NACCO Industries Inc. v. Applica Incorporated, No. 2541-VCL (Del. Ch. Dec. 22, 2009), read opinion here
This 63-page Delaware Court of Chancery decision rules on a Motion to Dismiss in connection with claims for damages arising out of a failed acquisition attempt and a terminated Merger Agreement between Applica Incorporated and NACCO Industries, Inc. The Court dismissed the claims for breach of the implied covenant of good faith and fair dealing, aiding and abetting a breach of fiduciary duty and equitable fraud. The Court allowed to proceed to trial claims for breach of contact, tortious interference with contract, fraud (faulty disclosures in SEC filings) and civil conspiracy.
Brief Factual Background
Applica initially entered into a Merger Agreement with NACCO but Applica terminated that agreement and agreed to be acquired by affiliates of Harbert Management Corporation. After a bidding contest, NACCO lost, and now seeks damages and other relief relating to that unsuccessful bidding contest. Harbert Management Corporation is an investment manager that oversees a hedge fund complex. The complaint names various entities affiliated with Harbert that were involved in the transaction and because many of those funds operate under the name “Harbinger,” the Court refers to those affiliated entities collectively as Harbinger. The Harbinger principals were previously dismissed from the suit for lack of personal jurisdiction. Applica markets, distributes and sells small household appliances. Prior to being taken private by Harbinger, the common stock of Applica traded on the New York Stock Exchange. NACCO is a holding company whose shares trade on the NYSE as well.
In 2005, NACCO approached Applica about a strategic transaction with Hamilton Beach. The parties signed a Non-Disclosure Agreement and exchanged confidential information but Applica broke off talks, inviting NACCO to re-approach in early 2006. In early 2006 Applica and NACCO began merger discussions anew and NACCO agreed to standstill provision that limited ability to act unilaterally to acquire Applica. About seven months later, when NACCO found itself in a bidding contest for Applica, the consequences of agreeing to the Standstill Agreement proved critical, because NACCO at the time was competing against Harbinger who was not similarly restricted, and had used its freedom to acquire a large block of Applica stock. In September 2006, Harbinger announced a bid to acquire all of the Applica shares it did not yet own.
Despite the Non-Disclosure Agreement that NACCO and Applica had signed, NACCO alleges that Applica disclosed confidential information to Harbinger to assist it in its acquisition of Applica. NACCO alleges that because Applica senior executives were at risk of losing their jobs in a deal with NACCO and Hamilton Beach, Applica insiders favored a Harbinger deal as a financial buyer likely to retain them.
Harbinger made several Schedule 13D filings in which it failed to disclose or inaccurately disclose its intentions with respect to its increasing purchases of Applica stock to a nearly 40% stake as well as its outgoing communication from Applica management and its communications with Applica management to avoid the restrictions of the Florida Control Shares Act that would have prevented Harbinger from voting its shares due to its newly acquired percentage of ownership. Although its August 2006 Schedule 13 filings continued to state that Harbinger was holding its shares for investment purposes without any plan to control Applica, on September 14, 2006, Harbinger offered to acquire all of the outstanding shares of Applica that Harbinger did not already own for $6 a share and at the same time amended its prior Schedule 13 forms. In October 2006, Harbinger again amended its Schedule 13D filings to state that as of September 14, 2006, its intent was to acquire all of Applica’s shares.
On September 15, 2006, Applica informed NACCO that the Harbinger bid was likely to be a superior proposal and engaged in merger discussions with Applica which was an exception to the “no-shop provision” in the Merger Agreement with NACCO but which otherwise limited the ability of Applica to explore competing transactions.
On October 10, 2006, Applica notified NACCO that it was terminating its Merger Agreement and would enter into a Merger Agreement with Harbinger. NACCO asserted that Applica had breached the no-shop provision and had failed to promptly advise of developments with Harbinger and that it had been mislead by the statements in the Schedule 13D filings of Harbinger.
Applica paid NACCO a $4 million termination fee and $2 million in expense reimbursement.
On November 2, 2006 Applica filed a preliminary proxy statement to solicit proxies in favor of the merger with Harbinger. The background section of the disclosures were much different from the disclosures in the Schedule 13D filings of Harbinger.
