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February 17, 2009 In this Issue.
advocates pushing the doctrine beyond its intended bounds, the doctrine has generated a great deal of confusion.
recently, in Gantler v. Stephens, the Delaware supreme Court, in an effort "[t]o restore coherence and clarity" to the doctrine of stockholder ratification, held that the doctrine "must be limited to its so-cal ed ‘classic' form; that is, to circumstances where a ful y informed shareholder vote approves director action that does not legal y require shareholder approval in order to become legal y effective." this holding, though seemingly straightforward, presents a number of complicated issues for corporate practitioners and their clients. Chief among these issues is what form, post-Gantler, a "stockholder ratification" vote must take and whether the benefit that any such vote might confer upon those seeking it is outweighed by the risk it entails.
the concept of "classic ratification," as articulated by the supreme Court in Gantler, cannot be properly understood without reference to the (now-overturned) concept of ratification as applied in the lower court's opinion. Gantler involved an action for breach of fiduciary duty against the directors and officers of First Niles Financial, Inc. ("First Niles") for their decision to effect a reclassification of common stock held by holders of 300 or fewer shares into non-voting preferred stock with senior dividend rights.the effect of the reclassification was to shift ful voting power to First Niles' large stockholders, who remained the sole holders of common stock fol owing the reclassification, and to facilitate First Niles' deregistration as a reporting company under the federal securities laws.the reclassification was approved by a five-person board consisting of two "inside directors," stockholder ratification: A review of the both of whom defendants "implicitly concede[d]" were neither Benefits and Burdens disinterested nor independent; one director who was found to be beholden to the Ceo and therefore not independent; and Contributed by: two directors found to be disinterested and independent.
Mark J. Gentile, John Mark Zeberkiewicz and the Chancery Court found that plaintiffs had alleged facts Megan R. Wischmeier, Richards, Layton & Finger, P.A. sufficient to demonstrate that a majority of the board was not disinterested or independent, which ordinarily would have Few doctrines of Delaware corporate law have been cal ed to rebutted the presumption of the deferential business judgment serve as many distinct functions as the common law doctrine of rule and triggered a review under the more exacting entire stockholder ratification. over the years, the doctrine has been fairness standard. But the Chancery Court never reached proffered to remove the taint of voidability from unauthorized that stage of the process.
corporate to moot claims of and to revive the presumption of the business judgment rule in transactions rather than applying the entire fairness standard, the that, due to disabling conflicts, would otherwise have been Chancery Court looked to the stockholder vote approving the reviewed under the rigorous entire fairness st reclassification—which, because it was effected through a whether as a result of the same term being used to describe charter amendment, required for its approval the affirmative conceptually distinct notions,or as a result of zealous vote of a majority of the outstanding shares of common 2009 Bloomberg Finance L.P. All rights reserved. BLoomBerg LAw rePorts is a registered trademark and service mark of Bloomberg Finance L.P.
Bloomberg Law reports® stock—and determined that it was sufficient to "‘revive[] the in In re Santa Fewhere it had reversed the lower court's powerful presumptions of the business judgment rule as the ruling that a "ratifying" stockholder vote on a merger had applicable standard of review for the challenged conduct.'" "extinguished" plaintiffs' breach of fiduciary duty claims arising to benefit from this change in the applicable review standard, from the defendant-board's adoption of defensive measures. defendants were required to demonstrate that "all material In that case, the supreme Court held that the doctrine was facts relevant to the transaction were fully disclosed" and inapplicable because santa Fe's stockholders "merely voted that the transaction was approved by a majority of the in favor of the merger and not the defensive measures." outstanding unaffiliated shares entitled to vote.on these points, the Chancery Court found that the disclosure in the what the supreme Court in Gantler did not say, however, is that proxy statement was adequate and that the reclassification matters that are ancil ary to the principal transaction for which had been approved by the vote of 50.28 percent of the stockholder authorization is legally required are incapable of unaffiliated shares eligible to thus, "because there was being ratified when voluntarily submitted to stockholders For adequate disclosure, the unaffiliated shareholders' ratification example, if a majority of the directors are receiving a special of the reclassification [was] valid," and, in the Chancery benefit from a merger, such as golden parachute payments, Court's view, that ratification brought "the Board's decision to there is no reason why the board could not submit the merger effect the reclassification back within the business judgment agreement to the stockholders for adoption thereby as required by laand request that the stockholders specifical y approve the special benefit, which would be fully disclosed in the proxy In reviewing the Chancery Court's rulings, the supreme statement and appear as a separate item on the proxy card. In Court found that the lower court had erred in finding that fact, the supreme Court's opinion suggests not only that this First Niles' disclosure was not materially misleading. Based additional, voluntarily-requested vote is within the bounds of on that finding, the supreme Court could have found the "classic" ratification, but that the disinterested stockholders' business judgment rule inapplicable (since the reclassification approval of the matter would revive the presumption of the would not have been approved by a fully informed vote of business judgment rule. thus, in its discussion of "director the unaffiliated stockholders) and thereby sidestepped action or conduct" that stockholders are "specifical y asked to the Chancery Court's ruling on the effect of the ratification approve," the supreme Court noted that "[w]ith one exception, vote. But the supreme Court decided instead to use the the ‘cleansing' effect of such a ratifying shareholder vote is to occasion to bring doctrinal clarity to an area of law riddled subject the challenged director action to business judgment with conflicting interpretations and uncertain applications. review, as opposed to ‘extinguishing' the claim altogether." Noting prior decisions alluding to the uncertainty caused by this further amplification demonstrates the application of the the doctrine's "compartmentalization" into distinct areas, doctrine of stockholder ratification that the supreme Court the supreme Court sought to cut back the various powers found objectionable: namely, "springing" ratification, or and functions that had been ascribed to the doctrine over the the attempt by defendants, post hoc, to transform the vote years and to confirm that its proper application is found in that they were legally required to obtain to authorize the its "classic" form. In this framework, stockholder ratification challenged transaction into a vote to authorize the transaction exists, and serves a function, where it involves the voluntary and to approve any and all conduct and factors that would submission of a matter to stockholders for approval thereby otherwise call into question the directors' disinterestedness in a situation where the stockholders' affirmative vote is not and independence.
