iIn the dynamic and ever-evolving landscape of mergers and acquisitions (“M&A”) and related corporate transactions, Delaware courts continue to play a pivotal role in shaping legal precedents and guiding corporate practices. Delaware cases over the past year have been no exception, with several landmark decisions having significant implications for M&A strategy, governance, and dispute resolution. The summary and analysis of cases below touch upon critical aspects of corporate law as it relates to future M&A transactions. As we delve into these pivotal Delaware M&A cases, we aim to shed light on the key legal principles and takeaways that corporate attorneys, executives, and advisors must understand to navigate the complex terrain of M&A transactions effectively.
Decisions and Impact on M&A Transactions
In re Edgio, Inc. Stockholders Litigation
In re Edgio, Inc. Stockholders Litigation, 2023 WL 3167648 (Del. Ch. May 1, 2023) continues to refine the principal established under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015) that approval by a majority of disinterested, fully informed and uncoerced stockholders will entitle a board to the deferential business judgment rule for post-closing claims for monetary damages in non-controlling stockholder transactions. In Edgio, the court considered whether to extend the application of Corwin to cleanse injunctive relief claims seeking to enjoin defensive measures.
In Edgio, in response to news that Limelight Network, Inc. was a target for activist investors, its board negotiated to acquire Edgecast, Inc., a business unit of Yahoo, Inc. Limelight issued $300 million of Limelight common stock to College Parent, L.P., Yahoo’s parent company, in exchange for 100% ownership of Edgecast, and changed its name to Edgio, Inc. Thereafter, College Parent retained a 35% stake in Edgio and three of nine board seats. As part of the transaction, College Parent entered into a stockholder agreement that included certain defensive measures to entrench the current board, including covenants (1) to vote in favor of the board’s recommendations with respect to director nominations and against any nominee not recommended by the board, (2) to vote with the board or pro rata with other stockholders for other non-routine matters, and (3) to not transfer its shares without the board’s consent for two years, and for an additional one year, to not transfer its shares to any entity on a list of fifty named activist investors. The board sought to cleanse the transaction by obtaining a majority vote of fully informed, uncoerced, disinterested stockholders. Post-closing, Plaintiffs sued to enjoin enforcement of the defensive measures in the stockholder agreement but did not seek monetary damages.
The court concluded that Corwin stops short of cleansing defensive measures and instead such claims for injunctive relief should be analyzed under the enhanced scrutiny of the Unocal line of cases (See Unocal v. Mesa Corp., 493 A.2d 946 (Del. 1985)). The Court reasoned that the underlying rationale of Corwin is to allow stockholders to make free and informed choices based on the economic merits of a transaction. In post-closing claims for damages, a vote is a confirmation that stockholders received the benefit of the bargain, notwithstanding any perceived or actual conflicts among dealmakers. In contrast, entrenching defensive measures enacted by boards cause “irreparable injury” to stockholders and thus cannot be considered as part of the economic merits of the transaction. Practitioners considering a Corwin cleansing vote should assess whether it is being utilized to ratify the economic terms of the transaction. If, as in Edgio, the board is acting defensively in response to a perceived threat, its decisions will likely face enhanced scrutiny.
Cygnus Opportunity Fund, LLC v. Washington Prime Group, LLC
Cygnus Opportunity Fund, LLC v. Washington Prime Group, LLC, 302 A.3d 430 (Del. Ch. 2023) explores what happens when fiduciary duties of officers conflict with one another and the LLC Operating Agreement fails to disclaim fiduciary duties of officers.
