Chancery Enjoins Unfair Merger Pending Corrective Disclosures, But Declines to Order a “Go Shop”
FrontFour Capital Grp. LLC v. Taube, C.A. No. 2019-0100-KSJM (Del. Ch. Mar. 11, 2019)
This decision involves an increasingly rare occurrence in Delaware: an expedited pre-closing fiduciary duty challenge to a proposed merger. Specifically, stockholders challenged a proposed combination of a publicly traded asset management firm (Medley Management) with two corporations that it advises pursuant to management agreements: Medley Capital Corporation and Sierra Income Corporation. The proposed transaction involved Sierra acquiring Medley Management, which is majority owned by the Taube brothers, and Medley Capital, of which the Taube brothers owned less than 15%. Medley Management stockholders were to receive cash and stock representing a 100% premium to its trading price. By contrast, Medley Capital stockholders were to receive only shares of Sierra stock providing no premium against its net asset value. When a Medley Capital investor brought suit in early February, the parties agreed to an expedited trial four weeks after the filing of the case, prior to a March 11 stockholder vote on the merger.
Among other things, the Court held that, notwithstanding their relatively small interest in Medley Capital, the Taube brothers were controlling stockholders in the context of the transaction. They were able to exercise de facto control because a majority of the members of a special committee formed to negotiate on Medley Capital’s behalf lacked independence. Among other things, the directors received fees totaling several hundred thousand dollars, and wished to remain as directors after the merger. They also “willfully deferred” to the Taube brothers by agreeing to the proposed merger after a truncated one-month negotiating period, and also agreed to a suite of deal protection that included a “no shop.” They permitted the Taube brothers to “dominate the process by: setting the deal structure; controlling the flow of information; withholding information; withholding details about [another constituent corporation’s] value and the existence of offers from third-parties, and locking out ‘interlopers’ through standstill agreements, deal protections, and an aggressive timeline; rushing the committee’s deliberations.” Among other troubling facts, the directors (i) believed incorrectly that recent prior efforts had been made to shop the company, (ii) were unaware that a prior sale process for Medley Management involved dozens potential acquirers entering into standstill agreements that would prohibit them from pursuing a transaction with Medley Capital, and (iii) were not informed of third-party expressions of interest. Due to these problems and the lack of persuasive evidence that the merger price was fair, the Court held that the Taube brothers and the defendant-directors breached their fiduciary duties. Relatedly, the disclosures soliciting stockholder approval for the transaction were deficient for failure to disclose these process flaws. In the circumstances, the deal protection measures also were unreasonable and therefore failed to withstand enhanced scrutiny.
With respect to the remedy, the Court enjoined the stockholder vote pending corrective disclosures. The Court reasoned, however, that controlling precedent prohibited the most equitable remedy: a Court-ordered “go shop” free from deal protections. Specifically, the Delaware Supreme Court’s decision in C & J Energy Services, Inc. v. City of Miami Gen. Empls. and Sanitation Empls. Ret. Tr., 107 A.3d 1049 (Del. 2014) prevented the Court from infringing upon the acquirer’s rights in the deal protection provisions without a finding of wrongdoing on its part. Although the plaintiffs alleged that Sierra aided and abetted the breaches of fiduciary duty, the record provided “no window into the deliberations on the Sierra-side of the negotiations,” because the members of Sierra’s special committee did not testify, and the plaintiffs’ briefing did not address the aiding and abetting claim against Sierra. The Court accordingly held it could not grant relief from the deal protection measures and order a “go shop.”