CEO’s Role in Preparation of a Proxy Statement for a Merger Exposes CEO to Duty of Care Claims
In In Re Baker Hughes Inc. Merger Litig., C.A. No. 2019-0638-AGB (Del. Ch. Oct. 27, 2020), the Delaware Court of Chancery declined to dismiss claims that the CEO of Baker Hughes Incorporated (“Baker Hughes”) breached his fiduciary duty of care by failing to include unaudited financial statements of the oil and gas segment of the General Electric Company (“GE O&G”) in a proxy statement soliciting the stockholder vote on Baker Hughes merger with GE O&G. As a result, the Court found that (1) the stockholder vote was uninformed, and (2) enhanced scrutiny under Revlon, Inc. v. McAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1986). (“Revlon”) not the business judgment review under Corwin v. KKR Financial Holdings LLC (125 A.3d 304, 306 (Del. 2015)), applied to its decision whether plaintiffs had adequately pled a predicate breach of fiduciary duty by the Baker Hughes board for purposes of an aiding and abetting claim asserted against General Electric Company (“GE”). At the time of its decision, none of the Baker Hughes directors were named as defendants in the action except for Baker Hughes’ CEO who was named as a defendant in the action solely in his capacity as an officer of Baker Hughes.
This case concerned the July 2017 merger of Baker Hughes with GE O&G. At the time of signing, GE O&G’s audited financial statements were unavailable and Baker Hughes had the right to terminate the deal if GE O&G failed to deliver audited financial statements that did not differ from the unaudited financial statements in a manner that was “material to the intrinsic value” of GE O&G. Baker Hughes’ proxy statement included GE O&G’s audited financial statements and disclosed that Baker Hughes’ termination right did not apply. GE O&G’s unaudited financial statements were publicly available at the time, but were not included in Baker Hughes’ proxy statement.
The plaintiffs, in this case, made four claims: two claims for breach of the fiduciary duty of care against the CEO and CFO of Baker Hughes and two claims against GE for aiding and abetting the Baker Hughes board’s breach of the fiduciary duty of care. The defendants moved to dismiss the consolidated complaint in its entirety under Court of Chancery Rule 12(b)(6) for failure to state a claim for relief. The Court dismissed all but plaintiffs’ claim against Baker Hughes’ CEO, finding that the complaint stated a claim that he breached his fiduciary duty of care by failing to include GE O&G’s unaudited financial statements in the proxy statement.
In reaching its decision, the Court first determined whether Baker Hughes’ omission of GE O&G’s audited financial statements was material. The unaudited financials of GE O&G were publicly available at the time of the stockholder vote on the merger, but had been disclosed in only “three out of scores of filings GE and Baker Hughes made with the SEC over several months after the parties had entered into the merger agreement”. Quoting Ark. Tchr. Ret. Sys. v. Alon USA Energy, Inc. (2019 WL 2714331, at *24 (Del. Ch. June 28, 2019)) the Court stressed that “[d]isclosures are not supposed to take the form of a scavenger hunt” and, quoting Zalmanoff v. Hardy, 2018 WL 5994762 (at *5 (Del. Ch. Nov. 13, 2018)), went on to note that “our law does not impose a duty on stockholders to rummage through a company’s prior public filings to obtain information that might be material to a request for stockholder action.” The Court then proceeded to assess the actions of the Baker Hughes board under Revlon for purposes of determining whether plaintiffs had stated a claim for breach of fiduciary by the Baker Hughes board that could support the aiding and abetting claim asserted against GE.
The Court noted that enhanced scrutiny under Revlon “is not a license for law-trained judges to second-guess reasonable, but debatable, tactical choices that directors have made in good faith” and that Courts will not substitute their business judgment for that of the directors, but will determine if the directors’ decision was, “on balance, within a range of reasonableness.” With these principles in mind, the Court reviewed (i) the approval of the merger agreement and (ii) the directors’ actions after they had obtained the audited financials. In reviewing the approval of the merger agreement, the Court quoted Chester Cty. Emps.’ Ret. Fund v. KCG Hldgs., Inc. (2019 WL 2564093, at *16 (Del. Ch. June 21, 2019) (quoting In re Answers Corp. S’holders Litig., 2011 WL 1366780, at *3 (Del. Ch. Apr. 11, 2011)) in noting that “[u]nder Revlon, ‘directors are generally free to select the path to value maximization, so long as they choose a reasonable route to get there’”. Specifically, the directors had: (i) reviewed the unaudited financials only because no audited financials were then available, (ii) received a fairness opinion from Goldman Sachs, (iii) conditioned closing of the transaction on receipt of audited financial statements, and (iv) disclosed in the proxy statement that audited financial statements for GE O&G had not been available at the time of signing. Based on the foregoing, the Court concluded that the Baker Hughes board had not acted blindly in reliance on unaudited financials but had “acted within the range of reasonableness in approving the Merger Agreement based on the Unaudited Financials.” With respect to the actions of the board after receipt of the audited financials, the proxy statement acknowledged that while there were in fact differences between the unaudited and audited financials, the difference did not trigger Baker Hughes’ termination right.
The plaintiffs argued that GE aided and abetted the Baker Hughes directors’ breach of the fiduciary duty of care by creating an “informational vacuum to induce the Board into a bad deal”. The Court found no evidence of a breach of fiduciary duty by the Baker Hughes board and that even if there had been one, there was no evidence of GE aiding and abetting any such breach. The Court considered a number of prior cases where aiding and abetting had been argued and identified that “each of these ‘informational vacuum’ cases share a common theme not present in this case. They each involved a player—privy to the internal deliberations or process of a target board that had conflicting financial interests—who deliberately withheld material information from the board, thus casting doubt on the integrity of a sale process.” In this case, however, the plaintiffs did not “allege facts suggesting that GE was privy to the internal process of the Baker Hughes Board or conspired with anyone who was” and consequently this claim failed.
In conclusion of this opinion, and with respect to the failure of the CEO to attach the unaudited financials to the proxy statement, the Court pondered if later discovery would show that such failure was inadvertent or handled by advisors on which the CEO reasonably relied. This decision highlights the enhanced risks officers face when participating in a sales process given that officers, unlike directors, may not be exculpated for breaches of the fiduciary duty of care under a charter provision authorized by Section 102(b)(7) of the General Corporation Law of the State of Delaware.