June 25, 2008

Duty Of Disclosure: Delaware Chancellor Further Limits Availability of Damages

From Travis Laster: Last week, Delaware Chancellor Chandler – in In re Transkaryotic Therapies, Inc. – granted summary judgment in favor of three directors who were alleged to have breached their fiduciary duties by supporting and voting in favor of the acquisition of Transkaryotic Therapies by Shire Pharmaceuticals. Here is a copy of the opinion.

Much of the opinion consists of the Chancellor’s rulings on the plaintiffs’ allegations of bad faith and disloyalty. From a doctrinal and practitioner perspective, the more important discussion focuses on the duty of disclosure (pages 17-28).

In summary, the Chancellor characterizes the duty of disclosure as a doctrine designed for pre-vote adjudication, leaving very little room for any post-closing remedy. In his words, “the Court grants injunctive relief to prevent a vote from taking place where there is a credible threat that shareholders will be asked to vote without such complete and accurate information. The corollary to this point, however, is that once this irreparable harm has occurred –i.e. when shareholders have voted without complete and accurate information–it is, by definition, too late to remedy the harm” (page 25).

Based on this principle, the Chancellor granted summary judgment for the defendant directors: “I hold that this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after that merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures” (page 27).

As a practical matter, the Transkaryotic decision obviously favors defendant directors, and it should increase their settlement leverage in cases where plaintiffs primarily assert disclosure claims but do not pursue injunctive relief. In other words, the cost of a post-deal clean-up settlement involving disclosure claims should go down. The logical response from the plaintiffs’ bar, however, should be to pursue more pre-closing disclosure-based injunction applications, since that is now the only real avenue available for a meaningful disclosure remedy and a commensurate fee award. In the long run, therefore, the Transkaryotic decision may result in more injunction applications and more disclosure litigation.

Two other points deserve brief mention. First, the Chancellor granted summary judgment on the claim that a director breached his fiduciary duties by soliciting so-called “empty votes” from stockholders who owned shares on the record date then sold them. The Court found that the director’s efforts to support the merger was “consistent with – rather than at odds with – his fiduciary duties” (page 39).

Second, the Chancellor permitted the plaintiffs to proceed with a challenge to the statutory validity of the merger, based on their assertion that the merger had not received sufficient votes. This challenge rested in part on testimony to the effect that the inspectors of election tallied the vote very quickly, yet the plaintiffs produced evidence of over-vote situations that would have taken additional time to resolve. Notwithstanding the passage of three years since the merger closed, the Court permitted the challenge to go forward. This holding emphasizes the need for care when tallying merger votes and counsels in favor of hiring a reputable outside firm, such as IVS, to act as the inspector for close votes.

I’ve been saying that companies should hire independent inspectors for a long time – and since you sometimes don’t know if your vote will be close until the last minute – you need to line up the inspector well in advance because they are in short supply!