Stockholder M&A challenges in the Delaware Court of Chancery have declined in the wake of the well-known Trulia (and its federal corollary Walgreens) and Corwin decisions, which respectively reduced incentives for pre-closing M&A challenges by outlining a strict standard of review for disclosure-only settlements; and confirmed that, regardless of whether the process at issue complied with Revlon, transactions approved by an informed and uncoerced stockholder vote are subject to the protections of the business judgment rule. Against this backdrop, the Court’s year-end decision in Lavin v. West Corp., C.A. No. 2017-0547-JRS, 2017 WL 6728702 (Del. Ch. Dec. 29, 2017), is of note, as it endorses the use of books and records demands to help stockholders meet Corwin’s pleading demands.
Prior to the merger at issue, West Corporation (the company) was a publicly traded corporation that provided global communications and networking services. It featured four business lines, the largest of which was its Unified Communications Services (UC) line, accounting for over 60 percent of the company’s revenue and operating income.
With respect to governance, approximately 25 percent of the company’s shares were owned by two private equity funds that together had owned a majority of the Company prior to recent share divestitures. Despite the divestitures, under a stockholder agreement, the two funds retained the right to appoint half of the members of the company’s 10-member board of directors (the board). Three of their designees were principals of the two funds, and two were putatively independent. The company’s chairman and CEO also served on the board.
In September 2015, the company began to receive unsolicited expressions of interest in acquisitions of one or more of the company’s business lines. By early 2017, the board focused on the sale of the company as a whole. Thereafter, the company received two offers from parties interested in acquiring business lines, other than the large UC line, at prices in excess of $2 billion. The board then began negotiating exclusively with Apollo Global Management (Apollo) toward an acquisition of the company as a whole. On May 9, 2017, the company signed a merger agreement for aggregate per share consideration of $2 billion in cash and the assumption of the company’s long-term debt of $3.2 billion.
The merger agreement contained a no-shop provision with a fiduciary out for “superior proposals,” with a caveat that such “superior proposals” must have been to acquire at least 70 percent of the company’s assets, revenue or shares. Given the size of the UC business line, this provision would effectively bar consideration of offers for one or more of the company’s other business lines even if such offers were preferable to Apollo’s offer for the Company.
Within days of the issuance of a proxy statement soliciting stockholder approval for the merger, federal securities class actions lawsuits were filed outside of Delaware alleging disclosure-based claims. The company filed a supplement mooting those claims. The merger was approved almost unanimously by the roughly 86 percent of the company’s stockholders who voted. In connection with the transaction, the company’s chairman and CEO received approximately $19 million in “golden parachute” payments. Other officers also received “golden parachute” payments. The company’s nonemployee directors each received a $100,000 cash payment and accelerated vesting of restricted stock units worth roughly an additional $100,000.
A week before the merger vote, the plaintiff made his books and records demand on the company. After the demand was rejected, the plaintiff filed suit on July 27, 2017, the date after the vote. Trial was held on a paper record on Oct. 9, 2017. The merger was scheduled to close by year end.
The Parties’ Arguments
The plaintiff argued that the facts provided a credible basis to suspect that the board knew that the most value-maximizing option was to sell one or more business lines, but that option, unlike the sale of the Company as a whole, would not provide personal benefits for the Company’s directors and officers or the large private equity fund stockholders who allegedly needed liquidity. The plaintiff argued the Company’s financial advisor similarly was incentivized to favor a Company sale, as its fee was largely contingent upon the consummation of the merger. The plaintiff accordingly argued that he had a credible basis to suspect that the Board violated its Revlon duties, possibly in bad faith. The plaintiff also alleged disclosure violations in that the proxy statement omitted analyses of the different business lines, the financial advisor’s sums-of-the-parts analyses, and disclosures of relationships between directors and the private equity funds.
In response, the Company argued that (i) that the plaintiff did not show that a majority of the Board suffered from disabling conflicts of interest, (ii) the plaintiff’s purported disclosure challenges were of the “tell me more” variety that are not actionable under Delaware law, and (iii) under Corwin, the fully-informed stockholder vote rendered the merger subject to the protections of the business judgment rule.
The Court’s Analysis
First, the court acknowledged that the “credible basis” standard to obtain books and records is the lowest burden of proof in Delaware corporate law, and merely requires “some evidence” of potential wrongdoing.
Turning to the purported Corwin defense, the court held that “Corwin does not apply in the Section 220 [books and records demand] context.” It reasoned that Corwin requires a plaintiff bringing a substantive challenge to a transaction approved by a stockholder majority to identify a disclosure deficiency. Further, Delaware courts’ “encouragement (or admonition)” that stockholders use the “tools as hand” before filing complaints that are subject to heightened pleading requirements is apt to M&A litigation in a post-Corwin world. Indeed, stockholders’ difficulty in meeting a heightened pleading standard while armed only with public filings was “precisely the dynamic that caused our courts to encourage use of the ‘tools at hand’ in the derivative context.” Moreover, the court reasoned, as long as the potential claims the stockholder seeks to investigate are not barred or subject to exculpation as a matter of law (and given the plaintiff’s allegations of bad faith, his potential claims were not), a plaintiff’s ultimate likelihood of success was not germane in a narrow books and records action.
In sum, the court reasoned that it was “simply recognizing” the stockholder’s burden in seeking to challenge the merger, and that documents received pursuant to a books and records demand “may enable him to prepare a better complaint[” which in turn “will assist the court in making an informed decision” at the motion to dismiss stage.
Having held that Corwin is not a defense in this context, the court found that the evidence revealed a credible basis to infer that the private equity funds, the board and members of management may have favored a whole company sale, versus a sale of specific business lines, to benefit their own interests at the expense of the stockholders as a whole. With respect to the scope of inspection, the court ordered the production of inter alia any sum-of-the-parts analyses, any indications of interest or offers for the company as a whole or any business lines, and communications related to a potential sale of the company or business lines between certain directors and the financial adviser or any potential acquirers, specifically including emails, memoranda and notes.
The Lavin decision makes it somewhat more viable for diligent stockholder-plaintiffs to bring post-closing challenges to M&A transactions in a post-Corwin world. Where a books and records suit is filed before closing, a stockholder will retain standing to seek documents needed to show whether the stockholder vote approving the transaction was fully-informed. The utility of this approach going forward will depend in part on the application of the “credible basis” standard. Here, facts regarding the private equity fund stockholders, the board and the incentives affecting each were sufficiently suggestive to the court of bad faith. Ultimately, however, whether Lavin affords a viable path forward for stockholders may depend upon various factors outside of a stockholder-plaintiff’s and the court’s control. Specifically, although the merger here was challenged outside of Delaware before the closing, those cases were mooted by supplemental disclosures—leaving stockholders free to bring claims. Had there been a settlement with a broad, classwide release, the potential path to fiduciary review endorsed by the Lavin decision may not have been viable.