DealLawyers.com Blog

Here’s news from Tom Bayliss of Abrams Bayliss:

On February 28th, the Delaware Court of Chancery issued In re Orchard Enterprises, Shareholder Litigation, C.A. No. 7840-VCL. In the ninety-page opinion on competing motions for summary judgment, Vice Chancellor J. Travis Laster:

– Rejects the argument that damages claims founded on disclosure violations were extinguished at closing under In re Transkaryotic Therapies, 954 A.2d 346 (Del. Ch. 2008);

– Holds that the entire fairness standard will apply at trial because the controlling stockholder failed to agree up front that its proposed transaction would only proceed with (a) the affirmative recommendation of a special committee of independent and disinterested directors and (b) the affirmative vote of the holders of a majority of the stock unaffiliated with the acquirer;

– Finds that the defendants must bear the burden of proof at trial because of material questions of fact regarding the independence and adequacy of the target’s special committee;

– Declines to hold that the Court of Chancery’s determination in a prior appraisal proceeding that the fair value of the target’s common stock was more than double the transaction price warranted a determination at summary judgment that the transaction was unfair; and

– Leaves open the possibility that the Court could award rescissory damages, quasi-appraisal damages or other relief if the plaintiffs ultimately prevail at trial.

The Orchard opinion will likely generate extensive commentary from practitioners and academics on the issues highlighted above and others, including the relationship between appraisal claims and fiduciary duty litigation and the breadth of remedies available to the Court of Chancery when assessing alleged breaches of the duty of loyalty.

Takeaways & Further Thoughts:

1. Orchard confirms that damages claims founded on disclosure violations will survive closing if they raise loyalty issues.

a. Under well-settled Delaware precedent, a breach of the duty of disclosure in connection with a request for stockholder action gives rise to a threat of irreparable harm sufficient to warrant an injunction.

b. In Transkaryotic, the Court identified an implicit corollary to this concept of irreparable harm: when stockholders “have voted without complete and accurate information – it is, by definition, too late to remedy the harm. If the Court could redress such an informational injury after the fact, then the harm, by definition, would not be irreparable, and injunctive relief would not be available in the first place.”

c. After Transkaryotic, practitioners wondered whether the Court’s language could be interpreted to mean that the Court would never award damages for disclosure violations. They also wondered whether stockholders needed to raise all disclosure claims pre-closing. Many doubted that a broad interpretation of Transkaryotic would survive a case in which the Court confronted egregious disclosure violations that had not been raised pre-closing but that might have misled stockholders about whether to vote down the deal or seek appraisal.

d. In several transcript rulings, Vice Chancellor Laster has expressed the view that at least in some circumstances, stockholders can obtain post-closing relief for disclosure violations. Chancellor Chandler noted the same possibility in a footnote in Hammons.

e. Orchard is now the clearest statement yet on the subject.

2. Instead of interpreting references to “irreparable harm” in pre-closing injunction rulings to mean that no remedy exists if stockholders raise disclosure claims after closing, Orchard interprets references to “irreparable harm” as acknowledgements that post-closing remedies are a “less perfect substitute.” The Orchard opinion notes that pre-closing remedies for disclosure violations are “superior and preferable,” but it rejects the notion of a post-closing “remedial impasse.”

3. The Court emphasizes the possibility of significant damages awards for disclosure violations. According to the Court, with the benefit of “full disclosure, [Orchard’s] stockholders could have voted against the merger, stopped the transaction and remained holders of equity in a going concern.” The Court reasons that, “if a stockholder has been deprived of property (shares) because of false or misleading disclosures, a court can compensate stockholders with the monetary value of the lost property (the fair value of the shares less the merger consideration).”

4. The prospect of significant damages awards for disclosure violations could potentially trigger a shift in strategy among stockholder plaintiffs who have overwhelmingly focused on bringing pre-closing disclosure claims and applications for injunctive relief. But several factors indicate that any potential shift will only be incremental.

a. First, Orchard’s holding only extends to disclosure claims that raise loyalty issues. The opinion is unlikely to have an immediate impact on challenges to disclosures in third-party deals.

b. Second, Transkaryotic and other rulings suggest that the Court will continue to dismiss damages claims for disclosure violations that should have been identified and challenged pre-closing. The Court could easily apply the laches analysis it routinely applies in other contexts to reach this result.

c. Third, any stockholder plaintiff seeking to recover damages for disclosure violations under Orchard will continue to confront significant obstacles, including exculpatory charter provisions and the requirement that they prove causation and damages. For example, it is unclear how a stockholder could prove that a particular disclosure violation caused other stockholders to vote for a deal they would have otherwise opposed or somehow dissuaded stockholders from seeking appraisal.

d. Fourth, the availability of expedited discovery and the hydraulic pressure created by deal timelines will continue to make pre-closing litigation an attractive environment for stockholder plaintiffs seeking to extract settlements.

