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 Delaware Chancery Court recently ruled that Wayfair Inc.’s exculpation clause shields its board from a pension fund’s derivative suit that accuses the directors of faithlessly selling a big stake in the online home products retailer too cheaply in order to fund its survival during a feared Covid-19 “economic maelstrom,” in Equity-League Pension Trust Fund v. Great Hill Partners L.P,. et al., No. 2020-0992-SG, opinion issued, (Del. Ch. Nov. 23, 2021).
In his November 23 opinion granting the board’s dismissal motion, Vice Chancellor Sam Glasscock said plaintiff made no pre-suit demand on Wayfair’s board to sue the directors for allegedly letting themselves be panicked into wasting corporate assets on a bargain-priced $535 million in convertible notes in a corporate insider-backed stock sale. Therefore, he said, Equity-League Pension Trust Fund was required to prove at least five of the nine board members could not objectively review the charges due to conflict of interest, and it was unable to do that.
Since four directors “participated” in the buy-side of the transaction, plaintiff needed to identify only one more conflicted board member from Wayfair’s three-director audit and deal review committee – a focal point of the pre-suit demand battle – to tip the balance in its favor, the court said, but it failed to show that any of them:
- Received a material personal benefit from the alleged misconduct,
- Faces a substantial likelihood of liability on any of the claims that would be the subject of the suit, or
- Lacks independence from someone who got a material personal benefit from the alleged misconduct.
The task of showing those independent directors would be swayed by the threat of legal liability was made significantly more difficult by Wayfair’s exculpation provision which shielded the directors from money damages for ordinary breaches of duty, forcing the plaintiff to show their conduct demonstrated bad faith or disloyalty.
COVID debt concern
Underscoring the importance of the ruling for corporate law specialists, the vice chancellor wrote that, “The decision if, how and when to take on company debt is a quintessential function of the board of directors…and the board of directors approved the transaction at a time of marked market turmoil and general uncertainty in the retail sales business, which is Wayfair’s business, resulting from the onset of the COVID-19 pandemic.” He noted that companies raised approximately the same amount in convertible debt financings in the second quarter of 2020 as they had during all of 2019.
Wayfair had expanded significantly since its founding in 2002, employed nearly 17,000 full-time employees and generated over $9 billion in annual net revenue but failed to achieve profitability by 2020 despite a series of cost-cutting measures. Nevertheless, the company’s financial forecasts, which reflected these recent modifications to its operations, projected optimistic results over the next six years even under the worst-case scenario forecast.
But these forecasts did not account for a global pandemic. On February 27, 2020, a week after Wayfair management presented the optimistic forecast to the board, the Dow Jones Industrial Average suffered its largest ever one-day decline and Wayfair’s stock price fell from over $72.50 per share on February 24, 2020 to $23.52 per share on March 19, 2020.
“Amid this economic maelstrom, Wayfair began negotiating a private investment in public equity transaction to raise $500 million through the issuance and sale of convertible notes, which culminated in the transaction;” the court said.
The pension fund’s suit charged that the directors breached their fiduciary duty by rubber-stamping a transaction that got too little for the company’s equity in a sale influenced by four directors with connections to the investors who were the convertible debt stock buyers.
The tipping point
Plaintiff contends the three audit committee directors face liability for failing to properly assess the value of the deal but it offers none of the particular pleadings needed to support its allegations and none of the necessary bad faith “intentional misconduct”, the vice chancellor said in his dismissal ruling.
“Importantly, where (as here) there is no adequate pleading of conflicted interests or lack of independence on the part of the [members of the Audit Committee], the scienter requirement compels that a finding of bad faith should be reserved for situations where the nature of [the Audit Committee members’] action[s] can in no way be understood as in the corporate interest,” the vice chancellor said, citing In re USG Corp. S’holder Litig., 2020 WL 5126671, at *29 (Del. Ch. Aug. 31, 2020) (quoting In re Saba Software, Inc. S’holder Litig., 2017 WL 1201108, at *20 (Del. Ch. Mar. 31, 2017). “Thus conceived, bad faith is similar to the much older fiduciary prohibition of waste, and like waste, is a rara avis,”he said quoting In re Chelsea Therapeutics Int’l Ltd. S’holders Litig., 2016 WL 3044721, at *1 (Del. Ch. May 20, 2016).
“We don’t care about the risks”?
Plaintiff claims the audit committee’s review of the deal was too short, too shallow and too dismissive of the risks to satisfy the its duty to the shareholders, but the vice chancellor said the record shows that the committee:
- Received in advance a summary of the process by which the transaction was identified and negotiated,
- Knew there were four directors participating on the buy side, and
- Even if it failed to be fully informed, was at most liable for a breach of duty of care (which the exculpation clause protects against) –- not bad faith.
Therefore, a majority of directors were not disqualified from considering the demand and the motion-to-dismiss is granted, the court explained.