An Eckert Seamans associate prepared this overview.
In the Delaware Court of Chancery decision captioned, In re Merge Healthcare Inc. S’holders Litig., C.A. No. 11388-VCG (Del. Ch. Jan. 30, 2017), Vice Chancellor Glasscock applied the business judgment rule and dismissed an action for failure to state fiduciary-related claims. This opinion is important because it highlights the deferential standard afforded to directors when the transaction at issue is approved by a vote of a majority of disinterested, uncoerced shareholders.
Background: This action arose from IBM’s acquisition of Merge Healthcare, Inc. (“Merge”). The merger was supported by a vote of a majority of Merge’s stockholders. However, the plaintiffs, former Merge stockholders (“Plaintiffs”), alleged that the sale process was improper. Because Merge did not include an exculpation clause in its charter (a rarity), the defendant directors (the “Directors”) were potentially exposed to liability for both duty of loyalty and duty of care violations.
Plaintiffs’ Allegations: Plaintiffs alleged that the Directors violated their duties of care and loyalty by putting their own personal interests first, and depriving the stockholders of the “true value inherent in and arising from” the company. Plaintiffs also asserted a claim for breach of the fiduciary duty of disclosure in failing to disclose material information to the stockholders. Plaintiffs sought a quasi-appraisal remedy and compensatory damages.
Defendants’ Allegations: The Directors moved to dismiss the complaint. The Directors relied on the cleansing effect of the majority vote, asserting that the favorable presumption of the business judgment rule applied.
Court’s Analysis: In perhaps a bit of foreshadowing, the Court opened by noting that it can be “problematic” to establish a duty of loyalty violation. A duty of care claim also requires the difficult showing of gross negligence, but that standard may be less burdensome then establishing disloyalty.
The Plaintiffs’ fiduciary claims were essentially two-fold: (1) disloyalty and care claims arising from the merger process, and (2) inadequate disclosure. Before determining whether Plaintiffs had adequately pleaded their fiduciary claims, the Court was required to consider the effect of the vote by the majority of the shareholders. Importantly, even where Plaintiffs alleged Director disloyalty, a vote by a majority of uncoerced and disinterested stockholders would have a cleansing effect on price and process claims in the merger context. This is so because where a majority of disinterested and fully informed ownership of the corporate asset approves a transaction, any director conflict is ameliorated, and the need for judicial oversight is concurrently reduced.
Vice Chancellor Glasscock quoted the Delaware Supreme Court in explaining that “Delaware corporate law has long been reluctant to second-guess the judgment of a disinterested stockholder majority that determines that a transaction with a party other than a controlling stockholder is in their best interests.” Corwin v. KKR Fin. Holdings, LLC, 125 A.3d 304, 306 (Del. 2015). Thus, “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.” Id. at 309. The only transactions subject to entire fairness review that cannot be “cleansed” by proper stockholder approval are those involving a controlling shareholder, who also receives a personal benefit from the transaction, as coercion is presumed under those circumstances. In the absence of such, when a transaction is approved by a fully informed, uncoerced majority of shareholders, the business judgment rule applies, despite the existence of individually conflicted directors.
Under the present circumstances, the Court determined that the business judgment rule applied. Even if Plaintiffs had accurately alleged the existence of a controlling shareholder, there was no evidence that a controlling shareholder also received a personal benefit out of the merger. Thus, the transaction was effectively “cleansed.”
To rebut the cleansing effect of the majority vote, Plaintiffs were required to sufficiently allege that the Directors’ merger-related disclosures were materially misleading. To the extent that Plaintiffs alleged that the vote was therefore uninformed, the Directors had the burden to show that the alleged deficiencies were immaterial as a matter of law. However, in reviewing the 12(b)(6) motion, based on the allegations in the complaint—and not facts or arguments first introduced in briefing—the Court found that Plaintiffs had failed to substantiate their bare assertions related to inadequate disclosure.
Based on the foregoing, the Court determined that the merger was approved by a majority of uncoerced, disinterested shareholders, without the presence of a controller who received personal benefits. Accordingly, the business judgment rule applied to the Directors’ decision to approve the merger.
Conclusion: The Court highlighted that application of the business judgment rule tends to result in dismissal. The present case was no exception. Given the cleansing effect of the shareholder vote, and application of the business judgment rule, dismissal was warranted.