On May 2, 2017, Vice Chancellor Laster of the Delaware Court of Chancery dismissed a purportedly derivative and putative class action brought by a minority stockholder of software company VMware, Inc. (“VMware”), a subsidiary of controlling stockholder EMC Corporation (“EMC”), in connection with EMC’s acquisition by Denali Holding Inc. (“Denali”). Ford v. VMware, Inc., C.A. No. 11714-VCL (Del. Ch. May 2, 2017). Plaintiff asserted breach of fiduciary duty claims against EMC, the dual directors of both EMC and VMware, and Denali, and brought aiding and abetting claims against Denali its affiliates. The alleged breaches included (i) failing to spin off VMware to activist EMC stockholder Elliot Associates, (ii) selling VMware to a “known looter,” (iii) restricting VMware’s operations under the merger agreement and (iv) Denali’s issuance of so-called “tracking stock.” The Court found that none of these theories sustained a viable breach of fiduciary duty claim and dismissed the action in its entirety.
Before the Denali acquisition, EMC held an 81.1% ownership interest in VMware’s common stock and 97.4% of its aggregate voting power, in addition to veto rights (based on VMware’s charter) to any defensive action proposed by the VMware board. The nine-member VMware board included two independent directors and seven directors affiliated with EMC. During the latter half of 2014, Elliot Associates acquired an interest in EMC and began to actively press the company to spin off VMware. In September 2014, Denali approached EMC about a possible transaction, and after more than a year of negotiation, the EMC board approved a merger with Denali on October 11, 2015. To help finance the contemplated merger, Denali issued a new class of stock which tracked the value of 65% of EMC’s 81% equity interest in VMware. This stock constituted part of the consideration paid to EMC stockholders in the acquisition. Though plaintiff filed suit after the merger was announced and purported to seek a preliminary injunction, plaintiff never pursued the preliminary injunction and the merger closed on September 7, 2016.
Plaintiff claimed that a spin-off would have benefited VMware more than the Denali sale and that EMC and the affiliated directors breached their duty of loyalty by preferring EMC’s interests, which were furthered by the Denali transaction. The Court rejected the argument, finding that EMC was entitled to decide when and how to sell its holdings in VMware and had “no obligation to alienate its shares by spinning off VMware for the benefit of VMware and its minority stockholders.”
VC Laster found the “known looter” theory equally unpersuasive, rejecting as conclusory and speculative plaintiff’s assertion that Denali might in the future use VMware’s assets to pay off Denali’s debt. The Court also noted that even if such a threat were cognizable, the complaint failed to allege any specific defensive action that VMware’s board could have taken to prevent the transaction.
The Court rejected out-of-hand plaintiff’s claim based on supposed restrictions on VMware under the merger agreement between EMC and Denali, noting that the purportedly restricted actions “involved the exercise of a voting right or consent right that EMC possessed in its capacity as a stockholder,” not action through VMware. Regarding allegedly harmful changes to VMware’s business operations undertaken by EMC after approval of the merger agreement, the Court concluded that “[t]he consequences of the restructuring . . . affected all of [VMware’s] stockholders, including EMC, proportionately” and that plaintiff alleged no specific factual allegations to support the vague assertion that the restructuring was undertaken by EMC “to facilitate [Denali’s] agenda.”
Finally, the Court rejected plaintiff’s claims based on Denali’s issuance of tracking stock. Though the Court acknowledged that a self-dealing claim against Denali (as controlling stockholder) might lie if VMware was forced to bear adverse tax consequences resulting from the issuance, the Court rejected the asserted claim as purely hypothetical. The Court deemed plaintiff’s theory that the issuance misappropriated VMware assets “nonsensical,” because the tracking stock was “an equity security created and issued by Denali, not VMware.” Nor was plaintiff’s market-price dilution theory cognizable, because nothing in the issuance of the shares “required any action by VMware, the VMware Board or any VMware officer,” and “[c]onsequently, neither EMC nor Denali violated any fiduciary duty.”
The decision is helpful in defining the fiduciary duties owed to a subsidiary by a controlling stockholder. The Court also suggested several defenses that might be used by a subsidiary board to resist a deal favored by its parent company and controlling stockholder. While such defenses were not available to the VMware board because of the veto rights afforded to EMC under VMware’s equity structure, VC Laster explained that a subsidiary board in similar circumstances might attempt to block a transaction pursued by a large or controlling stockholder by deploying a shareholder rights plan, diluting its own stock or pursuing other inventive strategies such as amending its bylaws to require that the proposed transaction be approved by a supermajority of directors. The Court also intimated that a plausible breach of fiduciary duty claim might have been asserted based on VMware’s repurchase of its shares after the stock price fell following announcement of the EMC-Denali transaction—a warning to other controlling stockholders contemplating similar repurchases—but concluded that plaintiff had waived any such claim because it had made no earlier effort to pursue it.
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