required by law to authorize the matter.thus, the stockholder "ratification" at issue in the Chancery Court's Gantler opinion could not have revived the application of the business judgment rule, because the sole vote that was sought and the principal question for corporate practitioners, post-Gantler, obtained—namely, the vote required under section 242 of the is when, if ever, is it appropriate to seek a ratification vote on general Corporation Law of the state of Delaware ("DgCL") a matter ancil ary to the matter for which stockholder approval to effect the charter amendment—was legally required to is legal y required. Practical considerations wil likely dictate authorize the transaction.
the answer—and in most cases would militate against seeking the additional, voluntary ratification vote. even if the board read literally, the supreme Court's articulation of "classic becomes aware of factors that could result in a rebuttal of the ratification" could lead to the conclusion that the doctrine presumption of the business judgment rule, it may be reluctant of stockholder ratification is inapplicable in any case where to seek a separate ratification vote as to those factors, since the board is seeking stockholder approval as to a matter doing so could be seen as a tacit concession that the directors that by law requires for its authorization an affirmative are neither disinterested nor independent.In addition, the stockholder But that conclusion would be inconsistent board, in seeking any such separate vote, would essentially with the gloss the supreme Court provided on its own be pleading for the stockholders' grace, since any effort to formulation of "classic" ratification. In clarifying the concept, provide stockholders with an incentive to vote in favor of the the supreme Court noted that "the only director action or ratification proposal, including conditioning the approval of the conduct that can be ratified is that which the shareholders transaction on the approval of the ratification vote, could be are specifically asked to and cited to its opinion found to be "coercive" and therefore impermissible.Finally, Bloomberg Law reports® even if the board is wil ing to risk seeking a separate ratification conclusion. to wit: in the case of a merger involving a vote on its disabling interests, it does so with little guidance control ing stockholder, a "ratifying" vote is incapable, under regarding how the vote should be conducted or which matters the supreme Court's opinion in Kahn v. Lynch, of restoring must be ratified. As noted above, Gantler instructs that "the the presumption of the business judgment rule. From this, only director action or conduct that can be ratified is that it may be inferred that the supreme Court was not referring which the shareholders are specifical y asked to approve. to the majority-of-minority vote, and to conclude otherwise But the board can never be certain that it will have adequately would be to suggest that the supreme Court, without anticipated all of the conduct and interests that a potential specific reference to Kahn, overruled its prior precedent.
plaintiff could challenge. And in light of the supreme Court's reference in its opinion to Santa Fe, it is unclear whether the board could seek a single vote from stockholders to ratify all of its actions and interests or whether it must seek a separate the Delaware supreme Court's clarification of the doctrine of vote on each decision, act, interest, conflict or other factor stockholder ratification effectively prevents defendants from that would conceivably require ratification.
claiming that the requisite vote of the unaffiliated stockholders on a matter that legally requires stockholder approval for its given the risks attendant to seeking a "classic" ratification authorization (as opposed to the vote of such stockholders on vote as to one or more ancillary matters—and considering that a matter that has been separately and voluntarily submitted to the supreme Court in Gantler foreclosed any defense based such stockholders) has the effect of restoring the presumption on the "ratification" vote on the principal matter at issue—it of the business judgment rule in cases where that presumption would seem that any board, when faced with potentially would otherwise be rebutted due to disabling conflicts. the disabling conflicts, would likely opt to use a special committee supreme Court's opinion should not be read to hold that the of independent, disinterested directors to negotiate the board may not seek a ratification vote on matters that are transaction and, if necessary, to make a recommendation to ancil ary to a matter that legal y requires stockholder approval. the full board with regard to the transaction.In the absence Nonetheless, given the elimination of the stockholder of a controlling stockholder, the use of a properly comprised ratification defense in its pre-Gantler incarnation, deal planners and functioning special generally will have the would be well advised to consider using a special committee effect of restoring the presumption of the business judgment of disinterested, independent directors in connection with any rule. thus, unless there are no directors who would qualify as transaction in which the directors could be alleged to have "disinterested" and "independent" and could easily comprise a disabling conflict. this will help to minimize the impact of a special committee, there would seem to be little comparative any potential conflicts and to preserve the presumption of the advantage to seeking the "classic" ratification vote on the business judgment rule. Finally, although the supreme Court matter giving rise to the potentially disabling conflict.
seemed to whittle the doctrine of stockholder ratification down to its "classic" form, the opinion should not be read as An additional question stemming from Gantler is what eliminating the use of a majority-of-minority vote as a cleansing impact, if any, the supreme Court's analysis of the doctrine mechanism in a transaction involving a controlling stockholder of stockholder ratification has on the continued viability of to shift the burden of proving entire fairness.
using the majority-of-minority vote as a cleansing mechanism in a transaction involving a control ing stockholder. Put Mark J. Gentile is a director, and John Mark Zeberkiewicz and simply, Gantler should have no impact on the viability of that Megan R. Wischmeier are associates, at Richards, Layton cleansing mechanism. since the supreme Court's decision & Finger, P.A., Wilmington, Delaware. Richards, Layton & in Kahn v. Lynch, the exclusive standard of review for Finger was involved in some of the cases discussed herein, transactions involving a control ing stockholder is entire but the opinions expressed in this article are those of the fairness, and the use of a cleansing mechanism, such as authors and not necessarily those of Richards, Layton & the majority-of-minority vote, only shifts the burden of proof Finger or its clients. on the issue of fairness from the control ing stockholder to the plaintiff. the purpose of this vote is not to legal y authorize the transaction but to provide minority stockholders 1 See Michelson v. Duncan, 407 A.2d 211, 218-19 (Del. 1979) the power to reject the proposed transaction and, in this (stating that "voidable acts are susceptible to cure by shareholder manner, compensate for the loss in bargaining power and provide some assurance that the control ing stockholder 2 See Harbor Fin. Partners v. Huizenga, 751 A.2d 879, 897-98 wil not use its position to treat the minority stockholders (Del. Ch. 1999).
