Wayne County Employees’ Retirement System v. Corti, Del. Ch., No. 3534-CC (July 24, 2009), read opinion here. A prior Chancery Court decision in this case was highlighted on this blog here.

In this 50-page decision, the Court of Chancery discusses claims of a former shareholder in a purported class action challenging the conduct of the board of directors in negotiating and approving a transaction that resulted in Vivendi S.A.  obtaining a majority of the voting stock of Activision, Inc. The court provides extensive and thorough descriptions of the background facts, a summary of  which would exceed the temporal and format limitations of this blog.

Overview of Claims

The plaintiff alleged that the Activision directors breached their fiduciary duties by failing to disclose allegedly material information to the shareholders of Activision in connection with the vote required to approve the combination of Vivendi S.A. and Activision (the “Combination”). The plaintiff also alleged that two directors of Activision, who were also Activision managers, led negotiations with Vivendi and breached their duty of loyalty by, among other things, favoring their own interests in obtaining employment benefits of the combined company over the interests of the shareholders of Activision. Plaintiff also alleged that other Activision directors breached their duty of loyalty by allowing those two managers to allegedly control both negotiations with Vivendi and advisors of Activision. In addition, the plaintiff asserted a claim under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). In this decision, the court explained why it granted a motion to dismiss pursuant to Chancery Court Rule 12(b)(6).

Overview of Issues Addressed

This decision has helpful discussions of the standards that the court will apply to disclosure claims. Also instructive is the discussion regarding the contours of Revlon duties. In addition to explaining why the entrenchment claims were rejected, the court provides useful clarity regarding the types of details that will be required to successfully assert claims for breach of the duty of loyalty that are needed to overcome the hurdles presented by the protections of Section 102(b)(7), related to a claimed breach of the duty of care.

Discussion of Claims

This case was initially filed to seek an injunction in connection with claims that the Director Defendants breached their fiduciary duties by failing to provide full and fair disclosure to shareholders in connection with the shareholder vote required for the Combination to proceed. In an opinion of July 1, 2008, the Court of Chancery denied that request for preliminary injunction. See Wayne County Employees’ Ret. Sys. v. Corti, 954 A.2d 319 (Del. Ch. 2008). A business unit of one of the parties is the creator of a video game called World of Warcraft, which the court described as the “enormously popular then-market leader in the massively multiplayer online game segment of the video gaming industry." In footnote 2, the court cited to its prior opinion in which it compared massively multiplayer role playing games such as World of Warcraft to the “world of Mergers and Acquisitions.” (citing Corti, 954 A.2d at 321 – 322).

The court exhaustively explained why the disclosure claims failed at this stage of the case for largely the same reasons that the court previously denied the motion for preliminary injunction.

Disclosure Obligations

The court recited the familiar disclosure obligations of directors. Specifically, the court observed that “when a board of directors seeks shareholder action the fiduciary duty of disclosure, which is a specific application of the duties of care and loyalty, requires that the board ‘disclose fully and fairly all material information within the board’s control.’" The court emphasized that a plaintiff bringing a disclosure claim must “identify the facts that are allegedly missing from the proxy statement and ‘state why they meet the materiality standard and how the omission caused injury.’” (citing Corti, 954 A.2d at 330.)

The court then explained the well known standard of materiality as requiring the following: “to establish the materiality of omitted facts under Delaware law, a plaintiff must show a substantial likelihood that the omitted facts would have assumed actual significance in the deliberations of a reasonable stockholder because, if disclosed, those facts would have significantly altered the total mix of information available to the stockholders.”

The court provided instruction on the preference under Delaware law to address disclosure claims before a shareholder vote, rather than after the vote and after the challenged transaction is completed–in part because it is almost impossible to remedy the situation “after the eggs have been scrambled.” (citing In Re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008)).

Barrier of Section 102(b)(7)

The court described the claims by the plaintiff for alleged breaches of fiduciary duty based on inadequate disclosure as purporting to be breaches of the duty of loyalty, but the court emphasized that the complaint failed to adequately plead facts that state a claim for damages that are not barred by the provision in the certificate that, pursuant to 8 Del. C. Section 102(b)(7), eliminates the personal liability of Activision’s directors for monetary liability for breaches of the duty of care. The court reasoned that 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.”

Fiduciary Duty Claims

The court reiterated well-established Delaware law that “directors of Delaware corporations are bound by the traditional fiduciary duties of care and loyalty. The appropriate starting place in evaluating plaintiff’s fiduciary duty claims, however, is with the well established presumption of the business judgment rule, which reflects and promotes the role of the board of directors, and not the Court, as the appropriate body to manage the business and affairs of the corporation. The business judgment rule, of course, is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken is in the best interests of the company.” (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)). Referring to the recent Delaware Supreme Court decision in Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 239 (Del. 2009), the court recited the recent reiteration of the Revlon standard that applies when a board of directors decides to sell control of the corporation, in which case the “board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise. Thus, a sale of control of the corporation does not implicate additional fiduciary duties, but instead requires the directors to exercise their fiduciary duties in the context of the particular decision being made.” (footnotes omitted.)

The court supported its holding by referring to the fact that because Activision had a certificate that contained a provision that bars claims for money damages against their directors based on breaches of the duty of care, in order to survive dismissal, plaintiff had to allege facts that were sufficient to state a claim that was not exculpated by the certificate, “such as a claim that the Director Defendants violated the duty of loyalty by, for example, acting in their own self-interest at the expense of the Company or otherwise failing to act in good faith.”

After reciting the applicable facts as alleged, the court concluded that the complaint failed to state that the directors were interested in the transaction or otherwise violated their fiduciary duty of loyalty.

The court also dispelled any arguments that entrenchment was involved. Specifically, the court noted that the employment agreements of directors Kotick and Kelly were approved by the directors which quashed any notion that the new employment agreements were either kept secret from the board or that the employment benefits were obtained without the knowledge of the Activision directors. Moreover, the court underscored that the plaintiff had not alleged facts to rebut the presumption that the members of the compensation committee exercised their independent and disinterested business judgment in approving the employment agreements. See pages 28 and 29 at footnote 52.

Revlon Standard

The opinion provided practical insights on the current state of the law in Delaware regarding the standard applied to directors involved in the sale of their companies. The court explained as follows:

“Delaware law does not hold directors liable for failing to carry out a perfect process in a sale of control. Moreover, a provision in Activision’s certificate exculpates Director Defendants from personal liability for monetary damages for breaches of the duty of care. Although plaintiff frames its attacks on the process employed by the Director Defendants as breaches of the duty of loyalty, the factual allegations in the complaint do not support such a claim.”

The complaint failed to establish that the directors suffered from a conflict of interest nor did it establish that they lacked independence or disinterestedness. Thus, in order to survive dismissal, the complaint had to plead facts that supported a failure of the directors to act in good faith.

However, the court emphasized that: “bad faith will be found if a fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. Bad faith cannot be shown by merely showing that the directors failed to do all they should have done under the circumstances. Rather, only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty. As the Delaware Supreme Court has recently proclaimed, the relevant question is whether the Director Defendants utterly failed to attempt to obtain the best sale price.” (citing Lyondell, 970 A.2d at 243 – 244).

There are many more details of the court’s opinion that warrant reading the entire 50-page opinion, but for present purposes I am merely highlighting key passages.