In Shandler v. DLJ Merchant Banking, Inc., C.A. No. 4797-VCS (Del. Ch. July 26, 2010), read opinion here, the Delaware Court of Chancery, in a 47-page opinion, addressed fiduciary duty claims brought against the controlling shareholder of a bankrupt company as well as its board of directors and financial advisor.


Shandler was appointed by the Bankruptcy Court as a Creditor Trustee for Insilco. He brought claims on behalf of Insilco against the controlling shareholder and a majority of the directors affiliated with the controlling shareholder, which was a group of DLJ funds. Shandler claimed  that Insilco was victimized by DLJ’s breach of fiduciary duties. The Court dismissed most of the counts for either failure to state a claim or because they were exculpated duty of care claims. However some claims that survived in this decision on a motion to dismiss were allowed to proceed because they raised duty of loyalty issues as a result of a transaction between the controlling shareholder and an affiliated entity.

Lastly, KeyBanc, a financial advisor for the challenged deal, was also kept in the case on a claim against it for aiding and abetting the directors’ breach of fiduciary duty of loyalty in connection with the challenged deal.



Although the plaintiff must have known that Delaware does not recognize a claim for "deepening insolvency",  many of the allegations are akin to such a claim, and the Court dismissed those arguments in any event. In essence, a large portion of the allegations complain about a failed strategy by the controlling shareholder, that dominated the board. The strategy included a string of acquisitions in anticipation of an IPO, but instead of positioning the company for an IPO, caused it to become insolvent. Shandler also accused the board of waiting longer than was reasonable to file bankruptcy so that the controlling stockholder could squeeze out more fees and related benefits before submitting to the jurisdiction of the bankrutpcy court. In particular, the Court summarized some of the key factual background as follows:

With the DLJ-affiliated directors making up a majority of the Insilco board, the board allegedly managed Insilco in such a way that benefitted DLJ to the detriment of Insilco. Specifically, Shandler claims that the Insilco board, and DLJ as majority shareholder, engaged in three forms of self-dealing to further the interests of DLJ. First, the board allegedly caused Insilco to retain various DLJ-related companies as financial advisors in connection with several M & A transactions and to facilitate Insilco’s entry into certain credit agreements, and caused Insilco to pay those advisors excessive fees for those roles. Second, the board and DLJ allegedly caused Insilco to sell ThermaSys to a company controlled by the DLJ Funds for an unfair price. Finally, once it was clear that DLJ’s business strategy for Insilco had failed and the company was insolvent, the Insilco board, at the behest of DLJ, supposedly delayed the filing of insolvency petitions for Insilco so as to allow DLJ to recoup some of its losses through the generation of additional advisory fees and through sales by the DLJ Funds of the Insilco debt that they owned. (emphasis added)

Challenged Transaction Suffers from Flawed Special Committee and Faulty Financial Advice

The primary transaction that was challenged involved a sale of the ThermaSys subsidiary,  regarding which Shandler claimed that the controlling shareholder "being on both sides of the deal", sold the division on terms that were unfair to Insilco. The deal also suffered from a lack of the type of procedural protections that would have provided additional defenses. The financial advisor for the deal also labored under a lack of independence. As the Court described it:

 … Shandler only focuses substantively on attacking one of the transactions, the sale of ThermaSys. In early 2000, defendant [director] Dawson allegedly recommended to Insilco’s CEO Kauer that Insilco engage in a so-called “value creation strategy” which involved Insilco selling ThermaSys for cash, and thereafter restructuring Insilco’s debt (the “ThermaSys Transaction”). Rather than implement that strategy in the usual fashion that would involve the appointment of a special committee of independent directors to, in the first instance, determine whether such a sale was in Insilco’s interest and at what price a sale made sense, the Insilco board instead struck a preliminary bargain whereby an entity in which the DLJ Funds owned a majority stake would buy ThermaSys for $147 million.

Only after the deal terms were struck was defendant [director] Ashton appointed to the board on July 5, 2000 and immediately named as a single person special committee. The resolution appointing Ashton indicated that he was “completely disinterested in the Proposed [ThermaSys] Transaction and [had] no financial interest in common with the proponents of the Proposed [ThermaSys] Transactions.” The complaint alleges that the resolution was misleading, one must assume (as the complaint is otherwise silent on this point) because the resolution does not address the fact that Ashton had served as the CEO of a DLJ portfolio company from 1995 to 1997.

Within five days, Ashton ratified all prior actions of the board related to the deal, including its prior retention of supposedly independent counsel Baker Botts and financial advisor, defendant KeyBanc, a subsidiary of Key Corp., and blessed the $147 million sales price. According to the complaint, Ashton made no effort to negotiate better terms or to seek other buyers for ThermaSys. Rather, Ashton relied upon a fairness opinion by KeyBanc, a banker who Shandler alleges had a previous underwriting relationship with DLJ.