After coming out of Chapter 11, Washington Prime Group, LLC (the “Company”) was 87% owned by Strategic Value Partners, LLC (“SVP”), but before reorganization, the Company was a publicly traded Indiana corporation. The Company Operating Agreement (the “Operating Agreement”) provided for a Squeeze Out mechanism whereby minority units would be converted into a right to receive cash that for the first eighteen months after bankruptcy could only be exercised with either approval by a majority of a committee of Independent Managers or by a majority of minority unit holders. After a failed two-tiered front-loaded tender offer priced at $25.75 per unit for the first two weeks and then at $25.00, SVP initiated a Squeeze Out priced at $27.25 and sent minority holders a five-page information statement asserting that a committee of one Independent Manager had approved the transaction. After being denied more information about the valuation, plaintiffs sued, alleging that the units were worth at least $60.00 per unit.
Since the Operating Agreement waived fiduciary duties for the Managers and SVP to the extent allowed by Delaware law, the court dismissed most claims against SVP and the Managers. However, it found plausible that the officers had a duty to disclose in relation to the tender offer and a duty to not make misleading partial disclosures in relation to the Squeeze Out and neglected to dismiss claims against the officers. While officers owed a duty of obedience to the Managers and through them to SVP, this duty did not trump the officers’ fiduciary duties to the minority unit holders.
Cygnus is reminder that practitioners must be aware of all stakeholders, especially in a case where officers are not protected by a waiver of fiduciary duties. In addition, practitioners should advise LLC Managers of the possible conflicts that may come into play when officers’ fiduciary duties are not waived.
Delman v. GigAcquisitions3, LLC
While the use of special purpose acquisition companies (“SPACs”) has all but come to a halt, SPAC-related disputes continue to be litigated. In Delman v. GigAcquisitions3, LLC, 288 A.3d 692 (Del. Ch. 2023), the court analyzed the importance of the duty of protecting SPAC investors, especially in cases where the management of the SPAC process is heavily concentrated in a few decisionmakers who have the potential to gain a windfall at the expense of public stockholders.
In Delman, GigAcquisitions3, LLC (the “Sponsor”), was the entity responsible for administering the SPAC. It sponsored the IPO of GigCapital3, Inc. (“Gig3”) which later merged with Lightning eMotors, Inc., (“New Lightning”) and held founder shares, obtained for $25,000 in total, representing around 20% of Gig3’s post-IPO equity. As is typical in SPAC transactions, public stockholders had the right to redeem their shares for the initial investment of $10 per share plus interest, or to participate in the post-merger entity. If the SPAC failed to merge within eighteen months of its IPO, the SPAC would liquidate, the public stockholders would receive a redemption value for their investment, and the founder shares owned by the Sponsor would effectively become worthless.
The directors of Gig3 were largely composed of directors of the Sponsor, and the resulting conflict of interest was disclosed to stockholders in an initial prospectus. In advance of the merger, Gig3 submitted a proxy statement to the SEC that contained rosy predictions of future growth, from $9M to $2B in revenue over the next five years. 98% of stockholders voted to approve the transaction, and 29% elected to redeem. After a quarter of lower than predicted earnings, New Lightning reduced its five-year projections, and the price of the publicly traded shares fell to $6.57 per share, well below the $10 initial price. Nevertheless, the founders’ shares were worth around $33M, significantly higher than the Sponsor’s initial investment.
Plaintiffs brought claims for breach of the duty of loyalty, claiming that the defendant Sponsor and its affiliates disloyally deprived stockholders of information essential to the redemption decision, and for unjust enrichment. Defendants argued that, under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015) the stockholder vote approving the transaction should lead the court to apply the deferential business judgment rule. Because the Sponsor essentially directed the merger negotiations, the court found that it was reasonably a controlling stockholder despite owning less than 50% of the equity in Gig3, and thus that Corwin did not apply. Instead, it applied the entire fairness standard and found it plausible that disclosures to public investors were inadequate, motivated to discourage redemption and engineered to maximize the Sponsor’s investment at the expense of the public stockholders.
In light of Delman, practitioners should analyze whether there are potential conflicts inherent in a structure where dealmakers have the potential to make outsize gains at the expense of other stakeholders. As the court pointed out, the remedy for this situation is more and more careful disclosure to public stockholders regarding potential conflicts, the dealmaking process, and target growth projections.
