The plaintiffs alleged a quid pro quo arrangement in which Eagle’s Board excessively increased director compensation and executive compensation following a change in ownership.  plaintiffs described the amount of   director compensation as  “reach[ing] levels that were generally three to four times” previous amounts despite the absence of  any corresponding change in duties.  They likewise alleged that “hand in hand with the extraordinary rise in director compensation came skyrocketing executive compensation awards, bearing no relationship to Company performance”.  In addition, Eagle allegedly entered into a service agreement with Delphin, a company run by Eagle’s CEO, and Delphin did not provide Eagle with reasonable compensation for its services.  The defendants moved to dismiss the plaintiffs’ complaint on two grounds. First, the defendants claimed the plaintiffs failed to plead demand futility with particularity in accordance with FRCP 23.1.  Second, the defendants argued that they were protected by the business judgment rule, and they moved to dismiss the complaint for failure to state a claim under FRCP 12(b)(6).  

The defendants moved to dismiss the plaintiffs’ complaint on two grounds. First, the defendants claimed the plaintiffs failed to plead demand futility with particularity in accordance with FRCP 23.1.  Second, the defendants argued that they were protected by the business judgment rule, and they moved to dismiss the complaint for failure to state a claim under FRCP 12(b)(6).  

The court first analyzed the defendants’ motion to dismiss under FRCP 23.1.  Under Delaware law, a derivative action allows an individual shareholder to sue directors and executives on behalf of the corporation so long as the shareholder first demands action from the board and executives.  Absent a sufficient demand, the shareholder must prove the demand would be futile.  To prove futility, the court must find a reasonable doubt that either “the directors are disinterested and independent [or] the challenged transaction was otherwise the product of a valid exercise of business judgment.”  It is also possible for the court to treat a related sequence of transactions as a single transaction in order to find reasonable doubt.

In examining the independence and disinterest of the board, the court considered the plaintiffs  “quid pro quo” allegations.  In alleging a sufficient inference of a causal link between the director self- compensation and the compensation paid to the executives, plaintiffs were not limited to a single board meeting.  “If an inference of a quid pro quo arrangement could never arise from non-contemporaneous transactions, those engaged in such misdeeds could too easily render their malfeasance immune from the disinfecting sunlight of shareholder derivative actions, simply by spreading the transactions across multiple board meetings.”

The court found that plaintiffs had alleged the requisite inference.  “Considering the Directors' decisions together and given the particularized factual allegations in Plaintiffs' Complaint, the quid pro quo arrangement alleged by Plaintiffs is a reasonable inference and creates a reasonable doubt as to the disinterestedness of a majority of the Directors with respect to their decisions regarding executive compensation and Delphin.”  Therefore, the court denied the defendants’ motion for dismissal under FRCP 23.1.

The court then analyzed the defendants’ motion to dismiss under FRCP 12(b)(6).  In order to survive a FRCP 12(b)(6) motion to dismiss, a claim must be “plausible on its face” and must allow “the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.”  With respect to claims concerning director compensation, plaintiffs must allege “compensation rates excessive on their face or other facts which call into question whether the compensation was fair to the corporation when approved, the good faith of the directors setting those rates, or that the decision to set the compensation could not have been a product of valid business judgment”. 

The court found that the allegations were sufficient to “call into question whether the compensation was fair to the corporation when approved, the good faith of the directors setting those rates, or that the decision to set the compensation could not have been a product of valid business judgment.”  Moreover, the court noted that  “[l]ike any other interested transaction, directoral self-compensation decisions lie outside the business judgment rule’s presumptive protection….”  As a result, the “’initial burden’” of establishing fairness rested with defendants.  As a result, the court declined to dismiss the case under Rule 12(b)(6). 

The primary materials for this case may be found on the DU Corporate Governance website.

According to the plaintiff,  HP paid $55 million to settle a qui tam action alleging violations of the FCA, AKA, and TINA  but  did not admit liability.   The complaint alleged that HP “allowed violations to continue until December 2009.” Plaintiffs further alleged that HP’s Board of Directors (“Board”) approved compensation to the CEO in the amount of $30,332,527, even though there were “allegations that [the CEO] actively participated in the kickback scheme.”

The Board sought dismissal alleging plaintiff’s failure to make demand.  Plaintiff argued that demand would be futile.  In order for demand to be excused,  the complaint must contain  “particularized factual allegations sufficient to establish that either (1) any of the directors are interested and that other directors are compromised in their ability to act independently of the interested directors, or (2) that at least half of the directors face a sufficiently substantial threat of personal liability.” [cite]

The plaintiff argued that the initial demand was properly excused because the Board was not protected by the business judgment rule.  Plaintiff asserted that the Board became aware of illegal conduct through the 2007 DOJ suit, yet “failed to take action to stop the illegal conduct [until December 2009].” The plaintiff further argued that Board members were interested because they could face personal liability.

