Triggering Delaware’s entire fairness review in stockholder litigation was once considered outcome determinate, but that view has waned. Numerous decisions have shown that defendants can overcome the unified fair process and fair price components of entire fairness review and avoid sizeable judgments. Despite a finding of liability against a controlling stockholder arising out his overreach into a committee’s process, the defense in In re Straight Path Communications Consolidated Stockholder Litigation, 2023 WL 6399095 (Del. Ch. Oct. 3, 2023) followed a well-worn path to success: proving the transaction’s fair price.
Background
A decade ago, a telecommunications firm, IDT Corp., created Straight Path Communications as a spin-off to hold certain assets. IDT’s founder and chairman, Howard Jonas, controlled both companies. During the spin-off, IDT also transferred to Straight Path certain broadcast spectrum licenses, which were considered inconsequential and were included for tax benefits.
Before the transfer, IDT had renewed the licenses with the Federal Communications Commission while engaging in allegedly deceptive practices. Several years after the spin-off, and thanks to the licenses’ newfound value, Straight Path’s stock price soared. But a short seller’s report exposed IDT’s earlier conduct, leading to an FCC investigation.
Straight Path had secured indemnification rights from IDT under the spin-off agreement. Straight Path and IDT coordinated and shared counsel during the FCC investigation, and several references were made to Straight Path’s indemnification rights during the process. Still, Straight Path never notified IDT that it intended to seek indemnification. After several months, Straight Path settled with the FCC for a $15 million fine and a forfeiture of numerous licenses, plus either a forfeiture of the remaining licenses, an $85 million penalty, or a percentage of the proceeds from a sale of the licenses. The sale-and-proceeds option was most attractive, and Straight Path’s board promptly pursued it. The board formed a special committee comprised of three independent directors.
The committee considered as part of the company’s assets a potential indemnification claim against IDT concerning the FCC settlement. The members explored excluding that claim from any sale. The company’s controller, Jonas, soon learned of the committee’s decision and strongly disagreed. He issued threats and hurled abuse at the members. Jonas made clear that he would reject any sale proposal that did not immediately and satisfactorily resolve the indemnification claim. He also suggested that he would remove the members from office. Jonas favored a $10 million settlement with IDT and other contingent rights.
Within weeks, the committee bowed to Jonas’s influence and agreed to his offer. The auction process soon concluded, with Verizon purchasing Straight Path for $3.1 billion. Several stockholders brought breach of fiduciary duty claims in the Delaware Court of Chancery arising from the settlement with IDT.
Court of Chancery Finds the Settlement Unfair, and Holds Jonas Liable, But Imposes Only Nominal Damages
Citing IDT’s status as Jonas’s flagship company, the Jonas families’ significant stake in IDT, and the ongoing interest in IDT post-transaction, the court found a nonratable benefit to Jonas as Straight Path’s controller and therefore applied entire fairness review. Defendants thus bore the burden of establishing entire fairness, measured by a fair process and fair price.
The court easily found the process unfair. According to the court, Jonas “made every effort to bully” the special committee into accepting his will regarding the indemnification claim. The court recounted his “campaign of abuse and coercion,” citing his incessant phone calls, threats, insults, and colorful language. The court also rejected the defendants’ attempt to characterize the committee as rogue directors set on irrationally preserving the claim in a manner threatening a lucrative sale, finding the position unsupported by the record. Jonas’s interference therefore was unjustified, and the defendants failed to demonstrate a fair process.
Despite the tainted process, the court found the price within the range of fairness. While the court rejected several of the defendants’ contentions, the court found the settled indemnification claim “economically worthless.” The court’s reasoning rested on Straight Path’s failure to fulfill the spin-off agreement’s notice and consent requirements for indemnification claims. Although the indemnification claim was an indemnifiable loss under the contract, it did not create a viable indemnification obligation for IDT. The contract’s indemnification terms included a requirement of prompt written notice and granted rights to IDT respecting any claim, including consent rights over settlement. While IDT was aware of the potential claim, Straight Path did not follow the formal procedure for demanding indemnification, and the court rejected the plaintiffs’ alternative theories of notice and consent.
Under the contract, Straight Path’s failure to provide adequate notice would relieve IDT of responsibility only if the failure “materially prejudices” IDT. And the court found material prejudice to IDT, citing IDT’s settlement consent rights. As the court observed, considering the FCC settlement’s sale-and-proceeds component IDT’s asserted liability to Straight Path easily exceeded its ability to pay. The court also concluded that Straight Path consciously chose to avoid giving adequate notice, preferring to control the settlement and promptly achieve the lucrative license sale.
Accordingly, the court found Straight Path’s indemnification claim valueless. But the analysis continued, as the court needed to determine “what the stockholders could have achieved, absent the inequities.” The court asked whether Jonas’s interference caused IDT to pay less than it would have. Reviewing the FCC settlement’s cost, the court assigned the indemnification claim an unadjusted value of approximately $294 million. The court then adjusted that valuation based on costs of litigation and the probability of success on various issues, arriving at an adjusted value of approximately $8.5 million. That valuation was below the $10 million IDT settlement payment that Jonas had brokered and thus fair.
Applying the unified entire fairness analysis, the court concluded that “while the price was fair, the transaction was tainted by [Jonas’s] flagrant breach of duty, and thus not entirely fair.” Given the fair price, Jonas’s liability was limited to nominal damages.
Key Takeaways
Straight Path reinforces that fiduciaries involved in a conflicted controller transaction featuring process flaws are not without hope in proceeding to a defense at trial. Another recent example is In re BGC Partners Derivative Litigation, 2022 WL 3581641 (Del. Ch. Aug. 19, 2022), aff’d 2023 WL 5127340 (Del. Aug. 10, 2023). Still, decisions imposing substantial liability abound and fiduciaries should heed their lessons. In that regard, Straight Path provides another sample of conduct to avoid. Overreaching by controllers unfortunately remains a repeat storyline in Delaware decisional law. The options to avoid or lessen the associated costs, distraction, and potentially liability include insulating the transaction by employing and respecting protection devices, such as the dual protections of Kahn v. M & F Worldwide, 88 A.3d 635 (Del. 2014).