In Altieri v. Alexy, C.A. 2021-0946-KSJM (Del. Ch. May 22, 2023) the court reviewed what constitutes a sale of “substantially all” assets for purposes of triggering the need for a stockholder approval for a transaction. In Altieri, the court applied the test from Gimbel v. Signal Companies, Inc., 316 A.2d 599, 606 (Del. Ch. 1974), which weighs quantitative and qualitative factors to determine whether a transaction strikes “at the heart of the corporate existence and purpose” and would thus require a stockholder vote.
In Altieri, cybersecurity firm Mandiant, Inc. sold its FireEye Business for $1.2 billion in 2021. In 2020, the FireEye line of business accounted for 57% of Mandiant’s revenue and constituted approximately 38% of its total assets. Although FireEye had consistent revenue growth over the prior five years, Mandiant projected declining growth and decided to sell. Following the announcement of the sale, Mandiant’s stock fell 17.62%, and a stockholder sued to void the sale, claiming that it represented a sale of substantially all of Mandiant’s assets, and thus required a stockholder vote.
Under the quantitative prong of the Gimbel test, Plaintiffs emphasized that FireEye accounted for 57% of Mandiant’s revenue, but the court instead focused on the percentage of Mandiant’s assets that FireEye represented to find that the factor weighed in favor of dismissal. Under the qualitative prong, the Court reasoned that the Gimbel test was not met because the sale of FireEye did not alter Mandiant’s core business as a cybersecurity firm, and thus the sale did not fundamentally alter stockholders’ expectations vis-à-vis the investment.
In light of Altieri, practitioners working on a sale of a large portion of a Delaware corporation’s assets should continue to weigh the effort of obtaining a stockholder vote against the risk of future litigation. The case confirms Delaware’s commitment to the idea that a corporation’s board, not stockholders, is in the best position to make most important corporate decisions.
In re Tesla Motors, Inc. Shareholder Litigation
In In re Tesla Motors, Inc. Shareholder Litigation, 298 A.3d 667 (2023) the Delaware Supreme Court confirmed the Chancery Court’s ruling that when the entire fairness standard applies to a conflicted transaction, the standard is met when the deal process and price are fair.
The claim from In re Tesla stemmed from Tesla’s all-stock acquisition of SolarCity Corporation in 2016. The plaintiffs alleged that SolarCity was insolvent at the time of acquisition, and Tesla aggressively overpaid for SolarCity due to Elon Musk’s influence and control over its Board of Directors. SolarCity was founded by two of Musk’s cousins, and at the time of the transaction, Musk owned approximately 22% of each of SolarCity and Tesla.
Under the fair dealing prong of the entire fairness test, the court pointed to the factors used in Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983) which looked at “how the deal was initiated and timed, how it was structured and negotiated, and how it was approved.” In examining the deal process, the court found factors that weighed in both directions. For instance, Musk had deal related conversations with his cousin outside of the boardroom, on the one hand, but an independent director led the negotiations on behalf of Tesla, on the other hand. The court ultimately concluded that it was the Board of Tesla, not Musk, who initiated the sale, and that market conditions were ideal for Tesla to initiate an acquisition. The court further concluded that the fair price prong was met as Tesla provided evidence that SolarCity was solvent at the time of the acquisition in response to the plaintiff’s limited argument based on a theory of insolvency.
In light of In re Tesla, practitioners should remember the importance of deal process and structuring. The boards should look to assess where there are any structural conflicts and whether there are any conflicts between the parties on both sides of the transaction and determine whether any measures need to be taken to mitigate that conflict.