The court held that the fact a board is subject to investigation or “the mere threat of personal liability” is insufficient to allege a breach of fiduciary duties. The plaintiff must show that the directors “face a ‘substantial likelihood’ of personal liability” through “detailing the precise roles that these directors played at the company, the information that would have come to their attention in these roles, and any indication as to why they would have perceived [the alleged violation].” The court reasoned that the Board actually did take action in 2007 because it hired a consultant to investigate the allegations. HP also had a company policy in place prohibiting bribery, and the Board received regular reports regarding compliance.

The court also held that the plaintiff failed to show how the Board was “not adequately informed” or acted in bad faith when exercising its business judgment to award the CEO’s compensation.  As the court reasoned:

In the Complaint, Plaintiff does not show that Hurd's compensation was egregious or irrational. Plaintiff notes that the Board based Hurd's compensation on HP's 'superior financial results, as well as significant achievement on a broad range of non-financial goals, including strategic acquisition, talent management, and succession planning.' These standards of evaluation indicate that the Board did, in fact, act in good faith in determining Hurd's compensation.

The primary materials for this case may be found on the DU Corporate Governance website.

The proxy statement contained no explanation of the attendance record.  Quite the contrary. The proxy statement noted that the director's "experience in the private equity industry brings a long-term strategic perspective to the board’s deliberations."  This "perspective" apparently did not require actual attendance at meetings to be delivered. 

Nor was the attendance issue an isolated event.  In 2010, the same director also failed to attend 75% of the meetings.  This time, however, the proxy statement at least provided some additional information about his role in the governance process.   

[The Director] has regularly advised our directors and executive offices on various matters of significance, including financings and strategic transactions. [The Director] has also made arrangements to have a colleague observe board meetings he has been unable to attend personally and brief him on the proceedings of the board.

That year he received a majority of the votes cast by shareholders.

He did not meet the 75% threshold in 2009, see Sirius Proxy Statement, March 2010 ("During 2009, there were eighteen meetings of our board of directors and two written consents in lieu of a meeting. Each director, other than [the Director] attended more than 75% of the total number of meetings of the board and meetings held by committees on which he or she served."), and again failed to receive a majority of the votes cast.  See Current Report on Form 8-K,  June 1, 2010 (408,528,344 votes for,458,481,167 votes against). 

The Directors did not attend at least 75% of the meetings in 2008, see Proxy Statement, at 14 ("During 2008, there were nine meetings of our board of directors and one written consent in lieu of a meeting. Each director, other than [the Director], attended more than 75% of the total number of meetings of the board and meetings held by committees on which he or she served."), or in 2007.  See Proxy Statement, at 10. 

All of this raises serious questions about the board's fiduciary obligations.  In Business Roundtable v. SEC, the case that struck down the shareholder access rule, the court essentially noted that board had a fiduciary obligation to oppose candidates for the board that were not the most "appropriate."  While the court noted the obligation in the context of the board's "duty" to resist a shareholder nominee, the same obligation presumably applies to the nomination of directors in the first instance. 

In other words, the board has an obligation to show how the nomination of a director who has not attended at least 75% of the board meetings for years was in the best interests of shareholders. 

Then there was the reason given by the lower court -- that plaintiff "had not demonstrated a need to inspect the Covington Report sufficient to overcome the attorney-client privilege and work product immunity protections."  The lower court's reasoning had two problems.  First, it was hard to justify a finding of an absence of need.  The Report went to both the informed nature of the decision and the "red flags" available to the Board, something that implicated good faith. 

Second, the opinion was narrow.  It allowed for the withholding of the Report only when it conflicted with privilege.  Given that Chancery Court's characterization of the Report as potentially "helpful" to plaintiffs, cases dealing with similarly sensitive material that did not implicate privilege would likely be subject to disclosure. 

The Supreme Court, therefore, did not rely on the lower court's analysis.  Instead, it relied on common law standards designed to allow courts to limit the scope of an inspection.  In effect, the court concluded that "scope" was limited to those documents that were "essential" to the alleged purpose (corporate wrongdoing) and that plaintiff had not made a sufficient showing to justify disclosure of the Report.  See Id.  (Plaintiff has not "shown that the Covington Report is essential to his stated purpose, which is to investigate possible corporate wrongdoing."). 

