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In  Peña v. MacArthur Group, (Del. Ch.; 10/25), the Chancery Court refused to dismiss claims that a corporation’s merger conversion into a limited liability company conferred a non-ratable benefit to the company’s insiders in the form of insulation from future liability for breaches of fiduciary duty.

The case originally arose as an appraisal action in connection with the MacArthur Group’s merger conversion into the LLC form, but discovery revealed that certain company officers had used company funds for personal reasons and caused it to into various questionable transactions. The plaintiff amended its complaint to raise direct claims for breach of fiduciary duty against those officers and the  corporation’s directors and officers.

The plaintiff alleged that the defendants orchestrated the conversion into an LLC to eliminate potential derivative liability for past breaches of fiduciary duty and, because the LLC’s operating agreement eliminated fiduciary duties, to eliminate the potential for future fiduciary duty claims. The plaintiff contended that these actions conferred a non-ratable benefit on the defendants in the form of a reduction in their potential liability, and that the entire fairness standard of review should apply.

Vice Chancellor Zurn first determined that because the transaction resulting in the surviving entity being “merely the same corporate structure under a new name,” the reorganization exception to the general rule that a target shareholder loses standing to pursue a derivative claim applied to this transaction.  Accordingly, she held that since the plaintiff could continue to pursue derivative claims post-closing, the aspect of the transaction did not result in a non-ratable benefit to the insiders.

She reached a different conclusion with respect to the elimination of potential future claims resulting from the conversion to LLC status.  She noted that in Palkon v. Maffei, (Del.; 2/25), which challenged TripAdvisor’s reincorporation merger moving the company from Delaware to Nevada, the Delaware Supreme Court distinguished between situations involving “existing potential liability” for the fiduciaries and “future potential liability” for the fiduciaries.  In that case, it concluded that any benefits from Nevada’s more lenient liability regime for corporate fiduciaries were purely prospective in nature, and did not result in a non-ratable benefit to the directors and controlling stockholder.

The Vice Chancellor went on to observe that the situation here was different, at least with respect to certain of the defendants:

Here, Mac LLC’s fiduciary duty waiver secured for the former MacArthur directors a waiver that is prospective. And Mac LLC’s fiduciary duty waiver eliminates “all future potential liability for all fiduciary duty claims, including claims for breach of the duty of loyalty.” The parties join issue on the maturity of the MacArthur directors’ litigation risk: whether fiduciary duties were waived on a clear day.

Per Maffei, in this context, the existence of a clear day turns on whether a complaint contains “allegations that the [transaction] decisions were made to avoid any existing threatened litigation or that they were made in contemplation of any particular transaction[.]” Well-pled allegations to that effect support a pleading stage inference that a reduction in mature litigation risk is sufficiently material to trigger entire fairness review. Allegations as to “unspecified corporate actions that may or may not occur in the future” do not suffice.

In this case, Vice Chancellor Zurn concluded that the plaintiff had adequately pled such allegations, at least as to the controlling shareholder and another director, and concluded that because they obtained a non-ratable benefit from the transaction, the entire fairness standard should apply to the allegations against them. However, because the plaintiff did not plead that the remaining directors received a non-ratable benefit or were otherwise conflicted or non-independent, the Vice Chancellor dismissed the plaintiff’s claims against them.

– John Jenkins