New Enterprise Associates 14, L.P. v. Rich
In New Enterprise Associates 14, L.P. vs Rich, 295 A.3d 520 (Del. Ch. 2023) the court held that stockholder covenants not to sue for breach of fiduciary duty were enforceable. The court applied the test from Manti Holdings, LLC v. Authentix Acquisition Co., 261 A.3d 1199 (Del. 2021) which held that, in order to be enforceable, such covenants need to be both narrow in scope and reasonable. The Rich court held that the contractual covenant not to sue met both prongs of the test and emphasized that the test is fact specific.
The plaintiffs in Rich were investment funds (the “Funds”) that invested in a startup named Fugue, Inc. The Funds unsuccessfully tried to sell Fugue over a period of six (6) months, and eventually needed to recapitalize. As part of the recapitalization, the Funds subordinated their equity to investor George Rich and others and signed a Voting Agreement which included a drag-along right and a covenant not to sue for claims of breach of fiduciary duties. In the ensuing months, Rich and the board consummated a sale of the company that met the drag-along requirements. The sale heavily advantaged Rich and other directors at the expense of the Funds and other stockholders. The Funds then brought suit alleging Rich and the directors breached their fiduciary duties during the sale process.
Under the “scope” prong of the Manti test, the Court held that covenant was sufficiently tailored because it applied only to certain types of transactions and met the eight specific criteria necessary to qualify as a drag-along sale. It also met the reasonableness prong of the Manti test because the covenant was sufficiently “clear and specific”. Further, the court emphasized that the Funds were “sophisticated repeat players who understood its implications”, and that this covenant was a normal part of the bargaining process.
In light of Rich, practitioners should be aware that covenants not to sue for breach of fiduciary duties can be upheld, especially if they are narrowly tailored and involve sophisticated parties in the transaction. It’s important to note that the validity of such covenants is fact-specific and therefore requires a thorough analysis on a case-by-case basis.
CCSB Financial Corporation v. Totta
In CCSB Fin. Corp. v. Totta, 302 A.3d 387 (2023) the Delaware Supreme Court upheld the Chancery court’s ruling that a Board of Directors cannot evade the fiduciary duty of loyalty through a corporate charter provision declaring that a Board’s evaluation of a stockholder voting limitation is “conclusive and binding.”
An anti-takeover provision in Defendant’s charter blocked any “Person” owning more than 10% of common stock from voting the shares in excess of 10% in an election. “Person,” as defined by the charter, included groups acting in concert. The charter additionally specified that the Board’s determination about who is acting in concert is “conclusive and binding” if made in good faith based on reasonably available information.
Plaintiff stockholder David Johnson beneficially owned 9.95% of Defendant’s stock. In an election for three seats on the Board, Plaintiff was in contact with a dissident slate of directors. The Board found that the Plaintiff and alternate directors were acting in concert, and accordingly, ordered 37,175 shares voted to not be counted in the election. Consequently, the incumbent directors were reelected. But for the Board’s exclusion of the votes, the Board takeover would have been successful.
Affirming the Court of Chancery, the Delaware Supreme Court held that the Board wrongly disenfranchised stockholders. First, the court found that the “conclusive and binding” charter provision was invalid because it attempted to exculpate the directors from their fiduciary duty of loyalty, which is prohibited both by Delaware statute and public policy. In claims alleging Board interference with a stockholder election, the Court did not apply business judgment review—as the Defendant alleged was appropriate due to the “conclusive and binding” provision—but instead applied a two-step enhanced judicial review, evaluating first whether the Board’s actions were legally valid under its charter, and second whether the actions were equitable. Additionally, Defendant failed to prove that all members of the “group” were acting in concert—one of the group members lacked any “agreement, arrangement, or understanding” regarding how to vote the stocks, and thus the Board misapplied an already invalid charter provision.
In light of Totta, practitioners should be mindful of corporate charter provisions that restrict the voting rights of stockholders. While these sorts of provisions are routinely upheld for different organizational forms, such as limited liability companies, Delaware corporate law generally has a narrower view when it comes to corporations.
