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.
In a recent ruling dismissing shareholder charges that Outerwall Inc.’s directors disloyally sold the automated vendor company too cheaply to avoid losing their seats in a looming proxy fight with an activist investor, the Delaware Chancery Court found the plaintiff fell short of showing that the board lacked independence and objectivity in Rudd v. Brown, et al., No. 2019-0775-MTZ opinion issued (Del. Ch. Sept. 11, 2020.)
Vice Chancellor Morgan Zurn’s September 11 opinion found although Outerwall’s directors’ allegedly self-interested failure to get the best price for the shareholders was subject to heightened scrutiny under the seminal Revlon ruling, that was insufficient to survive a dismissal motion because the board was protected by an exculpatory clause – which shields directors from money claims for duty-of-care breaches.
Under Revlon, the court must examine whether the directors of the corporation have performed their fiduciary duties “in the service of a specific objective: maximizing the sale price of the enterprise” in a change-of-control situation. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. 506 A.2d 173, 183 (Del. 1986).
More than Revlon
But even if the directors’ merger decision was defective and shortchanged the Outerwall investors, that, without more, would not constitute the breach of duty of loyalty charge that was needed to overcome an exculpatory clause adopted under 8 Del. C. §102(b)(7), the court said.
To state that type of claim, class action plaintiff Mark Rudd would have had to show that in addition to the merger price charge, each of the defendant directors had a disabling lack of independence or objectivity or exhibited bad faith, but he failed to do that, the vice chancellor said.
After the directors agreed to a two-step merger in which Rudd was forced to sell his shares when the first step was completed, Rudd filed suit in 2019 claiming that after Redbox video rentals, Outerwall’s core business, slumped, the directors caved in to pressure from activist investor Engaged Capital, LLC to sell.
Rudd claimed that instead of taking reasonable steps to increase Outerwall’s value, the directors and CFO Galen Smith panicked when Engaged set a deadline for action on a sale and self-interestedly agreed to a transaction that undervalued the company and misled investors about the deal and how it was negotiated.
Too much like Lukens
But Vice Chancellor Zurn said, Delaware courts “have expressed reluctance to find” that directors are conflicted “simply because they operate under the threat of a proxy contest.” She pointed to In re Lukens Inc. Shareholders Litigation 757 A.2d at 729 where the court rejected the plaintiffs’ assertion that the directors who approved the relevant merger were improperly motivated because of “the possibility of a proxy contest at the . . . annual stockholder meeting.”
Her Honor noted that in the three cases the plaintiff cited, where the court “found conflict in board decisions made in the shadow of a proxy contest,” it was “only where those decisions bore other indicia of gross negligence or disloyalty. Plaintiff’s allegations offer no such meat on the bone.”
“It is clear that a director’s independence is not compromised by virtue of his status as a stockholder appointee …Nor was it enough to allege that another was conflicted by virtue of the benefits he received from the acquisition,” the court said, adding that plaintiff’s theory that CFO Smith was conflicted by his pursuit of post-close employment is also insufficient to state a breach of duty claim.
The allegations in the amended complaint “boil down instead to the barebones conflict theory rejected in Lukens.” the vice chancellor concluded in dismissing all charges against the directors and the CFO.