The Delaware Supreme Court in Arkansas Teacher Retirement System, Fire & Police Pension Association of Colorado, et al. v. Ciafa et al., No. 530, 2009 (May 21, 2010), read opinion here, issued a unanimous en banc decision affirming the Court of Chancery’s approval of a settlement among a majority of Countrywide stockholders, Countrywide directors, and Bank of America (“BOA”), related to Countrywide’s merger with BOA. Former Countrywide stockholder, Arkansas Teachers Retirement Systems (“TRS”), had objected to the settlement on the basis that the Court of Chancery failed to value TRS’s derivative claim pending in a federal court action.

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

The Court of Chancery had determined that the derivative claim in a pending federal court action had no value and rejected TRS’ argument that the Court should place part of the merger consideration into a constructive trust in order to protect the value of its derivative claims. The Supreme Court agreed noting that “Delaware corporate fiduciary law does not require directors to value or preserve piecemeal assets in a merger setting.” However, the Supreme Court did recognize that TRS had alleged facts that “reflect[ed] conduct wholly inappropriate for Delaware corporate directors.” The Supreme Court was referring to Countrywide’s board settling of insider trading charges, improper stock repurchase, and predatory lending claims “while the company exposed itself to bad loans causing plummeting stock value that allegedly cost Countrywide $848 million to $25 billion.” None of the actions alleged by TRS, however, involved any fraudulent conduct or inadequate merger pricing.

Under Delaware law, other than in instances of fraud or reorganization, a shareholder loses standing to maintain a derivative suit where the corporation in which the shareholder owns stock merges with another company. Here the Supreme Court found that:

[t]he current record does not reflect that the directors prospectively sought and approved a merger, solely to deprive stockholders of standing to bring a derivative action. The extent of the Countrywide directors’ allegedly fraudulent conduct and breach of fiduciary duties by failing loyally to oversee the company’s practices in good faith would have necessitated (a) corporate rescue; and, (b) individual legal protection. A merger was one of few available alternatives that meet both of those objectives after the board’s allegedly fraudulent schemes bankrupted a multibillion-dollar company. Delaware law recognizes a single, inseparable fraud when directors cover massive wrongdoing with an otherwise permissible merger…. [and] [a]n otherwise pristine merger cannot absolve fiduciaries from accountability for fraudulent conduct that necessitated that merger.

The Supreme Court noted that TRS did not present the Court “with the proper vehicle to consider whether TRS meets the fraud exception to maintain a post-merger claim. If the Vice Chancellor had found that TRS had successfully pleaded its fraud claim, then TRS – rather than Countrywide – could recover from the former Countrywide directors. In that case, the injured parties would be the shareholders who would have post-merger standing to recover damages instead of the corporation.” As a result, the Supreme Court affirmed the Court of Chancery’s approval of the settlement finding that the Vice Chancellor did not abuse his discretion.