Louisiana Municipal Police Employees’ Ret. Syst. v. Fertitta, No. 4339-VCL (Del. Ch. Jul. 28, 2009), read opinion here.
Kevin Brady, a prominent Delaware litigator, prepared this synopsis.
In his final written opinion before leaving the bench on July 28, 2009, Vice Chancellor Lamb denied a motion to dismiss class action and derivative claims, noting that plaintiff Louisiana Municipal Police Employees’ Retirement system had adequately alleged claims for breach of the duty of loyalty and grounds to excuse demand as to the claim of waste with respect to an “abortive going-private transaction”. See Louisiana Municipal Police Employees’ Ret. Syst. v. Fertitta, C.A. No. 4339-VCL (Del. Ch. Jul. 28, 2009). He also gave followers of Delaware corporate law a practice pointer in Footnote 27 regarding Rule 12 motions and 100% wholly-owned shell corporation merger vehicles.
Background — June 2008 Merger Agreement
In January 2008, Tilman J. Fertitta, the Chairman, President, CEO and 39% stockholder of Landry’s Restaurants, Inc. (“Landry’s), made an offer to acquire all of Landry’s outstanding common stock for $23.50 per share. In response to the offer, the company formed a Special Committee of independent directors to evaluate the offer and consider any alternative proposals. On June 16, 2008, Landry’s and Fertitta, along with two of his wholly owned entities, Fertitta Holdings, Inc. (“FHI”) and Fertitta Acquisition Co. (“FAC”), entered into an agreement where FAC would be merged into Landry’s, and all outstanding common stockholders other than Fertitta would be cashed out at $21.00 per share (the complaint did not explain why there was a $2.50 decrease in the offer price from January to June 2008). The merger agreement also contained “two way” termination provisions. Landry’s would be required to pay $3 million to FAC if Landry’s terminated the transaction during a 45-day “go-shop” period, or $24 million if Landry’s terminated the merger agreement at any time after the “go shop” period. FAC would be required to pay Landry’s a $24 million reverse-termination fee if it failed to close the deal. Moreover, in the event of a material adverse effect (“MAE”), FAC was permitted to terminate the agreement without having to pay the reverse-termination fee. Prior to entering into the Merger Agreement, to finance the acquisition Fertitta entered into a debt commitment letter with three Lending Banks which also had an MAE clause in place to give them a carve-out in the event of such an MAE.
Hurricane Ike: A Material Adverse Effect?
On September 13, 2008, Hurricane Ike made landfall in Galveston Texas and damaged many of Landry’s restaurants and properties in the Galveston area to the point that a number of the restaurants were closed. After the hurricane, Landry’s issued a press release addressing the financial impact Ike had on Landry’s stating that the damage was limited to three cities, was temporary and that Landry’s intended to rebuild.
However, prior to any of the Lending Banks inspecting the damage to Landry’s restaurants, Fertitta sent a letter to the Landry’s Special Committee stating that due to the damage from Ike, the turmoil in the credit industry and the continued worsening of general economic conditions, Fertitta “believed” that the Lending Banks would likely determine that an MAE (as defined in their lending agreements) had occurred, which would result in a decision by the Lending Banks to withdraw funding which would give Fertitta “no choice but to exercise his right to terminate the original merger agreement.” Fertitta did not stop there however. He told the Special Committee that “he believed that he could possibly persuade the Lending Banks to move forward with the debt financing if he revised his offer to reflect Landry’s reduced value which he believed at that time was $17.00 per share.” There was no evidence proffered by Fertitta that the Lending Banks would do what he said they would. At the same time Fertitta was communicating with the Special Committee, he began purchasing Landry’s stock on the open market. He eventually purchased a total of 400,000 additional shares at prices from $11.83 to $14.11 per share.
In response to his letter, the Special Committee requested information regarding Fertitta’s financing efforts. Fertitta indicated that the Lending Banks were the only institutions interested in providing debt financing. He also demanded that the deal price be reduced to $17.00 per share. After a great deal of negotiation between Landry’s and Fertitta, on October 1, 2008, the Special Committee proposed a revised deal of $19 per share. Thereafter Landry’s publicly announced that the deal was in trouble, which resulted in the stock price dropping 35% to $8.44 in three days.
With Fertitta continually pressing for a lower offer, the two sides ultimately agreed in October 2008 to an acquisition price of $13.50 per share and a reduced reverse-termination fee from $24 million to $15 million. In exchange, Fertitta and the Lending Banks agreed not to claim an MAE for any event known as of the date of the amended agreement. Fertitta also negotiated on behalf of Landry’s an amended commitment letter where the Lending Banks would provide an alternative financing commitment, which would prevent Landry’s from defaulting on $400 million in senior notes in the event the merger was not consummated. Throughout this entire process, Fertitta increased his ownership of Landry’s stock from 39% of the company’s stock to nearly 60% by December 2008.
SEC Inquiry Leads to Termination of Agreement
In response to an SEC inquiry requesting certain information, the Lending Banks for some undisclosed reason refused to permit Landry’s to disclose the amended debt commitment letter and threatened to terminate their agreement if Landry’s disclosed the letter. Faced with a potential termination by the banks and a potential inability to refinance the senior notes, Landry’s terminated the merger agreement which in turn resulted in a waiver of the $15 million reverse-termination fee.
