parsons, V.C.)

Aug 07 2014

By David Bernstein and Meredith Laitner

On July 31, 2014, the Delaware Chancery Court issued its decision in Zutrau v. Jansing, C.A. No. 7457-VCP (Del. Ch. July 31, 2014) (Parsons, V.C.), requiring the parties to recalculate the payment to which the plaintiff was entitled because her 22% minority interest in a Delaware corporation was squeezed out through a reverse split that reduced her holding to less than one full share. The plaintiff in this case, a former employee of Ice Systems, Inc., brought a derivative suit in which she challenged numerous business decisions made by Ice Systems after her employment terminated and challenged compensation and expense reimbursement payments made to the CEO, who was also the 78% stockholder and the sole director. The plaintiff also (a) asked the Court to set aside the reverse split on the ground that it was made for the improper purpose of depriving her of the ability to bring a derivative suit, or alternatively (b) to increase the sum to which she was entitled as a result of the cancellation of her 22% interest through the reverse split.

The Court did not decide whether the plaintiff no longer had standing to sue derivatively because she was no longer a stockholder when she commenced the suit, because the defendant acknowledged that if Ice Systems would have been entitled to recover sums if the plaintiff had been able to sue derivatively, the corporation’s right to recover those sums would increase the amount to which the plaintiff is entitled because of the cancellation of her stock interest, and therefore, the outcome of her suit would be the same whether or not she was permitted to sue derivatively.

Gassis v. Corkery, C.A. No. 8868-VCG (Del. Ch. May 28, 2014)

May 29 2014

By Joanna Diakos and Mark Hammes

In Gassis v. Corkery, Civil Action No. 8868, Bishop Macram Max Gassis challenged his removal as Chairman of the Board and as a director of the Bishop Gassis Sudan Relief Fund, Inc., a Delaware charitable nonstock corporation (the “Fund”) dedicated to helping the people of southern Sudan. The Bishop also challenged the previous removal of two directors from the Fund’s board and the elections of two directors who replaced them.

Bishop Gassis’ removal at a 2013 board meeting came after years of friction with other board members, who contended that the Bishop was difficult to work with, negatively interacted with the Fund’s beneficiaries in Sudan, spent extravagantly on travels, invested in suspicious projects, and acted as though he had a personal interest in the Fund’s assets. These board members further argued that a provision of the Fund’s bylaws providing that the Bishop “shall serve [as Chairman of the Board] until his retirement or resignation” required him to be removed from the board upon his retirement as a Catholic Bishop, which was to occur on his seventy-fifth birthday on September 21, 2013.

Hamilton Partners, L.P. v. Highland Capital Management, et al., C.A. No. 6547-VCN (May 7, 2014) (Noble, V.C.)

May 09 2014

By David Bernstein

Plaintiff Hamilton Partners, L.P. challenged in the Delaware Chancery Court the fairness of a merger between a Nevada corporation, American HomePatient, Inc. (“New AHP”), a successor to a Delaware corporation of the same name (“AHP”), and Highland Capital Management, L.P. (“Highland”), which before the challenged transactions owned 48% of AHP’s stock and held most of its debt. The initial question was whether the validity of the actions was governed by Nevada law or by Delaware law. The Court said that most of the transactions took place under an agreement that was signed while the corporation was a Delaware corporation and that those transactions would be governed by Delaware law. However, transactions that were not approved by the Board until after the reincorporation in Nevada would be governed by Nevada law.

The Court then addressed whether the fairness of the merger should be determined under the business judgment rule or under the entire fairness test, which would apply if Highland was a controlling stockholder. The Court said that although there were prior Delaware decisions that made it possible that Highland’s 48% ownership interest alone might not have caused it to be viewed as a controlling person when determining whether the Board’s approval of the merger should be evaluated based on the business judgment rule or on the entire fairness test, the combination of Highland’s 48% stock interest and the fact that it had used its creditor position to force the corporation to engage in the series of transactions that was being challenged made it clear that Highland was a controlling person and that the entire fairness test should apply. Therefore, noting that it is almost never possible to dismiss a complaint in an instance in which the entire fairness test applies, the Court refused to dismiss the claim against Highland.

The Plaintiff also sued Joseph Furlong, the CEO and a director of AHP, claiming that he had a personal interest in the merger (he would receive a $6.5 million payment if it took place) and therefore his actions as a director should be evaluated under the entire fairness test. The Court said that because the Board consisted of three directors, and the other two directors, whose independence was not challenged and who were not claimed to have been dominated by Furlong, approved the merger, and their approval was governed by the business judgment rule, it made no difference whether Furlong’s approval was governed by the business judgment rule or was subject to the entire fairness test. The Court also pointed out that because the merger was approved by the Board after the corporation had reincorporated in Nevada, Furlong’s liability would be governed by a Nevada statute that exculpates a director from personal liability unless the director’s act or failure to act constituted a breach of fiduciary duties and the “breach of those duties involved intentional misconduct, fraud or a knowing violation of the law”. The Court found that the Plaintiff had not claimed that Furlong had been guilty of intentional misconduct, fraud or a knowing violation of law, and therefore Furlong was entitled to the protection of the Nevada exculpation statute. Accordingly, it dismissed the claims against Furlong.

hamiltonpartnersl p v highlandcapital1

Catagory:Business Judgment