Nguyen v. Barrett (Sept. 28, 2016) highlights yet again the Delaware courts’ recent narrowing of the circumstances under which plaintiffs can be successful in challenging M&A transactions–in this case, in the context of post-closing disclosure claims. Further, for the first time, the court has articulated the higher burden to a plaintiff in bringing a disclosure claim in a post-closing damages action as compared to a preclosing injunctive action and has stated that disclosure claims should be brought pre-closing, not postclosing.

Key Points 

  • The standard for avoiding dismissal of a disclosure claim in a pre-closing action for injunctive relief is that it is reasonably conceivable that the alleged omission or misrepresentation is material. (We note that the court’s decision in the earlier, pre-closing phase of the litigation, highlighted the higher bar than in the past for a plaintiff to establish materiality; and the court’s greater reluctance than in the past to grant expedited discovery to assist a plaintiff in attempting to establish materiality.)
  • In a post-closing action for damages, there is a higher bar to avoid dismissal of a disclosure claim because claims based on breaches by directors that are subject to exculpation will be dismissed. In a post-closing action for damages, even a material omission or misrepresentation would represent an exculpated breach of the duty of care, unless it is reasonably conceivable that it constituted a breach of the duty of loyalty (which could not be exculpated). Thus, the standard for avoiding dismissal of a disclosure claim in a post-closing action for damages is that it is reasonably conceivable both that the alleged nondisclosure was material and that it constituted a breach of the duty of loyalty (which requires that a majority of the directors were not independent and disinterested or acted in bad faith).
  • Disclosure claims generally should be brought pre-closing. The court clarified that, due to the court’s interest in ensuring a fully informed stockholder vote, disclosure claims not brought and pursued in a pre-closing injunctive action are likely to be viewed by the court, in a postclosing action for damages, as having been waived. (However, notwithstanding the court’s strong language (albeit in dicta) regarding waiver, in our view, it appears that a disclosure claim that reasonably indicates a possible breach of the duty of loyalty would not be viewed as waived even if first brought in a post-closing action.)

Background. Prior to closing of the merger of Millennial Media and AOL, the plaintiff, a stockholder of Millennial, moved for expedited proceedings and a preliminary injunction, based on a long list of alleged disclosure violations. In pursuing the injunctive relief, however, the plaintiff advanced only one disclosure claim that he viewed as the most “serious” (which related to certain financial information that Millennial’s bankers had relied upon (the “Financial Claim”)). The court, finding that it was not reasonably conceivable that the Financial Claim omission was material, denied the motions. The Delaware Supreme Court then denied the plaintiff’s request for an interlocutory appeal. Thereafter, over 80% of Millennial’s shares were tendered and the merger closed. In this post-closing action, the plaintiff sought damages based on both the Financial Claim and a claim that had been pled but not pursued pre-closing (which related to omission of the portion of Millennial’s banker’s fee that was contingent on the merger closing (the “Fee Claim”)). The court dismissed both claims.

Discussion

Post-closing disclosure claims will be dismissed unless the board breached its fiduciary duty of loyalty. Vice Chancellor Glasscock explained that, unless a majority of the board acted “disloyally” in failing to disclose material information, the disclosure claim could, at most, represent a breach of the duty of care, which would be exculpated under the company’s charter and thus (under the 2015 Cornerstone decision) dismissible at the pleading stage. The court reaffirmed that “bad faith” can be established only by “an extreme set of facts” indicating that the directors “acted deliberately to knowingly withhold material information” or that the omission or misrepresentation was so far outside the bounds of reason that the only conceivable explanation was bad faith. The court, noting that it had determined in the pre-closing action that the Financial Claim likely was not material, held that, whether or not it was material, the Claim should be dismissed because the plaintiff advanced no allegations that reasonably indicated that a majority of the board had acted “disloyally” or in bad faith in not making the disclosure.

