Delaware Holds That Directors May Choose Lower Value All-Cash Deal Over Stock Deal So Long As The Decision Is Made In Good Faith And Free Of Conflicts
Recently, the Delaware Court of Chancery dismissed fiduciary duty claims brought by former Essendant, Inc. (“Essendant”) stockholders after Essendant terminated its stock-for-stock merger with Genuine Parts Company (“GPC”) which was valued at $13.20 – $23.90 per share, including synergies, in favor of a lower all-cash offer of $12.80 per share, proposed by private equity fund Sycamore Partners (“Sycamore”), a minority stockholder of Essendant. Plaintiffs argued that Sycamore was a controlling stockholder of Essendant and either breached its fiduciary duties to Essendant’s stockholders or aided and abetted the Essendant directors’ breaches of fiduciary duty. Plaintiffs also argued that a majority of the Essendant directors acted disloyally or in bad faith in connection with the transaction. The Court dismissed the complaint, finding that the plaintiffs failed to adequately plead (1) non-exculpated claims against Essendant’s directors or (2) that Sycamore was a controlling stockholder or aided or abetted any breach of fiduciary duty. The Chancery Court decision, In re Essendant, Inc. Stockholder Litig., C.A. No. 2018-0789-JRS (Del. Ch. Dec. 30, 2019), was appealed to the Delaware Supreme Court on February 20, 2020.
In the fall of 2017, Essendant began negotiating a stock-for-stock merger with GPC, whereby an affiliate of GPC would merge with Essendant, resulting in Essendant’s stockholders owning 49% of the combined company. While the economics of the GPC merger looked promising on paper, both parties anticipated that the proposed transaction would confront serious antitrust compliance issues. On April 12, 2018, after the parties made mutual assurances about their respective commitment to the transaction, the parties proceeded to sign a merger agreement.
On April 17, 2018, Sycamore made a formal offer to acquire Essendant for $11.50 per share which Essendant rejected. On April 29, 2018, Sycamore sent a “renewed” proposal, also for $11.50 per share, which Essendant’s board determined was “reasonably likely to lead to a superior acquisition proposal” and exercised its fiduciary out to the merger agreement’s non-solicitation covenant. The Essendant board apparently changed its view of Sycamore’s offer after receiving information indicating that the merger with GPC was unlikely to be approved by antitrust regulators. While negotiating with Essendant, Sycamore began purchasing Essendant stock on the open market. Instead of negotiating a standstill with Sycamore, Essendant adopted a rights plan, which stopped Sycamore’s open market purchases on May 21, 2018, when Sycamore owned 11.16% of the company’s outstanding shares.
On September 10, 2018, Essendant’s board announced that it accepted Sycamore’s final offer for an all-cash merger at $12.80 a share. Although Essendant’s financial advisor had valued GPC’s offer at $13.30 to $23.90 per share, including synergies of $8.35 to $11.25 per share, it opined that Sycamore’s offer of $12.80 per share was fair to Essendant’s stockholders. Essendant terminated its merger agreement with GPC, paid a termination fee to GPC and approved the transaction with Sycamore.
In this action, plaintiffs alleged that Essendant failed to obtain the highest value reasonably available for stockholders by choosing the Sycamore transaction and brought claims for breach of fiduciary duty against Essendant’s board and CEO and Sycamore, as well as aiding and abetting claims against Sycamore. Given Essendant’s exculpatory charter provision, plaintiffs had to invoke loyalty and bad faith claims against the Essendant directors in order to survive the director defendants’ motion to dismiss. Plaintiffs attempted to show that the Essendant board breached its duty of loyalty by alleging that Sycamore was a controlling stockholder who dominated and controlled the Essendant board and that a majority of the members of Essendant’s board otherwise had conflicts of interest.
The Court rejected the plaintiffs’ allegation that Sycamore was a controlling stockholder because Sycamore only owned 11.16% of Essendant, did not have any other indicators of control, such as director nomination, removal or blocking rights, or commercial or other relationships with Essendant or its directors and two other entities held larger voting blocks in Essendant than Sycamore. Next, the Court found that the plaintiffs failed to plead facts with respect to each director that would allow the Court to determine on a director-by-director basis whether a majority of the board was interested or lacked independence. The Court rejected plaintiffs’ claims that the Essendant board was significantly influenced by Sycamore, or that the board chose a cash deal over a stock deal due to conflicts of interest. In so finding, the Court confirmed that Delaware law allows directors to consider whether, “under the circumstances,” cash is preferable to lower valued stock consideration when evaluating a proposal and that choosing cash consideration over other forms of consideration did not, in itself, create a conflict of interest for board members.
Further, plaintiffs alleged that the Essendant board acted in bad faith by breaching a non-solicitation covenant to pursue Sycamore’s proposal, and by failing to negotiate a standstill with Sycamore. The Court held that the plaintiffs’ pleadings did not support a claim that the Essendant Board acted in bad faith because the plaintiffs failed to show that the director’s decision to choose Sycamore’s offer over the GPC transaction “lacked any rationally conceivable basis associated with maximizing stockholder value.” Notably, the Court found that (1) Essendant board’s decision to breach its merger agreement with GPC did not support a non-exculpated breach of fiduciary duty claim because, even in an iron-clad contract, a board has the room for fiduciary discretion and may, at times, have a fiduciary duty to breach a contract, if the board determines that is what is in the best interests of the company and its stockholders, and (2) Essendant’s prompt use of a rights plan mitigated any bad faith claims related to the Essendant board failing to negotiate a standstill with Sycamore.