Search results for: primedia

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 Supreme Court recently revived an investor’s derivative challenge to a merger of energy companies, finding he retained standing because he sufficiently pled a direct claim attacking the fairness of the deal itself for undervaluing his claim against the controlling partner of one of the merger mates in Morris v. Spectra Energy Partners (DE) GP, LP, No. 489, opinion issued (Del. Supr. Jan. 22, 2021).

The justices unanimously reversed the Chancery Court’s dismissal of plaintiff Paul Morris’ charges that Spectra Energy Partners L.P. unitholders were shortchanged in a merger with Enbridge, Inc. because SEP’s controller failed to include the worth of a $661 million projected recovery from Morris’ suit. Morris v. Spectra Energy Partners (DE) GP, LP, 2019 WL 4751521 (Del. Ch. Sept. 30, 2019).

The high court remanded the case for the Chancery Court to decide whether to use a motion to dismiss or for summary judgment to resolve the matter.

Significance

The decision is noteworthy because the en banc court used the so-called Primedia test as a way to determine when a derivative plaintiff qualifies for an exception to the general rule that he loses his standing to continue his suit against his directors or controller if his stock is eliminated in a stock-for-stock or cash-out merger. In re Primedia, Inc. Shareholders Litigation. 13 67 A.3d 455 (Del. Ch. 2013).

The Primedia test, taken from a 2013 Chancery Court merger opinion, applies to claims challenging a merger because the equity owners are not being fairly compensated for the value of material derivative claims. To establish standing, the plaintiff must allege a viable derivative claim that:

  • Was material to the overall merger transaction,
  • Will not be pursued by the buyer, and
  • Is not reflected in the merger consideration.

“Under Primedia’s three-part test, which applies to claims alleging an unfair merger because the price does not reflect the value of derivative claims, the plaintiff must allege a viable derivative claim assessed by a motion to dismiss standard,” Chief Justice Collins J. Seitz Jr. wrote for the high court.

“The standing inquiry has assumed special significance in the area of corporate law,” the Chief Justice said, noting its pivotal role in merger challenge suits. “Classifying a claim as either direct or derivative bears directly on standing and is in many ways outcome-determinative in post-merger litigation.”

Background

After a $3.3 billion “roll up” of minority-held units that was part of a merger between Enbridge and Spectra, former SEP investor Paul Morris lost standing to litigate an alleged $661 million derivative suit on behalf of SEP against general partner Spectra Energy Partners (DE) GP, LP. Morris filed a new class action complaint that alleged the Enbridge/SEP merger exchange ratio was unfair because SEP GP agreed to a merger that did not reflect the material value of his derivative claims. The Court of Chancery granted SEP GP’s motion to dismiss the new complaint for lack of standing. In re Primedia, Inc. Shareholders Litigation. 13 67 A.3d 455 (Del. Ch. 2013}.

Double discount doubted

The Chancery Court held that to have standing, the plaintiff’s suit must reflect the public unitholders’ beneficial interest in the derivative litigation recovery. The court discounted the worth of the $661 million derivative suit to $112 million and then further reduced it to $28 million to reflect a one-in-four chance of prevailing in the litigation. Finally, the court compared the $28 million to the $3.3 billion merger transaction and found it immaterial to the $3.3 billion merger and dismissed it.

Thus, the court granted SEP GP’s motion to dismiss for lack of standing without reaching SEP GP’s alternative argument that Morris failed to state a claim for relief. During the litigation, and with the motion summary judgment pending, Enbridge acquired SE Corp in a stock-for-stock merger, eliminating Morris’ stock, becoming SEP GP’s ultimate parent and controller of SEP.

The appeal

Morris’ appeal argued that if the Chancery Court had accepted his well-pleaded factual allegations as true and drawn all reasonable inferences in his favor, it would not have discounted the potential value of the claim to the point that it was immaterial to the merger value. The high court found that Morris properly alleged that former public unitholders were harmed because “SEP GP has allowed Enbridge to engineer the Roll-Up Transaction on terms that were patently unfair and unreasonable to SEP and its public unitholders, and that could not have been approved in good faith by the New Conflicts Committee or the SEP GP Board.”

