DealLawyers.com Blog

On Friday, in In re Cloudfare Stockholders Litigation, (Del. Ch.; 10/26), the Chancery Court granted the stockholder plaintiffs’ motion to preliminarily enjoin Cloudflare’s proposed dual class recapitalization. The plaintiffs allege that the proposed recapitalization involved breaches of fiduciary duty by both the company’s board and its controlling stockholder. The decision is the most significant to date interpreting the statutory safe harbors for insider transactions established last year by SB 21.

What’s most interesting about Vice Chancellor Laster’s 142-page opinion is that although he appears to have largely accepted the defendants’ reading of the safe harbors in Section 144 of the DGCL, the Vice Chancellor nevertheless concluded that there was a reasonable probability that the special committee may not have acted in good faith:

The evidence makes it reasonably probable that the plaintiffs can show that the committee failed to act in good faith. How? By acting to placate the founders and give them what they wanted, rather than striving to obtain a transaction that served the best interests of the company and its stockholders as a whole.

Contemporaneous meeting notes suggest that the committee’s advisors knew from the start that the recapitalization would happen and set out to craft a narrative to support that result, including gives from the founders that would look like gets for the committee. There was also a critical point where one of the committee members had an unauthorized conversation with one of the founders in which he told the founder that he expected the committee to give the founder what he wanted.

When the committee’s next proposal differed from what the founder expected, he exploded. He berated the committee members in a text tirade, made threats, and appealed to boardroom allies not on the committee. Two of his allies inserted themselves into the committee’s process. The terms ended up where the founder wanted, and there is good reason to think that the founders’ concessions were less significant than portrayed.

While this isn’t the first Chancery Court decision interpreting the SB 21 safe harbors, it’s clearly the important and I expect that many law firms will weigh in on its implications in the near future. When they do, we’ll post those memos in our “Controlling Shareholders” Practice Area.

– John Jenkins