October 24, 2022
The Delaware Court of Chancery recently weighed key issues under state law involving claims of breach of fiduciary duty in several challenged corporate transactions.
Perfection Is Not Expected: Court Finds Flawed Acquisitions Entirely Fair
The Delaware Court of Chancery recently reviewed two acquisitions that were challenged by stockholders as flawed and/or the product of breaches of fiduciary duty by board members or controlling stockholders. In each case, the court, while at times expressing criticism of the process of the acquisitions, determined they were nonetheless fair to stockholders.
On Aug. 19, 2022, the Delaware Court of Chancery issued its post-trial decision for In re BGC Partners Inc. Derivative Litigation, rejecting claims that BGC Partners Inc.'s acquisition of Berkeley Point Financial LLC, an affiliate of Cantor Fitzgerald LP, was unfair. Although Vice Chancellor Lori Will acknowledged various flaws in the process, she nonetheless established, by examining the evidence under the entire fairness standard of review, that the transaction was fair as to both process and price.
The plaintiffs alleged that the controlling stockholder of both BGC Partners Inc. and Cantor Fitzgerald L.P. breached his fiduciary duties by initiating a deal in which he had financial incentive to cause BGC to overpay for Berkley Point, thereby benefiting himself at the expense of BGC's other stockholders. The plaintiffs maintained that the conflicted controller overstepped by participating in certain procedural aspects of the deal, particularly in identifying advisers to the special committee and requesting co-chairs to serve on the committee. Evidence also showed that the controller attempted to enforce his desired terms and timeline in one-off discussions with one of the co-chairs.
The court recognized flaws in the controller’s initial role in the special committee, but found that, when the committee became fully empowered, the controller separated himself from the committee's processes and the committee evidently ignored any of the controller’s efforts on important issues. Accordingly, it was clear to the court that the special committee acted independently by thoroughly negotiating on its own timeline and structure, along with making impartial decisions. The court also established that the special committee determined an equitable merger price through various deliberations, particularly evidenced by the committee’s negotiations on behalf of the stockholders and its demand that Cantor make major price adjustments.
Several months before BGC Partners, the Delaware Court of Chancery evaluated Tesla Motors Inc.’s 2016 acquisition of SolarCity Corporation pursuant to the entire fairness standard of review, and likewise concluded that both process and price were fair. In the post-trial decision for In re Tesla Motors, Inc. Stockholders Litigation, Vice Chancellor Joseph Slights rejected derivative action claims proposed by several Tesla stockholders.
Similar to the controller in BGC Partners, Elon Musk — operating as Tesla’s co-founder, CEO and chairman and as SolarCity’s largest stockholder and chairman — was accused of initiating, and later orchestrating, a self-serving deal. The plaintiffs alleged that Musk’s influence not only led many directors to initiate discussions regarding the deal, but also coerced Tesla to absorb an insolvent company.
In considering all the evidence, the court found no instances in which Musk exercised his power to construct a deal at the expense of Tesla, nor any indications that SolarCity was insolvent. The court acknowledged that Musk’s participation in the deal process was problematic, particularly when he engaged in undisclosed communications with SolarCity’s management and with Tesla’s financial adviser, assisted in the selection of Tesla’s outside deal counsel, and remained present for part of a Tesla board meeting in which the revised offer for SolarCity was discussed.
Nonetheless, the court determined that Musk’s involvement did not effectively corrupt the process. The court found that Musk’s involvement in the dealings was successfully neutralized by Tesla’s unbeholden directors. As evidence showed, the Tesla board, along with Tesla’s financial adviser, developed a productive decision-making process in order to establish a fair price in the interests of the disinterested stockholders. The board continuously rebuffed the expedited schedule favored by Musk. The board also remained transparent about SolarCity's unfavorable financial condition by providing the stockholders extensive disclosures before their vote.
Despite the outcome, the court deliberately emphasized Musk’s, and the rest of the Tesla board members’, mistake in not using a more objective procedural protection, namely, to have formed a special committee, in order to avoid expensive and time-consuming litigation. Nevertheless, as mentioned, “perfection is not possible, or expected” in a transaction; Elon Musk’s behavior, albeit imperfect, did not indicate a breach of fiduciary duties or effect the acquisition, nor did it cause the board to fail to obtain a fair price.