Two errors

The justices found as to the main issue on appeal, that the Chancery Court had erred twice, in that:.

1. It “strayed from the proper standard of review” under the Primedia test and Morris did retain standing for his claim because “it was ‘reasonably conceivable that the [SEP) general partner acted in subjective bad faith,” and

2. Even if it was proper to discount the $661 million in damages alleged in the complaint to reflect the public unitholders’ interest in the derivative recovery, the court should have compared the $112 million pro rata interest in the derivative claim recovery to the public unitholders’ 17% proportional interest in the merger consideration.

“If the plaintiff has alleged a viable derivative claim, where it is reasonably conceivable that the claim is material when compared to the merger consideration and could result in the damages pled in the complaint, the plaintiff has satisfied the materiality requirement at the motion to dismiss stage for standing purposes,’’ the justices decided.

Top Ten 2013 Delaware Corporate and Commercial Decisions

By: Francis G.X. Pileggi and Kevin F. Brady

This is our ninth annual review of key Delaware corporate and commercial decisions. During 2013, we reviewed and summarized over 200 decisions from Delaware’s Supreme Court and Court of Chancery on corporate and commercial issues. Among the decisions with the most far-reaching application and importance during 2013 are the “top ten” that we are highlighting in this short overview. Prior annual summaries are linked in the right margin of this blog.Photo of the Supreme Court Courthouse in Dover (The Supreme Court’s stately building in Dover is featured in the photo from the Court’s website.)

Whenever a “Top Ten” list is prepared, there remains a risk of omitting some opinions that also are noteworthy, so we encourage readers to send us suggestions for additions to this list. Hyperlinks below lead to both a synopsis and each slip opinion. Of course, all the opinions we reviewed in 2013 are available on this blog for those who would like to read all of them and make their own list. In chronological order, the winners are:

Supreme Court Determines that There is No Fiduciary Duty to Structure Executive Compensation to Take Advantage of Corporate Tax Deduction. Freedman v. Adams. This decision is another example of how difficult it remains to challenge compensation decisions on the basis of Delaware corporate law.

Supreme Court Enforces Duty to Negotiate in Good Faith. SIGA Technologies v. PharmAthene. Most lawyers will be surprised to know that an obligation to negotiate can be enforced in Delaware even when a term sheet is not complete or final.

Supreme Court Upholds Presumption of Good Faith in Agreement to Bar Claims. Norton v. K-Sea Transportation. This is one of many recent examples where an LP agreement waived all duties except the non-waivable implied duty of good faith, but the agreement also created a presumption of good faith that made it almost impossible to challenge wrongdoing. N.B. Waivers will be enforced. Read before signing to know what duties and rights are being waived.

Chancery Clarifies Fiduciary Duty of Disclosure Owed by Directors and Majority Shareholders when Purchasing Shares or Selling Shares to Existing Shareholders. In re: Wayport, Inc. Litigation. This opinion provides a textbook-style explanation of the duty of disclosure in general, as well as in the context of selling and buying shares among existing shareholders.

Supreme Court Establishes New Standard for Trial Courts to Determine Appropriate Penalty when Pretrial Deadlines are Not Met. Christian v. Counseling Resource Associates, Inc. This is a must-read for lawyers (and their clients) to understand when court approval is needed to extend pre-trial deadlines and the consequences of missing pre-trial filing deadlines.

Chancery Emphasizes Duty of Oversight Owed by Directors Includes Corporate Operations in Foreign Countries. Rich v. Chong and Puda Coal and In re:  China Agritech, Inc. Shareholder Derivative Litigation. This trio of decisions, all involving operations in China of Delaware corporations, should worry directors of companies with far-flung operations in distant countries unless they make visits to those countries or otherwise make themselves sufficiently aware of those operations.

Business Judgement Rule Announced as Standard Applicable to Controlling Shareholder Transactions with Safeguards.  In Re MFW Shareholders Litigation. This iconic Chancery decision provides a clear standard to practitioners who formerly had less definitive guidance (and multiple conflicting standards) to advise clients on the standard that would apply in Delaware to controlling shareholder freezeouts. This decision was appealed and on December 18, 2013, the Supreme Court heard oral argument en banc. When that decision is published, we will highlight it.

