In In re Tangoe, Inc. Stockholders Litigation, C.A. No. 2017-0650-JRS (Del. Ch. Nov. 20, 2018), the Delaware Court of Chancery denied the director defendants’ motion to dismiss the stockholder plaintiffs’ claim for breach of fiduciary duties on the basis that the stockholder vote approving the transaction was not informed and the defendants were therefore not entitled to business judgment rule deference at the pleading stage. The Court also found that the plaintiffs had adequately pled a breach of the fiduciary duty of loyalty against each of the director defendants, which would not be covered by the exculpatory clause in the company’s certificate of incorporation.

Tangoe, Inc. (“Tangoe”), a provider of information technology and telecom expense management software, found itself “sailing into a storm” in 2016. The SEC had identified problems in Tangoe’s filed financial statements, so the company would have to restate its financials for 2013, 2014 and three quarters of 2015 (the “Restatement”). Following this announcement, its stock lost a third of its value. While the Restatement was pending, Tangoe was unable to file its annual or quarterly reports because it could not provide audited financial statements. The Restatement process dragged on, in part because Tangoe did not provide all the information requested by the auditors, but Tangoe continued to disclose in filings that it was making progress and had “substantially completed” its investigation. It did not disclose, however, that this investigation had revealed that almost twice as much revenue had been incorrectly recognized as previously thought. Tangoe’s failure to timely complete the Restatement and file its late reports eventually led to NASDAQ’s delisting and the SEC’s threat of deregistration of Tangoe’s stock. Despite the troubles, the executive management team remained optimistic that Tangoe could continue operations on a standalone basis once the Restatement was complete. Meanwhile, private equity groups had been amassing substantial stakes in Tangoe and making sale overtures, but as the Restatement process dragged on, all but one suitor halted discussions. During the sale negotiations, Tangoe commissioned a quality of earnings report but did not disclose that report to the stockholders. Proxy contest clouds had also been gathering. Tangoe’s board of directors (the “Board”) received letters from two groups of activist stockholders threatening to replace the interim-CEO director, the Executive Chairman director, and six “outside directors” (collectively, the “Director Defendants”) if the Board did not take action.

The Board ultimately approved the final suitor’s offer and recommended the transaction to the stockholders. While the tender offer was pending, the SEC advised the interim-CEO that it had significant concerns as to whether investors had access to the financial information necessary to make a decision regarding the offer. Despite the SEC’s concerns, the offer continued without additional disclosure and closed with 78.2% of Tangoe’s outstanding common stock tendering at $6.50 per share, a 28% decline from the stock price prior to the Restatement announcement.

Several stockholder lawsuits followed resulting in this consolidated action. The stockholder plaintiffs allege that while Tangoe was buffeted by problems, members of the Board were “commandeering the lifeboats.” Throughout the Restatement process and while the potential sale was being negotiated, the Director Defendants caused Tangoe to enter into Equity Award Replacement Compensation Agreements (“EARCAs”), granting the Director Defendants significant substitute equity interests conditioned on a change of control, allowing them to collectively realize approximately $5 million when the tender offer closed. The Director Defendants moved to dismiss the complaint, arguing they were entitled to business judgment rule deference under Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015), because a majority of disinterested, fully informed, and uncoerced stockholders approved the transaction, or, alternatively, because Tangoe’s certificate of incorporation contained an exculpatory provision under Section 102(b)(7) of the Delaware General Corporation Law, and the stockholder plaintiffs were obliged, but failed, to plead a non-exculpated claim for breach of the duty of loyalty.

The Court determined that “Corwin ‘cleansing’ is not available at the pleading stage because it is reasonably conceivable that the stockholders’ approval was uninformed” and that the stockholder plaintiffs had “adequately pled a non-exculpated claim for breach of the duty of loyalty against the Director Defendants because it is reasonably conceivable they approved the [t]ransaction and recommended it to stockholders for self-interested reasons.” In Corwin, the Delaware Supreme Court extended business judgment rule deference to the pleading stage determination of the adequacy of a breach of fiduciary duty claim if the transaction is “approved by a fully informed, uncoerced vote of the disinterested stockholders,” 125 A.3d 304, 309, but “if troubling facts regarding director behavior were not disclosed that would have been material to a voting stockholder, then the business judgment rule is not invoked,” id. at 312. The Court found that financial information provided to stockholders throughout the Restatement process was “sporadic and heavily qualified” and other information in the Board’s possession, such as the quality of earnings report and the preliminary results of the Restatement investigation, were not disclosed. The Court held that this “information vacuum,” along with the failure to file quarterly and annual reports and the failure to hold an annual stockholder meeting for almost three years, supported a reasonable inference that stockholder approval of the transaction was not fully informed. The Court also indicated that calling a vote on the sale of Tangoe while the unresolved Restatement was pending and had not been adequately explained to stockholders may be “situationally coercive” under In re Saba Software, Inc. S’holder Litig., 2017 WL 1201108 at *16 (Del. Ch. Mar. 31, 2017).

The Court then turned to the Director Defendants’ exculpation defense, noting that that the stockholder plaintiffs “must well-plead a loyalty breach against each individual director” in order to plead a “non-exculpated claim for breach of fiduciary duty” for Section 102(b)(7) purposes. The Court took issue with the timing of the Board’s granting of substitute equity awards to the Director Defendants, noting it indicated a temporal connection between the adoption of the EARCAs and the Board’s decision to shift course away from the Restatement toward an allegedly ill-advised sale. Further, since the Director Defendants’ compensation was primarily based in equity awards, which were jeopardized by the Restatement, “it is reasonably conceivable that the EARCAs were material to each Director Defendant.” Finally, the threat of a proxy contest, when coupled with the struggle to complete the Restatement, the adoption of the EARCAs, and the recommendation to the stockholders to accept sale offers at decreasing prices, supported a reasonable inference that the Director Defendants were acting out of self-interest. While noting that Delaware “courts have expressed reluctance to find that business judgment rule deference is not available to directors simply because they operate under the threat of a proxy contest,” the Court also discussed in a lengthy footnote empirical evidence that proxy contests can significantly harm a director’s career and have a substantial effect on the director’s future earnings as a corporate director.

The Court, therefore, denied the Director Defendants’ motion to dismiss the stockholder plaintiffs’ claims on these bases, noting, “There is no basis in our law to deny corporate fiduciaries the protection of the business judgment rule simply because they make risky decisions when the company is navigating stormy waters…. But, when navigating a company through the storm, as always, fiduciaries must act first and foremost in the interests of the stockholders.” Boards of directors must take “commensurate care” to disclose all material aspects of the situation to stockholders—“how the company sailed into the storm, how the company has been affected by the storm, what alternative courses the company can take to sail out of the storm and the bases for the board’s recommendation that a sale of the company is the best course”—and carefully consider whether the board’s actions align the interests of directors and executives with the best interests of the stockholders.