3 unfairly.this is categorical y different from the stockholder See Lewis v. Vogelstein, 699 A.2d 327, 335 (Del. Ch. 1997) ("In all events, informed, uncoerced, disinterested shareholder ratification concept at issue in Gantler—i.e., the post hoc ratification of a transaction in which corporate directors have a use of the statutorily required vote to provide cover for the material conflict of interest has the effect of protecting the transaction board's otherwise disabling conflict. the supreme Court's from judicial review except on the basis of waste.").
observation that "the ‘cleansing' effect of such a [classic] 4 See Williams v. Geier, 671 A.2d 1368, 1379 n.24 (Del. 1996) ratifying shareholder vote is to subject the chal enged ("the term ‘ratification' is, in the dictionary sense, a generic term director action to business judgment review" supports this connoting official approval, confirmation or sanction. thus, it is not Bloomberg Law reports® incorrect to consider broadly that stockholder approval in either to a charter, Defendants must show that a majority of the unaffiliated sense may be called ‘ratification.'") (internal citation omitted); shares eligible to vote voted in favor of the reclassification." Id. Huizenga, 751 A.2d at 900, n.78 ("In using the word ratification in (footnotes omitted). the Court accordingly determined that the this opinion, I am keenly aware that ‘classic ratification' involves the requisite ratification vote could be derived through a "simple ratio" ‘voluntary addition of an independent layer of shareholder approval in that it expressed as follows: "the denominator is the number circumstances where such approval is not legally required.' Indeed, of outstanding shares at the time of the vote minus the number of my colleague Vice Chancellor steele recently noted that it was affiliated shares eligible to vote. the numerator is the total number of oxymoronical [sic] to call a necessary stockholders' vote in advance shares voted in favor of the reclassification minus the total number of a transaction's consummation ‘advance ratification.' For want of of affiliated shares entitled to vote." Id. at 42.
better nomenclature, I use the term as describing a stockholder vote 13 Id. at 44.
sufficient to invoke the business judgment rule standard of review.") 14 Id. at 58.
(internal citations omitted).
15 Id. As is often the case, the Court's decision not to apply entire 5 See, e.g., Solomon v. Armstrong, 747 A.2d 1098, 1114-15 fairness led to a dismissal of the claims. See, e.g., Nixon v. Blackwel , (Del. Ch. 1999) ("the legal effect of shareholder ratification, as it 626 A.2d 1366, 1376 (Del. 1993) (noting that "[i]t is often of critical relates to alleged breaches of the duty of loyalty, may be one of the importance whether a particular decision is one to which the business most tortured areas of Delaware law. A different rule exists for every judgment rule applies or if the entire fairness rule applies"); AC permutation of facts that fall under the broad umbrella of ‘duty of Acquisitions Corp. v. Anderson, Clayton & Co., 519 A.2d 103, 111 loyalty' claims.").
(Del. Ch. 1986) ("Because the effect of the proper invocation of the 6 Gantler v. Stephens, 2009 BL 18055, at 35-36 (Del. Jan. 27, business judgment rule is so powerful and the standard of entire 2009) (emphasis in original). the supreme Court's opinion in fairness so exacting, the determination of the appropriate standard of Gantler contains several other noteworthy findings and holdings, judicial review frequently is determinative of the outcome of derivative including that officers owe fiduciary duties that are identical to those owed by corporate directors, that a board's decision not to pursue 16 See Gantler, 2009 BL 18055, at 28-29 ("we conclude that a merger opportunity is normally reviewed within the traditional the Proxy disclosures concerning the Board's deliberations about the business judgment framework, and that enhanced scrutiny under First Place bid were materially misleading. Because we reverse the the so-called Unocal test did not apply to the claim that the officers dismissal of Count II on that basis, we do not reach the plaintiffs' and directors "sabotaged" the due diligence process and rejected remaining disclosure claims.").
a merger offer, given that the claim sounded in disloyalty rather than 17 See id. at 35 ("Under current Delaware case law, the scope improper defensive conduct. the supreme Court also made several and effect of the common law doctrine of shareholder ratification significant observations regarding the directors' duty of disclosure, is unclear, making it difficult to apply that doctrine in a coherent including in the context of partial disclosure. these topics, however, are outside the scope of this article and are not addressed herein.
18 See id. the supreme Court quoted In re Wheelabrator 7 Gantler v. Stephens, 2008 BL 30308, at 7-8 (Del. Ch. Feb. 14, Technologies, Inc., S'holder Litig., 663 A.2d 1194, 1201 (Del. Ch. 1995), for the proposition that the doctrine "might be thought to 8 Id. at 8-9.
lack coherence because the decisions addressing the effect of 9 Id. at 34-35.
shareholder ‘ratification' have fragmented that subject into three 10 As the Chancery Court noted: "the business judgment rule distinct compartments." presumption the Board acted loyally regarding the reclassification 19 See Gantler, 2009 BL 18055, at 35.
is rebuttable by facts establishing the Board was either interested 20 It is unclear whether the supreme Court intended its holding to in the outcome of the transaction or lacked the independence to apply to those situations where a stockholder vote is "statutorily" consider objectively whether the reclassification was in the best required, such as under sections 242, 251 and 271 of the DgCL, interest of the Company and its shareholders." Id. at 32.
or, more broadly, to any circumstance where stockholder approval is 11 Id. at 40 (citing Sample v. Morgan, 914 A.2d 647, 664 "legally" required to authorize the matter. Compare "the ratification (Del. Ch. 2007)). this formulation of "ratification" has, in recent doctrine does not apply to transactions where shareholder approval years, found support in several Delaware cases. See, e.g., is statutorily required" (Gantler, 2009 BL 18055, at 37) and In re PNB Holding Co. S'holders Litig., Consol. C.A. No. 28-N, "‘ratification' . . describes only corporate action where stockholder slip op. at 32, n.70 (Del. Ch. Aug. 18, 2006) ("[t]he fact that the approval is not statutorily required for its effectuation" (id. at 37, shareholder vote was required to give legal significance to the n.55), with "circumstances where a fully informed shareholder vote merger does not affect whether or not the vote itself has ratification approves director action that does not legally require shareholder effect."); see also Huizenga, 751 A.2d at 900, n.78.