Chancery Addresses Whether Notice Required Before Board Ousts CEO/Controlling Shareholder. Klaassen v. Allegro Dev. Corp. et al.,. This Chancery decision is the subject of an expedited appeal to the Delaware Supreme Court. Among the issues to be addressed by Delaware’s high court is whether the actions of a board to dismiss the CEO, who also had voting power over a controlling percentage of shares, are void — as compared to voidable. The trial court opinion considering a motion for a stay pending appeal provides a mini-treatise on the Delaware law applicable to notice requirements for board meetings and the consequences of ineffective notice. The opinion is also must-reading for anyone interested in the proper approach to contests for control among warring factions of dissident directors and competing shareholder groups.

Supreme Court Addresses Business Combination Not Requiring Shareholder Vote. Activision Blizzard Inc. v. Hayes, et al., No. 497-2013, order issued (Del. Oct. 10, 2013). In a rare ruling from the bench, after oral argument, the Delaware Supreme Court reversed an injunction granted by the Court of Chancery in  Hayes v. Activision Blizzard Inc., No. 8885, 2013 WL 5293536 (Del. Ch. Sept. 18, 2013).  The formal written Supreme Court opinion was issued on Nov. 15, 2013. The issue addressed was whether the structure of the deal qualified as the type of business combination that required a vote by public shareholders. In a unanimous ruling, Delaware’s high court ruled that no vote was required. Notably, merely a month or so transpired between the date of the complaint being filed and the Supreme Court’s oral ruling after its review of an injunction that was issued by the trial court. Especially in a major case like this, that remains remarkable celerity.

Chancery Addresses State Insider Trading Claims Twice in Two Weeks (Two cases tied for the last spot in top ten list). In re Primedia, Inc. Shareholders Litigation. In connection with discussing the elements of the claim, this opinion addressed whether equitable tolling of the state insider trading claim applied to extend or suspend the statute of limitations. In Silverberg v. Gold, for the second time in as many weeks, a state insider trading claim, called a Brophy claim in Delaware, was analyzed in a Chancery opinion. This 40-page decision denied a motion to dismiss based on an alleged failure to make pre-suit demand on the board.

UPDATE: The Harvard Law School Corporate Governance Forum published a version of this annual review on their blog.

In In Re Primedia, Inc. Shareholders Litigation Consolidated, C.A. No. 6511-VCL (Dec. 20, 2013), the Court of Chancery addressed defendants’ motion for a judgment on the pleadings in an action brought by minority shareholders of Primedia alleging that defendant directors of Primedia and Kohlberg Kravis Roberts & Co. L.P. (KKR), Primedia’s controlling shareholder, traded on inside information when purchasing shares of preferred stock of Primedia.  At issue were purchases  of  stock  which fell into two categories: (i) purchases made shortly before the public announcement of a sale of Primedia’s assets and (ii) purchases made before Primedia reported earnings that materially exceeded expectations. As to the first category, the Court granted the motion and as to the second, the Court denied the motion.

This opinion contains an excellent discussion about a Rule 12(b)(6) motion to dismiss and a Rule 12(c) motion for judgment on the pleadings and when the court could take judicial notice of information under Delaware Rules of Evidence 201 for purposes of a Rule 12(c) motion.  An earlier post on this decision can be found here.  There is also an excellent discussion on statute of limitations and equitable tolling which also factor prominently in the Court’s decision and are a recommended read for practitioners.  However, due to space limitations, those topics are not discussed in detail in this post.  Rather, the focus of this post is the Court’s discussion of the problems and hurdles stockholders face trying to survive the motion to dismiss stage on a claim for breach of fiduciary claim for insider trading especially in a situation where there is a controlling stockholder.

One of the determinations that the Court had to make concerned when a stockholder plaintiff is on inquiry notice for an insider trading claim that would survive a motion to dismiss.  First, the Court looked to see if there was sufficient information available to arouse a reasonable stockholder’s suspicions. Second, the reasonable stockholder must be able to commence an investigation and discover the facts necessary to plead the claim and survive the motion to dismiss.

