A plaintiff challenging a merger when a majority of the board approving the transaction is disinterested and independent and there is no controlling stockholder on both sides cannot state a cognizable claim of breach of fiduciary duty unless it can plead facts demonstrating that the business judgment rule does not apply. One way to plead around the business judgment rule is to assert that a merger partner offered material compensation to the opposing party’s lead negotiator in the midst of uncertain merger negotiations to incentivize him to do as little as possible to improve the merger consideration for his stockholders. That allegation would have to be coupled with a claim that the compensation was subjectively material to the lead negotiator and that he failed to disclose it to the full board. Such cases do not often arise so case law guidance concerning materiality in terms of director disclosure to fellow directors is less fulsome than that addressing the standard of materiality in the stockholder disclosure context. In City of Fort Myers General Employees' Pension Fund v. Haley, No. 368, 2019 (Del. Supr. June 30, 2020) the Delaware Supreme Court, by a 4-1 vote, reversed and remanded a Court of Chancery decision that Plaintiffs had failed to plead around the business judgment rule because the compensation package at issue and its non-disclosure was not material in light of what the Board already knew. The case is significant for articulating the standard applicable to evaluating director disclosure to fellow directors and what facts are necessary to plead that the business judgment rule does not apply when the plaintiff attacks the interest of only one officer and director.
This case involved a merger of equals, Willis Group Holdings Plc ("Willis") and Towers Watson & Co. ("Towers"). When the parties announced the deal, market reaction was negative for the Towers stockholders. Analysts noted, for example, that the Towers stockholders’ shares in the exchange ratio were valued at 9% below the unaffected trading price even though the financial performance metrics for Towers were much stronger than those of Willis. In this atmosphere of uncertainty over deal consummation, a representative of Value Act, a large stockholder of Willis, proposed a compensation package (“the Proposal”) to the CEO of Towers, John Haley, who was to serve as the CEO of the combined entity. That Proposal would have significantly increased the upside potential over three years from Haley’s existing compensation plan of $24 million to $140 million. When the parties issued their joint proxy, they did not mention the Proposal, the extent of the post-signing discussions or Value Act’s role in the executive compensation discussions with Haley.
The market reaction was so negative that Towers adjourned its stockholder meeting when it had received only about 43% stockholder approval. Thereafter, the Towers Board met to discuss potential revisions to the merger agreement. Haley did not disclose the Proposal at that meeting. The Board agreed to increase a special dividend from $4.87 to $10 per share. Plaintiff alleged that, because of his interest in the undisclosed Proposal, this increase reflected the bare minimum necessary to assuage the Towers stockholders. The Towers stockholders later approved the revised deal at a reconvened stockholder meeting.
In the litigation that followed, the Court of Chancery held that plaintiff had failed to allege that the non-disclosure of the Proposal was material because the Towers Board knew that Haley was going to be the CEO of the combined entity and that his compensation would be greater because the entity would be larger. Second, the Court held the Proposal was not binding and reflected upside potential only for pie-in-the-sky circumstances. The Court thus held Plaintiffs had not overcome the business judgment rule and dismissed the complaint.
In reversing, the Supreme Court reaffirmed that to state a claim in these circumstances, a plaintiff would have to allege that a director was materially self-interested; that the director failed to disclose his interest to the board; and that a reasonable board member would find the director’s material self-interest a significant fact in their evaluation of the proposed transaction. The Court defined “materiality” as “relevant and of a magnitude to be Important to directors in carrying out their fiduciary duty of care in decision-making.” (citation omitted). Id. at 29. Applying that standard, the Supreme Court held that “Plaintiffs are entitled to an inference that the prospect of the undisclosed enhanced compensation proposal was a motivating factor in Haley’s conduct on the renegotiations to the detriment of Towers stockholders.” Id. at 34. The Court noted that the fact that the compensation package ultimately approved post-closing had even greater upside reward led to the reasonable inference that the Board and Haley believed the milestones were attainable. The Court also found that Plaintiffs adequately alleged that Haley did not disclose the Proposal to the Towers Board. Finally, the Court also found that testimony from a disinterested director who served as Chair of the Compensation Committee that he would have wanted to know about the Proposal indicated that a reasonable director would have viewed the ValueAct Proposal as a significant fact in the evaluation of the transaction.
This case provides guidance on the application of the standard of materiality to disclosures of interest by board members to their colleagues. The fact that a dissenting Justice found that the disclosure of the Proposal was not material in light of the Towers Board’s knowledge that post-merger, Haley would be the CEO of the combined, larger entity, underscores that these judgments are not always clear-cut.