Delaware Court of Chancery Dismisses Claim that Acquirer Aided and Abetted Breach of Revlon Duty Based on Merger Payments to Preferred Holders and Zero Received by Common Stockholders

In Morgan v. Cash, C. A. No. 5053-VCS (Del. Ch. July 16, 2010), the Delaware Court of Chancery dismissed a claim that the acquirer of a small software company aided and abetted the directors of the acquired company to breach their fiduciary duties in connection with not obtaining the highest value for the company as required by the seminal decision in Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1985). Claims against the directors were not addressed in this opinion (only the aiding and abetting claims against the acquiring company.)

Background

The common shareholder who brought this suit (two years after she filed an appraisal action), claimed that the directors of the software company called Voyence breached their fiduciary duties by failing to take reasonable steps to maximize stockholder value in the sale of the company. Specifically, the cash consideration for the merger was only payable to the preferred shareholders who had the right to receive their full liquidation preference in a merger before the common shareholders received a dime. The argument by the claimant in this case was that the board members were mostly designees of the preferred shareholders and they accepted less consideration just so they could receive their liquidation preference at the expense of the common stockholders.

The aiding and abetting claim was based on two points: (i) The acquirer, EMC, attempted to buy off the Voyence management's support for its offer by promising them employment with the post-merger entity; and (ii) EMC exploited conflicts of interest between the Voyence directors, who all held preferred stock or were appointees of preferred stockholders, and Voyence's common stockholders.

Analysis

 The Court announced that: "It is not a status crime under Delaware law to buy an entity for a price that does not result in a payment to the entity's common stockholders. But that is in essence all that the plaintiffs allege that EMC did wrong."

The four elements that must be satisfied to succeed on a claim for aiding and abetting in this context, include: (i) the existence of a fiduciary relationship; (ii) breach of fiduciary duty; (iii) knowing participation in that breach by defendants; and (iv) damages proximately caused by that breach. See footnote 36.

Several cases were cited for the analysis of the "knowing participation" element and how that element can be satisfied by circumstantial evidence--that is, it can be inferred from factual allegations in the complaint in order to survive a motion to dismiss. However, the Delaware Supreme Court has previously explained that a bidder's attempt to reduce the merger price through arm's-length negotiations cannot give rise to liability for aiding and abetting, although a "bidder may be liable to the target's stockholders if the bidder attempts to exploit conflicts of interest in the board or conspires with the board to breach a fiduciary duty." See footnotes 37-38.

The plaintiffs relied primarily on two cases that the Court distinguished in the course of its reasoning to explain why it was dismissing the aiding and abetting claims relating to the argument that EMC exploited conflicts of interest withing the Voyence board to the detriment of Voyence's common stockholders. See Gilbert v. El Paso Co. and Zirn v. VLI Corp. at footnotes 45 and 46.

Unlike the present case where the Court viewed the complaint as silent on the matter, in Gilbert and Zirn, the complaints alleged that the acquirer used its knowlege of the target board's conflicts to collude with and exploit the target board at the expense of the target's shareholders.

The reality, according to the Court, is that there are entities that have a market value that is less than the amount that its preferred shareholders and/or bondholders are due in a sale--which means that the common stockholders would get zero.

The Court stated that Delaware law does not recognize a claim based on the mere fact that a bidder knowingly enters into a merger with a target board dominated by preferred holders at a price that does not yield a return to common stockholders--nor does this situation create an inference that the bidder knowingly assisted in fiduciary misconduct by the target board.

In closing, the Court reasoned that the "... requirement that a third party knowingly participate in the alleged breach--whether by buying off the board in a side deal, or by actively exploiting conflicts in the board to the detriment of the target's stockholders--is there for a reason." See footnote 59 (citing Malpiede, 780 A.2d at 1096)(emphasis in original).

Read more Delaware business litigation case summaries and commentary on Delaware Corporate and Commercial Litigation Blog, a blog hosted by Francis G.X. Pileggi, of Fox Rothschild LLP.