In Colon v. Bumble, Inc., 305 A.3d 352 (Del. Ch. 2023), the court reviewed whether corporate charter voting power formulas, which bestow voting rights based on the stockholder’s identity, are valid, despite creating disparate voting rights for members of the same class of stock.
As a Class A stockholder of Bumble, Inc., Plaintiff alleged that voting power formulas in Defendant Bumble’s charter impermissibly created an identity-based voting scheme. Bumble’s charter’ contained voting power formulas for two stock classes: Class A (with economic rights) and Class B (without economic rights). Both Class A and Class B shares received one vote per share except if held by a Principal Stockholder, who received 10 votes per share. As a result of the voting power formulas, Bumble’s founder and financial sponsor had superior voting rights to stockholders of the same class, and together controlled 92.2% of Bumble’s outstanding voting power. As a Class A stockholder of Bumble, Inc., Plaintiff alleged that voting power formulas in Defendant Bumble’s charter impermissibly created an identity-based voting scheme.
In granting Defendant’s motion for summary judgment, the Court held that the DGCL does not prohibit this type of “identity-based voting,” but rather provides flexibility for charters to design voting power formulas. As long as the formulas are applied to all stockholders evenly, differential power outcomes are acceptable.
The court was unconvinced by Plaintiff’s position that the formulas created de facto stock subclasses and was unsympathetic to Plaintiff’s argument that all stockholders should have equal opportunity. The Court clarified that nothing in Section 151(a) of the DGCL affords all stockholders the opportunity to join a group of holders with special rights by charter—in other words, the group with superior voting rights can be a “closed set.” Further, Section 151(a) expressly allows voting rights to depend on “facts ascertainable outside of the certificate of incorporation”—in this case, stockholders’ identities.
In Re Mindbody, Inc. Stockholder Litigation
In re Mindbody, Inc. Stockholder Litigation, 2023 WL 2518149 (Del Ch.) represents a warning to potential acquirors dealing with seller fiduciaries looking to tilt the deal process in their favor. Under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., once a business is “for sale,” seller fiduciaries have a heightened duty to find the best transaction reasonably available for stockholders. 506 A.2d 173 (Del. 1986). Buyers who are aware of seller fiduciary breaches and who benefit can be found liable for aiding and abetting.
In Mindbody, CEO Richard Stollmeyer and Mindbody’s primary private equity sponsor were motivated to quickly sell the corporation to Vista Equity Partners Management, LLC because both parties were in need of liquidity. Stollmeyer engaged an investment bank that found a few potential buyers, but only really entertained Vista, and began back-channel communications which allowed Vista to expediently make an offer. The Court found that Stollmeyer kept Mindbody’s Board in the dark as to his true relationship with Vista and made no real effort to find another buyer. In addition, the proxy statement issued in relation to the transaction omitted key details about Stollmeyer’s conflicts. Even though the stated minimum price Mindbody wanted was $40 per share, the Board approved a sale at $36.50 and sealed the transaction with a shareholder vote, hoping for Corwin cleansing.[1]
The Court found that because the proxy statement omitted key details about Stollmeyer’s relationship with Vista, the stockholder vote was not fully informed, and thus the transaction was not due business judgment review under Corwin. The Court found that Mindbody was for sale under Revlon, and thus Stollmeyer had a heightened duty to find the best possible deal for stockholders. His apparent motivation to sell quickly, along with evidence that he did not pursue other deals and that the price was insufficient was dispositive. Further, because Vista was aware of Stollmeyer’s duty and its violation, it was also liable for aiding and abetting the breach. In all, the parties were jointly and severally liable for $44 million in damages.
In light of Mindbody, sell-side practitioners should advise clients of the importance of a fulsome decision-making process, and buy-side practitioners should advise clients regarding the fiduciary obligations of seller representatives.
FOOTNOTES
[1] Under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), approval by a majority of disinterested, fully informed and uncoerced stockholders will entitle a board to the deferential business judgment rule for post-closing claims for monetary damages in non-controlling stockholder transactions.
