In Re: Affiliated Computer Services, Inc. Shareholders Litigation, (Del. Ch., February 6, 2009), read opinion here.
We are fortunate to have the following review and analysis of this case prepared by Kevin Brady, a partner in the Business Law Group at the Wilmington, Delaware, office of Connolly Bove.
In a dispute involving yet another victim of the credit crisis, the Court of Chancery dismissed a second amended complaint in a derivative suit arising out of the failed bid by Cerebus Capital Management LP (“Cerebus”) and Affiliated Computer Services Ins (“ACS”) to take ACS private. On February 6, 2009, Vice Chancellor Stephen P. Lamb dismissed the action after he found that: (i) the majority of the ACS board was independent; (ii) the directors had not breached their fiduciary duties to the ACS’ shareholders; and (iii) demand had not been excused.
In late 2005, ACS received an unsolicited buyout offer of $65 per share from a consortium of large private equity firms. While ACS rejected the offer, it stated that it was “continuing to consider additional alternatives for enhancement of shareholder value, but [those] alternatives do not include a sale of the Company.” On November 7, 2006, Darwin Deason, founder, chairman and significant stockholder of ACS, working with unnamed private equity sponsors, sent a buy-out proposal in the range of $60 to $62 per share to the ACS board, telling the board that he did not intend to vote his shares in favor of, or otherwise participate in, any transaction with a party other than his group.
At a special meeting of the board on November 9, 2006, Deason recommended that, among other things, his two potential private equity sponsors be permitted to engage in due diligence for two to three-weeks with ACS. The board ultimately agreed to a three-week due diligence process. On March 20, 2007, Deason and Cerberus (the “Buyout Group”) announced a proposal to acquire all of the outstanding stock of ACS (except for those shares owned by Deason and the company’s management team) for $59.25 per share in cash. Also on March 20, 2007, the ACS board held a special meeting and thereafter formed a special committee. On April 21, 2007, the Buyout Group raised its offer to $62 per share with a provision that there be a 40-day “go shop” period following the signing of a definitive merger agreement between ACS and the Buyout Group. On April 23, 2007, the special committee responded in a letter to Deason in which the special committee expressed its misgivings and “serious concerns” with regard to the company’s ability to attract other bidders during a “go shop” period given Deason’s five-year employment agreement, exclusivity agreement with Cerberus, and the head start that Cerberus had with respect to due diligence. On June 10, 2007, ACS and Cerberus executed a waiver pursuant to which Deason would be permitted to engage in discussions with potential bidding parties other than Cerberus. In exchange for this waiver, ACS agreed to pay Cerberus $7.5 million in compensation for its expenses incurred in connection with the buyout proposal.
After the credit crisis hit in the summer of 2007, the deal fell apart and on October 30, 2007, Cerberus withdrew its buyout offer. Thereafter, Deason accused all of the outside directors of ACS of various breaches of fiduciary duty, and demanded their resignation.
The outside directors responded by filing suit against Deason, the management directors and ACS on November 1, 2007, seeking a declaratory judgment that they had not breached their fiduciary duties. On November 21, 2007, the outside directors dismissed their complaint pursuant to a settlement agreement, resigned from the board and issued a statement that they were satisfied that the replacement director candidates were qualified and independent of Deason and the company’s management.
The complaint, which was filed on March 22, 2007 as a purported class action on behalf of the stockholders of ACS, challenged the buyout proposal made by Deason. When Cerberus withdrew its buyout proposal on October 30, 2007, the claims for injunctive relief in the complaint were effectively mooted. As a result, the plaintiffs file their first amended complaint on November 5, 2007 and asserted derivative claims for the first time, while continuing to plead their class claims in the alternative. On December 19, 2007, various defendants filed motions to dismiss the first amended complaint. In lieu of filing answering briefs to the motions to dismiss, the plaintiffs filed a consolidated second amended class and derivative action complaint which essentially supplemented the fact allegations in the first amended complaint. No new counts were added and the fundamental nature of the allegations remained unchanged. The claims alleged in the second amended complaint, like those in the first amended complaint, were based on the abandoned buyout process. Following the plaintiffs’ filing of the second amended complaint, the defendants renewed their various motions to dismiss for failure to make demand pursuant to Rule 23.1 and failure to state a claim pursuant to Rule 12(b)(6).