On November 13, 2006, NACCO filed this action against Applica and Harbinger seeking, among other things, a decree of specific performance and an order enjoining the Harbinger merger. NACCO sought expedited discovery in a trial but was informed that the Court’s calendar could not accommodate a full trial prior to the anticipated closing of the merger. NACCO then moved for a preliminary injunction but after an exchange of documents withdrew its injunction application in December.
A separate action filed by NACCO in federal court in Ohio also sought injunctive relief, but that new request for injunctive relief was denied and NACCO dismissed that federal case without prejudice. Between the end of December 2006 and January 2007, NACCO and Harbinger bid against each other for Applica. NACCO explained that it was at a disadvantage because while it was subject to a Standstill Agreement, Harbinger had acquired a 40% block of Applica’s stock. Thus, while Harbinger was effectively only bidding for 60% of Applica, NACCO was bidding for the entire company. That is, for every dollar that NACCO offered, Harbinger only had to match with sixty cents. On January 24, 2007, the stockholders of Applica approved the merger with Harbinger and NACCO terminated its offer.
Shortly after the stockholder approval of the merger with Harbinger, Applica and Salton entered into a Merger Agreement based on the efforts of Harbinger. In December 2007, the transaction closed and Harbinger owned 92% of the combined company.
In October 2007, NACCO amended its complaint and the individual defendants sought jurisdictional discovery. In February 2008, a Motion to Amend the Second Amended Complaint was filed and in May 2008 the motion was granted. In December of 2008, after Motions to Compel and jurisdictional discovery, the parties entered into a stipulation regarding jurisdictional facts. In the summer of 2008, the Court ruled that personal jurisdiction could not be obtained over the individual defendants.
Overview of Legal Analysis
I. Breach of Contract
After discussing in great detail the references to the motive of the senior managers of Applica to favor the Harbinger deal which would allow them to keep their jobs, and the timing of confidential information that was obtained by Harbinger during a period when the Confidentiality Agreement applied, the Court concluded that at the early pleading stage it would be appropriate to draw reasonable inferences in favor of the plaintiff as opposed to weighing competing inferences that might later be determined to have legitimate explanations.
The Court also emphatically rejected the argument that there were “no damages” because NACCO subsequently lost the bidding war. The Court reasoned that:
“If embraced as grounds for a pleadings-stage dismissal, the defendants’ theory would have serious adverse ramifications for merger and acquisitions practice and for our capital markets. Parties bargain for provisions in acquisition agreements because those provisions mean something. Bidders in particular secure rights under acquisition agreements to protect themselves against being used as a stalking horse and as consideration for making target-specific investments of time and resources in particular acquisitions. Target entities secure important rights as well. It is critical to our law that those bargained-for rights be enforced, both through equitable remedies such as injunctive relief and specific performance, and, in the appropriate case, through monetary remedies including awards of damages.”
Although it received a bargained-for termination fee as is customary in merger agreements, the right to terminate the agreement by Applica without further liability was dependant upon Applica complying with its other obligations under the agreement.
II. The Implied Covenant of Good Faith and Fair Dealing
The Court cited to well established Delaware law that when the subject at issue is expressly covered by the contract, a claim for the implied covenant of good faith and fair dealing does not apply. In this case, the merger agreement included detailed provisions governing the issues that have been raised; and the express terms that are claimed to have been violated leave no room for the implied covenant.
In Court IV, NACCO asserted a claim for common law fraud against Harbinger. The fraud claim turns exclusively on the statements that Harbinger made in its Section 13 filings between March and August of 2006.
1. State v. Federal Jurisdiction
The fraud (faulty disclosure) claim raises a jurisdictional issue of whether a Delaware Court can provide a common law fraud remedy for false statements in a filing required by the Exchange Act. The Delaware Supreme Court has held that such a remedy exists and that the Court of Chancery has the ability to enforce such a remedy where the Delaware entity has been accused of fraud. See Rossdeutscher v. Viacom, Inc., 768 A.2d 8 (Del. 2001). See also 15 U.S.C. Section 78aa and 78bb.
In that Viacom case, Delaware’s High Court explained that the “federal statutory remedies of the Act over which the federal courts have exclusive jurisdiction are intended to coexist with claims based on state law and not preempt them.” Id. at 17. The Court also discussed and analyzed multiple decisions of the United States Supreme Court and other federal courts to support its ruling on this issue.
