In a 2-1 decision, the Seventh Circuit has joined the Delaware Court of Chancery’s call for enhanced scrutiny of “disclosure-only” M&A settlements that involve no monetary benefits to shareholders. As previously discussed here, M&A litigation, typically alleging breach of fiduciary duty by directors and insufficient disclosures, often ends in settlement, with defendants agreeing to provide supplemental disclosures in exchange for broad releases of claims, while plaintiffs’ counsel “earns” large attorneys’ fees for providing the class with the “benefit” of the agreed-upon disclosures. In In re Walgreen Company Stockholder Litigation (“In re Walgreen Co.”), the Seventh Circuit rejected such a settlement, endorsing the standard for approval of disclosure-only settlements articulated by the Delaware Court of Chancery in In re Trulia, Inc. Shareholder Litigation (“In re Trulia”). In In re Trulia, the Court of Chancery held that disclosure-only settlements in M&A litigation will meet with disfavor unless they involve supplemental disclosures that address a “plainly material misrepresentation or omission” and any proposed release of claims accompanying the settlement encompasses only disclosure claims and/or fiduciary duty claims regarding the sale process.
On August 2, 2016, U.S. District Judge Edward Chen dismissed a shareholder lawsuit brought against children’s educational toymaker LeapFrog Enterprises, Inc. (“LeapFrog”) for failure to adequately plead statements were false or misleading, or made with requisite intent. Plaintiffs’ suit, which was consolidated in 2015, alleged that LeapFrog and its executives hid demand and inventory problems from investors. The judge disagreed, finding that the investors had been sufficiently warned of problems with LeapFrog’s product lines and that the allegedly misleading statements were forward-looking and cautionary, and therefore fell within the PSLRA’s safe harbor. Defendants’ public statements about many of the allegedly misleading topics helped drive home that Plaintiffs’ theory amounted to classic “fraud by hindsight.”
On July 28, 2016, the Delaware Chancery Court allowed claims of unfair dealing against the Board of property management company Riverstone National Inc. to survive where the directors facilitated a merger that forestalled a derivative suit against them. The court held that by orchestrating a merger that extinguished a possible derivative action, the director defendants obtained a special benefit for themselves. As a result, the directors were interested in the transaction, thereby rebutting the presumption of the business judgment rule, and triggering application of the “entire fairness” doctrine.
On July 7, 2016, Judge Paul A. Magnuson of the United States District Court for the District of Minnesota granted Defendants’ Motions to Dismiss a shareholder class action that had been initiated following a 2013 holiday season data breach involving customers of Target Corporation (“Target,” or “the Company”). The data breach, which resulted in the release of information of approximately 70 million consumer credit and debit cards, made headlines as one of the biggest privacy hacks at the time. Initially disclosed to the public in December 2013, with an estimated 40 million credit and debit cards affected, Target subsequently revealed a little less than a month later that additional consumer data, including customers’ names, mailing addresses, phone numbers and email addresses, were also stolen, and increased its initial estimate to 110 million.
On June 30, 2016, the Delaware Chancery Court extended the Supreme Court’s holding in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), to two-step mergers under DGCL § 251(h). The Chancery Court concluded that acceptance of a first-step tender offer by a fully informed and uncoerced majority of disinterested stockholders insulates a two-step merger from challenge except on the ground of waste, even if a majority of directors were not disinterested and independent. See In re Volcano Corp. S’holder Litig., C.A. No. 10485-VCMR. In this situation, the business judgment rule is “irrebutable” and dismissal is typically appropriate given the high bar for proving “waste” and the unlikelihood that a majority of informed stockholders would approve such a transaction. In re Volcano is the latest decision underscoring the critical importance of securing an uncoerced and fully informed majority vote of disinterested stockholders if boards wish to benefit from this extremely deferential standard of review.
On June 6, 2016, the Supreme Court of Delaware affirmed a decision of the Chancery Court finding that corporate directors and officers involved in a sales transaction breached a contract with option holders to fairly value their options (see here for a thorough explanation of the Chancery Court decision, and in particular, the Court’s criticism of the retained financial advisers that provided a valuation analysis). The Supreme Court decision also included a disproportionately lengthy dissent condemning both the Chancery Court’s findings and its reliance on “social science studies” to reach them.
On May 31, 2016, the Delaware Chancery Court rejected shareholders’ allegations of corporate wrongdoing in a derivative suit against a national healthcare company, Bioscrip, holding that Plaintiff failed to adequately allege demand futility with respect to Bioscrip’s board of directors. For the first time, the Delaware Court found that Plaintiff was required to demonstrate demand futility with respect to the board of directors that was in place after shareholders filed their derivative complaint. Park Emps.’ & Ret. Bd. Emps.’ Annuity & Ben. Fund v. Smith, No. 11000-VCG (Ch. May 31, 2016).
On May 19, 2016, the Delaware Chancery Court preliminarily enjoined the directors of Cogentix Medical from reducing the size of the company’s board because, under the facts presented, there was a reasonable probability that the board reduction plan was implemented to defeat insurgent candidates in a contested director election. Pell v. Kill, C.A. No. 12251-VCL (Del. Ch. May 19, 2016). The decision is a reminder that board actions that affect the shareholder vote—particularly decisions that make it more difficult for stockholders to elect directors not supported by management—will be subject to enhanced judicial scrutiny by Delaware courts on the lookout with a “gimlet eye” for conduct having a preclusive or coercive effect on the stockholder vote.
On May 6, 2016, the Delaware Supreme Court affirmed the Delaware Chancery Court’s ruling that Zale Corporation’s sale to Signet Jewelers withstood scrutiny under the business judgment rule because the transaction was approved by a fully-informed, uncoerced vote of the disinterested stockholders, and that an aiding and abetting breach of fiduciary duty claim against Zale’s financial advisor failed as a matter of law where the plaintiff failed to establish that the Zale board had acted with gross negligence. In so holding, the Court reaffirmed its holding in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), that in cases in which Revlon would otherwise apply, approval of the transaction by a fully-informed, uncoerced majority of disinterested stockholders invokes the deferential business judgment rule standard of review. While the Court also affirmed the Chancery Court’s dismissal of the aiding and abetting claim against Zale’s financial advisor, it called the Chancery Court’s reasoning for the dismissal into doubt and sounded a cautionary note to gatekeepers that they are not insulated from liability merely because they are alleged to have aided and abetted a non-exculpated breach of fiduciary duty by their director clients.
On February 29, 2016, the Delaware Court of Chancery denied a motion to dismiss fiduciary duty claims against certain current and former directors of Halt Medical and a 26% stockholder, American Capital, arising out of a transaction that was allegedly designed to “squeeze out” minority stockholders. See Calesa Associates, L.P. v. American Capital, Ltd., C.A. No. 10557-VCG. Vice Chancellor Glasscock found that the plaintiffs had adequately alleged that American, despite owning only 26% of the company’s shares, exercised sufficient influence over the Halt Medical board such that it and certain affiliates could be deemed “controlling stockholders” owing fiduciary duties to other stockholders. Among other things, the decision in Calesa reaffirmed that majority stock ownership is not the sole criterion for determining “control.” The decision also sounded a cautionary note, however, by suggesting that, where plaintiffs remain minority stockholders in the company after the allegedly dilutive transaction at issue, they must plead demand futility even where, as here, only direct claims are asserted, or face dismissal at the pleading stage.