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In City of Hialeah Employees Retirement System v. Insight Venture Partners, (Del. Ch.; 12/23), the Chancery Court rejected breach of fiduciary duty allegations against the directors of an acquiring company and its purported controlling stockholder arising out of the buyer’s purchase of the controller’s portfolio company. When the deal was announced, the buyer’s stock price declined by nearly 30%. The plaintiff pointed to the market’s reaction to the deal as support for its claim that the buyer overpaid for the portfolio company target, which benefited the controller at the buyer’s expense.

The buyer’s charter included a Section 102(b)(7) provision eliminating the directors’ liability in damages for breach of the duty of care, so the plaintiff sought to establish breaches of the duty of loyalty by contending that the directors approved the deal in bad faith and that a majority of the board was not independent of the controller.  Vice Chancellor Zurn rejected those claims. This excerpt from Shearman’s blog on the case discusses her analysis of the bad faith claim:

Plaintiff focused on aspects of the approval process, including an alleged lack of price negotiations, reliance on the financial advisor’s fairness opinion, and the alleged failure to consider a valuation of the Target based on the alleged controller’s prior investment in the Target.

As to plaintiff’s price-related contention, the Court found that the complaint’s own allegations showed that the board reasonably relied on the assessment of management regarding the “floor” that the Target would accept for the deal and the fairness opinion of the financial advisor. The court also noted that the board negotiated the cash portion of the cash/stock deal down from 50% to 20%, which enabled the Corporation to avoid having to raise funds for the deal.

Regarding the analysis of the Corporation’s financial advisor, plaintiff alleged that there were several flaws, including in the financial projections the advisor used. The Court, however, concluded: “Even if [p]laintiff’s criticisms are well-founded, quibbling with or criticizing a financial analysis falls far short of showing it was so facially flawed as to rebut the presumption that the directors relied on it in good faith.”

With respect to plaintiff’s allegation that the board was “unaware” of a relevant valuation of the Target based on a prior investment, the Court explained that the allegation assumed that the Target’s valuation was the same in 2018 as in 2021 and this “assumption is unreasonable.” The Court also noted that the allegation “sounds in the duty of care” and, therefore, does not present a substantial likelihood of liability for an exculpated board.

The Vice Chancellor also highlighted several aspects of the board’s process that undermined the plaintiff’s bad faith claims.  These included the discussion of the transaction and updates from management at multiple board meetings, the board’s retention of reputable advisors, and efforts to exclude the controller’s designated director from the process.

Vice Chancellor Zurn also rejected the plaintiff’s allegations that a majority of the board lacked independence.  In doing so, she noted that the Delaware Supreme Court had previously held that a controlling stockholder’s ability to elect and remove directors does not in itself establish a lack of independence.

The Vice Chancellor went on to reject claims that individual directors lacked independence based on, in the case of the CEO, alleged dependence on the controller for his salary, and in the case of the other directors, both the compensation they received for their service and their ties to the controller through service on boards of other companies in which the controller had investments.

– John Jenkins