A Brophy claim (named after the Delaware Court of Chancery’s decision in Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949)  is an action for breach of fiduciary duty premised on a fiduciary’s insider trading.  For a plaintiff asserting a Brophy claim, to survive a motion to dismiss, the complaint must plead particularized facts sufficient to support a reasonable inference that: (1) the corporate fiduciary possessed material, nonpublic company information; and (2) the corporate fiduciary used that information improperly by making trades because the fiduciary was motivated, in whole or in part, by the substance of that information.

The Court discussed the burden on stockholders and the level of due diligence they must exercise when monitoring corporate filings for potential claims.  The Court noted that stockholders are entitled to rely on the competence and good faith of a fiduciary but they are not entitled to ignore red flags. The Court said:

[T]he trusting plaintiff still must be reasonably attentive to his interests. Beneficiaries should not put on blinders to such obvious signals as publicly filed documents, annual and quarterly reports, proxy statements, and SEC filings.  Once a plaintiff is on notice of facts that ought to make her suspect wrongdoing, she is obliged to diligently investigate.

 With respect to the first category regarding purchases made before the public announcement of a material sale of assets, the Court identified several red flags.  First, KKR was Primedia‘s controlling stockholder, and several KKR representatives served on Primedia‘s board. Second, the KKR Form 4s showed that KKR was purchasing large quantities of preferred stock just weeks before the public announcement of a material sale of assets. Third, in response to the public disclosure of the asset sale, the trading price of Primedia’s common stock increased by double digits, and the trading price of one of the series of preferred stock increased by a much greater amount.  Based on those events, the Court found that a reasonable stockholder would have been suspicious, satisfying the first step of the test for inquiry notice.

The Court then focused its discussion on whether a reasonably suspicious stockholder could have conducted an investigation that would have uncovered the information necessary to file a complaint. A Primedia stockholder could have used Section 220 of the Delaware General Corporation Law to request board minutes concerning the sale which would have shown that the KKR directors were present at the meeting when the board approved the sale of assets subject to liabilities for approximately $115 million in cash. A reasonable investor reviewing those minutes would have focused on the fact that a KKR affiliate paid $8.5 million for preferred stock with a face value of $22.9 million on the same day that KKR representatives approved the sale.  A reasonable investor also would have noted that, less than two weeks later, an entity formed by KKR as a vehicle for purchasing stock, paid an additional $30.7 million for preferred stock with a face value of $84.9 million, before the sale was announced publicly.  A court may also infer scienter when a trade is sufficiently unusual in timing and amount.  Under the circumstances, a stockholder plaintiff would be entitled to an inference that defendants acted with scienter.  Thus, the Court found that a reasonable stockholder could have pled a Brophy claim that would have survived a motion to dismiss.

With respect to the second category regarding purchases made before Primedia reported earnings, the Court noted that a reasonable investor could have used Section 220 to request books and records showing what the KKR directors knew about Primedia‘s second quarter earnings and when they knew it.  If an investor had made such a demand, Primedia could have provided the documents that would have confirmed what the public filings showed: KKR was interested in purchasing, and then in fact purchased, preferred stock during July. But these documents would not have revealed anything about the reasons for KKR’s purchases or suggested that KKR made its decision to acquire preferred stock based on inside information.  The missing link would be an internal KKR memo, which Primedia did not have in its possession and therefore could not produce in response to a Section 220 demand.  Without that memo, the Court noted that it is “perhaps possible, but unlikely, that a stockholder could have pled a viable Brophy claim relating to the July purchases.”   Nothing in the Section 220 documents would have shed light on when the KKR representatives or the board learned of Primedia‘s better-than-expected earnings results.  Nor would KKR’s purchases necessarily have given rise to an inference of scienter.  KKR owned nearly 60% of Primedia’s common stock and purchased the entire Series J Preferred Stock issuance for $125 million in August 2001. Purchasing $30.5 million of another series of preferred stock might not be deemed sufficiently unusual in timing or amount to support a claim. Moreover, KKR purchased another $5 million of preferred stock on August 8, after the earnings release, which was an amount larger than the purchases on July 12, 15, and 26.  Thus, without the internal KKR memo, a court might well think that it was unreasonable to draw the inferences necessary to support a Brophy claim.