KeyBanc made a presentation on July 14, 2000 at which it conveyed its opinion that the fair value of the ThermaSys Transaction was $143 million as of July 14, 2000 (the “Fairness Presentation”), and, thus, that the $147 million price was fair to Insilco. But, according to the complaint, the Fairness Presentation was flawed because it adopted an EBITDA multiple that was below the floor of the range of EBITDA multiples for automotive transactions during that time period. Specifically, Shandler argues that KeyBanc’s Fairness Presentation represented that the average EBITDA multiple of automotive transactions from January 1998 to July 2000 was 7.7, with the high of that range being 12.3 and the low being 5.6. But, the Thermasys Transaction used an EBITDA multiple of only 4.1. If the Thermasys Transaction had been at the average EBITDA multiple of 7.7, Shandler argues, the price of ThermaSys would have been $274.89 million.

Moreover, Shandler argues that KeyBanc had given DLJMB [one of the DLJ funds that made up the controlling stockholder] a fairness opinion for the ThermaSys Transaction just three weeks before KeyBanc was retained by Insilco. An internal analysis of the Investment Committee of DLJMB valued the ThermaSys Transaction at $174 million as of February 29, 2000, but reduced that valuation estimate to $150 million on June 8, 2000. According to an internal memorandum, DLJMB’s reduced valuation relied, in part, on a fairness opinion that KeyBanc had created for DLJMB. That is, KeyBanc had been advising DLJMB on the ThermaSys Transaction weeks before it was hired by Insilco to provide the same service. (emphasis mine).

Delaying the Bankruptcy Filing

The Court refers to the complaint in turn as contradictory and confusing, but still reads it to allege that for more than one year the conflicted board knew that it was insolvent though it delayed the filing of a bankruptcy petition for several reasons: (i) to try to sell the company before filing; (ii) to avoid the scrutiny of  a bankruptcy trustee that would expose the insider transactions; and (iii) to obtain more fees for the affiliates of the controlling stockholder.

While delaying the bankruptcy, the complaint alleges that the majority controlled board was trying to favor its own position to the detriment of other shareholders. Specifically, Shandler claims that the majority stockholder was conflicted due to the following "hats that it wore": majority equity holder, senior lender, financial advisor, and syndication agent for the company’s loans.

Insilco filed a Chapter 11 bankruptcy petition in December 2002. A Liquidation Plan pursuant to Chapter 11 was confirmed and became effective in October 2004. Part of the Liquidation Plan was the creation of a Creditor Trust and the appointment of a Creditor Trustee, Shandler, who filed the instant case.

Procedural Background

Shandler was authorized to bring claims on behalf of the corporation and filed claims in the Bankruptcy Court in 2004, shortly after he was appointed, that largely mirror the claims that were later brought in the Court of Chancery. The Bankruptcy Court dismissed the fiduciary duty claims on the theory that as "non-core claims" the Bankruptcy Court did not have subject matter jurisdiction. After that dismissal was final in October 2008, Shandler filed his fiduciary duty claims in this court in August 2009.


Indemnification and Res Judicata arguments described by Court as "silly and frivolous"

In the bankruptcy proceedings, the directors and Shandler entered into an Indemnification Stipulation in which Shandler agreed that the directors would be indemnified up to the amount of insurance coverage available for indemnification. The directors argued that the stipulation was an acknowledgment  that the directors acted in good faith because, they argued, Section 145 of the DGCL only allows indemnification for good faith actions of the directors–in their view.

"Silly and frivolous" and lacking in merit or equity, is how the Court described their argument, before rejecting it. The stipulation was only designed to provide for insurance coverage to pay for legal fees and lacked a key element for res judicata–a final prior adjudication. See footnotes 102 to 104.

Non-Exculpated  Fiduciary Duty Claims Survive Against Directors regarding ThermaSys Deal

The Court explains that the well-pled allegations about the ThermaSys Transaction involved both substantive and procedural unfairness, and suffice to survive a motion to dismiss. The Court noted that despite the protestations to the contrary by the directors, they cannot establish the fairness of the transaction on a motion to dismiss. See footnote 108. The Court added that the complaint supports a rational inference that the ThermaSys Transaction was designed to benefit the controlling stockholder at the unfair expense of Insilco.

Director Defendants.

The Court analyzes the claims against the directors on an individual basis. The Court takes a special interest in one director who it describes as the "oxymoronic one man special committee" who approved the interested ThermaSys Transaction a mere 5 days after joining the board, and who later became the CEO of the spun-off subsidiary, ThermaSys. Also worthy of mention was the failure to disclose in the resolution appointing him to the board, that he had previously served as the CEO of a company that was also controlled or affiliated with the controlling stockholder of Insilco. See footnote 111.

