Chancery Court Dismisses Complaint, Holding That Directors Were Not Conflicted in Approving a Merger Simply Due to the Threat of a Looming Proxy Contest
In Rudd v. Brown, et al, C.A. No. 2019-0775 MTZ (Del. Ch. Sept. 11, 2020), the Delaware Court of Chancery (the “Court”) dismissed the plaintiff’s claim that the board members and the chief financial officer of Outerwall, Inc. (the “Company”) disloyally pursued and disclosed a two-step merger, finding that the plaintiff failed to show that the defendants were conflicted, despite the potential that the director defendants would lose their seats in connection with a threatened proxy contest.
The Company operates and maintains self-service kiosks, including Redbox and Coinstar kiosks. During 2015 and 2016, the Company experienced declining revenues. In 2016, Engaged Capital, LLC, an activist investor (“Engaged”), purchased significant holdings of the Company’s stock. Engaged filed a public disclosure, expressing dissatisfaction with the Company’s corporate governance and strategy and threatening to replace multiple directors at the upcoming annual meeting.
Shortly thereafter, the Company’s board of directors started exploring a sale of the Company and approached potential bidders. After reviewing numerous acquisition proposals, the board agreed to sell the Company to Apollo Global Management and certain of its affiliates (“Apollo”). In September 2016, Apollo completed the purchase of the outstanding shares of the Company through an all-cash tender offer and subsequent short-form merger (the “Acquisition”). In September 2019, the plaintiff filed a class action, seeking damages on the theory that the defendants breached their fiduciary duties in connection with the Acquisition. In particular, the plaintiff claimed that the defendants failed to take reasonable efforts to maximize the value of the Company and accepted inadequate consideration. Additionally, the plaintiff claimed that the defendants failed to disclose material information concerning the Acquisition, specifically as it related to the Company’s financial projections disclosed on a consolidated basis instead of segment-by-segment.
The defendants moved to dismiss the suit pursuant to Court of Chancery Rule 12(b)(6), for failure to state a claim upon which relief can be granted, presenting three grounds for dismissal. They argued that the plaintiff’s 2019 suit, based on the 2016 Acquisition, was barred by laches. Secondly, they argued that the plaintiff failed to plead a non-exculpated fiduciary duty claim against the director defendants, because the Company’s certificate of incorporation contained a provision that exculpated the directors for monetary damages for duty of care violations. Thirdly, the defendants argued that the suit should be dismissed under the Corwin v. KKR Financial Holdings decision (125 A.3d 304 (Del. 2015)), which held that the acceptance of a first-step tender offer by fully informed, disinterested stockholders in a two-step merger has the same cleansing effect as a vote in favor of the merger by fully informed, disinterested stockholders. Despite the plaintiff-friendly pleading burden, , the Court concluded that the plaintiff failed to plead viable claims against each defendant and dismissed the case.
Addressing the defendants’ exculpation defense, the Court noted that the Delaware courts have consistently held that an exculpatory charter provision under 8 Del. C. §102(b)(7) bars the recovery of monetary damages from directors for a duty of care claim. Thus, a shareholder’s complaint must allege well-pled facts that implicate breaches of the duties of loyalty or good faith. The fact that the Acquisition was subject to intermediate scrutiny under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 183 (Del. 1986) because it involved a change of control, did not eliminate the requirement that the plaintiff plead sufficient facts to support a non-exculpated claim for breach of fiduciary duty.
To support a claim that the defendants acted disloyally, the plaintiff asserted that each director lacked disinterestedness or independence due to the desire to avoid being replaced by Engaged directors. The Court noted that the Delaware Courts are reluctant to find that directors are conflicted merely because they might face reelection opposition, but acknowledged that the threat of a proxy contest might infer a conflict when coupled with other factors. Distinguishing cases cited by the plaintiff, the Court discussed factors such as directors who revised their equity compensation agreements to benefit from a change in control, neutralized a proxy contest by selling the company’s assets to an insider board member, or sold the company for less than fair value in response to activist pressure. In contrast, the plaintiff did not allege factors other than the proxy contest that would make it reasonably conceivable that the defendants were conflicted. The Court added that the plaintiff’s failure to adequately plead a non-exculpated breach of fiduciary duty claim also compelled dismissal of the plaintiff’s disclosure claim. Even assuming that the challenged disclosures were deficient, the plaintiff failed to plead that the disclosures were made disloyally or in bad faith.
Next, the Court addressed the plaintiff’s claims that particular defendants were conflicted for reasons unrelated to the proxy contest. The Court responded that a defendant is not conflicted merely because he or she might receive accelerated compensation in connection with a sale transaction. Additionally, a director is not conflicted merely because the director was the nominee of an activist shareholder. Finally, the Court found that the plaintiff’s argument that the chief financial officer was conflicted due to the possibility of post-closing employment was conclusory and did not support a breach of duty claim, noting that the disclosures stated that Apollo did not discuss the retention of the Company’s executives during the negotiation process.