This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Court of Chancery has tossed out a shareholder class action that accused Essendant Inc.’s directors and CEO of disloyally jilting merger mate Genuine Parts Co. in favor of a less lucrative union with private equity firm Sycamore Partners’ office supply subsidiary, Staples Inc., in the case styled In re Essendant Inc. Stockholder Litig., No. 2018-0789-JRS, memorandum opinion (Del. Ch. Dec. 30, 2019).

Vice Chancellor Joseph R. Slights III’s December 30 memorandum opinion following oral argument dismissed all defendants after finding insufficient proof that the directors breached a duty of loyalty by scraping a superior stock-for-stock merger pact with GPC for Sycamore’s all-cash deal to form an office supply giant.

He said Delaware-chartered Essendant’s directors were shielded from money liability for ordinary duty-of-care charges by an exculpatory provision under 8 Del. C. §102(b)(7) of the Delaware General Corporation Law, forcing plaintiffs to try to prove the directors were controlled by Sycamore or acted out of self-interest or bad faith.

The vice chancellor said plaintiffs Joseph Pietras and Michael J. Sultan, on behalf of Essendant investors, did not “come close” to meeting that formidable standard and did not show CEO Richard D. Phillips had any liability — even without the exculpatory protection.

According to the court, shortly after signing a merger agreement with automotive and industrial parts and business products distributor GPC in the spring of 2018, the Essendant directors received an all-cash offer from Sycamore, which they initially rejected as too low.

Door left open

But when Sycamore said it might increase its offer —raising the possibility of an unsolicited bid higher than GPC’s that might let the directors escape the merger pact’s no-solicitation ban and its $12 million termination fee penalty for encouraging a successful competing bid — Essendant’s board left the door open.

The vice chancellor said on April 9, 2018, three days before Essendant and GPC signed their merger pact that would give Essendant 49 percent of a combined office supply company, Sycamore representatives made the first of several offers that led to a “superior” bid on May 31.

Only then did the Essendant board reveal Sycamore’s interest to GPC, which asserted its right to match the first Sycamore offer but declined to match a September 10 $12.80 a-share cash bid, triggering Essendant’s obligation to pay GPC the termination fee, the court said.

Two-front merger fight

That decision resulted in litigation on two fronts.  In addition to this shareholder suit, GPC sued Essendant for breaching their merger agreement.  In that action, Vice Chancellor Slights, on September 9 denied Essendant’s motion to dismiss, finding that if GPC might prove Essendant breached the pact, damages might not be limited to the termination fee payment.  Genuine Parts Co. v. Essendant Inc., 2019 WL 4257160 (Del. Ch. Sept. 9, 2019).

The shareholder suit focused on the directors’ alleged failure to get the highest value for investors by choosing a Sycamore deal that amounted to corporate waste.  It initially charged that Sycamore aided and abetted the Essendant board’s breach, but later amended the complaint to claim Sycamore breached its duty as a controlling stockholder by misusing its influence over Essendant’s directors.

In order to prove that charge and survive Essendant’s motion to dismiss despite the exculpatory provision, the complaint must “invoke loyalty and bad faith claims” as required by the Delaware Supreme Court’s In re Cornerstone Therapeutics decision, Vice Chancellor Slights said.  In re Cornerstone Therapeutics Inc. S’holder Litig., 115 A.3d 1175, 1179 (Del. 2015).

Plaintiffs confuse various theories as to how the majority of Essendant’s directors were either interested in the merger deals or lacked independence, but more crucially, he said, they fail to show how Sycamore exerted “formidable voting and managerial power” over the board despite its less than 12 percent interest.

No liability for choosing cash

The board’s preference for a cash deal does not support claims of director interest or lack of independence because “Delaware law empowers directors to consider whether, under the circumstances,” stock or non-cash consideration is preferable to cash, he ruled, citing Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2 34, 44 (Del. 1994).

That means that the Essendant directors were not conflicted and did not “cave in to the will of the controller” and that Sycamore has no liability or fiduciary duty, even as an aider and abettor. Moreover, no viable claim of corporate waste can be made, because the Sycamore deal offered a 51% premium to Essendant’s unaffected stock price, the court said.

In addition, no director exhibited bad faith by “demonstrating a conscious disregard for … her duties” or making “a knowing or intentional misstatement or omission of a material fact” in the merger process or the disclosures about it, the vice chancellor ruled in dismissing the complaint with prejudice.