v. Elgamal, C.A. No. 6120-VCN (Del. Ch. March 30,
2012). See summary
of prior Chancery decision in this matter highlighted on these pages.
Whether it was premature to rule on a fiduciary duty
claim based on the entire fairness standard, at the motion to dismiss stage.
[Note: This is one of 5 opinions issued within the last
week or so by the same Vice Chancellor, with the average length of each case
being about 30 to 40 pages long. Yet another example of how prolific the Court
of Chancery is.]
This purported class action challenges a merger of
American Surgical Holdings, Inc. with AH Merger Sub, Inc., a wholly-owned
subsidiary of AH Holdings, Inc., which, in turn, is an affiliate of Great Point
Partners, I LP. After the appointment of a Mergers and Acquisitions
Committee, and months of negotiations between American Surgical and Great
Point, a merger agreement was entered into and structured as a reverse
triangular merger. Under the terms of the merger agreement, each share of
American Surgical common stock was converted into a right to receive $2.87 in
cash. The merger agreement also contained several defensive devices,
including a termination fee, a matching rights provision, and a no-shop clause.
The Court referred to certain defendant directors of
American Surgical and two key employees of American Surgical as representing
the "Control Group." In addition to the merger agreement, each member of
the Control Group executed a stockholder voting agreement, an exchange
agreement that allowed them to retain interest in the company following the
merger, and employment agreements which became effective at the time of the
The complaint alleges that the valuation opinions were
flawed and that the comparable company analysis was not done properly, with the
result being that the merger price was too low. The complaint also
alleges that not all aspects of the fairness opinion were fairly disclosed to
the shareholders, and that the Control Group, with its ongoing interest in the
company, would benefit from the synergies of the merger, but this fact was not
disclosed in the definitive proxy statement.
This suit was filed after the preliminary proxy statement
was filed. The subsequent definitive proxy statement contained
supplemental disclosures that mooted the disclosure claims in the complaint.
The complaint alleges that the Control Group, as
controlling shareholders, violated their fiduciary duties of loyalty and care
owed to the public shareholders of American Surgical by usurping the benefit
for themselves of an ongoing interest in the company on terms that were unfair
to the class. Count II alleges that the Control Group was unjustly
enriched as a result of the merger. Court III alleges that the board
breached their duty to ensure that the transaction was entirely fair even
though they were standing on both sides of the transaction. Count IV
alleges that the purchasing entities aided and abetted the breaches of
The remedy the complaint seeks is to certify this action
as a class action, rescind the merger or, in the alternative, recover
rescissory damages, have the defendant account for all the damages they caused
the purported class, and to recover the costs of this action, including
reasonable attorneys' fees.
The defendants filed a joint motion to dismiss pursuant
to Court of Chancery Rule 12(b)(6), arguing that the allegations are
insufficient to rebut the presumptions of the business judgment rule.
The Court reviewed the Delaware standard for a motion to
dismiss under Rule 12(b)(6), which is "reasonable conceivability," (and is
different than the federal standard under Rule 12(b)(6)). See Central
Mortgage Co. v. Morgan Stanley Mortgage Capital Holdings, LLC, 27 A.3d 531,
537 (Del. 2011).
The Court described the transaction involved here as
similar to the merger involved in the Chancery case of In Re John Q. Hammons
Hotels Inc. S'holdr Litig., 2009 WL 3165613, at *10 (Del. Ch. Oct. 2,
2009). That is, where as in this case a corporation with a controlling
stockholder merges with an unaffiliated company, the minority stockholders of
the controlled corporation are cashed-out, and the controlling stockholder
receives a minority interest in the surviving company. In that situation,
the controlling stockholder does not "stand on both sides" of the merger and
therefore the Delaware Supreme Court decision in Kahn v. Lynch
Communications Systems, Inc., 638 A.2d 1110 (Del. 1994), does not mandate
that the entire fairness standard apply, notwithstanding any procedural
protections that were used.
The Court added that business judgment would be the
applicable standard of review if the transaction were: "(1) Recommended
by a disinterested and independent special committee, and (2) Approved
by stockholders in a non-waivable vote of the majority of all the minority
stockholders." Hammons, at *12. (emphasis in
original.) The Court emphasized, however, that if a transaction is not
conditioned on "robust procedural protections," then the entire fairness is the
appropriate standard of review. In this case, because the merger was
not conditioned on "robust procedural protections," the merger will be
reviewed for entire fairness.
The Court reiterated the settled principal of Delaware
law that when a Control Group exists, it is accorded controlling shareholder
status, which means that its members owe fiduciary duties to the minority
shareholders of the corporation. See Dubroff v. Wren Holdings,
LLC, 2011 WL 5137175, at *7 ("Dubroff II") (Del. Ch. Oct. 28, 2011).
As in the Hammons case, in this case the
controlling stockholder entered into a merger with an unaffiliated company, and
in the merger, the minority stockholders were cashed-out while the controlling
stockholder retained the ability to participate in the future profits of the
corporation and its future growth. The Court in Hammons
determined that even when an independent and disinterested special committee
negotiates on behalf of a minority, a merger will still be subject to entire
fairness review unless it is conditioned on "robust procedural
protections." Without these protections, it is reasonable to infer
that the controlling stockholder might "agree to a lower sale price in order to
secure a greater profit from its investment in the surviving entity." See
Hammons at *12.
There were no robust procedural protections in this case,
such as "non-waivable vote of the majority of all the minority
stockholders." Where, as here, the entire fairness standard applies,
"controlling stockholders can never escape entire fairness review, but they may
shift the burden of persuasion by showing "that the transaction was approved by
an independent board majority (or in the alternative, a special committee of
independent directors)." See In Re Southern Peru Copper Corp
S'holder Deriv. Litig., 2011 WL 6440761, at *20 (Del. Ch. Oct. 14, 2011,
revised Dec. 20, 2011).
The determination of whether a defendant has met the
burden of entire fairness will normally be impossible by examining only the
documents the Court is free to consider on a motion to dismiss. See
footnote 74. See generally footnote 75 which is an expansive
discussion of the Court's awareness of transactions, that are not prohibited by
Delaware law, which involve a private equity fund purchasing companies with the
condition that critical members of management continue on in employment in
the new company. The Court cited as a decision excepting such
structure the Chancery opinion in the case of In Re OPENLANE, Inc.,
S'holders Litig., 2011 WL 4599662, at *5 (Del. Ch. Sept. 30, 2011).
Because the merger will be reviewed for entire fairness,
the motion to dismiss Count I was denied. Although the claim for unjust
enrichment in Court II appeared to be duplicative of the breach of fiduciary
duty claim, Delaware law permits a plaintiff to simultaneously assert two
equitable claims even if they overlap. See MCG Capital Corp. v. Maginn,
2010 WL 1782271, at *25 n.147 (Del. Ch. May 5, 2010). Although a plaintiff
can only receive one recovery, at this early procedural juncture, the Court
allowed both claims to proceed and denied the motion to dismiss that claim.
The Court also refused to dismiss Court III which alleged
a breach of fiduciary duty to ensure that the merger was fair to the minority
shareholders and that those shareholders were provided with all material
information with which to seek an appraisal. Even though the charter
included an exculpatory provision under DGCL Section 102(b)(7), the defendants
recognized that this early stage in the case was not the appropriate time to
address the impact of the exculpatory provision under Section 102(b)(7), which
would need to be decided at trial or after further summary disposition.
Therefore, Court III will proceed to trial. However, the Court granted the
motion to dismiss Count IV regarding the aiding and abetting claim.
Read more Delaware business
litigation case summaries and commentary on Delaware
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