The Court of Chancery engaged in a thorough review of the applicable law on this jurisdictional issue and concluded that “the extent to which a state law claim necessarily raises a federal issue is inherently a question of degree, requiring a pragmatic judgment based on the particulars of the individual case.” Referring to multiple decisions regarding removal of cases from state court to federal court, the Court of Chancery reasoned that Section 27 of the Exchange Act does not confer exclusive jurisdiction on the federal courts to hear common law fraud claims based on statements in federal securities filings. The Court referred to multiple federal decisions in which plaintiffs have asserted both securities fraud under Rule 10b-5 or another federal provision and common law claims for fraud and misrepresentation.
Those decisions consistently exercised federal jurisdiction over the state law claim under a theory of supplemental jurisdiction (or its predecessors pendent and ancillary jurisdiction), not federal question jurisdictional under 28 U.S.C. Section 1331, nor exclusive Exchange Act jurisdiction under Section 27. This was compared to a claim to enforce Section 13 of the Exchange Act or asserting a claim for violation of Section 13 regarding false statements made in a Schedule 13D filings with related fraud claims under state law, a case in which the Court of Chancery would not have jurisdiction and which could only be heard in federal court. (citing Lowenschuss v. Options Clearing Corp., 1989 WL 155767, at * 2-3 (Del. Ch. Dec. 21, 1989) and Diceon Elecs., Inc. v. Calvary Partners, L.P., 772 F.Supp. 859 (D.Del. 1991)).
By contrast, the Court explained that “if a Delaware entity engages in fraud or is used as part of a fraudulent scheme, that entity should expect that it can be held to account in the Delaware Courts.” (Slip op. at 42.)
2. Element of Falsity
For the pleaded fraud claim, NACCO was required to allege a fraudulent misrepresentation which Court of Chancery Rule 9(b) requires to be plead with particularity so that there is sufficient detail to apprise a defendant of the basis of the claim, although the state of mind of the defendant, including its intent, need not be plead with particularity. The pleading requirements also take into account whether “the facts lie more in the knowledge of the opposing parties than of the pleading party.” The Court also referred to the Restatement (Second) of Torts, Section 530, for the established law that “permits a misrepresentation regarding intent to form the basis for a fraud claim,” specifically quoting Section 530 as follows: “a representation of the maker’s own intention to do or not to do a particular thing is fraudulent if he does not have that intention.”
In sum, reading the complaint as a whole, the Court found that there were sufficient detailed allegations to plead that the disclosures of Harbinger in its Schedule 13 filings were false.
The Court also rejected an argument by Harbinger that in the “community of hedge funds” who frequently file Schedule 13Ds that one need not disclose any intent other than investment intent until one actually makes a bid. The Court observed that Harbinger could not offer legal support for their view but rather the recent persuasive rejection of that self-serving and formulistic interpretation was noted in the case of CSX Corp. v. Children’s Fund Mgmt. (UK) LLP, 562 F.Supp. 2d. 511 (S.D.N.Y. 2008), aff’d, 292 F.App’x 133 (2d. Cir. 2008)
3. Reliance and Materiality
The Court noted that a false statement is not a strict liability offense but rather to plead a claim of fraud, one must have the “intent to induce the plaintiff to act or refrain from acting” and the plaintiff must in fact have acted or not acted “in justifiable reliance on the representation.” Of equal importance is that the false statement must have been material. Especially in the context of a fraud claim based on a statement in a filing required the Exchange Act, the reliance inquiry plays an important role to legitimize a Delaware Court in providing a remedy. Despite the “unusual and extreme facts” plead in the complaint, the Court admits that it is “frankly troubled by the reliance inquiry” and views it as a “close call.”
4. Causally-Related Damages
The Court emphasized that to be actionable, a false statement must cause harm and that the necessary causal connection has two parts. First, the false statement must be a factual cause of the harm in the sense that the harm would not have occurred but for the false statement. Second, the false statement must be a legal cause of the harm, meaning that the false statement must be a sufficiently significant cause of the harm to impose liability. (citing Restatement (Second) of Torts, Section 548A, cmt. a-b.) As with the element of reliance, the Court viewed this question of causation of damages as a close one but at the Motion to Dismiss stage, similar to the reasoning on the reliance argument, the Court concluded that NACCO had sufficiently plead that its harm was causally connected to the false disclosures of Harbinger. In the reliance analysis, the Court was concerned with imposing an unfair burden on NACCO to prove “what might have happened” or to penalize a victim in insulating a wrongdoer who argues that the victim “should have known better.” (Slip op. at 54.)