The Court gave three reasons for affirming the right of the Company to withhold the Report.  First, the Report, according to defendants, "does not discuss the 'for cause' issue."   

• If the Covington Report discussed the "for cause" termination issue, then Espinoza's claim would stand on a significantly different footing. But, as HP represented to both the Court of Chancery and this Court, the Covington Report contains no discussion or analysis of the "for cause" issue.

In other words, the Court considered the absence of any specific language about a "for cause" dismissal to be outcome determinative.

Second, plaintiff had not shown "by a preponderance of the evidence" that the Report was "central" to the Board's decision to enter into the separation agreement, rather than terminate [the CEO] for cause."

• It is conceivable that the Board consulted the Covington Report when it deliberated whether or not to terminate Hurd "for cause." Even if that were so, it is undisputed that the Report was not prepared for the purpose of the Board considering the "for cause" issue. Nor does it otherwise appear from the record what role, if any, the Report actually played in the Board's termination decision.

The third reason given by the Court was that HP had already "disclosed the information contained in the Covington Report that is essential to Espinoza's Section 220 stated purpose."  This included "considerable documentation of the circumstances of [the CEO's] departure." The "considerable documentation" included records documenting much, if not all, of the misconduct that the Board's investigation uncovered and that the Covington Report chronicled." 

We will discuss the implications of the decision in the next post.  Primary materials for the case at the trial level can be found at the DU Corporate Governance web site.

The CEO informed the general counsel of the letter and the company initiated an investigation.  As the opinion described:

• The Board retained Covington & Burling to conduct the inquiry and, based on that firm's findings, to advise the Board accordingly. On July 28, 2010, the Board was presented with the Covington Report, which contained interim factual findings and analysis arising out of the Covington firm's investigation.

A week later, the CEO agreed to a confidential settlement.  The next day, the company announced the CEO's departure.  In the announcement, the board noted that the "internal investigation did not show that [the CEO] had committed sexual harassment" but did "reveal that [the CEO] had breached HP’s Standards of Business Conduct." The board approved a separation agreement that provided for "among other benefits, severance payments estimated as worth over $30 million."

Plaintiff sought documents to determine whether execution of the separation agreement violated the board's fiduciary obligations.  The company made some documents available, "subject to a confidentiality agreement". The disclosure (which the court described as "extensive documentation") did not include the Covington Report.   

Plaintiff sought to compel disclosure of the Covington Report.  According to the Court:

• Espinoza’s complaint alleged that he was entitled to relief because the Covington Report “uniquely detail[s] . . . the bases for the possible courses the Board evaluated and why it chose not to terminate Hurd for cause,” and that “[t]his information is unavailable from any other source.” Espinoza further claimed that that Report “contained the scope of the investigation, the investigative activities undertaken, findings of possible violations, and potentialdisciplinary options for HP.”

The Company declined to turn over the Report asserting that it was "protected from disclosure under the attorney-client privilege and work product immunity doctrine."

The Chancery Court sided with HP.  The Chancery Court conceded that the report contained information that "might be helpful to the plaintiff in that it is something the board considered in making its decision" but because it did not contain "the thought process of the board or any committee" it was "not necessary to the plaintiff's investigation into the board's thought process in deciding not to fire" the CEO for cause.  The lower court, therefore, took the position that, in failing to show necessity, plaintiff had not met its burden of overcoming the privilege.

As we will see in the next post, the Court found a way to allow the company to withhold the report but declined to follow the reasoning of the Chancery Court. 

Primary materials for the case at the trial level can be found at the DU Corporate Governance web site.

This case illustrates the approach.  The obligation to show that a document is "essential" or "central" falls on shareholders.  As the Court noted:

• Espinoza’s specific investigatory purpose is to “investigate why the Board paid tens of millions of dollars rather than dismiss [Hurd] for ‘cause.’” Espinoza bears the burden of proving that the information contained in the Covington Report is essential to that purpose, taking into account the books and records HP has previously furnished.

Shareholders are, of course, at a disadvantage.  They do not have a copy of the relevant documents and do not, therefore, precisely know their contents, making it harder to meet this requirement.  The companies know the contents and know the relative importance of the requested material but they do not have the burden.

One way to address this disparity is to have the document inspected by the court.  An in camera review can determine the overall importance of the contents. In that way, the courts do not have to rely on barriers imposed by difficult pleading standards but can actually resolve the matter on the merits. 

