Court of Chancery Reaffirms Significant Deference Given to Independent Board in Change of Control Context Post-Lyondell
In two actions involving challenges to a consummated acquisition, the Court of Chancery in In re Nymex Shareholder Litigation, Nos. 3621-VCN, 3835-VCN and Greene v. New York Mercantile Exchange, Inc., et al., No. 3835-VCN (Del. Ch. Sept. 30, 2009), read opinion here, dismissed a multitude of conclusory allegations regarding breaches of fiduciary duties of loyalty, due care and candor in the sale of NYMEX to CME. In doing so, the Court reaffirmed the considerable deference Delaware law provides to an independent Board facing a change of control situation post-Lyondell.
Kevin Brady, a highly respected Delaware litigator, prepared this synopsis.
The Merger
NYMEX “was the largest commodity futures exchange in the world.” The defendants were all members of the Board of Directors of NYMEX including Richard Schaeffer (chairman of NYMEX) and James Newsome (President and Chief Executive Officer). The Plaintiffs consisted of common stock owners (the “NYMEX Plaintiffs”) and Shelby Greene who brought an action on behalf of the Class A Members of the NYMEX Exchange.
In the middle of 2007, the NYMEX Board established a Strategic Initiatives Committee (“SIC”) in order to “consider, negotiate and recommend any significant transaction involving NYMEX.” At about the same time, New York Stock Exchange (“NYSE”) Chairman John Thain spoke with Schaeffer about NYSE purchasing NYMEX for $142 per share, which represented a large premium above NYMEX’s then trading price. However, NYSE never made a formal offer allegedly because “Schaeffer personally demanded a senior executive position for himself as a pre-condition of the deal.”
Prior to Thain’s expression of interest, Schaeffer and Newsome had initiated negotiations between NYMEX and CME and at the beginning of 2008, a confidentiality agreement was entered into between the two companies. After the confidentiality agreement was announced, the NYMEX Board approved a change of control severance plan “which provided more than $97 million in change of control payments to senior management.”
Three weeks later, NYMEX announced that “CME had offered to buy NYMEX for approximately $119 per share, which represented a 2.1% premium over the closing price of NYMEX shares on that day and an 11% premium above the closing price of NYMEX shares on the last trading day prior to the announcement. . . . [and that a] substantial portion of the merger consideration was payable in CME stock.” NYMEX also announced that it had entered into a 30-day exclusive negotiating period with CME which was later extended to March 15, 2008.
No Collar Negotiated; No Protection Against Drop in Share Price
Prior to the announcement, CME stock was trading at $635.14 per share, but within a week of the announcement it fell to $485.25 per share. Notably, the CME offer did not contain a collar, which would have provided protection against fluctuations in stock price. As a result of the lack of a collar and because much of the merger consideration was in CME stock, the decline in stock price resulted in a substantial decline in the merger consideration. According to the Complaint, CME offered to “collar” the stock portion of the merger consideration but that offer was rejected by Schaeffer and Newsome (although they supposedly never mentioned the offer of a collar to the rest of the Board).
On March 17, 2008, CME and NYMEX announced the merger agreement, consistent with the original offer in January 2008, by which CME agreed “to acquire all of NYMEX’s common stock in exchange for $36 per share in cash and 0.1323 shares of CME common stock per NYMEX share.” By this date, the merger consideration had fallen to $100.30 per share. Nonetheless, J.P. Morgan and Merrill Lynch provided fairness opinions in favor of the deal. The Board unanimously approved the merger and more than 95% of the shares were voted in favor of the deal. The merger closed on August 22, 2008.
Plaintiffs’ Allegations
Plaintiffs in the NYMEX action brought numerous allegations of breaches fiduciary duties of loyalty, due care and candor arising out of the sale of NYMEX to CME. Plaintiffs also alleged that the Board was controlled by Schaeffer, and that the Board agreed to sell NYMEX through an unfair process at an inadequate price in order for Schaeffer and Newsome to obtain nearly $60 million in severance payments. Further, the shareholder class alleged that the directors breached their fiduciary duties by, among other things:
• omitting or misstating necessary information in NYMEX’s proxy materials with respect to the CME deal;
• agreeing to CME’s first and only offer;
• failing to inquire into other potential transactions;
• agreeing to a 30-day exclusive negotiating period with CME;
• causing investment bankers to allegedly understate the value of NYMEX shares in fairness opinions supporting the transaction;
• agreeing to a $50 million breakup fee; and
• agreeing to the $97 million change in control plan with an acquisition agreement imminent.
Plaintiffs also asserted that the CME Defendants aided and abetted the NYMEX Defendants in the breach of the above duties.
Does Revlon “Change of Control” Scrutiny Apply to Mixed Cash/Stock Deals?