approval in order to become legally effective" (id. at 36). See also 12 Gantler, 2008 BL 30308, at 41. the Court noted that, because the id. at 37 ("Here, the reclassification could not become legally reclassification required for its approval the vote of a majority of the effective without a statutorily mandated shareholder vote approving outstanding stock entitled to vote under section 242 of the DgCL, it the amendment to First Niles' certificate of incorporation."). reading was appropriate to require the ratification vote to be a majority of the the opinion to stand for the latter proposition would raise additional unaffiliated shares outstanding. "the court in PNB Holding, in the issues with respect to the effect on the standard of review for votes context of a ratification of a merger approved by interested directors, that are not required under the DgCL but are otherwise required held that the appropriate vote should be a majority of the unaffiliated by applicable law. For example, under section 280g of the Internal stockholders' shares eligible to vote, and not merely a majority of revenue Code of 1986, as amended, stockholder approval of the unaffiliated shares that were actually voted. An unreturned proxy "parachute payments" to "disqualified individuals" is required vote is akin to passive dissent; to not include a dissenting vote would under certain circumstances to avoid adverse tax consequences. contravene 8 Del. C. § 242, which requires a vote of a ‘majority of See I.r.C. § 280g. thus, the 280g vote, in one sense, is "legally" the outstanding stock of the corporation entitled to vote' for charter required to obtain the favorable tax treatment being sought. But the amendment approval. thus, for purposes of ratifying an amendment board authorizing the "parachute payments" could have a disabling Bloomberg Law reports® conflict. It is unclear, then, whether the 280g vote itself would be 29 the Delaware courts have held that stockholder ratification is sufficient to cure the disabling conflict, or whether the board would only effective if it is not "coerced." See Lacos Land Co. v. Arden be required to seek an additional, voluntary "cleansing" vote to revive Group, Inc., 517 A.2d 271, 278-79 (Del. Ch. 1986) (finding that the application of the business judgment rule.
the stockholder vote was fatally flawed by the implied and expressed 21 Gantler, 2009 BL 18055, at 36.
threats that, unless the proposed amendments were authorized, the 22 In re Santa Fe Pac. Corp. S'holder Litig., 669 A.2d 59, 68 stockholder-officer-director would oppose future transactions that the board of directors might determine to be in the best interests of all stockholders); see also Eisenberg v. Chicago Milwaukee Corp., 24 In addition, the opinion does not appear to alter the principle 537 A.2d 1051, 1061 (Del. Ch. 1987).
of stockholder ratification, articulated in In re General Motors 30 Gantler, 2009 BL 188828, at 36.
(Hughes) S'holder Litig., No. Civ. A. 20269 (Del. Ch. mar. 4, 2005), aff'd 897 A.2d 162 (Del. 2006), relating to the effect of a special 32 Under section 141(c) of the DgCL, a board committee does not vote of stockholders of a particular group or class that may have have the authority to approve or recommend to stockholders any interests that diverge from those of other stockholders. In that case, action that requires for its approval stockholder authorization under the former holders of general motors' Class H stock—a tracking the DgCL. See 8 Del. C. § 141(c). this includes, for example, the stock designed to represent the financial performance of Hughes approval of virtually any merger, any charter amendment, any sale of electronics Corporation, a wholly-owned subsidiary of general all or substantially all of the corporation's assets, and any dissolution motors—challenged the split-off transaction pursuant to which of the corporation.
general motors sold a significant stake in Hughes to the News 33 For a court to grant deference to a special committee's decision, Corporation and exchanged each Class H share for one share of the committee members must be disinterested in, and must have Hughes' common stock. the Class H holders alleged that gm's broad authority with respect to, the transaction at issue. this includes, directors breached their duty of loyalty in failing to deal fairly with, among other things, whether the committee has the "power to say and failing to adequately compensate, the Class H holders in the no." In re First Boston, Inc. S'holders Litig., C.A. No. 10338, slip op. split-off. Id. Noting that the split-off transactions were approved by at 15 (Del. Ch. June 7, 1990).
a majority of the outstanding unaffiliated Class H shares and that 34 See In re Western Nat'l Corp. S'holders Litig., C.A. No. 15927, the relevant disclosure document sufficiently described the effect slip op. at 68-69 (Del. Ch. may 22, 2000) ("[B]ecause the absence of stockholder ratification, the Court found that such approval was of a controlling shareholder removes the prospect of retaliation, the sufficient to maintain the presumption of the business judgment rule. business judgment rule should apply to an independent special committee's good faith and fully informed recommendation.").
25 See 8 Del. C. § 251.
35 C.A. No. 8748 (Del. Ch. July 9, 1993), rev'd, 638 A.2d 1110 (Del. 26 See Gantler, 2009 BL 18055, at 37.
1994), on remand, C.A. No. 8748 (Del. Ch. Apr. 17, 1995), aff'd, 27 Id. the "one exception" is that stockholder ratification "can validly 669 A.2d 79 (Del. 1995).
extinguish . . a claim that the directors lacked the authority to take 36 See Huizenga, 751 A.2d at 900-01 ("Indeed, it appears that a action that was later ratified." Id. at 36, n.54. the supreme Court was corporation with a controlling or majority stockholder may, under careful to note that it did not intend to suggest that acts that are void, current Delaware law, never escape the exacting entire fairness ultra vires, gifts or waste could be ratified by less than unanimous standard through a stockholder vote, even one expressly conditioned stockholder approval. Id. moreover, the supreme Court specifically on approval by a ‘majority of the minority.' Because of sensitivity stated that its clarifications in the opinion applied only to the common about the structural coercion that might be thought to exist in such law doctrine of stockholder ratification and were not intended to alter circumstances, our law limits an otherwise fully informed, uncoerced the established jurisprudence regarding the effect of a stockholder vote in such circumstances to having the effect of making the plaintiffs obtained under section 144 of the DgCL. For a discussion of the prove that the transaction was unfair.").
