Chancery Rules Failure to Disclose “Intrinsic Value” Precludes Corwin Defense – But Does Not Necessarily Suggest a Breach of the Duty of Loyalty
In In re USG Corp. S’holder Litig., 2020 WL 5126671 (Del. Ch. Aug. 31, 2020), the Court of Chancery granted the director-defendants’ motions to dismiss post-closing money damages claims arising out of the sale of USG Corporation (“USG”) for less than what USG’s directors allegedly thought was its intrinsic value. Although the failure to disclose such “intrinsic value” prevented dismissal under Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015), Vice Chancellor Sam Glasscock III held that, in the circumstances, that omission and the directors’ approval of the sale did not suffice to plead a breach of the directors’ fiduciary duty of loyalty.
The stockholder-plaintiffs’ claims arose from the 2018 acquisition of USG, a leading American producer of building materials, by Gebr Knauf KG and its affiliates (collectively “Knauf”). Knauf was a German manufacturer that owned 10.6% of USG’s stock. Berkshire Hathaway owned an additional 31.1% and had indicated publicly that it wished to exit its investment.
USG initially rebuffed Knauf in order to pursue the potential superior long-term value suggested by its strategic plan. Knauf then began to seek Berkshire Hathaway’s support, and re-approached USG to propose an all-cash acquisition at $40.10 per share. After consulting financial advisors, USG’s board of directors (“Board”) responded that the offer was inadequate when compared with USG’s standalone prospects.
Knauf then publicly made an all-cash offer at $42 per share, and discussed a transaction at that price with Berkshire Hathaway. After again consulting advisors, the Board again rejected Knauf’s approach in favor of the higher intrinsic value implied by its strategic plan.
Knauf then began to solicit stockholders to withhold support for USG’s nominees at its upcoming annual meeting to elect directors (the “Withhold Campaign”). Knauf’s proxy materials criticized USG’s decision not to sell and noted Berkshire Hathaway’s support for a transaction. Berkshire Hathaway announced its support for a sale and the Withhold Campaign. USG advocated publicly against both. USG also contacted several other potential acquirers, but none could rival Knauf’s bid at the time.
Proxy advisory firms publicly supported the Withhold Campaign. Informed by its advisors that a majority of stockholders likely would too, the Board authorized negotiations within a range of $48-51 per share. The directors, however, followed management’s recommendation not to announce publicly their view of USG’s intrinsic value. USG also made a counteroffer of $50 per share.
At the annual meeting, 75% of USG’s stockholders voted against USG’s director nominees, which resulted in them not being reelected and instead having the status of holdover directors. In subsequent negotiations, Knauf offered $43.50, USG countered at $47, and Knauf made a “best and final” $44 per share offer. After considering the potential for USG to proceed on a hostile basis and to oppose USG’s nominees at the next annual meeting, the Board unanimously resolved to accept it. USG’s Proxy Statement stated that the Board believed $44 per share provided “attractive value” in light of financial analyses and the cyclical nature of the industry.
Stockholder-plaintiffs then sued and unsuccessfully moved to enjoin the merger. After the transaction closed, the plaintiffs amended their complaint to assert only money damages claims against the director-defendants, who moved to dismiss on the basis of Corwin, among other grounds.
The Court of Chancery's Decision
The Vice Chancellor ruled that one of the plaintiffs’ disclosure claims adequately plead a material omission – i.e., that the director-defendants failed to disclose their actual conclusions of USG’s higher “intrinsic value.” The Court reasoned that, as recent Delaware appraisal cases have suggested, “intrinsic value” or “fair value” are “nebulous, even illusory, concepts.” With a “but see” cite to Delaware’s appraisal statute, the Court reasoned that “[b]elief in any particular intrinsic value, by any being less than an omniscient god, is necessarily a belief that is subjective in nature.” The Court held, however, that “because the Proxy Statement disclosed that the Board held a view of intrinsic value and frequently referenced such a view during its disclosures about the sales process, USG’s stockholders were entitled to know the Board’s opinion of USG’s intrinsic value, even if it was unachievable due to market forces and Knauf’s threats to launch a hostile takeover.”