The parties disputed whether this case should be evaluated under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., as involving a fundamental change of corporate control or whether it should be evaluated under the business judgment rule. While “Revlon scrutiny applies only to transactions ‘in which a fundamental change of corporate control occurs or is contemplated,’ such ‘change of control’ does not occur for purposes of Revlon where control of the corporation remains, post-merger, in a large, fluid market.”
“In transactions . . . that involve merger consideration that is a mix of cash and stock,” the Court noted that “[t]he [Delaware] Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.” Indeed, the Court contrasted In re Santa Fe Pacific Corp. Shareholder Litigation (merger transaction involving consideration of 33% cash and 67% stock did not trigger Revlon) with In re Lukens Inc. Shareholders Litigation, (merger transaction involving consideration of 60% cash and 40% stock likely triggered Revlon).
The mixed cash/stock deal (44% cash and 56% CME stock) before the Court in NYMEX provided an opportunity for the Court to further narrow the 33%-60% range noted above and give guidance as to when Revlon would be triggered.
However, the Court decided that it did not need to address the threshold Revlon applicability issue because NYMEX’s Certificate of Incorporation contained an exculpatory clause authorized by 8 Del. C. § 102(b)(7) that protects the NYMEX directors from personal monetary liability for breaches of the duty of care. If the Plaintiffs failed to show that the either a majority of the directors were interested, lacked independence or failed to act in good faith, then their only remaining claim would be a breach of a duty of care which is addressed by §102(b)(7). Thus, even if Revlon applied, application of the §102(b)(7) exculpatory clause would lead to dismissal “unless the Plaintiffs have successfully pleaded a failure to act loyally (or in good faith), which would preclude reliance on the Section 102(b)(7) provision.”
Post-Lyondell Duty of Loyalty Discussed
As to the breach of the fiduciary duty of loyalty, the Plaintiffs alleged that the disinterested members of the Board were dominated and controlled by Schaeffer, and acted in bad faith. However, the Court held:
[t]hat directors acquiesce in, or endorse actions by, a chairman of the board—actions that from an outsider’s perspective might seem questionable—does not, without more, support an inference of domination by the chairman or the absence of directorial will. The NYMEX directors were otherwise unquestionably independent—this is not an instance where certain relationships raised some concern but not sufficient doubt to sustain a challenge to director independence. In short, the Complaint alleges nothing more than a board which relied upon, and sometimes deferred to, its chairman. It does not allege dominance such that the independence or good faith of the board may fairly be questioned.
Consequently, the claim for breach of the duty of loyalty failed as a matter of law and was dismissed.
“Because the Plaintiffs’ allegations were too conclusory to support an inference of domination,” the Court noted that for the Plaintiffs to succeed, they had to “convert into a loyalty claim their aversion to the process the Board employed in negotiating the merger” and the most the Plaintiffs could show was that “the Board’s process was not perfect.” Relying on the Delaware Supreme Court’s 2009 decision in Lyondell Chemical Co. v. Ryan, 970 A. 2d 2235 (Del. 2009) and the Court of Chancery’s decision in Wayne County Employees’ Retirement Systems. v. Corti, 2009 WL 2219260 (Del Ch. June 24, 2009), the Court explained :
The Delaware Courts have repeatedly held that “there is no single blueprint that a board must follow to fulfill its duties.” In any event, claims of flawed process are properly brought as duty of care, not loyalty, claims and, as discussed, those claims are barred by the exculpatory clause of NYMEX’s Certificate of Incorporation. Moreover, to the extent the Complaint alleges that the Board acted in bad faith, such allegations must fail because, based on the facts in the Complaint, it cannot be said that the Board intentionally failed to act in the face of a known duty to act, demonstrating a conscious disregard for its duties. More precisely, the Complaint has not alleged that the Board “utterly failed to obtain the best sale price.”
As a result, the Court granted the motion to dismiss the Complaint as to the breach of fiduciary duty claims.
Court Rejects Breach of Fiduciary Duty Claims Against Schaeffer
and Newsome as Sole Negotiators
Plaintiffs alleged that Schaeffer and Newsom breached fiduciary duties by “active participation in wrongdoing” in serving as the principal negotiators, specifically by:
[r]ejecting and keeping secret CME’s secret collar offer, ignoring the SIC, and withholding information regarding strategic opportunities and bids from fellow directors, as well as in ‘committing’ to CME that NYMEX would not attempt to renegotiate any of the economic terms of the proposed sale and failing to advise the Board of such a commitment, and in entering into an agreement with CME to vote their shares in favor of the proposed acquisition.
Moreover, Schaeffer was alleged to have breached his fiduciary duties by “rejecting NYSE’s interest in the Company due to NYSE’s failure to abide by his personal demands.” The Court dismissed these claims by holding that “[i]t is well within the business judgment of the Board to determine how merger negotiations will be conducted, and to delegate the task of negotiating to the Chairman and the Chief Executive Officer.” In addition, because the Board was “clearly independent,” there was no need for the utilization of the SIC.
