As the Battle over the Universata Acquisition Rages, the Chancery Court Finds that the Appropriate Standard of Review Regarding Actions of a Stockholders’ Representative is “Subjective Good Faith”
As the battle over the acquisition of equity in Universata, Inc. continues, the Court of Chancery, in Houseman v. Sagerman, C.A. No. 8897-VCG (Del. Ch. July 20, 2021), resolved two general exceptions asserted by Plaintiffs to the Special Master’s Final Report (“Final Report”). In doing so, the Court decided that an escrow fund was properly created pursuant to the Merger Agreement, and further held that the appropriate standard of review regarding actions of the Stockholders’ Representative is “subjective good faith.” However, the ultimate resolution of all the exceptions awaits further briefing by the parties.
The litigation, initiated in 2013, concerns a challenge to the actions of the Stockholders’ Representative, Defendant Thomas Whittington (“Whittington”), following a 2011 merger between Universata and a wholly-owned subsidiary of HealthPort Technologies, LLC. Plaintiffs, former stockholders and a director of Universata, were not part of the subset of shareholders owning 72% of Universata that signed the Merger Agreement. Pursuant to the Merger Agreement, HealthPort agreed to acquire Universata for $17.5 million (the “Purchase Price”), $2.5 million of which was to be held in escrow. As part of the Merger Agreement, Whittington was designated to act as Universata’s Stockholder Representative with the full power to take any and all acts necessary in connection with the Agreement in his sole and absolute discretion. The Merger Agreement further provided that the action of the Stockholders’ Representative was binding on all owners and stockholders.
This “latest (alas not the last)” round of litigation between the parties concerns the Final Report issued by the Court appointed Special Master. On February 2, 2015, the Chancery Court appointed a Special Master to conduct a review and make findings regarding the actions of the Stockholders’ Representative, specifically the administration of a certain portion of the proceeds following the merger. On October 19, 2020, the Special Master issued his Final Report, which largely, but not entirely, supported the actions of the Stockholders’ Representative. Pursuant to Court of Chancery Rule 144, the Plaintiff took exceptions to the Special Master’s Final Report.
Here, the Court resolved two general exceptions raised by the Plaintiffs, leaving the specific exceptions to be addressed at a later time. The Court identified these two general exceptions as: (1) The Final Report erroneously found that the Escrow Amount was correctly funded by all of Universata’s former shareholders instead of the signatories responsible for indemnifying HealthPort; and (2) The Final Report applied the wrong standard of review regarding the actions taken by Shareholders’ Representative in connection with the Merger. Ultimately, the Court determined that the appropriate standard for actions of the Stockholders’ Representative is subjective good faith and that the escrow fund was properly created as called for in the Merger Agreement.
Specifically, the Court found that when addressing exceptions from a Master’s Final Report, a Court applies a de novo standard of review for both issues of fact and law, and will only order a new hearing before the Vice Chancellor when “exceptions raise a bona fide issue as to dispositive credibility determinations.” Without such an issue, the Chancery Court conducts its review on the record without the need for additional live testimony. Here, the Court determined there was no need for live testimony.
Plaintiff’s first general exception challenged the Final Report’s conclusion that the escrow fund was properly funded. Plaintiffs “seem[ed] to argue” the escrow amount should not have been established from the total purchase price. Instead, the Plaintiffs argued, it should have been established with funds from the stockholders who signed the Merger Agreement, not all the stockholders. The Court disagreed, finding that Section 1.3 of the Merger Agreement clearly provided that the Escrow Amount was part of the $17.5 million purchase price. The Court also made it clear that Section 8.2(a) of the Merger Agreement did not change its analysis because that Section outlined the types of claims the Owners are required to indemnify; it did not state who would fund the escrow.
The second challenge by the Plaintiffs concerned the appropriate standard of review regarding actions of the Shareholders’ Representative applied by the Special Master. Plaintiffs contended that the Shareholders’ Representative could not act on everyone’s behalf since not all shareholders appointed the Representative. The Court was not convinced, stating that the actions of a shareholders’ representative are generally binding on all stockholders. To further support this rationale, the Court relied upon Aveta Inc. v. Cavallieri, 23 A.3d 157, 171, 178 (Del. Ch. 2010), in which the Court of Chancery determined that non-signatories can be bound by the actions of a shareholder representative regardless of whether the Agreement explicitly provides as such. This is because 8 Del. C. Section 251 requires only that an individual be designated as the one who will follow the procedures and make or participate in the determinations called for by the Purchase Agreement. Here, like in Aveta, the Court determined the Merger Agreement designated a Shareholders’ Representative to carry out the actions contemplated by that Agreement. Thus, all the shareholders, to the extent the Merger Agreements allows, are bound by the actions and determinations of the Shareholders’ Representative regardless of whether they are signatories or not.
The Court then delved into the key takeaway from the opinion — what is the appropriate standard of review regarding the actions of a Shareholders’ Representative. The Special Master applied an abuse of discretion standard, contrary to the Plaintiffs’ contention that an “accounting” standard should have applied. The Court determined that neither party was correct, concluding that the fiduciary duties of the Shareholders’ Representative were intended to be limited to a duty of “subjective good faith.” The Court found that the Shareholders’ Representative was an agent of the shareholders whose powers and responsibilities are circumscribed by contract. Here, the Merger Agreement provided that the Shareholders’ Representative only has duties and responsibilities as “expressly set forth” in the Agreement, explicitly rejecting the Shareholders’ Representative’s common law duties. The Court determined this language to be a duty of “subjective good faith,” such that “the discretion of the Shareholder’s Representative is cabined by his determination that a contemplated action is ‘necessary, proper or convenient’ in connection with carrying out the Merger Agreement on behalf of the Shareholders.” The Court concluded by acknowledging that this was only the “first phase” of its review, and ordered the parties to set a schedule for briefing the remaining exceptions. After receiving the supplemental memoranda, the Court will further consider the Plaintiffs’ specific exceptions to the Special Master’s Final Report.