Post-closing disclosure claims will likely be dismissed if they were not pursued first pre-closing. The court rejected the plaintiff’s contention that recent judicial decisions have established a “new regime” in Delaware under which a plaintiff can elect to bring disclosure claims either pre- or post-closing and the court will review them in either case on the same basis. Rather, the court clarified, disclosure claims brought pre-closing will survive a dismissal motion if it is reasonably conceivable that the omission or misrepresentation was material; while disclosure claims brought post-closing will survive a dismissal motion if it is reasonably conceivable that the omission or misrepresentation was material and that it constituted a breach of the directors’ duty of loyalty. In addition, the court strongly indicated (albeit in dicta) that, in a post-closing action for damages, it likely will view a disclosure claim that was not brought and pursued in a pre-closing action as having been waived. The Vice Chancellor explained that bringing a claim pre-close was “the preferred method” because it would enable the court to ensure a fully informed stockholder vote. The court based its dismissal of the Fee Claim (which had been brought but not pursued pre-closing) on the merits, however (finding that the alleged omission likely was neither material nor made in bad faith). (We note that, of course, the outcome would be different in the case of disclosure claims that could only be identified through post-closing discovery.)

Open issue as to whether the court would deem as waived a post-closing disclosure claim not first pursued pre-closing if it is reasonably conceivable that the alleged omission or misrepresentation was material and made in bad faith. In its 2015 Chen v. Anderson decision, the court refused to dismiss a disclosure claim because it could not be determined at the pleading stage whether the alleged nondisclosure constituted a breach of the duty of care or of the duty of loyalty. In Nguyen, the court distinguished Chen on the basis that, in Chen, unlike Nguyen, there were strong allegations of the directors’ possible non-independence, non-disinterestedness, and bad faith. Thus, notwithstanding the court’s dedication to ensuring fully informed stockholder votes, and its strong language in Nguyen to the effect that disclosure claims “should be brought pre-close, not post-close,” in our view, the decision suggests that, if a disclosure claim first advanced post-closing reasonably indicates a material disclosure and possible breach by directors of the duty of loyalty, the court likely would not deem it to have been waived.

Practice Points

  • Strategy of deferring disclosure claims to a post-closing action for damages (after stockholders have tendered or voted and the remedy of supplemental disclosure is no longer available) is generally not likely to be effective. Nguyen clarifies that (i) a plaintiff’s burden in avoiding dismissal of a disclosure claim at the pleading stage is significantly higher in a post-closing action than in a pre-closing action, and (ii) a disclosure claim not brought and pursued pre-closing will likely be viewed by the court, post-closing, as having been waived (although, as discussed, in our view, the court likely would not view as waived a disclosure claim that reasonably indicates the directors acted “disloyally” or in bad faith).
  • Disclosure that a “substantial portion” of a banker’s fee is contingent, without specifying the portion that was contingent, is generally sufficient. The court reaffirmed that disclosure that a “substantial portion” of a financial advisor’s fee was contingent on closing of the transaction would be sufficient unless (i) there were “some indication that the fee was exorbitant or unusual, or otherwise improper” or (ii) “nearly all” of the fee was contingent (as was the case, the court noted, in its 2011 Atheros decision, where 98% of the fee was contingent). 
  • Reminder of the court’s recent trend of establishing a higher bar for materiality of details about financial information utilized by bankers. The court confirmed that there is no per se requirement that all information provided by management on which the banker relied in its DCF valuation must be disclosed. The plaintiff had argued that the unlevered, after-tax free cash flow forecasts (UFCF) prepared by the company, which the banker had relied on in its DCF analysis, should have been disclosed. The UFCF (or at least the components used to derive it) were material, the plaintiff contended, because the stockholders were being asked, in the merger, to exchange their ownership stake, and thus to forego the company’s future cash flows, for cash consideration. The materiality of the UFCF forecasts was greater in this case than usual, the plaintiff argued, because two of the financial advisor’s DCF projections, which relied on the UFCF, resulted in a price per share of zero. The court held (in the pre-closing phase of the litigation) that the omission of the UFCF from the company’s disclosure likely was not material.