Vice Chancellor Glasscock has held that a merger designed to eliminate derivative claims against a majority of directors justified the application of the entire fairness standard of review in a direct challenge to the merger.

In In re Riverstone National, Inc. Stockholder Litigation, C.A. No. 9796-VCG (July 28, 2016), two minority stockholders had provided notice of, but not yet filed, claims asserting that a majority of the board of directors of Riverstone National, Inc. (“Riverstone”) had usurped a corporate opportunity. Riverstone then entered into a merger agreement in which Riverstone’s purchaser agreed to waive the purported derivative cause of action. Thus, through the merger, the directors assured themselves that the derivative claim would not be pursued against them. In response to a standing challenge, the Court concluded “that the Complaint adequately alleges that a majority of the Director Defendants were interested in the Merger, and that the Plaintiffs have alleged sufficient facts to show that the Merger was unfair” (Slip Op. at 18), entire fairness review applied, and the complaint withstood motions to dismiss.

At the time of the merger, Riverstone’s board was composed of five directors. Two of those directors controlled Riverstone’s majority stockholder, CAS Capital Limited (“CAS”) and another company, Regis Group Plc (“Regis”). Riverstone had been one of the largest multifamily real estate management companies in the U.S. Following the financial crisis, Riverstone sought to move into the single-family market, acquiring homes at depressed prices, rehabilitating them, leasing them and then managing the leases. Riverstone’s financial advisors recommended that it partner with an entity experienced in buying homes and jointly raise additional capital. The Treehouse Group (“Treehouse”), which had such experience on a smaller scale, Riverstone and Regis then created a new entity, Treehouse Residential Fund, LP (“Treehouse Residential”) to effectuate this strategy on a national scale. Treehouse Residential and the Blackstone Group LP (“Blackstone”) then created Invitation Homes LP (“Invitation Homes”), which “quickly grew to be the nation’s largest single-family rental company” (id. at 7), with a portfolio of approximately 45,000 homes via a total investment of $7.5 billion from Blackstone. Riverstone, despite remaining “integral to the Invitation Homes business model” (id.), never received an ownership interest in Invitation Homes, but did enter into agreements with Blackstone to act as its property manager. Likewise, Invitation Homes “quickly became integral to Riverstone’s business” (id. at 8), which created a separate division focused solely on Invitation Homes properties and advanced significant funds to develop Invitation Homes. Riverstone’s directors provided services directly to Invitation Homes, including payments by Riverstone to the directors and reimbursement by Riverstone of expenses incurred on Invitation Home’s behalf, including payments directly to Regis. Most problematic, while “Riverstone never received an ownership interest in Invitation Homes, many of Riverstone’s directors and officers were given that opportunity and did invest.” (Id. at 9.) Plaintiffs alleged that the directors knew that the opportunity to invest personally was in conflict with their duties to Riverstone, yet all but one of Riverstone’s then directors invested in, and became officers of, Invitation Homes.

Thereafter, plaintiffs, minority stockholders in Riverstone, presented Riverstone with the derivative claim that the directors had breached their fiduciary duties by usurping the Invitation Homes opportunity. Plaintiffs also demanded books and records relating to the directors’ equity interests in Invitation Homes. Riverstone refused the books and records request, and plaintiffs filed a Section 220 proceeding. On the same date the Section 220 action was filed, Riverstone executed a merger agreement with Greystar Real Estate Partners, LLC (“Greystar”), a Greystar affiliate, and CAS, through which all common stock of Riverstone would be cashed out. CAS, as majority stockholder in Riverstone, had approved the merger the day before. The merger agreement provided that the acquirers would release claims relating to the usurpation of opportunity and misclassification of loans.

Viewed through Vice Chancellor Glasscock’s lens of a post-merger attack on the fairness of the merger, the issue became “rather simple.” (Id. 1.) By using the merger agreement as a vehicle to not only sell the Company, but also eliminate the purported derivative claims against a majority of the directors, “the defendant directors—to the extent they were stockholders—received the same benefit as the other stockholders, but they received an additional benefit not so shared: they were relieved of potential liability they faced in the usurpation claim.” (Id. at 1.) Thus, the asset of Riverstone—the potential claims against the directors—“was not sold, but was obliterated, and the directors received a special benefit of the sale: relief from potential liability.” (Id. at 21.) Because of this benefit, the former minority stockholders had plausibly pled a cause of action that (1) a derivative claim of usurpation of corporate opportunity against a majority of directors existed pre-merger, (2) the directors were aware of their potential liability for the derivative claims at the time they contemplated the merger, (3) the risk posed by the derivative claim was material to the directors, and (4) the merger agreement obtained by the directors “both eliminated the threatened derivative suit by operation of law, and eliminated any pursuit of the matter as a corporate asset purchased by the acquirer, as a matter of contract.” (Id. at 2; see also id. at 23-38.) Plaintiff former minority stockholders thus had adequately pled “that a majority of the Defendant directors received a material benefit from the merger not shared by the common stockholders” (id. at 2), and thus had pled that a majority of the directors were interested in the transaction and “the presumption of the exercise of business judgment overcome.” (Id. at 38.) Under entire fairness, the directors must “establish that the merger was the product of both fair dealing and fair price.” (Id. at 38-39.) Plaintiffs pled that the merger price was unfair in failing to account for the material benefit received by the directors. Plaintiffs had stated a claim sufficient to withstand a motion to dismiss. (Id. at 38-40.)

Vice Chancellor Glasscock, however, warned that the “Court must be wary” of allegations that directors were interested in a merger transaction.

If a conclusory allegation—that a potential derivative suit against directors existed, but was extinguished by a merger—was sufficient to show that directors were interested in the merger, much ground for strike suits and other mischief would be possible. Here, however, the Plaintiffs plead particularized facts with respect to individual directors showing the existence of a chose-in-action against the directors which, if brought as a claim would have survived a motion to dismiss; that the director at the time of negotiating and recommending the merger was aware of the potential action; that the potential for liability was material to the director; and that the directors obtained and recommended an agreement that extinguished the claim by contract.

(Id. at 22.) These particularized allegations, against a majority of directors, were “sufficient to rebut the business judgment rule” (id.), and serve as a warning to future boards of directors of how not to try to dispose of derivative claims against them.