While the failure to disclose the Board’s view precluded Corwin deference, it did not necessarily follow that the plaintiffs had stated a money damages claim, because the directors were exculpated from liability for duty of care claims pursuant to a charter provision authorized by 8 Del. C. § 102(b)(7). Accordingly, the plaintiffs had to show that the disclosure violation arose from a breach of the directors’ duty of loyalty, either because the directors were (i) interested in the transaction and/or lacked independence, or (ii) acted in “bad faith.”
The Court rejected the plaintiffs’ principal argument that the directors faced an “inherent positional conflict” from the prospect of future adverse proxy solicitations or takeover attempts, which the plaintiffs argued would harm the directors’ reputations and business prospects. Plaintiffs pointed to a law review article by then-Chief Justice Strine stating that independent directors are “highly sensitive to resisting institutional campaigns at any company on whose board they serve for fear that they will be targeted for withhold campaigns at all companies with which they are affiliated.” Leo E. Strine, Jr., Who Bleeds When the Wolves Bite?: A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System, 126 Yale L.J. 1870, 1926 (2017). The Court emphasized that, even accepting that as true, it was inapt in the specific circumstances alleged, in which the directors “had already lost a public fight” in the Withhold Campaign; by resisting Knauf leading up to the annual meeting, the directors had “accept[ed] the reputational harm of an institutional campaign defeat in order to continue to pursue the corporate interest.”
The Court also found that the plaintiffs did not adequately plead “bad faith” – i.e., that the directors “intentionally withheld their view of intrinsic value in conscious disregard of their fiduciary duties.” Because the plaintiffs failed to plead that the directors were improperly influenced by extraneous considerations, the Court reasoned that the plaintiffs “must allege bad faith ‘in the disclosures themselves.’” (quoting Morrison v. Berry, 2019 WL 7369431, at *18 (Del. Ch. Dec. 31, 2019)). Other disclosures in the Proxy Statement, however, negated any potential inference of scienter. Among other things, the Proxy Statement disclosed that the Board’s insistence upon a $48-51 per share negotiating range was informed by the Board’s view of intrinsic value. The Court also emphasized that the Proxy Statement disclosed that “the Board had chosen not to make that very disclosure [i.e., of intrinsic value].” The Court reasoned that a Board acting with scienter would not have affirmatively disclosed its decision to withhold this information.
The Court otherwise rejected the Plaintiffs’ argument that allegations of violations of so-called “Revlon duties” to attain the highest reasonably achievable price in a sale of control sufficed to state a non-exculpated claim against the directors. Rather, the plaintiffs bore the burden to show a “bad faith” process leading up to the transaction. The plaintiffs alleged no facts from which the Court could infer that the “negotiation process was a sham or that the Board was not actually seeking a higher price for USG.” While the Plaintiffs may contend that the Board negotiated poorly or unreasonably, that alone is insufficient to show bad faith. Although the Board was “against the ropes after being trounced by its two largest stockholders in the Withhold Campaign[,]” the Board tried to negotiate a higher price with the help of financial professionals, and tried to solicit competing offers. This was far from the “extreme set of facts” needed to show a bad faith sale process.
Accordingly, the Court granted the director-defendants’ motions to dismiss.
This case illustrates certain challenges that stockholder-plaintiffs face in pursuing post-closing damages claims where a majority of the board of directors are disinterested and independent; “bad faith” disclosure violations and sales processes are not easy to show. The opinion also supports that, depending upon the circumstances, a decision to sell for less than directors’ subjective views of potential “intrinsic value” may not evince “bad faith” indifference to directors’ duties; here, the directors apparently took into account the potential disruptive effects of defending a hostile takeover and USG’s stockholders’ support for a sale transaction. The Court’s discussion that concepts of “intrinsic value” or “fair value” necessarily are subjective and may even be “illusory” add to recent Delaware appraisal decisions expressing like sentiments.Share