IV. Equitable Fraud
Regarding Count V, in connection with the claim for equitable fraud, because NACCO is a sophisticated party and none of the defendants occupied a special relationship towards NACCO, nothing about the case suggests any equity that has traditionally moved this Court to relax the pleading requirements for fraud and therefore equitable fraud is not appropriately invoked in this case.
V. Count III for Tortious Interference of Contract
The Court declined to dismiss Count III for the tort of interference with contractual relations, which is intended to protect the economic interest of a promisee in the performance of a contract by making actionable any “improper” intentional interference with the performance of the promisor. The elements of a claim for tortious interference with contract are: (1) a contract; (2) about which defendant knew; (3) an intentional act that is a significant factor in causing the breach of such contract; (4) without justification; and (5) which causes injury.
In this case, based on the breach of contract analysis performed by the Court regarding Count I, the complaint adequately alleges that Harbinger knew about the no-shop clause, but nevertheless engaged in contacts and communications that violated those clauses. Elements three and four were also covered in the breach of contract analysis.
Similar to the related but different claim for tortious interference with prospective business relations, the Court of Chancery has explained that “claims for unfair competition and tortious interference must necessarily be balanced against a party’s legitimate right to compete,” but misrepresentations of fact “are not legitimate vehicles of competition.” (citing Agilent Technologies, Inc. v. Kirkland, 2009 WL 119865, at * 8 (Del. Ch. Jan. 20, 2009)).
The Court also cited to another decision in which the defendant was held liable for tortious interference where that defendant obtained an unfair advantage by using confidential information it had obtained from other defendants in violation of contractual agreements. See Cura Fin. Servs. v. Elec. Payment Exch., Inc., 2001 WL 1334188, at *18 (Del. Ch. Oct. 22, 2001).
VI. Count VI Regarding Aiding and Abetting a Breach of Fiduciary Duty
This claim was abandoned during briefing.
VII. Claim for Civil Conspiracy in Count VII
The elements of a claim for civil conspiracy are: (1) a confederation or combination of two or more persons; (2) an unlawful act done in furtherance of the conspiracy; and, (3) actual damage. It is well established that each conspirator is jointly and severally liable for the acts of co-conspirators committed in furtherance of the conspiracy.
It is essential that there be an underlying wrongful act, such as a tort or a statutory violation, but a breach of contract is not an underlying wrong that can give rise to a civil conspiracy claim. (citing Kuroda v. SPJS Holdings, LLC, 971 A.2d 872, 892 (Del. Ch. 2009)).
The Court explained that Delaware “recognizes the concept of efficient breach” (citing Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1039 (Del. Ch. 2006)). The Court added that Delaware law generally elevates contract law over tort to allow parties to order their affairs and bargain for specific results, to the point where Delaware law enforces contractual provisions that eliminate the possibility of any tort liability short of actual fraud based on explicit written contractual representations (citing Abry Partners, 891 A.2d at 1061-64).
Thus, a claim of conspiracy to commit tortuous interference against the party to a contract would undercut the foregoing principles and replace the predictability of the parties’ agreement with a far less certain judicially created tort remedy; and recognizing such a “round-about claim” would circumvent the limitations on tort liability that are a fundamental aspect of Delaware law. Therefore, to the extent that Count VII asserts that Applica and Harbinger conspired to breach the Merger Agreement, the Court dismisses that claim as well as the claim that there is liability in tort for civil conspiracy to engage in tortious interference with that agreement.
However, NACCO argues that fraud provides the necessary underlying wrong and that Applica conspired with Harbinger to engage in fraud for which they should be liable. As previously explained, because there is a sufficient basis for the fraud claim, and for the foregoing reasons, there is a sufficient basis to state a claim for civil conspiracy based on fraud.
In conclusion, the Court required the parties to provide a scheduling order that would bring the matter to trial within 12 months. The Court also emphasized that this is a “pleadings-stage decision” and whether NACCO ultimately prevails and obtains a remedy will depend on the evidence presented, any defenses, and the ultimate equities of the case.