effect of section 144, see general y Blake rohrbacher, John mark 37 See id.; see also In re Cox Commc'ns, Inc. S'holders Litig., Zeberkiewicz & thomas Uebler, Finding Safe Harbor: Clarifying the 879 A.2d 604, 643-44 (Del. Ch. 2005). In Cox, the Court Limited Application of Section 144, 33 DeL. J. CorP. L. 719 (2008).
suggested that, should a control ing stockholder merger be 28 moreover, the disclosure that would be required to ensure that the "subject from inception to negotiation and approval of the merger ratifying stockholder vote is "fully informed" would likely rise to the by an independent special committee and [approval by the majority level of self-flagel ation. Any plaintiff attacking stockholder ratification of disinterested stockholders], the business judgment rule should of a board's actions wil chal enge the disclosures made in connection presumptively apply." Id. Also, in In re Pure Res., Inc., S'holders with the ratification vote. Nonetheless, the board "must meet [the] Litig., 808 A.2d 421, 444 n.43 (Del. Ch. 2002), the Court noted affirmative ‘burden of demonstrating full and fair disclosure.'" that a "tailoring [of the Lynch rule] could include providing business See Sample, 914 A.2d at 655 (Del. Ch. 2007) (quoting Loudon v. judgment protection to mergers negotiated by a special committee Archer-Daniels-Midland Co., 700 A.2d 135, 140-41 (Del. 1977)). and subject to majority of the minority protection," but in In re PNB And, as the Chancery Court has stated, "it is noteworthy that Delaware Holding Co. S'holders Litig., Consol. C.A. 28-N, slip op. at 19 law does not make it easy for a board of directors to obtain ‘ratification (Del. Ch. Aug. 18, 2006), the Court noted that the use of both effect' from a stockholder vote. the burden to prove that the vote of the procedural protections would not yet ensure application of was fair, uncoerced, and fully informed falls squarely on the board. the business judgment rule, stating: "[a]bsent clarifying guidance given the fact that Delaware law imposes no heightened pleading from our supreme Court, after Lynch, it is difficult for this court standards on plaintiffs alleging material nondisclosures or voting to subject such a merger to anything but entire fairness review, coercion and given the pro-plaintiff bias inherent in rule 12(b)(6), it regardless of whether the proponents of the transaction employed is difficult for a board to prove ratification at the pleading stage. If the al the procedural protections necessary to replicate an arms-length board cannot prevail on a motion to dismiss, the defendant directors merger, by negotiating the transaction with a special committee of will be required to submit to discovery and possibly to a trial." Harbor independent directors and conditioning the transaction on a non- Fin. Partners v. Huizenga, 751 A.2d 879, 899 (Del. Ch. 1999).
waivable majority-of-the-minority vote." Bloomberg Law reports® 38 the Court of Chancery has held that the majority-of-minority vote Blockbuster made a recommendation to stockholders about will only be an effective cleansing mechanism if the transaction is the exchange offer. the prospectus did not disclose the names expressly contingent upon approval by the majority of the disinterested of the Blockbuster directors on the special committee.
shares. See Rabkin v. Olin Corp., C.A. No. 7547, slip op. at 13 (Del. Ch. Apr. 17, 1990), aff'd, 586 A.2d 1202 (Del. 1990) (tABLe).
Fol owing the exchange offer, Blockbuster's business faltered 39 See Weinberger v. UOP, Inc., 457 A.2d 701, 703 (Del. 1983).
and, in 2006, Blockbuster restated its cash flows for 2003 40 Gantler 2009 BL 18055, at 36.
41 In the past, when the supreme Court has overturned a prominent through 2005. Beverly Pfeffer, a former Viacom stockholder case (or portions thereof), it has called attention to the effect of its who tendered her shares in the exchange offer, filed a class holding. See, e.g., Brehm v. Eisner, 746 A.2d 244, 254 (Del. 2000). action suit in the Delaware Chancery Court on behalf of this is evidenced in Gantler itself. See id. at 36 & n.54 (after holding all Viacom stockholders who tendered their shares and that a "classic" ratification vote subjects the challenged action to Blockbuster stockholders who held shares on the record business judgment review but does not "extinguish" the claim, the date for the special dividend. Pfeffer asserted breach of supreme Court noted: "to the extent that Smith v. Van Gorkom fiduciary duty claims against the Viacom board, NAI, and other holds otherwise, it is overruled").
defendants. the Chancery Court dismissed Pfeffer's claims with prejudice for failure to state a claim under Chancery Court Directors & Officers
rule 12(b)(6). See Delaware Chancery Court Dismisses Breach of Fiduciary Duty and Disclosure Claims Arising out of Viacom Spin-Off of Blockbuster, Bloomberg Law reports, mergers & Acquisitions, Vol. 2, No. 3 (mar. 2008).
Delaware supreme Court Affirms Dismissal of stockholder suit against Viacom Board Pfeffer appealed the dismissal of only the first four counts of for Breaches of Fiduciary Duties in her complaint. those counts alleged that the Viacom directors breached their fiduciary duties of loyalty, care, and disclosure, Blockbuster spin-off and NAI, as Viacom's majority stockholder, breached its duty of loyalty, by making material misstatements and omissions with Pfeffer v. Redstone, No. 115, 2008, 2009 BL 14710 respect to the special dividend and exchange offer. Pfeffer (Del. Jan. 23, 2009) argued that these counts should have been reviewed under an entire fairness standard because of redstone's and NAI's the Delaware supreme Court recently affirmed dismissal, financial interests in the transactions.
by the Delaware Chancery Court, of a stockholder suit against the board of directors of Viacom, Inc. and affiliated defendants Entire Fairness Review Not Required relating to Viacom's spin-off of Blockbuster, Inc. the court held that the transaction was not subject to entire fairness on appeal, the Delaware supreme Court first concluded review and that the Chancery Court did not err in ruling that that the special dividend and exchange offer were not the plaintiff failed to state a claim with respect to alleged subject to entire fairness review. NAI, as Viacom's controlling breaches of fiduciary duties.
stockholder, had no duty of entire fairness under Delaware law in making what was a non-coercive exchange offer. the The Blockbuster Special Dividend and Spin-Off Viacom directors did have a duty to structure the exchange offer to be non-coercive and disclose al material facts relating In 2004, Viacom divested its 82.3 percent interest to the exchange offer. the supreme Court agreed with the in Blockbuster through a special dividend and spin-off. Chancery Court that the Viacom directors met this duty.
