March 27, 2024

M&A Disclosure: Del. Supreme Court Overrules Chancery on Materiality of Undisclosed Advisor Conflicts

Earlier this week, in City of Dearborn Police & Fire v. Brookfield Asset Management, (Del.; 3/24) the Delaware Supreme Court overruled the Chancery Court and held that allegations of undisclosed conflicts of interest involving a special committee’s legal and financial advisors were sufficient to deny the defendants’ motion to dismiss breach of fiduciary duty claims.

The case arose out of a squeeze-out merger involving the sale of TerraForm Power, Inc. to an affiliate of Brookfield Asset Management, Terra Form’s controlling stockholder.  The plaintiffs alleged various breaches of fiduciary duty in connection with the transaction, while the defendants responded that the transaction satisfied the MFW standard, and the board’s actions should be deferred to under the Business Judgment Rule.  The Chancery Court dismissed the plaintiffs’ claims in a bench ruling, although it acknowledged that the disclosure claims involved a “close call.”

The Supreme Court overruled the Chancery Court’s decision to dismiss claims premised on the proxy statement’s failure to disclose alleged material conflicts of interest involving the special committee’s legal and financial advisors. The Court found the Chancery’s analysis of the disclosure issues to be problematic because it focused on whether the conflicts were significant enough to support a claim that the special committee breached its duty of care in retaining its advisors and did not adequately address whether the conflicts were sufficiently material to require disclosure in the proxy statement.

In that regard, the Court’s discussion of the materiality of an investment by the special committee’s financial advisor in Brookfield noted that although it represented only approximately 0.10% of the advisor’s overall portfolio and was not necessarily “material” to it, the magnitude of that investment could be material from the perspective of a reasonable TerraForm stockholder:

It is reasonably conceivable that from the viewpoint of a stockholder, Morgan Stanley’s nearly half a billion-dollar holding in Brookfield was material and would have been material to a stockholder in assessing Morgan Stanley’s objectivity. Delaware law places great importance on the need for transparency in the special committee’s reliance on its advisors: “‘it is imperative for the stockholders to be able to understand what factors might influence the financial advisor’s analytical efforts . . . .’” Further, “[b]ecause of the central role played by investment banks in the evaluation, exploration, selection, and implementation of strategic alternatives, [the Court of Chancery] has required full disclosure of investment banker compensation and potential conflicts.”

It does not matter whether the financial advisor’s opinion was ultimately influenced by the conflict of interest; the presence of an undisclosed conflict is still significant: “‘[t]here is no rule . . . that conflicts of interest must be disclosed only where there is evidence that the financial advisor’s opinion was actually affected by the conflict.’” Although the size of the investment vis-à-vis the size of Morgan Stanley’s overall portfolio may be considered in the analysis, the stockholder’s perspective is paramount.

With respect to the special committee’s legal advisor, the Court held that although the firm’s prior and concurrent engagements with Brookfield may not have been sufficient, standing alone, to support a claim that the special committee was negligent in retaining the firm, it was “reasonably conceivable” that this information involved “material facts for shareholders that required disclosure.”

John Jenkins