February 27, 2008

Rejecting Merger Proposal/Approving Reclassification: Delaware Chancery Court Dismisses Breach Claims

From Kevin Miller of Alston & Bird: A few weeks ago – in Gantler v. Stephens – Vice Chancellor Parsons granted defendants’ motion to dismiss claims alleging that certain directors and officers of First Niles Financial breached their fiduciary duties by:

– sabotaging the due diligence process in connection with a board authorized sales process; rejecting a solicited merger proposal that First Niles’ financial advisor deemed acceptable; and terminating the sales process;

– submitting a materially false and misleading proxy to First Niles’ shareholders in connection with soliciting their approval for a subsequent reclassification that would, among other things, (i) reclassify shares of common stock held by holders of 300 or less shares into shares of preferred stock and (ii) effect a deregistration and delisting of First Niles common stock; and

– effecting the reclassification (in breach of their duty of loyalty).

The court held that:

– Plaintiffs failed to allege specific facts or argument as to how causing a delay of a matter of days, or at most a couple of weeks, conceivably could be a breach of fiduciary duty to the company;

– Plaintiffs had not alleged sufficient facts to overcome the presumption of the business judgment rule with respect to the Board’s decision to reject the merger proposal and terminate the sales process; and

– Although a majority of the Board may have been interested in the reclassification or not independent, a majority of the unaffiliated shareholders of the company – those not defendants in the case – ratified the reclassification with sufficient disclosure to revive the business judgment rule as the appropriate standard of review.

This case is likely to receive substantial attention as a result of its holding that the business judgment rule is the legal standard generally applicable to a board’s decision not to pursue a merger. However a potentially more interesting issue relates to whether the reclassification was ratified by a sufficient number of shareholders of the company to revive the business judgment rule as the appropriate standard of review.