A pair of recent decisions from the Delaware Supreme Court in connection with completed acquisitions of public companies emphasizes the importance of providing, before closing, proper disclosures to stockholders in order to defend directors, after closing, from stockholder claims.
In both cases, the Court of Chancery had relied on the Corwin doctrine — which gives directors the benefit of the business judgment rule in most cases when a transaction has been ratified by a fully informed and uncoerced majority of disinterested stockholders — to dismiss stockholder claims that directors breached their fiduciary duties. In both cases, the Supreme Court reversed, finding that the disclosures made to stockholders had omitted material information or had been materially misleading. According to the Supreme Court, the Corwin doctrine must be “careful[ly]” applied, given its potentially dispositive impact, and cannot be supported by “partial and elliptical disclosures.”
As has become increasingly common, the lawsuits in both cases were filed after the transactions had closed. The directors thus did not have the opportunity to respond to the lawsuits by amending or supplementing the prior disclosures. The cases demonstrate the need, before stockholder action (such as a vote or a tender) is taken, for directors and companies to make proper disclosure to stockholders so that the directors can obtain the benefit of the business judgment rule and end litigation at an early stage.
In 2015, the Delaware Supreme Court laid out what has now become known as the Corwin doctrine. In effect, the doctrine holds that, in many cases, a disinterested stockholder vote can “cleanse” purported breaches of fiduciary duty, if that vote is fully informed and uncoerced. As the Supreme Court explained, when stockholders can “easily protect themselves at the ballot box by simply voting ‘no,’” the benefits of a standard of review more intrusive than the business judgment rule are outweighed by the higher costs of litigation and inhibitions on risk-taking.
Morrison v. Berry (The Fresh Market)
In Morrison v. Berry, the company had agreed to be acquired by a private equity firm in a transaction in which the company’s founder had agreed with the acquirer to roll over his existing equity stake into shares of the acquirer’s entity, rather than selling his shares for cash along with the other stockholders. The company issued a Schedule 14D-9 with the board of directors’ recommendation that stockholders accept the tender offer. After the acquisition closed, a plaintiff shareholder filed suit against the directors for breaches of their fiduciary duties. The Court of Chancery, after reviewing the company’s disclosures, found that the transaction was “an exemplary case of the utility of the ratification doctrine, as set forth in Corwin.”
The Supreme Court, however, found that the company had failed to disclose several facts (according to the plaintiff’s complaint and the then-existing record) that “would have helped [stockholders] reach a materially more accurate assessment of the probative value of the [company’s] sale process”:
The Chancery Court had found that disclosure of the founder’s intent to sell his shares would not have made stockholders less likely to tender. The Supreme Court, however, emphasized, “[t]hat is not the test.” The Supreme Court reiterated that “[o]mitted information is material if there is a substantial likelihood that a reasonable stockholder would have considered the omitted information important when deciding whether to tender her shares or seek appraisal.” The definition includes facts that a stockholder would “generally want to know in making a decision, regardless of whether it actually sways a stockholder one way or the other, as a single piece of information rarely drives a stockholder’s vote.”
Appel v. Berkman (Diamond Resorts International)
The Morrison decision reiterates some of the themes raised by the Delaware Supreme Court earlier this year in Appel v. Berkman. In that case, the board of directors had recommended that stockholders tender their shares in a negotiated tender offer. The company’s Schedule 14D-9 disclosed that the company’s founder, largest stockholder, and chairman had abstained from the board vote, but it did not disclose that he had abstained because he was disappointed in the price and in company management for not having run the business in a manner that would command a higher price and he believed it was not the right time to sell the company. Two months after the deal closed, the plaintiff stockholder filed suit.
The Supreme Court held that the founder’s reason for abstaining from the board vote was a material fact that should have been disclosed. The Supreme Court declined to find that a director’s reasons for abstaining or dissenting must always be disclosed, but found that courts should consider whether such disclosure is required to ensure that other disclosures do not present a materially misleading picture. Ultimately, the Supreme Court held that, in that case, “the 14D-9’s representation to stockholders that they would ‘receive a fair price in the merger was materially misleading without an additional simultaneous, tempering disclosure’ that [the founder] believed that this was ‘a bad time to sell’ and had expressed the reasons for that view to the board.”
In many respects, these cases follow a familiar fact pattern: a transaction is announced, a shareholder files suit, and the company’s disclosures are alleged to be inadequate based on internal documents produced by the company. In past cases, the litigation routinely began before the transaction closed. Accordingly, before the stockholder vote or tender actually took place, the company could often have disclosed additional information as a potential avenue for settling the case, thereby preserving the transaction and ameliorating the risk of director liability. However, over the past few years, Delaware courts have pushed back against the profusion of shareholder litigation in acquisitions. Partly as a result of that push, those stockholder suits that are being filed increasingly are being filed after the transaction closes, eliminating the potential response of making additional disclosures.
Transacting parties and their directors, in appropriate cases, can seek the protection of the Corwin doctrine and limit their exposure to liability in this evolving landscape by making proper disclosures. Nonetheless, the Delaware Supreme Court continues to signal that these protections come at a price: complete disclosure, before the stockholders act, of the material information in the transaction.
Summer Associate Ben Lucy contributed to the writing of this alert.