Class Action and Derivative Litigation Ensues
In February 2009, a class action and derivative complaint was filed alleging four counts: “(i) a class claim for breach of fiduciary duty against Fertitta; (ii) a class claim for aiding and abetting breach of fiduciary duty against FAC and FHI; (iii) a class claim for breach of fiduciary duty against the directors of Landry’s; and (iv) in the alternative, a derivative claim for waste against the board for failing to require Fertitta to pay the reverse-termination fee.” The defendants moved to dismiss under Rule 12(b)(6).
Court Denies Motion to Dismiss Because of Facts Suggesting Fertitta’s Influence
The Court denied the motion to dismiss, identifying three facts that taken together, “lead to the reasonable inference, though by no means the certain conclusion, that Fertitta used his influence on the corporation as controlling stockholder and/or corporate officer to his own benefit and to the detriment of the interests of the minority stockholders. These are: 1) Fertitta’s negotiation (and the board’s acquiescence to his taking that role) of the refinancing commitment on behalf of the company as part of the amended debt commitment letter; 2) the board’s apparent and inexplicable impotence in the face of Fertitta’s obvious intention to engage in a creeping takeover; 3) the board’s agreement to terminate the merger agreement, thus allowing Fertitta to avoid paying the $15 million reverse-termination fee.” The Court also noted that “these same facts also lead to the reasonable inference that the board and/or the special committee willingly acquiesced to Fertitta’s scheming because he was the controlling stockholder.”
Footnote 27 — Aiding and Abetting – Corporate Shells – Rule 12(b)(6) Motion
It is interesting to note the Court’s discussion about the inability to grant a Rule 12(b)(6) motion for aiding and abetting a claim for breach of fiduciary duty where there are 100% wholly-owned shell corporations used as acquisition vehicles. The Court noted:
Because FAC and FHI were vehicles with little existence other than to serve Fertitta’s purposes in the acquisition, and were integral to the transactions at issue, the court cannot dismiss the aiding and abetting claim against them. To state a claim for aiding and abetting a breach of fiduciary duty, the plaintiff must allege (i) an underlying breach of fiduciary duty, (ii) that the alleged aider and abettor knowingly participated in that breach, and (iii) damages resulting from the breach. [citations omitted]. Having already determined that the plaintiff has adequately alleged the first prong (and the third prong in this case being beyond contention by the defendants for the purposes of a motion to dismiss) the issue firmly rests on the question of knowing participation by FAC and FHI. “Knowing participation in a . . . fiduciary breach requires that the third party act with the knowledge that the conduct advocated or assisted constitutes such a breach.” [citations omitted]
Here, two 100%-owned corporate shells, created for no other purpose than to facilitate related transactions of the fiduciary, are alleged to have “knowledge” of the alleged breach. It would elevate form too far over substance to suggest, in the procedural posture of a Rule 12(b)(6) motion, that it is not a reasonable inference that facts known to Fertitta were also known to FAC and FHI.
Court Rejects Defendants’ Argument that Fertitta did not have Fiduciary Obligations
The question arose as to whether Fertitta was a controlling stockholder (at least until December, when he had gained majority control) and as an extension of that issue whether Fertitta owed fiduciary duties to the minority stockholders in any of those actions. In analyzing the case, the Court quoted the Delaware Supreme Court’s decision in Citron v. Fairchild Camera & Instrument Corp. on the “control by a non-majority stockholder” issue: “[f]or a dominating relationship to exist in the absence of controlling stock ownership, a plaintiff must allege domination by a minority shareholder through actual control of corporation conduct.” 569 A.2d 53, 70 (Del. 1989).
In finding that Fertitta was subject to a fiduciary duty to act in the best interests of the corporation and the stockholders as a whole, the Vice Chancellor noted that “Fertitta exercised actual control of Landry’s at all relevant times — he was not only the 39% stockholder, but the CEO and chairman of the company as well” and with respect to the negotiation of the refinancing commitment in the amended debt commitment letter, the Court stated that either: 1) “Fertitta was negotiating as CEO of the corporation, with at least tacit permission of the board; or 2) Fertitta was negotiating with the Lending Banks as controlling stockholder of Landry’s.” The Court found that under either scenario, Fertitta had fiduciary obligations.
The Court also noted that “with respect to Landry’s decision to act to terminate the merger agreement, by January 2009 it is indisputable that Fertitta was actually the majority owner of Landry’s, raising a presumption of control on his part.” The Court also rejected the board’s contention that it “had no choice but to terminate the agreement, rather than forcing Fertitta to do so” and risking bankruptcy. The Court noted that “the board must have recognized that the risk that Fertitta would have permitted that to happen, rather than terminating the agreement and paying the reverse break-up fee himself, was low.” At this point in time, Fertitta owned common stock worth between $78 million and $119 million which presumably would have dropped precipitously in value if Landry’s “had defaulted on the $400 million note redemption and been forced into bankruptcy.” The Court found that it was “unreasonable to think” that Fertitta would allow that to happen to save the $15 million termination fee. While that raised the issue of whether “the board’s decision to terminate and entirely excuse Fertitta’s performance constituted a rational exercise of business judgment,” the Court noted that that issue could not be resolved at the pleading stage.
Court Finds that Complaint Alleges Grounds to Excuse Demand
Because the Court had already noted that there was an issue about whether the board’s activities were “the product of a valid exercise of business judgment” (which is one of the tests of demand futility under Aronson v. Lewis), the Court concluded that demand was excused.
Supplement: Prof. Steven Davidoff on The New York Times’ DealBook blog here, provides his commentary on the case.