Belated Use of Special Committee and Uninformed Stockholder Vote Undermine Bid for Business Judgment Review of Going-Private Merger
The Court of Chancery’s recent decision in Salladay v. Lev, 2020 WL 954032 (Del. Ch. Feb. 27, 2020) denied the director-defendants’ attempt to invoke procedural safeguards – a special committee and independent stockholder approval – to dismiss a stockholder suit challenging a going-private merger. While there was no controlling stockholder and the defendants contended that any board-level conflicts were appropriately addressed, Vice Chancellor Sam Glasscock III reasoned that a special committee of independent directors was not utilized ab initio in the buyout discussions, and that the disclosures to stockholders were materially incomplete.
In 2017, Intersections, Inc. (the “Company”) experienced financial difficulties due to a delayed rollout of a new version of its signature product. It formed a special committee of independent directors to explore financing options (the “Committee”). The Committee hired Houlihan Lokey, Inc. (“Houlihan Lokey”) as its financial advisor. After the Company secured some financing, the Committee ceased functioning.
Thereafter, a group of investors approached the Company to explore taking it private. Beginning on September 14, 2018, the buyout group engaged in a series of meetings with the Company’s Chairman and CEO (Stanfield), as well as a director designated by its largest stockholder (Loeb) who also was Loeb’s managing director. The buyout group began due diligence. On September 27, Stanfield allegedly told the buyout group that the Company’s board would be receptive to a deal at $3.50 to $4.00 per share. Three of the Company’s six directors – including Stanfield and Loeb’s board designee – indicated they wished to roll over a substantial majority of their shares into the new entity. Stanfield also stood to receive lucrative “golden parachute” payments and a consulting agreement with the post-merger Company.
On October 5th, the board resolved not to approve any transaction that was not first approved by the Committee. Four days later, the buyout group proposed a merger at $3.50 per share (i.e., the low end of the range allegedly signaled by Stanfield). The Committee resolved to condition any transaction upon a majority-of-the-minority stockholder vote, and hired a “nationally recognized investment banking firm” as a financial advisor. The proxy statement did not identify the new firm, and suggested the Committee had ceased using Houlihan Lokey. But the (unidentified) new advisor soon “abruptly terminated” its engagement (the proxy statement did not say why), which caused the Committee to hire a third advisor with only eight days to opine on the fairness of the transaction. On October 29, the Committee met, the advisor delivered a fairness opinion, and the Committee recommended in favor of a sale at $3.68 per share, which the Court observed was “just below the midpoint of the range [allegedly] suggested … by Stanfield.”
The Court's Decision Denying the Defendants' Motions to Dismiss
A former stockholder filed a class action challenging the merger, and the defendants moved to dismiss. They argued that, even assuming that three of six directors were “interested,” the procedural safeguards used – a special committee of independent directors and a majority-of-the-minority vote – each independently restored business judgment review. The Court agreed that, in the absence of a controlling stockholder, each procedural safeguard could result in business judgment review. It reasoned, however, that the plaintiff alleged facts sufficient to doubt that each was effective.
With respect to the Committee, the Court agreed that, under the reasoning of precedent like In re Trados Inc. S’holder Litig., 73 A.3 17, 65 n. 39 (Del. Ch. 2013), “if there is no controller present, then a fully constituted, adequately authorized, and independent special committee can cleanse” a transaction in which there is no disinterested or independent board majority. But the Court also looked to recent Delaware Supreme Court decisions – such as Kahn v. M&F Worldwide, Flood v. Synutra Int’l, Inc. and Olenik v. Lodzinski– emphasizing that in the controlling stockholder context a special committee must be established ab initio – i.e., before substantive economic negotiations begin. The Court found those same concerns apply even without a controlling stockholder, because “commencing negotiations prior to the special committee’s constitution may begin to shape the transaction in a way that even a fully-empowered committee will later struggle to overcome.” Here, the Court found it reasonable to infer that communications with the buyout group before the transaction was conditioned upon Committee approval, particularly including Stanfield’s alleged unauthorized suggestion of a price range, could have influenced the subsequent negotiations.
With respect to the stockholder vote, while the Delaware Supreme Court’s Corwin decision affords business judgment deference to transactions approved by a fully-informed vote of disinterested and independent stockholders, the plaintiff sufficiently alleged that the proxy statement failed to accurately disclose all material facts.
First, the proxy statement disclosed that, in connection with a related financing transaction, the buyout group obtained the contractual right to designate a majority of the members of the board if the merger did not close. That was inaccurate, however, due to a NASDAQ rule prohibiting director designation rights that provide board representation out of proportion to the holder’s level of equity ownership. While a savvy stockholder theoretically could have taken steps to calculate the buyout group’s equity ownership percentage in the event of a failed transaction, and theoretically could have assessed the effect of NASDAQ’s rule (the text of which was also disclosed), there was no straightforward statement that the rule would apply to prevent the buyout group from designating a majority of the directors. The Court reasoned that the issue of whether control could shift to the buyout group was “fundamental” and required more than an “ambiguous, incomplete or misleading” disclosure.
The Court also held that the reasons for the Committee’s changes in financial advisors could be material in the circumstances. The moves away from two different advisors in succession lended themselves to nefarious explanations, such as that advisors were terminated because they were unable to support the transaction. The Court also reasoned that stockholders should not be forced to speculate on an issue – abrupt changes of advisors in the midst of a fast-moving process to sell the Company – that clearly would have been important to the Committee members themselves.
The Court accordingly denied the defendants’ motions to dismiss, and the case will proceed to discovery.
The Court of Chancery’s decision reaffirms that, in the absence of a controlling stockholder, employing the procedural safeguards of either a special committee or independent stockholder approval can restore business judgment review to a transaction – even when there is no independent board majority and entire fairness review otherwise would apply. It also clarifies that the ab initio requirement from MFW and its progeny applies in this context. This reinforces the importance of individual officers and directors promptly presenting to the board any expressions of interest in a transaction, and then deferring to the board’s decision on how best to respond. If the board decides to explore a transaction that involves board-level conflicts of interest, then it should consider establishing a special committee at the outset. The decision also reinforces that fiduciaries seeking the benefit of stockholder ratification under Corwin must fairly communicate all material facts, particularly in potentially important areas like the impact of a “no” vote on control of the company, and a special committee’s change of financial advisors in the middle of a sale process.Share