Court Rejects Breach of Fiduciary Duty Claim Against Schaeffer and Newsome For Failure to Obtain a Collar
Characterizing Plaintiffs’ claim that Schaeffer and Newsome violated fiduciary duties by rejecting CME’s offer of a collar as speculative and conclusory, the Court held that
[t]he mere failure to secure deal protections that, in hindsight, would have been beneficial to shareholders does not amount to a breach of the duty of care. The presumption of deference to the judgment of management is only superseded by a showing of gross negligence, bad faith or conflicting personal interest. Plaintiffs have failed to plead the facts necessary to overcome this presumption.
The decision to omit a collar while negotiating merger terms was within the Board’s judgment. A post-facto analysis of the merits of a collar “is of no legal moment.” Accordingly, this claim was dismissed.
Direct v. Derivative Claims and the Parnes Exception
Returning to the NYSE offer, Plaintiffs alleged that Schaeffer stymied the potential bid (which Plaintiffs assert would have been greater than the ultimate deal with CME) by seeking a post-merger position for himself in the combined entity. The Court reasoned that these claims are not protected by the § 102(b)(7) clause because they pertain to breaches of a duty of loyalty. However, because claims pertain to a proposed NYSE acquisition and an entrenchment claim against Schaeffer, the claim was derivative. Following the merger, Plaintiffs’ standing to bring derivative claims was lost.
The general rule for determining “direct v. derivative” claims is set out in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004) as a two-part test: “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually).” The Court noted a very narrow exception to the general rule in Parnes v. Bally Entertainment Corp., 722 A.2d 1243 (Del. 1999). There, the Court held that “in order to state a direct claim with respect to a merger, a stockholder must challenge the validity of the merger itself, usually by charging the directors with breaches of fiduciary duty resulting in unfair dealing and/or unfair price.” A direct claim in such circumstances can be found only “[i]f the side transactions are alleged to have reduced the consideration offered to the target stockholders to a level that is unfair, then an attack is labeled as individual because it goes directly to the fairness of the merger.”
Here, the Court found that the “Plaintiffs’ allegations regarding the NYSE negotiations fell well outside the Parnes exception because the alleged breaches of fiduciary duty were far too attenuated from the ultimate CME transaction and the price that CME paid to establish a causal link.” As a result, the claim against Schaeffer was derivative and thus subject to dismissal. Moreover, because the confidentiality agreement with CME did not begin until months after NYSE’s interest waned, the Court noted that “it cannot be said that the failed negotiations with NYSE are in any way causally linked with the consideration ultimately offered in the CME transaction. . . . [and] there is no suggestion that the alleged breach occurred in order to benefit CME.”
Disclosure Claims
Plaintiffs claimed that the Board breached disclosure duties by failing to disclose:
• “more details concerning the NYSE’s then-potential offer of $142 per share;”
• “Schaeffer’s alleged self-interest in connection with an NYSE/NYMEX business combination;”
• “the fact that Schaeffer had been negotiating the terms of the transaction with CME;” and
• “additional information regarding the underlying assumptions of the fairness opinions, including an explanation for why J.P. Morgan and Merrill Lynch both used two transactions in their precedent transaction analysis that were never consummated.”
Plaintiffs also alleged that the bankers’ fairness opinions should have been updated in light of the reduced merger consideration relative to the time the opinions were initially made.
The Court started its analysis by noting that “the fiduciary duty of disclosure is a specific application of the duties of care and loyalty; it ‘requires that a board of directors ‘disclose fully and fairly all material information within the board’s control when it seeks shareholder action.’’” The Court then dismissed Plaintiffs’ disclosure claims for two reasons. First, to the extent the allegations were tied to the directors’ duty of care, they were barred because of the § 102(b)(7) charter provision. Second, to the extent they were tied to the duty of loyalty, they were dismissed because “[a] mere conclusory allegation that the alleged disclosure violations also constitute a violation of the duty of loyalty is not sufficient to survive a motion to dismiss, particularly in light of the holding that the Complaint fails to otherwise state a non-exculpated claim against the Director Defendants for breach of fiduciary duty.”
Dismissal of Aiding and Abetting Claims Against CME
Plaintiffs alleged that the CME Defendants aided and abetted the alleged breaches of fiduciary duty by the NYMEX Defendants. Because Plaintiffs were only able to muster conclusory allegations of the CME Defendants’ “knowing participation” in the alleged breach as non-fiduciaries, the Court found that their claims failed as a matter of law. The Court also noted that the complaint did not contain any allegation that the CME Defendants induced Schaeffer and Newsome to commit the alleged breaches.
