Court Relies on Fully Informed Uncoerced Stockholder Vote in 'Revlon' Challenge
Vice Chancellor Joseph R. Slights III's decision In re OM Group Stockholders Litigation, Consol. C.A. No. 11216-VCS (Oct. 12, 2016), represents the latest Delaware Court of Chancery decision to apply Corwin v. KKR Financial Holdings, 125 A.3d 312-314 (Del. 2015), and rely on the business judgment standard of review to dismiss a Revlon challenge to a cash-out merger.
In the sale of a company for cash, the duty of the board of directors is to seek the transaction offering the best value reasonably available. Before Corwin and since the Delaware Supreme Court's 1986 decision in Revlon v. MacAndrews & Forbes Holdings, 506 A.2d 173 (Del. 1986), Delaware courts applied the intermediate standard of review of "enhanced scrutiny" when evaluating challenges to the directors decision-making involving the sale of control. The court has justified enhanced scrutiny rather than the more deferential business judgment standard because of the potential conflicts that fiduciaries face when considering whether to sell the corporation, to whom and on what terms. In 2015, the Delaware Supreme Court in Corwin substantially circumscribed the Revlon standard of review in post–merger transaction challenges if a majority of disinterested stockholders, who are fully informed and not coerced, have approved the merger. In that instance the irrebuttable business judgment rule would apply, and the board's decision to approve the merger would be insulated from all attacks (except waste) even if the board had Revlon duties in the merger. The rationale for Corwin is that the body of disinterested and informed stockholders remains a qualified decision-maker to which the court should defer, even if the board is compromised by the situational pressures subjecting it to enhanced scrutiny.
The plaintiffs in OM Group initially sought and obtained expedited proceedings and discovery to enjoin the sale of the company to Apollo Global. They later abandoned their preliminary injunction motion, but with the benefit of discovery during the expedited proceedings, they filed an amended complaint alleging breach of the board's fiduciary duties and seeking post-closing rescissory damages.
The complaint alleged that the board's sale process was unreasonable and that the directors did not meet their fiduciary duties when reviewed under Revlon's enhanced scrutiny lens. The three primary attacks on reasonableness were: the board, fueled by a desire to avoid a public confrontation and proxy fight with a vocal dissident, shut out strategic buyers from the sale process (who would be interested in acquiring pieces of OM's business) in favor of a quick deal with a financial sponsor willing to buy the whole business; the board failed to manage conflicts among its contingently compensated investment bankers, and the board relied upon and allowed the bankers to rely on manipulated financial projections that understated OM's prospects in an effort to drive the bankers to conclude that a less than reasonable merger price was fair. The plaintiffs also alleged that the stockholders' vote overwhelmingly to approve the merger should be disregarded because it was the product of incomplete and misleading disclosures to stockholders regarding a director conflict, the extent to which the Board managed banker conflicts, and material details of an indication of interest received by the Board during a post-signing go-shop time period.
Recognizing the outcome-determinative impact under Corwin of stockholder approval, if found to be fully informed and uncoerced, the court first analyzed the disclosure claims. It concluded they could be disposed of as a matter of law from the existing complaint and discovery. Ultimately, the court ruled that none of the disclosure allegations was meritorious or undermined the stockholders approval.
With respect to the allegedly incomplete disclosures about a competing bid, the court found no omission of material information from the proxy's discussion of the competing bid. With respect to the disclosure allegations regarding a certain director's conflicts of interest, the court ruled the allegations were conclusory, did not reveal an actual conflict and did not indicate in any event that such director could exercise undue influence over the other indisputably independent board members. Finally, as to the board's handling of banker conflicts, the court found the disclosures adequate and that the alleged omissions would not have significantly altered the total mix of information available to stockholders.
Notably for future Revlon cases, the court acknowledged Corwin's caveat that "if troubling facts regarding director behavior were not disclosed that would have been material to a voting stockholder, then the business judgment rule is not invoked." The court also noted the complaint's failure to allege the board's omission from the proxy of facts that "would allow stockholders to appreciate the factual bases of the gravamen of the plaintiff's breach of fiduciary duty claim, including the financial advisors' views that separate sales of OM's divisions would yield more value for stockholders than a sale of OM in the aggregate, the rushed timing of the transaction to avoid a confrontation with a stockholder activist, or the flaws in management projections used by the OM board to value OM." While it has long been the law in Delaware that a board's disclosure obligation does not require it to engage in "self-flagellation," both Corwin and OM Group suggest that the board's failure to disclose unfavorable facts affecting its ability to obtain the best value reasonably available in a Revlon setting may be material.
The continuing vitality of the Revlon doctrine as a basis for shareholders attacking allegedly underpriced mergers remains very much in doubt. Under Corwin, full disclosure and resulting business judgment deference effectively insulates the transaction from attack. An allegation of waste, which business judgment review does not foreclose, has little real world relevance in merger transactions. Stockholders simply are not likely to approve a transaction that is wasteful.
Continuing development of the law will reveal whether enhanced disclosure, including disclosure of director concerns with the sales process, will become the norm to increase the likelihood of obtaining Corwin business judgment review.
Finally, further case development may reveal whether the Corwin doctrine will change the negotiation dynamics between the buyer and seller in M&A transactions. It may lead buyers to press for increasingly favorable deal terms in the belief that full disclosure and a resulting favorable stockholder vote will insulate it from Revlon's enhanced scrutiny review.