Since the Delaware Supreme Court’s decision in Corwin v. KKR Fin. Holdings, LLC1 and the handful of cases interpreting it, corporate directors have enjoyed the “Corwin cleanse” of business judgment rule protection in connection with challenges to acquisition transactions not subject to entire fairness review and that had been approved by a fully informed, uncoerced majority of disinterested stockholders. No case since Corwin invoking the Corwin cleanse had failed to enjoy business judgment rule protection – until now. The Delaware Chancery Court’s decision in the Saba Software, Inc.2 stockholders litigation (Saba) is the first to find the factual circumstances surrounding an acquisition sufficiently unusual to prevent the Corwin cleanse from washing away director liability.
Saba Software, Inc. was a formerly publicly traded company the SEC found had fraudulently and materially overstated its pre-tax earnings from 2008 to 2011. Over several years, the company claimed it would restate its financial statements but never did so. In June 2013, the company was delisted by NASDAQ. In 2014, the company reached a settlement with the SEC, which included a restatement deadline by February 2015. In late 2014, the board formed a committee to explore its strategic options, a potential buyer emerged, and the company announced it would miss the restatement deadline. In January 2015, the company received an offer from Vector Capital for an all cash merger. When the company missed the restatement deadline the following month, the SEC deregistered the company. In March 2015, the company signed a merger agreement with Vector, and six weeks later the stockholders approved the merger and the sale closed. Following the closing, former stockholders filed a complaint alleging direct claims against the company’s directors for breach of their fiduciary duties in connection with the merger approval process.
The Saba court determined the stockholder vote was neither fully informed nor uncoerced and therefore failed to satisfy the Corwin requirements due to the usual circumstances surrounding the merger approval process, rendering the transaction subject to enhanced scrutiny and the Corwin cleanse inapplicable. The stockholders were not fully informed because the proxy statement was deficient for at least two reasons. First, the proxy statement failed to provide any description of the circumstances or reasons for the company’s repeated failure to complete the restatement, which the Saba court held was an omission of factual developments that drove the sale process and, if not corrected, would materially affect the company’s standalone value going forward. Second, the proxy statement failed to provide material facts regarding the committee’s 2014 consideration of strategic options and whether the company was viable as a going concern if the merger was not approved when it was evident the company would miss the restatement and be deregistered.
The Saba court went on to hold that the stockholder approval was also situationally coerced due to the proxy statement’s failure to include sufficient facts for stockholders to meaningfully reach conclusions regarding the value of their stock if they declined to approve the merger under the circumstances, thereby depriving them of the ability to determine whether rejecting the merger and retaining their stock made economic sense. In essence, the proxy statement presented stockholders with a Hobson’s choice between keeping their deregistered illiquid stock and accepting a depressed merger price in comparison to what it had traded for prior to the company’s deregistration, leaving the stockholders with no practical alternative but to approve the merger. Even in the absence of any alleged affirmative coercive action taken by the directors, the Saba court deemed this to be a coerced stockholder approval under the circumstances.
Finally, even though the company conducted what appeared to be an adequate sales process including utilization of an independent special committee, outreach to and receipt of indications of interest from multiple potential buyers, a fairness opinion engagement and sustained (but ultimately unsuccessful) purchase price negotiations with Vector, the Saba court held that the directors may have acted in bad faith and otherwise breached their duty of loyalty. The plaintiffs alleged the directors never intended the company to complete the restatement in order for the company to be deregistered, resulting in the elimination of regulatory scrutiny that would have otherwise prevented issuance of certain equity awards to directors shortly before closing. They further alleged the directors then rushed the sales process, ignored sale alternatives and proposed the merger for approval in order to then cash out their equity awards that otherwise would have been worthless in the absence of the merger. In what it described as a “close call,” the Saba court deemed these allegations sufficient to defeat the directors’ motion to dismiss these fiduciary duty claims.
The Saba court emphasized the Corwin cleanse only failed to apply due to the highly unusual factual context in this case. Thus, the Saba case should not be viewed in our estimation as a deviation from the Chancery court’s general interpretation and application of Corwin going forward but rather as articulating a rare exception where it simply cannot be applied. Even so, Saba serves as a valuable lesson for companies and their directors. It highlights the premium they must place on efficient resolution of outstanding corporate hygiene problems, especially prior to commencing a sales process. It further underscores the need to carefully consider any unusual constellation of facts that could affect the conduct, timing and perception of a sales process and the care required in crafting proxy materials to communicate such facts clearly and completely to stockholders when requesting transaction approvals.