Two weeks after this opinion, Chancery against addressed another state insider trading claim, highlighted on these pages.

The procedural background and factual details about this case were highlighted on these pages in connection with several prior decisions by the Court of Chancery and the Delaware Supreme Court.

In re: Primedia, Inc., Shareholders Litigation, Cons., C.A. No. 6511-VCL (Del. Ch. May 10, 2013).

Issue Addressed:  Whether insider trading claim based on state law should be allowed to proceed despite motion to dismiss by special litigation committee.
Short Answer:  Motion to dismiss denied.

Brief Background

Details of this case were previously highlighted on these pages in connection with a decision by the Delaware Supreme Court to reverse a prior ruling by the Court of Chancery in this matter, as referenced at this link. That Delaware Supreme Court decision, captioned Kahn v. Kohlberg Kravis Roberts & Co., L.P., 23 A.3d 831, 842 (Del. 2011), clarified Delaware law regarding insider trading based on the Delaware Court of Chancery’s opinion in Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949).  This latest decision can be compared with the recent Chancery decision highlighted in Wayport, highlighted on these pages, and that discussed the fiduciary duty of disclosure and candor owed by directors to shareholders, which involved some factual situations akin to insider trading although those exact words were not directly used in the opinion as allegations as they were in this case in the Brophy context.

Highlights of Case

●          The court describes the extensive procedural history which includes the motion to dismiss filed by the special litigation committee in connection with claims challenging the redemption, as well as an alleged usurping of corporate opportunities and the insider trading claim based on Brophy case.  After that motion to dismiss was filed, the plaintiffs engaged in discovery for approximately 18 months to consider the basis for that decision and the composition of the committee, which they then used to oppose the motion to dismiss.

●          The court discussed at pages 17 and 18 the hearing that it conducted prior to the appeal to the Delaware Supreme Court, and the factors that it considered pursuant to Zapata Corp. v. Maldonado, 438 A.2d 779, 788 (Del. 1981).  During that hearing, the court inquired into the independence and good faith of the committee and the bases supporting its conclusions.  The second step that the court engaged in during the Zapata hearing, which is a step that the court takes in its discretion, was to apply its own independent business judgment regarding whether the motion to dismiss should be granted.  Even though the SLC has the burden of proving its independence and good faith and that it conducted a reasonable investigation, performing the second step of the analysis means that the committee could establish its independence and sound bases for its good faith decisions, but still have the motion to dismiss denied.

●          The court recited the elements of an insider trading claim based on the Court of Chancery’s Brophy decision.  See page 21.

●          The court listed the different cases by the Court of Chancery which over the years took a different approach on, and had different interpretations of, an insider trading claim based on the Brophy case.  See page 26.

●          The Court of Chancery in this opinion explained that if it were aware that the Delaware Supreme Court decision would have allowed damages for full disgorgement under Brophy, then it would not have dismissed the Brophy claim in response to the motion to dismiss by the SLC.  See page 27.  Likewise, the court explained the impact of the Supreme Court decision on its application of the second prong of the Zapata analysis.  See page 32.

Standing of Derivative Plaintiff Post-Merger

●          The court recited the three-part test under the Delaware Supreme Court decision in Parnes to determine the standing of a derivative plaintiff to sue post-merger to challenge the fairness of the merger.  See pages 36 and 37.  On page 35, the court explained the basis for the claim in this case for alleging that the merger was not fair to the minority.

●          The court applied the three-part test to the facts of this case in a thorough analysis to determine the standing of derivative plaintiffs post-merger.  See pages 37 through 52.

●          Next, however, after determining standing, the court still had to address whether or not the complaint stated a claim.  That analysis was conducted from pages 52 to 60.

