An Eckert Seamans associate prepared this overview.
In the case styled In re Saba Software, Inc. S’holder Litig., C.A. No. 10697-VCS (Del. Ch. Apr. 11, 2017), the Court of Chancery recently declined to allow board members to invoke the business judgment rule where the plaintiff plead facts to support that a stockholder merger vote was coerced and uninformed. The court further found that the plaintiff adequately plead allegations of bad faith and breach of the duty of loyalty in defendants’ failure to disclose material information to the stockholders before the vote.
Background: This action arose out of the acquisition of Saba Software, Inc. (“Saba”) through an all-cash merger by entities affiliated with Vector Capital Management L.P. (“Vector”). Saba’s stockholders were offered a far lower share price than the shares had previously been trading for due to recent disparaging allegations by the SEC. Due to SEC violations, stockholders would be forced to accept the low share price, or hold onto illiquid stock as a result of impending deregistration of the company’s shares. If the merger was approved, Saba board members stood to receive significant financial incentives. The plaintiff, a former Saba stockholder (“Plaintiff”), brought a fiduciary claim against Saba’s board of directors and an aiding and abetting claim against Vector defendants.
Defendants’ Contentions: The defendants moved to dismiss the complaint on the following grounds: (1) the merger was “cleansed” by a fully informed, uncoerced stockholder vote such that the business judgment rule applied; (2) Plaintiff’s derivative claims were extinguished by the merger; (3) direct claims were exculpated by DGCL § 102(b)(7); and (4) if the underlying claims failed, Vector could not be held liable for aiding and abetting.
Court’s Analysis: The court concluded that: (1) a cleansing vote did not occur; (2) Plaintiff’s claims were direct—not derivative—and therefore they survived the merger; (2) defendants were not exculpated by § 102(b)(7); and (4) Plaintiff failed to plead an aiding and abetting claim as a matter of law.
First, the court found that the Corwin doctrine—which allows for the presumption of the business judgment rule to apply when certain conditions are met, such as when a stockholder vote is fully informed and uncoerced—did not apply. Plaintiff was able to identify material deficiencies in the disclosure, including: (1) an explanation of the facts leading up to the merger, which was necessary to appreciate the consequences of merger in light of the SEC allegations, (2) information material to determining whether Saba could meet its financial projections as set forth in the disclosure, and (3) details concerning the effects of deregistration, which “caused a fundamental change to the nature and value of the stockholder’s equity stake in Saba.”
Notwithstanding this finding, the court also reiterated its “consistent position” that management was not required to disclose future financial projections that did not yet exist. Additionally, any minute omission that did not alter the “total mix” of the disclosure was not material, and therefore needed not be disclosed. The court cautioned that simply arguing that more information could have been disclosed is insufficient to establish that a vote was uninformed; the omissions must be material.
Next, the court found that Plaintiff adequately plead that the stockholder vote was coerced. In conducting this fact-intensive and “relationship-driven” analysis, the court considered the fiduciary obligations of the board members. The court labeled the stockholder’s choice between keeping their deregistered, illiquid stock, or accepting a reduced share price, a “Hobson’s choice,” which “was hoisted upon the stockholders because the Board was hell-bent on selling Saba in the midst of its regulatory chaos.” Accordingly, Plaintiff was able to establish that the forced timing of the merger and the aforementioned material omissions were enough to set forth an inference of coercion.
Although the proxy stated the facts surrounding the merger neutrally and in a non-threatening manner—which is normally an indicator of non-coercion—the board created a coercive situation as a result of its wrongful actions regarding the overall circumstances of the merger and SEC issues. As such, because Corwin was inapplicable, the court applied enhanced scrutiny under Revlon in evaluating the breach of fiduciary duty claim.
Direct v. Derivative
The viability of Plaintiff’s fiduciary claim turned on whether the claim was derivative or direct, as the merger would eliminate Plaintiff’s standing as a stockholder if the claim was derivative. While claims of corporate mismanagement are typically derivative, the current action challenged the board members’ recommendation regarding the merger to the stockholders. Thus, Plaintiff’s claims were direct claims that “constitute[ed] a direct challenge to the fairness of the merger itself; they [were] not extinguished by the merger.”
102(b)(7) Not Applicable to Bad Faith Claim
The court then determined that the board members were not exculpated by an exculpatory charter provision, as defendants could not be insulated by § 102(b)(7) in the face of well-plead allegations of bad faith. Although a “close call,” in applying Revlon, the court found that Plaintiff was able to sufficiently plead bad faith by alleging that the board members “knowingly and completely failed to undertake their responsibilities” and “utterly failed to attempt to obtain the best sale price.” The SEC’s allegations regarding fraud loomed over the transaction.
Moreover, cash payments administered to board members on the eve of merger, in lieu of equity grants that would be devalued by the impending deregistration, were sufficient to set forth a reasonable inference of self-interest. Therefore, the exculpatory charter provision was inapplicable, and the court denied the board members’ motion to dismiss.
Despite the sufficiency of the fiduciary allegations against the board members, Plaintiff was unable to state an aiding and abetting claim against Vector. An aiding and abetting claim requires the difficult task of establishing scienter. Allegations involving the receipt of confidential information, and that a party received “too good of a deal,” without more, were insufficient to allow for a reasonable inference that Vector knowingly aided and abetted the board members in any breach of their fiduciary obligations.
Conclusion: Ultimately, the court determined that the unscrupulous circumstances surrounding the merger were sufficient to adequately set forth a claim for breach of the duty of loyalty. However, Plaintiff failed to plead a claim for aiding and abetting because he failed to allege facts to support that Vector knowingly participated in the breach of fiduciary duties.