Blockbuster issued a $5 per share dividend to its stockholders, including Viacom. Fol owing the issuance of the special Duty of Disclosure Claims Legally Insufficient dividend, Viacom spun off Blockbuster by an exchange offer pursuant to which each tendered Viacom share was Pfeffer chal enged the dismissal of her duty of disclosure claims exchanged for 5.15 Blockbuster shares. significantly, for four reasons. First, she claimed that she adequately pleaded neither Viacom's then-Ceo sumner redstone nor National that the prospectus disclosures regarding Blockbuster's cash Amusements, Inc. (NAI), which held 71 percent of Viacom flow were material. second, she argued that she adequately and was control ed by redstone, participated in the pleaded that the Viacom board knew, or should have known, exchange offer.
that Blockbuster would have a cash flow problem after the spin-off. third, she maintained that the Chancery Court erred the exchange offer prospectus disclosed, among other in finding that the Viacom board's method for determining things, that NAI would not participate in the exchange the exchange ratio was not material. Fourth, she claimed offer; Blockbuster's ability to operate may be impaired by that the Chancery Court erred in finding that the composition the increased debt incurred to pay the special dividend; a of the Blockbuster special committee was not material.
special committee of Blockbuster's independent directors had recommended approval of both the special dividend and the supreme Court rejected al four reasons for appeal. It exchange offer to the entire board; and neither Viacom nor agreed with the Chancery Court that Pfeffer's complaint Bloomberg Law reports® failed to al ege how the cash flow disclosure was a material and business information processing, and reduce costs misstatement, since the subsequent restatement of cash associated with financial disclosure.
flow in 2006 merely reclassified certain numbers without affecting the total, and the restatement did not affect Interactive Data Financial Statements Blockbuster's stock price. the court also concluded that Pfeffer failed to sufficiently plead that certain cash flow the seC explained that the new rules will not change the calculations prepared before the exchange offer were disclosure requirements under the federal securities laws made available to the Viacom directors or were the type and regulations, and companies will still be required to use of information routinely provided to directors. regarding the AsCII and HtmL electronic formats for filings. Under the determination of the exchange ratio, the court held that the new rules, however, in addition to the AsCII or HtmL such information was not material, and therefore was not filing format, companies will also have to submit their financial required to be disclosed, because Viacom did not make any statements in an interactive data format using XBrL as representation in the prospectus that the value implied by an exhibit to periodic and current reports and registration the exchange ratio was fair. Final y, the court concluded that statements. the use of interactive data will be required for the omission of the identities of the special committee members entire financial statement, including footnotes and financial was not material because the prospectus did not suggest statement schedules, but not for management's Discussions that the special committee took any action that could not and Analysis, executive compensation, or other financial, have been taken by the entire board.
statistical, or narrative disclosures. According to the seC, new rule 405 of regulation s-t sets forth the basic tagging Viacom Directors and NAI Did Not and posting requirements for XBrL data, while the eDgAr Breach Duty of Loyalty Filer manual contains detailed tagging requirements.
the supreme Court also rejected Pfeffer's assertion that As the seC explained, a primary difference between its she stated claims against the Viacom directors and NAI voluntary program for submitting interactive data and the for breaches of the duty of loyalty. According to the court, new rules is the requirement that footnotes in financial Pfeffer's claim against the Viacom directors was insufficient statements be tagged using XBrL. the new rules will because she did not plead that the directors stood on both require four levels of detail for footnote data tagging: sides of the exchange offer or that they received a benefit from (1) a single block text tag for each ful footnote; (2) a single the transaction not enjoyed by Viacom stockholders general y. block text tag for each significant accounting policy within Pfeffer's claim against NAI also failed because she failed a footnote; (3) a single block text tag for each table in a to allege that NAI orchestrated the special dividend or the footnote; and (4) a tag for each monetary value, percentage, exchange offer. Accordingly, the court affirmed the Chancery number, or other amount within a footnote. only the first level Court's dismissal of Pfeffer's claims.
of tagging wil be required for a filer's first year of interactive reporting. thereafter, all four levels will be required, but a filer will have a 30-day grace period in the second year to submit the interactive data.
Disclosure & reporting Phase-In of the New Rules seC Adopts Final rules on Interactive According to the seC, the new rules will be phased-in over Data to Improve Financial reporting three years. Domestic and foreign large accelerated filers using U.s. generally accepted accounting principles (gAAP) that seC release Nos. 33-9002; 34-59324; 39-2461; have a worldwide public common equity float above $5 bil ion 1C-28609; File No. s7-11-08 (Jan. 30, 2009) will be required to provide interactive data for fiscal periods ending on or after June 15, 2009. All other large accelerated the securities and exchange Commission adopted filers will begin providing interactive data for fiscal periods final rules requiring companies to provide financial ending on or after June 15, 2010. Finally, all remaining U.s. statements to the seC in an interactive data format using gAAP filers, and foreign filers using international financial the eXtensible Business reporting Language (XBrL). reporting standards (IFrs), will begin filing interactive data Building upon a voluntary program for the submission of for fiscal periods ending on or after June 15, 2011. the seC interactive data begun in 2005, the new rules require filers explained that the multi-year phase-in is designed to (1) allow to attach standardized tags to items contained in financial companies to plan and implement data tagging with the benefit statements thereby al owing the information to be directly of the experience of the first year filers, (2) allow the seC to downloaded to spreadsheets, analyzed using commercial monitor implementation of the rules and make any necessary software, or used in investment models. the new rules adjustments, and (3) allow additional time to develop IFrs wil be phased-in over a three-year period. According to data tags. In the first year of XBrL submission, companies will the seC, the new rules wil make financial data easier for have a 30-day grace period and will be permitted to submit investors to use, assist in automating regulatory filings their interactive data as an amendment to a filing.