●          The court concluded that the claims for breach of fiduciary duty against KKR based on the grounds that the merger was not entirely fair to the minority in light of the fact that no value was assigned or given to the Brophy claim, would survive a motion to dismiss, and therefore the motion to dismiss as to that claim was denied.

●          The court also rejected a defense based on DGCL Section 102(b)(7) because such a defense is not available at this stage of the proceedings due to the loyalty aspect of the entire fairness claim, regardless of what the court described as “relatively insubstantial allegations of bad faith . . ..”

 

On June 20, 2011, the Delaware Supreme Court in Kahn v. Kolberg Kravis Roberts & Co., L.P., No. 436,2010 (June 20, 2011), reversed and remanded a decision by the Court of Chancery interpreting “a Brophy claim as explained in Pfeiffer.” Read opinion here. For those readers who do not practice in the Court of Chancery on a regular basis, the issue before the Court was whether a stockholder had to show that the company had suffered actual harm before bringing a breach of loyalty claim that a fiduciary improperly used the company’s material, non-public information (a Brophy claim).  The Supreme Court also rejected that part of the Court of Chancery’s decision in Pfeiffer v. Toll, 989 A. 2d 683 (Del. Ch. 2010), which required a showing of actual harm to the company. 

The plaintiffs are shareholders of Primedia, Inc., who appealed the Court of Chancery’s decision granting the Primedia Special Litigation Committee’s (“SLC”) Motion to Dismiss claims arising out of a series of alleged violations of fiduciary duty by defendants, Kohlberg, Kravis, Roberts & Co. (“KKR”), Primedia, Inc., and other Primedia officers and directors. In particular, the plaintiffs challenged the redemption of Primedia’s preferred stock.  The defendants moved to dismiss (which the Court denied) and then Primedia formed an SLC.  Thereafter, the litigation was stayed pending the SLC’s investigation. When the SLC investigation was completed the plaintiffs presented a new claim that the KKR defendants breached their fiduciary duty to Primedia by purchasing the preferred stock at a time when they possessed material, non-public information. The Court granted the SLC’s Motion to Dismiss and the stockholders appealed.  On appeal. the stockholders argued that the Court of Chancery erroneously held that, among other things, “disgorgement was not an available remedy for its Brophy claims, consistent with Pfeiffer’s holding.”

In discussing the Court of Chancery’s Zapata analysis (the standard that applies to an SLC’s motion to dismiss) the Supreme Court focused on the discretionary second prong of Zapata where the Supreme Court stated that “the Court of Chancery’s function under Zapata’s second prong is to “strik[e] a balance between ‘legitimate corporate claims’ as expressed in the derivative shareholder suit and the corporation’s best interest as ascertained by the Special Litigation Committee.” In reviewing the lower court decision, the Supreme Court noted that the Vice Chancellor started from “the proposition that there is a Brophy claim [] that would blow by a motion to dismiss on failure to state a claim.” Then the Vice Chancellor held that “under the law, as explained in Pfeiffer v. Toll, disgorgement is not an available remedy for most of the Brophy claims.° But, Pfeiffer’s holding which requires a plaintiff to show that the corporation suffered actual harm before bringing a Brophy claim—is not a correct statement of our law. To the extent Pfeiffer v. Toll conflicts with our current interpretation of Brophy v. Cities Service Co., Pfeiffer cannot be Delaware law.”

The Supreme Court went on to note that as “recognized in Brophy, it is inequitable to permit the fiduciary to profit from using confidential corporate information. Even if the corporation did not suffer actual harm, equity requires disgorgement of that profit.”  The Supreme Court also noted that it has previously cited Brophy approvingly when discussing how the duty of loyalty governs the misuse of confidential corporate information by fiduciaries in In re Oracle Corp. Deriv. Litig.867 A. 2d 904 (Del. Ch. 2004).  There the Supreme Court affirmed the Court of Chancery’s articulation of the elements essential for a plaintiff to prevail on a Brophy claim: “1) the corporate fiduciary possessed material, nonpublic company information; and 2) the corporate fiduciary used that information improperly by making trades because she was motivated, in whole or in part, by the substance of that information.”

