Binks v. DSL.net, Inc., C.A. No. 2823-VCN (Del. Ch. Apr. 29, 2010), read opinion here.
Main Issue Addressed
This 44-page opinion of the Court of Chancery addressed whether the business judgment rule protected the decision of the Board of DSL.net, Inc. on the following issue: Whether to file for bankruptcy or borrow funds from co-defendant MegaPath, Inc.?
The Board chose the deal with MegaPath which involved a loan from MegaPath and the issuance to MegaPath of convertible notes which were exercised to give MegaPath more than 90% of the common stock of DSL, after which it proceeded with a short-form merger and eliminated the minority stockholders. One of those minority stockholders brought this action.
After extensive anlaysis, the Court dismissed the claims for two primary reasons. First, the Plaintiff lost his standing to sue derivatively as a result of the merger. Second, he challenged the actions of the Board of Directors which was comprised of a majority of independent and disinterested directors who had reasonably evaluated the options of the company and solicited responsible advice.
The Business Judgment Rule and Revlon Duties
The Court recited the familiar presumption that directors of corporations enjoy when they act “independently, with due care, in good faith, and in the honest belief that their actions were in the stockholders’ best interests.” This business judgment rule presumption operates, as the Court explained, to “protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments.” See footnotes 37 to 40.
The Court further explained that Delaware courts apply the protections of the business judgment rule “to decisions made by disinterested and independent directors acting in good faith and with due care. Where business judgment rules are applicable, the board’s decisions will be upheld unless it cannot be attributed to any rational business purpose.” See footnotes 41 and 42.
However, where a transaction constitutes a “change in corporate control,” then Revlon duties “refocus the Board’s traditional fiduciary duties and require it to try in good faith to seek the best value reasonably available to the stockholders." Where the duty under Revlon applies, the Court’s ordinarily deferential rational basis review is changed to an objective reasonableness standard of review, both to the process and the result, under which the Court evaluates whether the board has complied with its fundamental fiduciary duties. See footnotes 43 and 44.
It was not clear that Revlon applied to the particular transaction involved in this case although the Court recognized that even if it was a two step transaction, for analytical purposes the relevant events would be “collapsed” into a single transaction for purposes of determining the applicable standard of review. The Court has applied the Revlon standard to a transaction that has the net effect of a change in corporate control, especially where “corporate action plays a necessary part in the formation of a control block where one did not previously exist.” See Equity-Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1055 (Del. Ch. 1997).
The Court in the instant case was more flexible because of a pro se Plaintiff and acknowledged that by applying the Revlon standard it would arguably allow for a direct claim. However, the Court concluded that even if the Revlon standard applied the obligations of Revlon were met for the following reasons:
1) The board was independent and disinterested regarding the challenged transaction;
2) The board was well-informed by independent advisors of the available alternatives to the company other than the loan from MegaPath; and
3) The board acted in good faith in arranging and committing the company to the challenged transaction, especially in light of the paucity of other options available.
The Court thoroughly examined the basis for its conclusion that the directors were both independent and disinterested, as well as being fully informed. That part of the opinion is factually rich.
The "entire fairness standard" did not apply because MegaPath was not a controlling shareholder at the time of the contested transaction, and that standard would only apply to an actual–not a potential–majority shareholder. See footnote 78.
Decision of the Board Not to File Bankruptcy
The Court relied heavily on the Equity-Linked Investors’ case in its analysis about why the Revlon standard was upheld in connection with the decision of the board to obtain loans as opposed to filing for bankruptcy. The Court rejected the argument from the Plaintiff that bankruptcy was the only other option that would have been preferable because:
"There can be several reasoned ways to try to maximize value. [Thus] the Court cannot find fault so long as the directors chose a reasoned course of action.” See footnote 66. Moreover, the conclusion of the board that the financing transaction was preferable to bankruptcy was within the exercise of its business judgment, and the argument of the Plaintiff to the contrary does not meet the test that the board “utterly failed” to obtain the best price for the shareholders.
In the Equity-Linked Investors case, the preferred shareholders questioned the judgment of the board on the “lip of insolvency” when the board was required to complete a financing transaction rapidly, or else face bankruptcy. The preferred shareholders preferred to have the company liquidated and the assets distributed but the board declined an offer that was perhaps superior to the offer of a third party. Nonetheless, the Court in that case concluded that a board’s obligation to maximize the present value of the firm’s equity was “not obvious” where: (1) The transaction is not a merger or a tender offer with a price for shares; and (2) the transaction or other alternatives were not otherwise easily reduced to a present value calculation. See footnote 69.
Therefore, the Court reasoned that: “The board could have reasonably concluded that pursuing a course that maintained the possibility of further benefits from the company’s assets, including its intellectual property, was arguably superior to the liquidation of the firm."
The Court acknowledged the difficulty of applying the Revlon test in such circumstances where judgment is required, but reasoned that :
“All that the law may sensibly ask of corporate directors is that they exercise independence, good faith and attentive judgment, both with respect to the quantum of information necessary or appropriate in the circumstances and with respect to the substantive decision to be made.” See footnote 70.
The Court relied on the holding in the Equity-Linked Investors case in which the board was found to have acted reacted reasonably in pursuit of the “highest achievable present value” of the common stock in concluding in good faith that the “corporation’s interests were best served by a transaction that it thought would maximize potential long-run wealth creation.”
Likewise in the instant case, the Court reasoned that the Plaintiff had failed to plead adequate grounds to infer that the board was anything other than independent, disinterested, and sufficiently well informed ,and therefore his personal opinion that the bankruptcy would have been a superior course of action, cannot sustain a Revlon claim.
The Court also observed the well settled standard for liability of a director for breach of the duty of care as being based on the concept of “gross negligence.” See footnote 56. However, because any duty of care violation would be exculpated by Section 102(b)(7) of DSL’s charter, the Plaintiff was unable to prevail in that aspect of his claim either.