In a recent decision by the Delaware Supreme Court, Appel v. Berkman, No. 316, 2017 (Del. Feb. 20), the court held that a board's failure to include information about the chairman of the board's reasons for abstaining on the vote rendered the proxy statement materially misleading. This decision serves as a stark reminder that boards of directors should carefully consider whether to disclose in a proxy statement the reasons for a director's abstention on a vote to approve a sale.
Diamond Resorts International was founded by Stephen Cloobeck in 2007, and he served as its chairman and CEO from inception through December 2012. When the company went public in 2013, he continued to serve as the company's chairman. In early 2016, the board of Diamond Resorts began considering strategies for the future of the company, including the potential for its sale. The board received several indications of interest, and ultimately received two bids – one from the ultimate purchaser, Apollo Global Management, and the other from "Sponsor B." The board voted in favor of the sale to Apollo; however, Cloobeck abstained from voting and expressed his reason for it in two separate board meetings. As described in the company's meeting minutes: he was disappointed with the price and the company's management for not having run the business in a manner that would command a higher price, and that in his view, it was not the right time to sell the company.
The board issued a lengthy proxy statement to its stockholders, recommending that they tender their shares to Apollo as part of the sale process and indicating the reasons for and against the tender. While the proxy statement did indicate that Cloobeck had abstained from the vote, it provided no insight into the reason behind the abstention.
Several weeks later, the plaintiff-stockholder made a Section 220 demand to inspect the company's books and records, and, about two months after the sale was consummated, filed a putative class action against the directors and their financial adviser. The plaintiff-stockholder alleged that the proxy statement was materially misleading in part because of the failure to disclose the reasons underlying Cloobeck's abstention. The Delaware Court of Chancery dismissed the case, holding that, as a matter of law, the company need not include the reasons for a director's abstention on a vote in a proxy statement.
The Delaware Supreme Court's Analysis
On appeal, the directors argued that, because Cloobeck's reason for abstaining was nothing more than opinion-as opposed to a fact-that it necessarily did not need to be included in the proxy materials. But the court noted that many of the statements in the proxy were subjective statements of opinion as to why the transaction was favorable to the company and why the directors had voted in favor of it. These positive opinions, in the court's view, had a "lulling effect" on the stockholders. Had Cloobeck's rationale for abstention-that he did not think it was the right time to sell the company-been disclosed, it would "significantly alter the total mix of information" in the proxy statement.
The directors relied on a line of cases, beginning with Newman v. Warren, for the proposition that the reasons for abstention could never be material and thus require disclosure. But the court disagreed, finding that such a reading conflicted with Delaware's corporate law and directors' fiduciary duties and disclosure obligations. It rejected a finding that directors operated "as monolithic bastions of groupthink" and instead held that stockholders are entitled to proxy statements that do not "airbrush away" the "imperfections and inconsistencies" of the proposed transaction.
The court declined to adopt a per se rule about the need for disclosure of the reasons for a director's abstention on a vote. Instead, it found that a contextual approach was more appropriate and more consistent with Delaware corporate law. Thus, such a disclosure would only be necessary when the facts of the case dictated that it would have a material effect on a stockholder's decision. Specifically, the court identified one such factor that could be considered – the abstaining director's reason for doing so.
In this particular case, the court found that the failure to disclose was material. Cloobeck was the founder of the company and a key member of the board. He had articulated his reasons for abstention in two separate board meetings, and those reasons could have provided insight to stockholders that the sale price was too low and thus potentially cause them to not tender their stock. It was not enough, the court concluded, for the proxy statement to allude to the abstention and assume that the stockholders would be able to guess the reasons why. Because Delaware law requires disclosures in proxy statements to be balanced and truthful, this proxy statement was materially misleading. Therefore, as the directors did not enjoy the protection of the business judgment rule, reversal was required.
As the Delaware Supreme Court declined to adopt a per se rule to the disclosure of a director's reasoning for abstaining from a vote, boards should consider carefully whether they need to include such information in proxy materials distributed to stockholders. On the one hand, because proxies are typically distributed in order to induce stockholders to do something, boards might be hesitant to include information that may negatively affect stockholders' decision-making. On the other hand, as the court made clear in this case, boards must be careful to not "airbrush" their proxy statements such that stockholders do not have the benefit of the full picture.
Two things were fundamental to this proxy statement being found materially misleading: the abstaining director's position in and authority with the company and the clear – and repeated – articulation of the reason for the abstention. However, because each case will be assessed on its own facts, these may not be the only indicia of materiality. Boards should weigh the cons of disclosing information that may discourage stockholders from taking action against the potential for a successful challenge to the transaction if it is approved and the reasons for an abstention are not disclosed.