Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.              

The full Delaware Supreme Court recently reversed the dismissal of a shareholder challenge to a private equity consortium’s acquisition of Inovalon HoldingsInc. after finding the cloud-based healthcare industry support provider’s directors did not fully reveal to investors the conflicted roles of the deal’s financial advisors, as the high court’s seminal MFW ruling requires, in City of Sarasota Firefighters Pension Fund et al. v. Inovalon Holdings Inc., Del. Supr., No. 305, 2023 (May 1, 2024).

The justices unanimously reversed the Court of Chancery’s decision that the transaction met the standard Khan v. M & F Worldwide Corp. 88 A.3d 635 (Del. 2014) demands of controller-dominated deals to qualify for review under the defendant-friendly business judgment standard. The high court said MFW required Inovalon’s special committee of directors that negotiated the merger terms to reveal the full extent of their financial advisors’ involvement with counterparties in this transaction.  Without that information, the Inovalon minority shareholders could not cast the informed merger vote that would justify business judgment review and dismissal of the suit, Justice Karen Valihura wrote.

The decision marked the second time in as many months that the high court overturned a Chancery Court merger ruling on grounds that, the justices found, too little was required of the challenged deal’s proponents under MFW.  In the case styled In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024), Chancery had allowed an asset reshuffle that allegedly dealt less value and more debt to pension fund investors compared to IAC insiders. The high court said, in a controller-dominated deal, all the directors of the negotiating committee—not just a majority—had to be independent to avoid review under the exacting entire fairness standard.

Background

Three pension funds challenged the Nordic-led acquisition of Inovalon claiming it was a controller transaction that failed to qualify for protection under MFW because the deal did not have the benefit of a fully independent review committee from the outset and did not get a completely informed approval vote from a majority of the minority shareholders.

The suit claimed that Inovalon CEO Kieth Dunleavy and director Andre Hoffmann controlled a majority of Inovalon’s stock through multiple vote shares but did not establish a functioning, fully-independent negotiating committee from the outset of bidding. And it charged that the minority knew only part of the conflicts involving Inovalon’s investment banker financial advisors.

The trial court ruling

In a bench ruling, the Chancery Court dismissed, finding that the deal and disclosures about it to investors met MFW’s requirements. Concerning the ab initio requirement for the special committee, it found that the alleged conflicts did not arise until Nordic “formally requested that Dunleavy participate in an equity rollover as part of its written offer on July 21, 2021,” which marked the official beginning of the negotiations.   The trial court found that the conflicted roles of the advisors was adequately revealed.

The appeal ruling

On appeal, the high court focused on the plaintiffs’ contention that “judicial cleansing under the MFW framework is unavailable because the Proxy omitted material information that rendered the minority stockholders’ vote to approve the Transaction uninformed.”  The full court agreed.

The justices noted that MFW requires of controller buyouts that the business judgment standard of review will be applied “if and only if:”

(i)     the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;

(ii)    the Special Committee is independent;

(iii)   the Special Committee is empowered to freely select its own advisors and to say no definitively;

(iv)    the Special Committee meets its duty of care in negotiating a fair price;

(v)     the vote of the minority is informed; and

(vi)    there is no coercion of the minority.

Full disclosure required

The high court said, “the trial court’s due care analysis concerning the retention and management of the advisors did not sufficiently address all of the disclosure issues and “Delaware courts have required full disclosure of investment banker compensation and potential conflicts.”

Conclusion

It was not enough to simply disclose to investors that the advisors might have received fees from counterparties to the transaction, the high court  said, because, “when a board chooses to disclose a course of events or to discuss a specific subject, it has long been understood that it cannot do so in a materially misleading way, by disclosing only part of the story, and leaving the reader with a distorted impression.” Rather, “[d]isclosures must provide a balanced, truthful account of all matters they disclose.”