Recently in In re Xura, Inc. Stockholder Litigation, the Delaware Chancery Court denied a motion to dismiss a claim for breach of fiduciary duty brought against a merger target company’s CEO, alleging that he orchestrated the company’s sale to a particular bidder in order to secure his position post-merger, which he stood to lose if the transaction did not occur. The CEO argued that dismissal was required under Corwin v. KKR Financial Holdings LLC, which holds that a non-controlling stockholder merger approved by informed, disinterested stockholders will be reviewed under the deferential business judgment rule. The Court rejected that argument because the complaint adequately alleged that the stockholders’ vote was not fully informed, in light of numerous material omissions regarding the CEO’s negotiation of the transaction. The In re Xura decision provides salient lessons on best practices for Delaware companies and their directors, officers, and advisors embarking on a merger.
In October 2015, Siris Capital Group approached Philippe Tartavull—the CEO and a director of Xura, Inc.—with an offer to acquire Xura for $35 per share. Siris’ initial bid letter, and each one that followed, stated that Siris was “excited about the opportunity of working with ... [Xura’s] leadership team.” In response, Xura’s board of directors engaged a financial advisor and formed a “Strategic Committee” consisting of Tartavull and two other directors to evaluate the proposal and negotiate with Siris. Tartavull conducted almost all of the negotiations alone, with the Strategic Committee “function[ing] essentially as a weekly check-in with Tartavull.” The Strategic Committee “never took any formal action and never kept minutes nor any written record of its activities,” and one of its members did not even realize the committee existed until his post-merger deposition. Tartavull also regularly communicated with Siris without informing the Strategic Committee or financial advisor, including a meeting where he allegedly tipped Siris as to the price that Xura’s board would accept. This meeting likewise was not disclosed in Xura’s proxy statement. After Siris further lowered its offer to $24 per share, the Special Committee and financial advisor decided to go “radio silent,” yet Tartavull continued to discuss next steps with Siris. Throughout the negotiations, Tartavull was aware that Xura’s major stockholders were questioning his performance and that the board was considering replacing him if the company was not acquired. In May 2016, Xura and Siris executed a merger agreement at $25 per share, and in August 2016 the transaction closed after approval by a majority of Xura’s stockholders.
Xura stockholder Obsidian Management LLC dissented from the merger and sought appraisal of its shares. After obtaining discovery in the appraisal proceeding, Obsidian sued Tartavull for breach of fiduciary duty and Siris for aiding and abetting that breach. The Court held that Corwin did not apply to the claim against Tartavull because “Xura’s stockholders could not have cleansed conduct about which they did not know,” and Obsidian had adequately alleged several material omissions from Xura’s proxy statement—including that Tartavull repeatedly communicated and negotiated with Siris without the knowledge or approval of Xura’s board; Siris’ offer letters made clear it intended to work with Tartavull and other management post-merger; and Tartavull knew during negotiations that his job was in jeopardy if Xura was not acquired. The Court also rejected Tartavull’s argument that the claim failed because a majority of the board was disinterested and independent, and those directors approved the merger in good faith. “[E]ven assuming that board ratification would be a defense to a CEO’s alleged breach of fiduciary duty,” the Court reasoned, that defense was unavailable because “[t]he board, like shareholders, cannot approve (and ratify) what it did not know.” The Court then held that Obsidian stated a viable claim that Tartavull breached his duty of loyalty based on allegations that his desire to maintain his CEO position caused him to favor Siris over other bidders and accept an underpriced bid.
In re Xura reinforces a number of crucial points in negotiating mergers and similar transactions. However, the rather extreme facts of the case also make it important to emphasize that the case is not a retreat from prior Delaware case law.
- The decision underscores the centrality of disclosures. The adequacy of disclosures in a company’s proxy statement is one of the most frequently challenged issues in deal litigation. Accordingly, documenting and disclosing the negotiation process is critical from the beginning of any merger. But this issue assumes heightened importance where directors or officers are arguably conflicted—especially if they play a leading role in the negotiations—and the transaction, absent Corwin “cleansing,” may be subject to the demanding “entire fairness” standard of review. Companies should be particularly mindful of documenting and disclosing the procession of negotiations (including less-formal communications between counterparties) and discussions of post-merger employment for any officer or director.
- Process is key—a board or special committee should take an active role, with responsibilities clearly delineated. The Court was clearly troubled by the deficient process by which the merger was negotiated, including the Strategic Committee’s abdication of its responsibilities and failure to monitor or rein in a negotiator who repeatedly flouted its instructions. The board or special committee should remain involved and informed throughout negotiations and ensure that its instructions are faithfully executed. The importance of this is further illustrated by the Chancery Court’s suggestion that the approval of informed, well-functioning directors might possibly “ratify” an alleged breach of fiduciary duty by another conflicted director or officer.
- Companies must remain cognizant of the heightened risk of officer liability. In re Xura also highlights the differences between officer and director liability under Delaware law. As the Court noted, it is “not settled in our law, and that there is a lively debate among members of the academy, regarding whether corporate officers may avail themselves of business judgment rule protection.” Further, Section 102(b)(7) of the Delaware General Corporation Law, which allows corporations to adopt bylaw provisions eliminating directors’ liability for monetary damages for breaching their fiduciary duty of care, does not apply to officers. For these reasons, corporations should remain particularly vigilant in structuring processes to minimize the risk of officer liability. Stockholders bringing merger challenges routinely allege that a company’s officers and/or directors were conflicted in negotiating or approving a merger because they planned to remain in their roles post-merger. Courts have often rejected these claims, explaining that the prospect of continued employment does not itself present a disqualifying conflict, and that there is nothing inherently improper with such an officer or director taking part in merger negotiations.In re Xura differs from the typical case because of additional allegations that (1) Tartavull’s position was in serious jeopardy if the merger did not occur, (2) Tartavull was incentivized to “steer” the process toward a particular bidder to maintain that position, (3) detailed Tartavull’s alleged efforts to actively undermine the Strategic Committee’s negotiating position, and (4) detailed the Strategic Committee’s alleged neglect in overseeing the process. Where an officer or director arguably suffers such a conflict of interest, the board or special committee should structure its process so that it is not unduly reliant on that individual’s efforts. It is also advisable, where feasible, to agree upon the substantive terms of the merger before negotiating the terms of post-merger employment.
- Document preservation and pre-complaint discovery are critical. The allegations against Tartavull were based largely on discovery obtained in the Obsidian appraisal proceeding, including the deposition admission that a Strategic Committee member did not realize the committee existed until his post-merger deposition. Without the benefit of document production and depositions, which a plaintiff typically lacks at the pleading stage, it is far less certain whether Obsidian could have crafted a complaint that could survive dismissal. Further, this discovery brought to light that several executives (including Tartavull and two Siris executives) had lost or destroyed their cell phones under suspicious circumstances, which brought the defendants under additional scrutiny. In re Xura thus stands as another reminder that companies may consider (1) resisting pre-suit discovery whenever possible (e.g., by rejecting books-and-records demands if there is a basis for doing so), (2) dedicating adequate resources to preparing witnesses for depositions, (3) regularly reminding employees and directors to exercise discretion when sending written communications while a major transaction is under consideration, and (4) remaining aware that the duty to preserve documents may be triggered before litigation is filed.