Whether directors breached their duty of loyalty in connection with the sale of a company based on their domination and/or intimidation by the largest shareholder.
This case involved the claim that the directors of infoGROUP in March 2010 breached their fiduciary duty of loyalty in connection with the sale of the company. The allegations which survived the motion to dismiss were, in essence, that the sale of the company was orchestrated by the largest shareholder, Vinod Gupta, because he desperately needed liquidity. His need for liquidity was derived largely from his debt of millions of dollars that he owed in connection with settlements of prior derivative actions and SEC investigations. See, e.g., In re: infoUSA, Inc. S’holders Litig., 953 A.2d 963 (Del. Ch. 2007) (See highlights of this decision on blog here). The record indicated that Gupta did not have a material source of cash flow since he resigned as CEO several years ago, and more than half of his net worth was invested in his infoGROUP stock, which had ceased paying a dividend.
The Court reviewed allegations that only a sale of the company would generate the liquidity that Gupta needed because he would have suffered a substantial discount if he were to sell only his non-controlling shares, and it was observed also that if he sold all of his shares on the open market it would likely exert a downward pressure on the share price due to the large percentage of his ownership.
The allegations were that the other board members capitulated to Gupta’s demands for a sale after succumbing to pressure exerted through his pattern of threats and bullying, and unauthorized efforts to promote a sale of the company. His methods to campaign for a sale included what the Court referred to as “rather indelicate methods of persuasion,” such as threatening other board members with lawsuits. One chairman allegedly resigned as a result of Gupta’s bellicose behavior.
Gupta also allegedly disrupted the sale process by influencing the list of potential bidders, conducting unsupervised negotiations and leaking information about the sale of the various parties.
The Deficiencies in the Sale Process and Unfair Price
The alleged deficiencies included not treating all the bidders equally and favoring one bidder over another, as well as refusing to consider a counteroffer from another bidder and refusing to provide information to all interested bidders.
The Court referred to a recent Delaware Supreme Court decision in which motions to dismiss under Court of Chancery Rule 12(b)(6) would be viewed from the traditional standard which requires a denial of a motion “unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof.”
(1) Duty of Loyalty Claims
The claims included a breach of the fiduciary duty of loyalty against Gupta, as a director, because of his receipt of a unique financial benefit, namely liquidity, at the expense of other shareholders. Moreover, the allegations include that the remaining members of the board approved the sale in breach of their duty of loyalty and that they were controlled and bullied by Gupta and were therefore not independent.
(2) Business Judgment Rule and Entire Fairness
The Court reiterated the truism that the business judgment rule “is a presumption that directors of a corporation act independently, with due care, in good faith and in the honest belief that [their] actions were in the stockholders’ best interests.”
The Court recited the method to overcome that burden by alleging facts which, “if accepted as true, establish that a majority of the individual board members had a financial interest in the transaction or were dominated or controlled by a materially interested director.” If that presumption is rebutted, the “entire fairness standard of review” is applicable, with the initial burden of proving the entire fairness of the transaction to be borne by the defendants.
(3) Liquidity as a Special Benefit to Gupta Only
The Court noted prior case law (at footnote 32) which recognized liquidity “as a benefit that may lead directors to breach their fiduciary duties.” The record was replete with evidence that Gupta had substantial cash requirements but very little cash flow. Gupta ultimately received over $100 million in cash for the sale of his shares in the company and the Court, in an understatement, based on the facts of this case, stated that: “It would be naive to say, as a matter of law, that $100 million in cash is immaterial to a man in need of liquidity.”
The Court found that the liquidity benefit received by Gupta was a personal benefit not equally shared by other shareholders even though there was no allegation that Gupta received any additional compensation for his shares as the result of the merger from either side deals or other special terms such as compensation as an executive with the surviving company or golden parachutes.
Although all shareholders received cash in the merger, liquidity was a unique benefit to Gupta based on the illiquidity that resulted from the larger percentage of his ownership in the company, which was approximately 34%. The next largest shareholder had only 6% of the stock and all other shareholders also held relatively small, liquid positions, and therefore liquidity was not a benefit to them as it was to Gupta. Therefore, the Court found that Gupta suffered a disabling interest when considering how to cast his vote in connection with the sale.
4) Directors’ Lack of Independence
The Court found that in addition to Gupta who was an “interested director,” the other directors also lacked independence because they were dominated by a pattern of threats that intimidated them, even though there was no allegation that they were financially dependent upon Gupta or that there were disabling family or business relationships. The Court found that the intimidation by Gupta so dominated the other board members that it could be reasonably inferred that they capitulated to his demands through a pattern of threats that rendered them non-independent for purposes of voting.
(5) Direct v. Derivative
The Court performed an analysis about whether the claims were direct or derivative and concluded that the claims against the directors were of a type that allowed them to be pursued as direct claims and not as derivative claims.