Demand Futility and the Amended Complaint
Under Delaware law, unless the plaintiffs can show futility, they must make a demand on the board of directors before a derivative action may be instituted on behalf of the corporation. The Court in this case was faced with two issues:
(i) against which board is the claim of demand futility to be tested–the old board that was still in office on November 5, 2007, or the new board that was in office at the time of the filing of the second amended complaint; and
(ii) if it is the new board, are the claims presented by the second amended complaint already “validly in the litigation”?
The Court found that the plaintiffs had made no allegations of demand futility with respect to the new board and so, if the complaint were to survive the motion to dismiss, the plaintiffs had to prove that demand futility should be tested with respect to the old board. As a result, the Court turned to the second issue — what it means for a claim to be “validly in litigation.
” Under Delaware law, there are three circumstances that must exist in order to excuse a plaintiff from showing demand futility as of the time of filing the amended complaint: (1) “the original complaint was well pleaded as a derivative action;” (2) “the original complaint satisfied the legal test for demand excusal;” and (3) “the act or transaction complained of is essentially the same as the act or transaction challenged in the original complaint.” The first and third prongs of the test were not contested by the parties so the Court focused on the second prong.
Demand is excused under Aronson and its progeny if either prong of a two-part test is met:
(i) whether a reasonable doubt is created that the directors are disinterested and independent; and (ii) whether the pleading creates a reasonable doubt that the challenged transaction was anything other than the product of a valid exercise of business judgment.
Disinterested and Independent
Directors will be deemed interested for demand purposes under Aronson where the complaint alleges specific facts establishing that “the potential for liability is not ‘a mere threat’ but instead may rise to ‘a substantial likelihood.’” Simply being named as a defendant is not enough. “Independence means that a director’s decision is based entirely on the merits of the subject before the board rather than extraneous considerations or influence.” Vice Chancellor Lamb, in analyzing the first amended complaint to determine if it adequately plead demand futility with respect to the board as it existed at the time the amended complaint was filed, found that the plaintiffs had pled nothing to suggest that the outside directors had any financial interest in the proposed transaction beyond their interest as stockholders.
The plaintiffs, however, did raise a novel issue — can a board in the midst of internal warfare, with the majority of its members preparing to resign, be expected to properly consider a stockholder demand? The Court found that the analysis focuses on whether the majority of the board could fairly be said to have abandoned their duties, such that making a demand upon them would be futile. In this instance, before tendering any resignation, the outside directors insisted on passing on the qualifications of their replacements, to ensure that the board would remain with a majority of independent directors in order to protect the minority stockholders.
Business Judgment Rule
The Court then turned to the second prong of Aronson and found that the plaintiffs failed to plead any facts to undermine the presumption that the outside directors of the board, and in particular the special committee, failed to fully inform themselves in deciding how best to proceed to get out from under the exclusivity agreement and attempt to run a robust sale process. Nor did the complaint challenge to the board’s or the special committee’s good faith in pursuing the course it chose in dealing with Deason. The plaintiffs simply argued that they “would have run things differently.” As a result, the Court found that the business judgment rule had not rebutted.
Demand Not Excused – Second Amended Complaint Dismissed
The Court concluded that the plaintiffs failed to plead facts in the first amended complaint that raised a reasonable doubt under either prong of Aronson. The derivative claims in the first amended complaint were therefore not validly in litigation when the plaintiffs amended their complaint the second time. Thus, the plaintiffs were required to either make a demand at the time they filed their second amended complaint, or to plead that a demand would be futile at that time, and therefore excused. Because plaintiffs failed to do so, Vice Chancellor Lamb concluded that pre-suit demand on the board of directors of ACS was not excused and the second amended complaint was dismissed.