A recent Delaware case provides useful guidance that corporations (and their counsel) can use to fend off challenges to breach of fiduciary duty claims in certain M&A transactions. The takeaway from this case - a disinterested, uncoerced, fully informed stockholder vote can “cleanse” a transaction otherwise subject to the “entire fairness” standard of review, absent a conflicted controlling stockholder. The import of this point of law is that it provides a clear description of how to structure M&A decision-making processes in order to dispose, at an early stage, shareholder claims of breaches of fiduciary duties.
In Larkin v. Shah, C.A. No. 10918-VCS (Del. Ch. August 25, 2016), former shareholders of Auspex Pharmaceuticals, Inc. (Auspex) sued Auspex’s board of directors for breach of fiduciary duties in connection with the sale of the business to Teva Pharmaceutical Industries Ltd. (Teva) for roughly $3.2 billion in cash in a two-step, short form merger. Under this structure, Teva first acquired a majority of the outstanding voting equity by publicly offering to buy shares of Auspex’s stock directly from its shareholders (the Tender Offer). Auspex would then be merged into a Teva subsidiary (without a shareholder vote) pursuant to Section 251(h) of the Delaware General Corporate Law (DGCL). This structure, known as a “two-step” merger, streamlined the acquisition because it eliminated the time and expenses associated with conducting a shareholder vote since, through the Tender Offer, Teva acquired a majority of the voting power, thus rending the results of a shareholder vote a foregone conclusion.
The plaintiffs alleged that the board of directors (many of whom were affiliated with certain venture capital firm stockholders of Auspex) engaged in a flawed sales process that failed to yield the best value for the company’s public stockholders. According to the plaintiffs, in order to meet personal liquidity needs, the venture capital stockholders controlled and caused the board to accept the first all-cash transaction they could find, at the cost of considering other offers with cash and stock components and to the detriment of Auspex’s other stockholders. Alternatively, the plaintiffs argued that the directors approved the transaction under a conflict of interest. In either scenario, the “entire fairness” standard (the highest level of judicial scrutiny applicable to board actions) would apply.
Vice Chancellor Joseph Slights III, writing for the Delaware Court of Chancery, disagreed with the assertion that entire fairness applied to the transaction due to the presence of an uncoerced, fully informed, disinterested shareholder vote in favor of the transaction, without a conflicted controller, that “cleansed” the transaction such that the business judgment standard of review (the least exacting level of scrutiny) inarguably - applied. If the business judgment rule inarguably applies to the transaction, the board action may only be overturned by judicial intervention based on a claim of corporate waste–i.e., that the decision “cannot be ‘attributed to any rational business purpose’”–a very high standard for plaintiffs to meet. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993).
First, the fact that 78% of the Auspex shareholders decided to sell their shares pursuant to the Tender Offer satisfied the uncoerced, fully informed, disinterested stockholder voting requirement. A few months prior to Larkin, the Court of Chancery held that the tender offer portion of a “two-step” merger under DGCL § 251(h) has the same cleansing effect as an uncoerced, fully informed, disinterested shareholder vote in favor of the transaction, notwithstanding the fact that a tender offer is statutorily required or that the transaction would otherwise be subject to heightened Revlon scrutiny. In re Volcano Corporation Stockholder Litigation, C.A. No. 10485-VCMR (Del. Ch. June 30, 2016) (a stockholder is no less exercising her “free and informed chance to decide on the economic merits of a transaction” simply by virtue of accepting a tender offer rather than casting a vote).
Second, there was no conflicted controller present. Although a stockholder (or block of affiliated stockholders) owning less than a majority of the outstanding shares may be deemed a “controller,” such a holder must wield “such formidable voting and managerial power that, as a practical matter, [it is] no differently situated than if [it] has majority voting control” and that it “triggers the . . . concern that independent directors’ free exercise of judgment has been compromised.” Larkin, C.A. No. 10918-VCS at 34. In Larkin, the venture capital stockholders collectively held 23.1% of Auspex’s stock, and the plaintiffs’ complaint failed to state any well-pled allegations that would permit a reasonable inference that any such controller or control block could “exercise actual control over [Auspex’s] board.” Id. at 36.
Larkin provides a clear roadmap for corporations to follow when structuring a M&A decision-making process, particularly when the target is a publically-traded entity.