MFW to the Rescue; Guidance for Company Controllers
In City Pension Fund for Firefighters and Police Officers in The City of Miami Beach v. The Trade Desk, Inc., Vice Chancellor Paul Fioravanti of the Delaware Court of Chancery granted the defendants’ motion to dismiss for failure to state a claim.
The plaintiff alleged that the defendants breached their fiduciary duty by passing an amendment to the certificate of incorporation which extended a dilution trigger that would end the company’s dual-class stock structure. Specifically, the amendment extended the timing of a requirement that all outstanding high-vote Class B shares be converted into low-vote Class A shares if the amount of outstanding Class B shares fell below 10% of the combined amount of all Class A and Class B shares. This amendment allowed the company’s co-founder and CEO, who controlled 98% of the Class B shares, to remain the controller while continuing to sell his Class B shares regardless of the previous 10% threshold.
Because the controller was an interested party, the court normally would evaluate the motion to dismiss under the entire fairness standard of review. However, since the 2014 Delaware Supreme Court case Kahn v. M & F Worldwide Corp. (MFW), the Delaware courts have used the following six-part test to determine if a case that normally would be subject to the entire fairness standard can instead be evaluated under the more deferential business judgment review standard:
(i) the controller conditions the transaction on the approval of both a special committee and a majority of the disinterested stockholders;
(ii) the special committee members are independent and disinterested;
(iii) the special committee is empowered to select its own advisers and to say no to the transaction;
(iv) the special committee meets its duty of care in negotiating a fair price;
(v) the vote of the disinterested stockholders is fully informed; and
(vi) there is no coercion of the disinterested stockholders.
The plaintiff challenged two aspects of the MFW framework. The first was to the independence of the special committee and the second was that the disinterested stockholders were not fully informed.
The plaintiff alleged that the chair of the special committee was not independent because of payments received in 2016 for consulting services related to the company’s IPO and a salary paid for serving on the company’s board of directors. The plaintiffs also alleged that the director dominated the process of the committee, although the court found no evidence to support this claim. Because the plaintiff did not meaningfully challenge the independence of the other two members of the special committee, a majority of the committee was independent. The court also opined that because the plaintiff did not challenge that all members of the special committee must be independent for MFW to apply, the court need not address that open question of Delaware law. The third allegation plaintiff made regarding the special committee was that its members were acting under a controlled mindset by attempting to ingratiate themselves to the controller, by voting to allow him to remain as the controller. The court found that the plaintiff’s evidence merely suggested wrongful business decisions on the part of the committee, which does not meet the standard required to find gross negligence.
Thus, the court rejected all three of the plaintiff’s challenges and found the committee’s independence satisfies the second clause of the MFW test. While the court conceded that some of the information the plaintiff argued was not disclosed, it did not find any of it to be material and rejected the challenge to the fifth clause of the MFW test as well.
Court: Directors Were Not Independent and May Have Faced Pressure to Approve Stock Offering
In In re Carvana Co. Stockholders Litigation, the Delaware Court of Chancery, in an opinion by Chancellor Kathaleen McCormick, denied the motions brought by Carvana’s chairman, president and CEO to dismiss derivative claims brought by stockholders alleging a breach of fiduciary duties by such individual who, along with his father, controlled the company. The decision addresses only Carvana and Carvana’s chairman, president and CEO, with the arguments made by his father addressed in a separate decision.
The claims relate to a direct stock offering of $600 million of common stock, sold in March 2020. The offering was made to investors “handpicked” by the controllers, including the controllers, when the stock price was depressed due to the pandemic and at a time when the company was in a “sound financial position” not requiring a capital raise.
The decision hinged on the relationship of two directors with the CEO and his father, and the court held that such directors “lack[ed] independence” from the CEO and his father who received “material personal benefit from the alleged misconduct.” One director had a close professional and personal relationship with the CEO’s father of over 30 years, during which the CEO’s father was an important investor in the director’s media company and the director received censure on the CEO’s father’s behalf due to the violation of NYSE rules. The other director also had strong professional ties with the CEO’s father, including providing employment opportunities to each other’s children, the granting of equity compensation offered to no other directors, and preferential investment opportunities received by such director to the company.
The court held that as half of the board of directors (the CEO and two directors) was compromised when voting on the offering, the plaintiffs’ claims could proceed.
Authors would like to thank case assistants Colin Hopkins and Josephine Johnson for their assistance in drafting this article.