Claim Regarding Excessive Fees Rejected

The Court rejected this claim because it merely alleged that "excessive fees" were paid to affiliated entities, but "the complaint does not plead any factual basis to support this mere conclusion." The Court noted the Chancery decision in Nelson v. Emerson, (summarized on this blog), that rejected a similar claim for excessive compensation, in a bankruptcy context, due also to the lack of an adequate basis to support the allegations. See footnote 119.

Claim for "Delaying Bankruptcy Filing" Dismissed

The Court viewed the complaint as fatally lacking any pled facts "that plausibly support an inference that DLJ could rationally benefit from knowingly diminishing Insilco’s enterprise value by purposely delaying bankruptcy when DLJ knew that filing was the value maximizing option." See footnotes 127 to 130.

Moreover the Court reasoned that:

"In this regard, it is critical to note that Shandler cannot base his fiduciary duty claim on the premise that the board did not do what was best for a particular class of Insilco creditors. Even when Insilco was insolvent, the board was entitled to exercise a good faith business judgment to continue to operate the business if it believed that was what would maximize Insilco’s value. Although the rambling complaint makes the cursory allegation that the board did not consider strategic alternatives, it then immediately says that the board retained Bain & Company and consulted with a DLJ affiliated workout specialist for just that purpose. The complaint indicates later that efforts to find buyers took place but did not succeed." See footnote 129.

A memorable money quote on this issue comes from footnote 130 and the Trenwick case:

"Directors may, in the appropriate exercise of their business judgment, take action that might, if it does not pan out, result in the firm being painted in a deeper hue of red."

Entities Affiliated with Controlling Stockholder Considered Alter-Egos for Motion to Dismiss

Useful statements of Delaware law regarding the Alter Ego theory of piercing the corporate veil are found in the text of this opinion accompanying footnotes 133 to 139.  Specifically, for purposes of the motion to dismiss, the Court explained that there was enough overlapping of the affiliated entities to allow them at this early pleading stage to be treated as one-entity for purposes of analyzing the actions of the controlling stockholder which was made up of those related entities.

However, an important limitation emphasized by the Court is that if a director is insulated from liability for due care claims by Section 102(b)(7), then a majority stockholder cannot be held liable for the same allegations. The Court explained further as follows:

"Without conflating their existence for all purposes, there is a pleading stage inference that these entities acted jointly together as if they were a single controlling stockholder and on that basis owed fiduciary duties to Insilco.

Because, however, the premise of controlling stockholder fiduciary responsibility is to hold the controller liable for actions its causes using its control of the company’s board, liability under this theory is largely coextensive with the liability faced by the corporation’s directors. That is, a controlling stockholder cannot be held liable for a
breach of the duty of care when the directors are exculpated. The purpose of controlling stockholder liability is to make sure that controlling stockholders do not use
their control to reap improper gains through unfair self dealing or other disloyal acts." See footnote 140.

Aiding and Abetting Claim Survives Against Financial Adviser

In light of this blog post already being much longer than is customary, I will cover the last but important part of this opinion in the following bullet points:

  • The allegation is that KeyBanc, as a financial advisor, aided and abetted the board in breaching their fiduciary duty by, for example, knowingly providing a valuation for ThermaSys that was far lower than appropriate
  • Most of the Court’s discussion was centered on the defense that the claims were time-barred because they were not part of the original claims in bankruptcy nor were they covered by the Delaware Savings Statute, 10 Del. C. Section 8118(a).
  • Without addressing the esoterica of Section 8118, for those who need to know about the Savings Statute, refer to this opinion and be aware that the Court analogized the Savings Statute to Court of Chancery Rule 15(c)(2) which allows a party to amend a pleading when the amendment arose out of the same conduct, transaction or occurrence that was referred to in the original pleading.See footnotes 159 to 164.
  • KeyBanc argued that Ohio law should apply because its contract with Insilco specified as much, but the Court rejected that argument on the basis that Delaware has a greater interest. The Court distinguished that contract based claim with Delaware’s "paramount interest" in addressing claims related to breach of fiduciary duty, even though, or maybe especially since, Ohio does not recognize such a claim against KeyBlanc in this context. See footnotes 165 and 166,
  • The Court does not engage in extended discussion of the elements of the aiding and abetting claim. Rather, relying on its foregoing comprehensive analysis of the breach of the fiduciary duty of the directors, the Court merely describes why the defenses offered by KeyBanc are unavailing for purposes of the motion to dismiss.

SUPPLEMENT: The Supreme Court, by Order dated Sept. 14, 2010 available here, denied an interlocutory appeal.