In Pfeffer v. Redstone, 2009 WL 188887 (Del. Jan. 23, 2009), the Delaware Supreme Court confirmed a Chancery Court holding that under Delaware law the heightened scrutiny of “entire fairness “ is not imposed on controlling shareholders, that make non-coercive tender or exchange offers to minority shareholders. The case arose out of the Viacom's spin off of Blockbuster. The plaintiffs alleged that Sumner Redstone and the other directors of Viacom and Blockbuster (as well as parent companies) breached duties of disclosure, care and loyalty in connection with a tender offer and related special dividend. The court rejected the application of “entire fairness” scrutiny to defendants’ Rule 12(b)(6) motion due to the non-coercive nature of Viacom’s proposed tender offer. The court went on to find that the complaint failed to adequately plead disclosure violations, despite actual misstatements and omissions by defendants, because plaintiffs failed to adequately plead the materiality of those misstatements and omissions.
In 2004, Sumner Redstone owned a controlling stake in National Amusements, Inc. (“NAI”) which owned a 71% interest in what was then Viacom, Inc., and what is now known as CBS Corporation. At the time, Viacom held a vast majority of the equity and almost all of the voting power in video giant Blockbuster. Viacom determined that Blockbuster would perform better as a separate entity and, on February 10, 2004, announced the divestiture of 81.5% of its interest in Blockbuster. The divestiture involved two transactions forming the basis of the class action suit: (1) a special $5 dollar dividend paid to Blockbuster stockholders, including Viacom (the “Special Dividend”); and (2) an offer to Viacom stockholders to voluntarily exchange Viacom shares for Blockbuster shares (the “Exchange Offer”). On September 8, 2004, Viacom issued a prospectus that detailed the relevant terms of the Exchange Offer and, importantly, made certain disclosures about the nature of the Exchange Offer.
The Exchange Offer was successful and Blockbuster was spun out from Viacom. However, following the Exchange Offer, Blockbuster struggled to remain profitable. On March 9, 2006, following an SEC investigation, Blockbuster announced a restatement of reported 2003-2005 cash flows to correct a longstanding accounting error. Soon after, a class action was filed on behalf of Blockbuster shareholders who held shares at the time of the Blockbuster Special Dividend and on behalf of all Viacom shareholders who tendered Viacom shares for Blockbuster shares in the Exchange Offer.
Entire Fairness Rejected
At the Chancery Court, Plaintiffs alleged breach of the duties of disclosure, loyalty and care against Viacom’s board of directors, and breach of the duty of loyalty against controlling shareholder NAI. The Chancery Court granted the defendants’ motion to dismiss with prejudice, finding the complaint conclusory and poorly pleaded.
On appeal to the Delaware Supreme Court, plaintiffs maintained that the defendants’ complaint should have been reviewed under a stricter “entire fairness” standard on the ground that NAI, the controlling shareholder of Viacom, allegedly elevated its own financial interest over that of the class members, minority shareholders of Viacom. Plaintiffs appealed to the Delaware Supreme Court. Under Delaware law, the entire fairness standard requires defendants to prove the entire fairness of a subject transaction, which includes fair dealing and fair price.
In Pfeffer the Delaware Supreme Court held that the heightened scrutiny of “entire fairness “ is not imposed on controlling shareholders, like NAI, that make non-coercive tender or exchange offers to minority shareholders. The Court noted that the Exchange Offer prospectus issued by the Viacom board never recommended that Viacom shareholders participate in the tender offer. The prospectus also disclosed that NAI, which owned the majority of Viacom shares, would not participate in the Exchange Offer. In addition, the court found nothing to suggest that the directors who approved the Exchange Offer structured the transaction to put their own interests above those of Viacom or a specific group of Viacom shareholders.
Because “entire fairness” did not apply and the Court of Chancery’s ruling could only be reversed if, on further review, plaintiffs’ complaint adequately pleaded disclosure violations.
Claim of Breach of the Duty of Disclosure Not Legally Sufficient
The court acknowledged that a duty of disclosure is not an independent fiduciary duty, but only arises due to existing duties of care and loyalty. The court then addressed the four disclosure issues raised by plaintiffs on appeal.
First, plaintiffs argued that the fact that Blockbuster issued a corrective restatement of reported cash flows sufficiently alleged a breach of disclosure by Viacom at the time it issued the Exchange Offer prospectus. The complaint did not, however, adequately plead that a reasonable person would consider the accounting restatement important in deciding whether or not to tender Viacom shares for Blockbuster shares. Accordingly, the court found that the complaint failed to allege how the accounting restatement was material so as to constitute a cognizable claim.
Second, plaintiffs asserted that the Viacom board of directors knew or should have known of Blockbuster’s operational cash flow problems prior to the Exchange Offer. The court, however, found that plaintiffs failed to establish a reasonable inference that the Viacom board would have access to this information. Plaintiffs’ allegation that a cash flow analysis performed by a mid-level Blockbuster treasury manager would routinely be available to the board of directors of Blockbuster’s parent company, Viacom, was conclusory and not well-pleaded.
Third, plaintiffs argued that Viacom should have disclosed the pricing methodology used to set the Exchange Offer ratio (5.15 shares of Blockbuster for each Viacom share tendered). Under Delaware law, a board owes no duty to disclose pricing methodology for non-coercive voluntary tender offers, unless the board assumes a duty to offer a fair price or makes a partial disclosure that implies a fair price. Here, the Exchange Offer prospectus disclosed that the Viacom and Blockbuster boards offered no recommendations whether or not Viacom shareholders should participate in the Exchange Offer. The prospectus disclosed that the Exchange Offer was voluntary and non-coercive and never stated that the offering price was fair. Since Viacom shareholders could not have reasonably relied on the fairness of the exchange ratio, the court found methodology used to calculate the ratio was immaterial.
Fourth, plaintiffs contended that Viacom’s disclosure in the prospectus that a special committee recommended the Exchange Offer, without also disclosing the special committee members’ names, breached a disclosure duty. The court deemed the omission of the committee members’ names immaterial because there was no representation in the prospectus that the committee was independent of parent company NAI and because the prospectus’ language did not induce shareholders to rely on the special committees’ decision. Because the composition of the committee was immaterial, plaintiffs failed to allege a material omission by the defendants.
Claims of Breach of the Duty of Loyalty Not Legally Sufficient
The court further ruled that plaintiffs’ breach of loyalty claim against the Viacom board was deficient because plaintiffs never alleged that the Viacom directors stood on both sides of the Exchange Offer or that parent NAI or majority shareholder Redstone received unique financial benefits that were not also available to Viacom’s minority shareholders. The court likewise rejected Plaintiffs’ breach of loyalty claim against NAI because they did not establish a connection between omissions in the prospectus and any conduct on the part of NAI or a duty owed by NAI.
The Pfeffer decision from the Delaware high court provides important guidance to practitioners. First, from the corporate prospective, a controlling shareholder in a tender offer that wants to avoid “entire fairness” should not make a recommendation that minority shareholders participate in the exchange. Any materials issued in connection with the tender offer should disclose that shareholder participation is voluntarily and non-coercive. Second, the court's ruling confirms that a plaintiff claiming breach of fiduciary duty in connection with tender offer disclosure must properly allege facts sufficient to indicate that the misstated or omitted information was material to the shareholders in making their decision on whether to tender their shares.