Contract and fiduciary duty law intersect when how a board acts, including the vote required, is affected by a shareholder agreement. Such agreements are common to enable investors to protect their investment, either through negotiated buybacks or issuance of additional shares upon certain milestones, through board seats or through super-majority vote requirements where the investment, while substantial, does not result in majority control. When a dispute arises over the effect of a shareholder agreement on a board vote a Delaware court will apply traditional principles of contract interpretation to ascertain and enforce the parties' intent. The language the parties use to reflect their agreement at the time of the investment will determine the outcome of the dispute when it arises long after, such as when the board acts to dissolve the entity. The Delaware Court of Chancery's well-reasoned decision in The Huff Energy Fund v. Gershen, C.A. No. 11116-VCS (Del. Ch. Sept. 29), illustrates the care by which a Delaware court will examine the potential contractual and fiduciary duties at issue when a board adopts a plan of dissolution following a sale of a significant portion of its assets.
Background
Huff arises out of a decision in May 2015 by the board of Longview Energy Company to dissolve after selling a significant portion of its assets. Plaintiff Huff Energy Fund, a holder of 40 percent of Longview stock with two board designees, had insisted that Longview dissolve following any significant asset sale to avoid a tax burden. When Longview actually dissolved, Huff Energy claimed that because the plan of dissolution had a material adverse effect on Longview's stockholders, a unanimous vote was required under a shareholders agreement entered into at the time of Huff Energy's investment. The plaintiff claimed that because a Huff Energy director abstained, the vote was not unanimous and therefore invalid. The plaintiff also claimed that the board breached fiduciary duties under Revlon by dissolving without exploring more favorable alternatives or Unocalby approving the plan of dissolution as an unreasonable response to a perceived threat. Defendants claimed directors who were not parties to the shareholders agreement cannot be liable for breach of contract by Longwood, that unanimous approval was not required because the plan of dissolution did not harm Longwood's shareholders and had no material adverse effect on Huff Energy, that neither Revlon nor Unocal applied and that in any event, the uncoerced, fully informed vote of a majority of shareholders results in the business judgment rule irrebuttably applying and thus required dismissal. As explained below the court sided with defendants in dismissing Huff Energy's complaint.
Court Rejects Huff Energy's Contract Claims
The court reaffirmed that directors who are not parties to a shareholders agreement cannot be liable for breach of that contract. The court also rejected the plaintiff's attempt to argue that director defendants' adoption of the plan of dissolution tortiously interfered with Huff Energy's rights under the shareholders agreement. That was because the plaintiff never pleaded that claim, and also because nothing in the complaint reflected nonconclusory facts that the director defendants intentionally caused Longwood to breach the shareholders agreement or to act without justification. Finally, the court found that unless the shareholders agreement created a right, as opposed to referencing a right that is extra-contractual, the parties did not intend such right to be "set forth" in the shareholders agreement. That is significant because only actions or omissions that would have a material adverse effect on the rights of any Longview shareholder "as set forth" in the shareholders agreement required unanimous board approval. Under that analysis the court found that the parties in the shareholders agreement did not intend for verbiage acknowledging a right of Longview shareholders to sell their shares to create a right of transferability— the plaintiff conceded that its right of transferability was not created by the shareholders agreement—and therefore any effect of the plan of dissolution on Huff Energy's right to transfer its shares did not require unanimous board approval.
Court Rejects Applicability of Entire Fairness Standard, 'Revlon' and 'Unocal'
In rejecting the plaintiff's attempt to argue that a majority of the board that approved the plan of dissolution was not disinterested and independent because certain directors received severance payments, the court relied upon well-settled precedent that "the possibility of receiving change-in-control benefits pursuant to pre-existing employment agreements does not create a disqualifying interest as a matter of law." Moreover, the severance payments at issue resulted from the asset sale that preceded the adoption of the plan of dissolution, and therefore the severance payments were not relevant to the board's conduct in approving that plan. More significant was the court's determination that the adoption of a plan of dissolution was not a "final stage" transaction that implicated Revlon. The court reasoned that under Delaware law the corporation remains in existence for at least three years following dissolution, and the directors retain their fiduciary duties and remain in control of the remaining assets. Therefore, the adoption of a plan of dissolution does not result in a cash sale, breakup or change of control transaction that fundamentally alters ownership rights so as to trigger enhanced scrutiny under Revlon. Similarly, the court found no support for the proposition that the adoption or filing of a plan of dissolution in this case implicated the "omnipresent specter" of a board acting for entrenchment purposes that might argue for enhanced scrutiny under Unocal.
Court Finds Stockholder Vote Cleansed Transaction
The court also grounded its dismissal on the effect of stockholder approval on any claim attacking the adoption of the plan of dissolution regardless of whether enhanced scrutiny was warranted. With the court finding that the plaintiff's claim lacked merit that the Board was required to disclose the reasons why one director abstained, and further that it was not misleading to state that the board recommended the plan of dissolution even though the vote was not unanimous, the plaintiff lacked a viable disclosure claim. Therefore, the court, extending the holding from Corwin beyond the merger and acquisition and tender offer context to a stockholder vote on dissolution, held that the business judgment rule irrebuttably applies and the complaint must be dismissed unless the plaintiff could plead waste which the court found it failed to do.
Lessons Learned
Delaware courts enforce shareholders agreements and apply the objective theory of contract interpretation to ascertain the parties' intent. If a party wishes to have veto power over the board's adoption of a plan of dissolution, it should so state in plain language. Absent such clear expression, a Delaware court will not enforce a unanimous vote requirement for board action. Moreover, regardless of whether enhanced scrutiny arguably might apply to measure a board's fiduciary conduct, a fully informed, uncoerced stockholder vote will create an irrebuttable presumption that the business judgment rule applies to a stockholder vote on dissolution, leaving a plaintiff with no claim other than waste. Huff Energy demonstrates that a plaintiff will have a difficult time stating a claim when fully informed stockholders approve a transaction that does not involve a controlling stockholder.