Bloomberg Law reports® Covered Reports liability rules, interactive data wil be deemed filed for purposes of rule 103 under regulation s-t, giving filers the benefit of As the seC explained, the new rules on interactive data apply rule 103's safe harbor for electronic transmission errors that to financial statements contained in periodic reports filed are promptly corrected. According to the seC, the modified under the securities exchange Act of 1934 (exchange Act) application of the federal securities laws balances avoiding on Forms 10-Q, 10-K, and 20-F, the Form 40-F annual report, unnecessary costs and expenses with encouraging accuracy and Forms 8-K and 6-K that contain revised or updated by allowing issuers and service providers time to become financial statements. In addition, filers will be required to comfortable with the tagging requirements. the limitations on provide interactive data for financial statements in transition liability will be phased-out by october 31, 2014.
reports on Forms 10-Q, 10-K, or 20-F. registration statements filed under the securities Act of 1933 (securities Act) will be In discussing liability for interactive data files, the seC required to include interactive data when financial statements explained that new rule 406t omits any reference to are included directly in the registration statement. the new interactive data in viewable form. the seC stated that rules, however, will only require filers to submit interactive interactive data in viewable form as displayed on the seC's data after a price or price range has been determined and any website should be treated in the same manner as the related time thereafter when the financial statements are changed. interactive data file. However, the seC noted that interactive Interactive data will not be required for initial public offerings data in viewable form displayed on other websites is subject or for financial statements contained in registration statements to the general anti-fraud principles applicable to republication filed under exchange Act Forms 10-K, 10-Q, 20-F, and 40-F.
of a person's statements.
the seC noted that interactive data will not be required for officer certifications in periodic reports under exchange Act Shareholder Derivative
rules 13a-14 and 15d-14, explaining that excluding such certifications balances avoiding unnecessary costs with encouraging accuracy. the seC further stated that as it monitors implementation of the new rules it may make changes Demand on the Board regarding officer certifications.
second Circuit Affirms Dismissal of Pfizer shareholder Derivative suit for Failure Website Posting to Adequately Plead Demand Futility the new rules wil require that by the end of the calendar day on the date of filing, companies post to their corporate In re Pfizer, Inc. Derivative Securities Litig., No. 07-cv-3547, website the same interactive data they provided to the seC. 2009 BL 14760 (2d Cir. Jan. 27, 2009) According to the seC, making this information available on the company's website wil further encourage the widespread the United states Court of Appeals for the second Circuit dissemination of information and help lower access costs recently affirmed the dismissal of a shareholder derivative for users by making data available directly from the issuer lawsuit against Pfizer, Inc. for failure to adequately allege rather than from third-party sources that may charge a fee. demand futility under Federal rule of Civil Procedure (FrCP) the new rules also require that the web posting not be a 23.1. In an unpublished opinion guided by applicable Delaware hyperlink to the seC's website and that the information be law, the court held that the bases asserted by plaintiffs for posted for 12 months.
demand futility were not sufficient to establish a reasonable doubt that a majority of Pfizer's board of directors either lacked Liability for Interactive Data Files independence or were not disinterested.
Interactive data files submitted within 24 months of a filer's Shareholders Allege Directors and Officers Knew first submission will be subject to the federal securities laws or Should Have Known About Damaging Side in a modified manner pursuant to new rule 406t. During this Effects of Pfizer's Arthritis Drugs period, interactive data wil not be deemed part of a registration statement or prospectus for the purposes of sections 11 Plaintiff shareholders al eged that defendants, al former Pfizer and 12 of the securities Act or deemed filed for purposes directors and officers, were or should have been aware of the of section 18 of the exchange Act or section 34(b) of the significant cardiovascular risks associated with two of Pfizer's Investment Company Act of 1940. In addition, interactive data most successful arthritis drugs—Celebrex and Bextra. Plaintiffs files will not be subject to liability under the foregoing sections. claimed that defendants permitted Pfizer to market and sell However, interactive data files will be subject to the anti-fraud these drugs even after becoming aware of their risks. As a provisions of the federal securities laws, except with respect result of defendants' actions or failure to act, plaintiffs alleged to a failure to comply with tagging requirements that occurs that Pfizer was forced to defend hundreds of product liability despite a good faith effort to comply and is promptly corrected and consumer fraud lawsuits and suffered significant losses in after the filer learns of the failure. Finally, under the modified market capitalization. the present derivative lawsuit asserted Bloomberg Law reports® several theories of liability, including breach of fiduciary duty, view, scienter required a showing of knowledge alone, while gross mismanagement and waste of corporate assets. the demand futility claims required not only knowledge but also district court dismissed the suit for failure to allege sufficient that such knowledge created an affirmative duty to act that facts to establish demand futility and plaintiffs appealed.
was consciously ignored.
Directors' Personal Liability Limited the court concluded that plaintiffs' pleaded facts did not in Accordance with DGCL show that defendants had the requisite actual knowledge and that, even if the court permitted knowledge to be presumed, At the outset, the court noted that Pfizer's shareholders had plaintiffs failed to show how the information gave rise to a limited directors' monetary liability by exculpating directors for duty to act that was consciously ignored by defendants. breaches of the duty of care as permitted by Delaware general In reaching this conclusion, the court also dismissed as Corporation Law § 102(b)(7). As a result, the defendants could insufficient claims that members of Pfizers' audit committee only be held personal y liable for a breach of their duties of good were not disinterested because their knowledge of the drugs' faith or loyalty. the threshold of proof for these types of breach risks rendered the financial statements misleading. Final y, the was general y higher than for a breach of the duty of care and, court observed that plaintiffs' allegations of insider trading, in the court's view, was not met by plaintiffs' al egations.
with the exception of certain trades that defendants conceded were interested, were not pled with the requisite particularity.
