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Deals where preferred stockholders come out whole while common stockholders end up with peanuts often end up with the common stockholders crying foul.  Wei v. Levinson, (Del. Ch.; 6/25), is the latest example of that kind of case to make its way to the Chancery Court.  The case arose out of Amazon’s $1.3 billion acquisition of Zoox. Under the terms of that transaction’s merger agreement, most of the merger consideration went to the target’s noteholders and preferred stockholders, without much leftover for its common stockholders.

The plaintiffs asserted breach of fiduciary duty claims against the target’s directors and certain of its officers, as well as aiding and abetting claims against Amazon.  The defendants responded by filing a motion to dismiss those claims.  In her opinion, Chancellor McCormick refused to dismiss claims against the management directors and directors affiliated with the preferred stockholders, but she dismissed claims against the other members of the board and the aiding and abetting claims against Amazon.

The plaintiffs’ fiduciary duty claims were premised on alleged conflicts of interest on the part of the director and officer defendants.  With respect to the directors who were appointed as representatives of the preferred stockholders, the plaintiffs pointed to the economics of the two series of preferred stock laid out in the target’s charter documents. In effect, the terms of the preferred created a “dead zone” above around $1.07 billion in merger consideration where no preferred stockholder received additional consideration unless the deal price exceeded $2 billion. The plaintiffs argued that within that zone, the preferred directors had no incentive to risk losing the value the preferred stockholders would receive in a deal by pushing to increase the value of the deal for the common.

Chancellor McCormick agreed. She cited Vice Chancellor Laster’s comments in Trados to the effect that it was “intermediate cases” – transactions in which preferred holders get paid out while common stockholders lose most of their investment & and future upside – that give rise to conflicts.  The Chancellor said this was a “classic intermediate case,” and that the establishment of a bonus plan for members of management paid for in part by the common stockholders added fuel to the conflict of interest fire:

Atop the typical distortive effects that the economic rights of preferred stockholders offer in the intermediate case, the Bonus Plan supplied an additional conflict. At first, the Board contemplated that the preferred stockholders and noteholders would absorb the full cost of the Bonus Plan for the first $1 billion of consideration. But the preferred stockholders and noteholders never approved that deal and ultimately sought to re-trade, placing the preferred and common stockholders at odds on the question of allocation. In the end, the Board approved a deal that imposed 25% of the costs of the Bonus Plan on the common stockholders.

She concluded that it was reasonably conceivable that the plaintiff’s claims would be evaluated under the entire fairness standard, and that the plaintiffs were required to plead that the merger was “not the product of both fair dealing and fair price.” Chancellor McCormick concluded that the plaintiffs adequately alleged unfair dealing by the preferred directors, management directors and a noteholder director, but failed to plead that the other directors were conflicted.  As a result, the process-based claims against those directors only supported a claim that they breached their duty of care, as to which they were entitled to exculpation under the Chancery Court’s 2015 decision in Cornerstone Therapeutics. She therefore dismissed those claims.

Chancellor McCormick declined to dismiss the plaintiffs’ claims against the management directors. She concluded that the plaintiffs’ adequately pled conflicts of interest due to non-ratable benefits that they would receive from the Amazon transaction and statements made after the deal indicating that they did not attempt to maximize the target’s value in negotiating a potential sale. However, she dismissed the aiding and abetting claim against Amazon, holding that the plaintiffs failed to adequately plead that, even if Amazon was aware of the conflicts of interest among the target’s fiduciaries, it took any action to exploit them.

– John Jenkins