In Espinoza, however, there is no evidence in either opinion, the one by the Chancery Court or the one by the Supreme Court, that either court ever actually examined the Covington Report.  They were therefore prepared to make findings about the "essential" nature of the document without ever actually examining the contents. 

The Supreme Court in Espinoza hinted that this was problematic.  As the Court stated:  "In a dispute over the contents of the demanded materials, in camera inspection by the trial court may be appropriate to reach a decision."  Id. at n. 20.  Presumably this is designed to encourage trial courts to actually examine the relevant document in these sorts of circumstances. 

Nonetheless, as this case illustrates, in camera inspections are not required.  In these circumstances, it will be the pleading standards rather than the actual merits that determine the outcome of the issue. 

The Delaware courts, however, have generally interpreted "proper" in a narrow fashion.  Rare exceptions aside (see City of Westland v. Axcelis), they require shareholders to mostly allege that the records are necessary to investigate possible wrongdoing.  Wrongdoing in turn means breach of fiduciary obligations. 

That by itself limits the availability of inspection rights.  Shareholders cannot inspect matters that are simply important, whether a major shift in business or a material acquisition.  They cannot look at compensation matters unless the purpose is to investigate wrongdoing. 

In addition, the courts have grafted onto the statute a requirement that shareholders present a "credible basis" for any purpose alleged.  Delaware courts represent that the "credible basis" standard is a low one but in fact it is a common basis for dismissing claims.  This is because, as Seinfeld illustrates, the courts do not permit shareholders to obtain documents when the facts speak for themselves (that case involved allegations that the company paid $200 million in compensation to three officers over a three year period).

Instead, they require affirmative evidence of a breach of fiduciary duties.  Given that a breach often requires a showing of a procedural deficiency, this type of evidence can be difficult to allege at a pre-discovery stage. 

Finally, if plaintiffs want to inspect and the company declines, Delaware does not automatically permit shareholders to recover litigation costs.  Instead, they must assert and establish "bad faith" by the company, a standard that makes recovery of fees very difficult. 

Nonetheless, sometimes shareholders succeed in presenting a proper purpose and in producing the requisite "credible basis."  In those circumstances, they can typically obtain such antiseptic documents as board minutes and meeting agendas.  Because these documents are often "thoroughly advised," they are likely to be written in a manner that reveals as little as possible.  See Mercier v. Inter-Tel (Del.), Inc., 929 A.2d 786, 797 (Del. Ch. 2007) ("The meeting was clearly and thoroughly "advised," shall we say, and the meeting minutes do not reflect the obvious reality driving the need for the meeting: the Merger was going down to defeat the next day.").

There are other documents, however, that may be exceedingly sensitive and important.  Investigative reports are an example.  Often when the board has concern with possible misbehavior inside the corporation it will commission an investigation.  This is sometimes necessary to meet the board's fiduciary obligation of good faith.  The investigations are commonly conducted by lawyers and may well be written in a manner that is "thoroughly advised."  Nonetheless, while one cannot generalize about all reports, it is likely the case that they will at least sometimes contain highly sensitive information about the behavior under investigation. 

In Espinoza v. HP, the Delaware courts confronted an inspection request for an investigative report.  Plaintiffs had a proper purpose for seeking the report and met the "credible basis" standard.  Both the Court of Chancery and the Delaware Supreme Court nonetheless concluded that shareholders could not obtain the report, although the two courts did not agree on the basis for the determination. The Supreme Court in the end denied access by imposing onerous standards that plaintiffs must meet in describing the relevant records that ought to be disclosed once a proper purpose and credible basis has been established. 

We will examine the Supreme Court's decision in the next few posts. 

Posts on the Chancery Court decision begin here.  Primary materials for the case at the trial level can be found at the DU Corporate Governance web site.

The court held that this was not a sufficient red flag to put the board on notice that the subsidiary “systematically and continuously engaged in illicit conduct.”  In doing so, the court emphasized language in the settlement disclaiming wrongdoing.  The court pointed to a statement that the company "denies that any of the payments, services, or renumeration were illegal, improper, or resulted in any false or fraudulent claims."  Similarly, the agreement stated that it was "neither an admission of any facts or liability by DePuy nor a concession by the United States that its claims are not well founded."

As a result, the court concluded that it was "not clear whether the settlement itself suggested to the Board that DePuy had engaged in illegal behavior.”  As for the amount of the settlement, the court also found this ambiguous.  

• Of course, one could argue that the Board should have known from the large amount of the settlement—$85 million— that DePuy must have engaged in illicit conduct. But, on the other hand, the Board may have reasonably concluded that the settlement reflected nothing more than a business decision on DePuy's part. Even if the directors assumed that the settlement was merely a business decision, and that the directors' assumption was erroneous, nonetheless they would not be subject to liability if they made that assumption in good faith.