5. Orchard confirms that, under In re MFW, a controlling stockholder can obtain business judgment review of a squeeze-out transaction only if the controller conditions its proposal on the recommendation of a disinterested, independent and fully-empowered special committee and the affirmative vote of a majority-of-the-minority stockholders before negotiations begin.

6. The result in Orchard demonstrates how difficult it can be for defendants to obtain burden-shifting under the procedural framework established in Americas Mining/Southern Peru. In Americas Mining, the Delaware Supreme Court held that the burden-shifting benefit of (a) employing a disinterested, independent and fully-empowered special committee or (b) conditioning the transaction on a majority-of-the-minority vote would only apply if the defendant established the effectiveness of one of those mechanisms at summary judgment. Thus, a stockholder plaintiff can defeat burden-shifting simply by raising questions of fact. This dynamic reduces the incentive to employ any burden-shifting mechanism in the first place.

7. The Orchard Court finds that plaintiffs raised a question of fact about the effectiveness of the Special Committee by presenting evidence challenging the independence of one member (Donahue) of a five-member committee. The Court’s ruling emphasizes that Donahue was the chair of the committee, acted as the principal point person in negotiations, and was alleged to have extensive ties to Dimensional. The Court does not address the potential argument that the roles of the other four Special Committee members cleansed Donahue’s conflict.

8. The Court’s refusal to grant summary judgment on “fair price” despite a prior appraisal decision resulting in a “fair value” determination of more than twice the transaction price seems generous to defendants. This component of the ruling is easier to understand as a practical ruling given the anticipated need to assess witness credibility at trial even if plaintiffs prevailed on this point.

9. The Court’s holding that incorrect statements in statutorily-required disclosures are material per se is an important reminder that an error in a disclosure mandated by the Delaware code can trigger seemingly disproportionate consequences.

10. The Orchard Court discusses “quasi-appraisal” damages at length. According to the Court, “quasi-appraisal” damages consist of the fair value of the applicable stock less the price paid for it in the transaction. The Court indicates that “quasi-appraisal damages” are simply one of many different measures of damages (including “reliance damages, expectancy damages, rescissory damages, disgorgement and punitive damages”) and are available in and outside the short-form merger context. Critically, this conception of “quasi-appraisal” (as a measure of damages) is far different from the concept of a “quasi-appraisal proceeding” that mimics the appraisal process and requires defendants to pay the difference between fair value and the deal price regardless of fault or culpability.

11. The Orchard Court carefully distinguishes between two often-conflated legal concepts: the “fair price” prong of entire fairness analysis and the appropriate measure of damages in an entire fairness case. The Court emphasizes that courts apply the “fair price” prong of the entire fairness test to determine liability. Once courts determine liability, they choose from a menu of potential remedies, one of which could be a “quasi-appraisal” damages award that would likely track the court’s analysis of fair price.

12. Orchard indicates that “when a case involves a controlling stockholder with entire fairness as the standard of review, and when there is evidence of procedural and substantive unfairness, a court cannot summarily apply Section 102(b)(7) on a motion for summary judgment to dismiss facially independent and disinterested directors.” Although this holding can be read to conflict with others in similar contexts, it is not new law, and it reflects how even completely disinterested and independent directors can be swept towards trial by the rigors of entire fairness scrutiny.

13. The Orchard Court’s refusal to rule out the possibility of rescissory damages was not academic. The opinion references the fact that Orchard merged with an affiliate of Sony Music pursuant to an agreement executed on March 3, 2012. If the Court grants rescissory damages, it could award the minority stockholders the value of their stock as of the date of judgment (presumably at or near the value implied by the Sony transaction).

14. The transaction challenged in Orchard involved at least two unusual features. The first was a go-shop feature (employed despite the existence of a controlling stockholder). The Court recognized that the efficacy of any go-shop in that context would turn on whether and under what circumstances the controller would be willing to sell. The second feature was a “flip” provision that required Dimensional to share the proceeds if it sold 80% or more of Orchard’s equity or assets within six months after the merger. One wonders whether the existence of the flip provision raised questions about the Special Committee’s confidence in its own sale process.