Court of Appeals Refuses to Presume Knowledge by Pfizer Board Members of Drugs' Risks In affirming the dismissal of the action, the court also found that the district court's refusal to grant plaintiffs leave to Plaintiffs argued that defendants had knowledge of the amend the complaint was not an abuse of discretion because cardiovascular risks associated with Pfizer's drugs because any new allegations to be proposed were simply variations of (1) there were several sources available to defendants, including those that had been previously rejected by the court.
several published studies and an internal Pfizer clinical study, that suggested such risks and cal ed for an assessment by drug companies and (2) a number of lawsuits relating to these Shares & Shareholders
cardiovascular risks had been brought against Pfizer between 2001 and 2005. Plaintiffs claimed that even if defendants did shareholder rights not have first hand knowledge of these risks, the court should Delaware Chancery Court Denies Preferred presume or infer such knowledge because it related to Pfizer's shareholders' request for temporary "core activity." to support its argument, plaintiffs cited cases where courts have presumed knowledge or information relating restraining order to Preserve Investment to a corporation's core activities. this knowledge, plaintiffs in Closely-Held Corporation; orders further al eged, made the directors "interested" for demand futility purposes because it exposed them to potential personal Parties to Negotiate a status Quo order liability arising from a breach of fiduciary duty.
Topspin Partners, L.P. v. Rock Solid Systems, Inc., C.A. In finding that plaintiffs had not sufficiently al eged demand futility, No. 4275-VCL, 2009 BL 13549 (Del. Ch. Jan. 21, 2009) the court found no legal basis for plaintiffs' conclusion that the mere existence of scientific studies, without more, permitted a the Delaware Chancery Court recently denied a request court to infer that directors had knowledge of their existence for a temporary restraining order (tro) by certain preferred and relevance, especial y given the innumerable studies Pfizer shareholders of rocksolid systems, Inc., a closely-held would likely have conducted. the court rejected cases cited by software company. Plaintiffs sought the tro to prevent plaintiff, observing that these cases involved information of a rocksolid from spending the remainder of plaintiffs' "far greater magnitude" than the information presented by the $1.25 million investment in contravention of the terms of a drug studies at issue in the current case. Pfizer at 5.
letter agreement between plaintiffs and rocksolid. In a letter opinion responding to plaintiffs' expedited request, Vice Requirements For Pleading Demand Futility Not Chancellor stephen P. Lamb was persuaded that plaintiffs' Analogous to Proof of Scienter in Securities delay in seeking relief made it inequitable for the court to grant Fraud Class Actions; Judgment Affirmed the tro. Although plaintiffs' request was denied, the court ordered the parties to negotiate a status quo order to protect In arguing that the court should presume the defendants' the interests of all parties going forward.
knowledge of the studies and risks associated with the drugs, plaintiffs cited cases arising not in demand futility Plaintiffs' Rights Governed by Modified claims but rather in securities fraud class actions where an inference of scienter was required to maintain the claim. the court observed that demand futility inquiries were different Under the terms of a stockholders' agreement, rocksolid was from inquiries involving scienter and fraud. In the court's obligated to deposit the proceeds from its sale of $1.25 mil ion Bloomberg Law reports® of series A Preferred stock into a segregated account and redemption rights and the funds in question were designated these funds could not be disbursed without the approval as the source from which their stock would be redeemed. of rocksolid's board of directors, including the consent of Proceeding on the assumption that plaintiffs had met their plaintiffs' board representatives. If the funds were not approved burden of imminent, irreparable harm, Vice Chancellor Lamb for disbursement by march 1, 2008, plaintiffs were permitted initially observed that plaintiffs satisfied the low burden of to request that the shares be redeemed for the purchase price demonstrating a colorable claim for breach of contract, paid. However, the defendants failed to carry out the terms and the defendants admitted a contractual right had been of the shareholders' agreement. rocksolid never set up a violated. However, the court denied the tro, finding segregated account and its officers used, and continued to evidence of the two remaining factors, which the court viewed use, the funds for general corporate purposes without board as interrelated.
approval while plaintiffs did not request a redemption of their shares. Defendants indicated that less than $300,000 of the Because the tro would have effectively put rocksolid out original $1.25 million remained.
of business and prevented it from completing the software product that was the focus of the company, the court was Plaintiffs, concerned that if the funds were depleted they persuaded that the harm in imposing the tro was greater could not recover their investment, brought the present action than the risk to plaintiffs in denying their request. the court seeking, aside from the tro, the dissolution of rocksolid, was swayed by defendants' claim that their product was the appointment of a receiver to oversee the dissolution and near completion and the tro would result in the loss of a redemption of their preferred shares.
great deal of value. Furthermore, plaintiffs' delay in bringing the action made the court wary of their motives. Plaintiffs had Court Balances the Equities and Denies TRO; not taken any prior actions to enforce their rights under the Status Quo Order to be Negotiated stockholders' agreement, nor had they taken any steps to satisfy their redemption rights. Although the court refused to to successfully obtain a tro under Delaware law, a party rule on defendants' accusation that plaintiffs hoped to steal was required to prove a threat of imminent, irreparable injury. If rocksolid's near-completed software product by means of proven, a court could issue the tro unless it was shown that the lawsuit and keep the potential profits for themselves, the (1) there was no colorable claim; (2) the risk of harm in granting court agreed that plaintiffs' slowness in bringing a claim made the tro was greater than the risk to plaintiff of denying it; or defendants' accusations of laches at least plausible.
(3) the plaintiff did not proceed as promptly as it should have and "therefore contributed to the emergency nature of the Although the court denied plaintiffs' request for a tro, it did application and [was] guilty of laches." Topspin at 3.
order that the parties negotiate a status quo order to preserve intact as much of rocksolid's business as possible while also Plaintiffs argued that the threatened dissipation of corporate limiting the use of the disputed funds. the order must require assets constituted irreparable harm for purposes of a tro that any expenditures over a set dollar amount require the because plaintiffs held preferred shares with enforceable agreement of the parties or a court order.
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