In the end, the Supreme Court explained that it:

“decline[d] to adopt Pfeiffer’s thoughtful, but unduly narrow, interpretation of Brophy and its progeny. We also disagree with the Pfeiffer court’s conclusion that the purpose of Brophy is to ‘remedy harm to the corporation.’ In fact, Brophy explicitly held that the corporation did not need to suffer an actual loss for there to be a viable claim. Importantly, Brophy focused on preventing a fiduciary wrongdoer from being unjustly enriched.  Moreover, we have found no cases requiring that the corporation suffer actual harm for a plaintiff to bring a Brophy claim.  To read Brophy as applying only where the corporation has suffered actual harm improperly limits its holding….We decline to adopt Pfeiffer’s interpretation that would limit the disgorgement remedy to a usurpation of corporate opportunity or cases where the insider used confidential corporate information to compete directly with the corporation. Brophy was not premised on either of those rationales. Rather, Brophy focused on the public policy of preventing unjust enrichment based on the misuse of confidential corporate information.”

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

Supplement: Professor Stephen Bainbridge, a noted corporate law expert, kindly links to this post here, and provides his own scholarly analysis of this case here. A review of the case on The Harvard Law School Corporate Governance Blog is available here.

In the case of In Re Primedia, Inc. Derivative Litigation, 2006 WL 3365544 (Del. Ch. Nov. 15, 2006), read opinion here, the Chancery Court presents a "guidebook", based on settled bedrock principles of Delaware law, for the duties of controlling shareholders in an interested transaction. Although the duties of a controlling shareholder are not new at all, this opinion summarizes them neatly and applies them in the context of an intricate web of interlocking entities that the court drilled through with laser-like precision to find the controlling amalgamation of interest. Of course, the result of such a finding is that the defendants will not be entitled to the protection of the Business Judgment Rule. To the contrary, they will need to carry the burden of proving the entire fairness of the transaction in which they stood on both sides of the table. The transaction at issue was the redemption by the corporation of preferred shares owned by the controlling shareholder, at a handsome profit. The corporation, however, was not required to redeem the preferred shares for several more years. The common shareholders did not share in the lucre of the transaction. The court found this case to be squarely within the teaching of the hoary case (and its progeny) of Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971).

Also notable is the extensive discussion in footnote 45 of why the directors were considered by the court to be lacking in independence. Procedurally, the court observed that the motion to dismiss filed was under Rule 12(b)(6) and not based on Rule 23.1, thereby virtually conceding that the director defendants were not independent. In addition, the procedural hurdle of a 12(b)(6) motion is much easier for a plaintiff to overcome compared to a motion under Rule 23.1.

In my view,  a most memorable quote from the end of the court’s opinion addresses the point that the breach of the duty of loyalty in this context is considered so important as a matter of public policy, that even if the measure of damages caused by the breach is not entirely clear, the court will be flexible on that element, which ordinarily is an essential component to any case, after a breach is established. Here is the quote that I think is destined to be referred to often as a summary of this key concept:

If the plaintiffs ultimately prove such a breach of the duty of loyalty, this court should not unduly narrow the scope of their recovery.FN46 Even in a case where transactional damages are not present, a disloyal fiduciary may still be held liable for incidental damages.FN47 Concerns of equity and deterrence justify “loosen [ing] normally stringent requirements of causation and damages” when a breach of the duty of loyalty is shown.FN48 As the Delaware Supreme Court long ago noted, the duty of loyalty “does not rest upon the narrow ground of injury or damage to the corporation resulting from a betrayal of confidence, but upon a broader foundation of a wise public policy that, for purposes of removing all temptation, extinguishes all possibility of profit flowing from the breach of confidence imposed by the fiduciary relation.” FN49

[For the convenience of the reader, I am including below the footnote contents for the footnotes in the above quote.]

FN46. Thorpe v. CERBCO, Inc., 676 A.2d 436, 445 (Del.1996). FN47. Id. FN48. Id. (quoting Milbank, Tweed, Hadley & McCloy v. Boon, 13 F.3d 537, 543 (2d Cir.1994)).FN49. Guth v. Loft, Inc., 5 A.2d 503, 510 (Del.1939).