Chancery Finds Inadequate Disclosure in Connection With a Tender Offer Prevents Dismissal of a Class Action Complaint

The Corwin doctrine provides substantial protection to directors of companies engaged in a sale process. Once a transaction closes, if a stockholder cannot allege that a majority stockholder vote approving a transaction was uninformed or coerced, then the court will dismiss a complaint attacking the fairness of the transaction under the business judgment standard of review. The rationale is that majority disinterested stockholder approval via a vote or a majority tender cleanses the transaction unless plaintiff can meet the high burden of pleading waste. Directors are also protected if a company’s charter contains protections under Section 102(b)(7) of the Delaware General Corporation Law (DGCL) and a plaintiff cannot allege that a majority of the directors acted disloyally or in bad faith. The Court of Chancery’s well-reasoned decision in In re Tangoe Stockholders Litigation, Cons. C. A. No. 2017-0650-JRS  (Del. Ch. November 20, 2018), provides important guidance for directors seeking protection under either Corwin or Section 102(b)(7) when a board of a publicly traded company runs a sale process while it is attempting to restate its financials, its stock has been de-listed, and the Securities and Exchange Commission is threatening de-registration.

Court Finds Uninformed Stockholder Tender Rendered ‘Corwin’ Inapplicable at the Pleadings Stage

The Tangoe court denied directors’ motion to dismiss under Corwin. It held that,  in the context of a failed attempt by the board to accomplish a restatement of its financials (restatement) and the board’s decision to focus instead on a sale of the company, the board’s failure to provide audited financial statements and an adequate explanation of the status of the restatement were material omissions. While acknowledging that audited financial statements are not per se material, the court held that the company’s prior disclosure of financial information being sporadic, the failure of the board to disclose a quality of earnings reports it had received from a third-party adviser, the failure to file multiple 2016 quarterly reports and the failure to hold an annual stockholders meeting for three years, “support[ed] a reasonable inference that stockholder approval of the Transaction was not fully informed in the absence of adequate financial information about the company and its value. The court also held that the board failed “to take special care to explain to stockholders what was happening with the restatement” in light of the delisting and threatened de-registration. Simply stated, “when deciding whether to tender their shares, Tangoe stockholders did not know whether the company would ever complete the restatement, let alone when.”

Court Finds Complaint Adequately Alleged Disloyal Conduct

The specific facts alleged in the complaint also supported the court’s conclusion that plaintiff pleaded a non-exculpated claim for breach of fiduciary duty. The context mattered to this conclusion, i.e., the fact that the board created and issued alternative compensation for directors because the normal issuances of equity under an existing equity incentive plan became impossible while the restatement was unfinished. The new compensation awards vested on an accelerated basis upon a change in control. These facts supported plaintiff’s allegation that the new compensation “incentivized the director defendants as beneficiaries of those awards to steer Tangoe into a sale of the company, not because a sale was in the best interests of stockholders, but because a sale was the most likely means by which the director defendants would receive  generous [compensation] that approximated the generous equity awards they would have received if only the company could complete the restatement.” That the board adopted the new compensation awards shortly after the company failed to meet the NASDAQ’s deadline to earn regulatory compliance led the court to “reasonably infer a temporal connection between the adoption of the [new compensation awards] and the board’s decision to shift course toward an allegedly ill-advised sale of the company.” The court found that the new awards provided “reasonably conceivable material benefits to the director defendants” totaling $5.0 MM upon consummation of the sale versus the  “increasingly chimerical” prior equity issuances as the restatement remained unfinished. Finally, while again acknowledging that generally the mere existence of a looming proxy contest does not by itself remove business judgment protection to subsequent board conduct, the looming proxy contest becomes more relevant in light of other pleaded facts concerning the inability to complete the restatement, the timing of the adoption of the alternative compensation awards, and that the board recommended that stockholders accept steadily decreasing offers.

Lesson Learned

Directors wishing to obtain business judgment review of their conduct in a sale process under Corwin must ensure that any stockholder vote is informed. Context matters. Thus, while audited financial statements are not per se required to be disclosed, the failure to provide such information can become material when the company has been unable to restate its financials,  the company has been de-listed, the board has failed to convene an annual meeting of stockholders for three years, the company’s prior financial disclosures have been sporadic, and the board declines to fill the information vacuum by not sharing a quality of earnings report it had received. These pleaded facts also caused the court to give greater weight to the existence of a looming proxy contest in weighing whether directors’ potential self-interested motives rendered business judgment rule deference inappropriate and prevented a Section 102(b)(7) defense at the pleadings stage. The existence of the Corwin doctrine and Section 102(b)(7) continue to provide protections to directors but a plaintiff who can plead a failure to make adequate disclosure and specific facts creating inferences of self-interested and disloyal conduct can survive a motion to dismiss.