As a result, "the Court cannot infer from Plaintiffs' allegations that the Board knew that the DPA related to an Anti-Kickback Statute violation."

Plaintiffs, therefore, successfully alleged that the board knew about the settlement with the government and the $85 million payment but the court found that this did not amount to a "red flag."  In other words, the board had no duty to investigate or otherwise become informed even when learning of these developments. 

For primary materials on this case, go to the DU Corporate Governance web site.

Plaintiffs did more than attribute knowledge to the board through a committee.  Plaintiffs also asserted that the board was aware of "red flags" by virtue of the information disclosed by the company in its annual report on Form 10-K.   Plaintiffs pointed out the annual report disclosed the receipt of a subpoena from the United States Attorney's Office, District of Massachusetts “seeking documents related to sales and marketing of eight drugs to Omnicare, Inc., a manager of pharmaceutical benefits for long-term care facilities.”

The court more or less accepted that disclosure in the annual report was sufficient to put the board on notice of the subpoena.  Instead, however, to be a red flag, "the pertinent question is not whether the Board knew about the subpoena but whether the subpoena is a determination of wrongdoing."  The disclosure in the annual report did not mention kickbacks “nor does it suggest that J&J or its subsidiaries acknowledged wrongdoing.”  As the court summarized:

• At least one court has suggested that subpoenas, and other forms of preliminary matters in an investigation of corporate misconduct, do not shed light on whether the corporation actually engaged in misconduct.  I find this reasoning persuasive because such red flags do not suggest that a board was aware of corporate misconduct—they suggest only that the board was aware that the company was under investigation.

Similarly, the plaintiffs also alleged that the board was aware of the violations because of the disclosure of two qui tam suites in the annual report on form 10-K.  The court, however, held that disclosure in the annual report alone was not enough. 

• “Noticeably absent from Plaintiff's allegations, however, are any facts indicating that the Board received copies of the qui tam complaints. To the extent the existence of the suits is reported in a 10-K form, that does not communicate to the directors anything about the nature of the claims asserted.  Without that information, the Court cannot discern whether the Board knew that . . . kickback behavior [continued] after the 2005 subpoenas were issued.”

The court, therefore, held that directors have no duty to inquire or investigate when they learned that a subpoena had been issued by a regulatory body capable of bringing criminal charges. In other words, notice of a potential criminal investigation was not enough to trigger a duty by the board to look into the matter. 

The holding demonstrates a central weakness in the board's fiduciary obligations.  Even when aware of an investigation there is no duty to investigate.  The approach encourages a "head in the sand" approach to management.  Moreover, the court's decision also encourages the company (and the board) to make minimal disclosure whenever an investigation occurs.  The less disclosed, the less likely knowledge will be attributed to the board. 

For primary materials on this case, go to the DU Corporate Governance web site.

Plaintiff argued that the board ignored red flags alerting them to corporate misbehavior.  Some of the red flags arose out of alleged kickbacks paid by the company in connection with an off-label marketing scheme. As evidence of the red flags, plaintiffs asserted that the company had received a subpoena from the US Attorney’s Office and that employees had testified before a grand jury. 

Plaintiffs did not allege that the board had been directly informed of these events.  Instead, plaintiffs contended that these facts could be attributed to the board through a committee.  The Public Policy Committee consisted of two directors and a number of officers of the company, including the General Counsel and the Chief Compliance Officer. 

Plaintiff suggested that the directors learned of the subpoena and investigation from the officers serving on the committee.  According to the complaint: 

• "The members of the Public Policy Advisory Committee were regularly apprised by the General Counsel and other senior executives of the Company of regulatory affairs and compliance matters affecting the Company regularly reported to the full Board concerning significant issues and concerns arising at the committee’s meetings.

Complaint, P. 299.  Similarly, the chief compliance officer provided "a critical additional source of reporting and information to this committee and, through it, the entire Board."

The court, however, declined to accept the reasoning.  Membership on a committee was not enough to establish knowledge by the board.  As the court reasoned: 

• Contrary to Plaintiffs' assertion, New Jersey and Delaware-based courts do not infer Board knowledge from committee membership alone. While other courts have looked solely to committee membership, Plaintiffs have not pointed to any authority from courts in New Jersey or Delaware for that proposition. Indeed, New Jersey and Delaware-based courts require Plaintiffs to allege, with particularity, how often the committee and the Board met, who on the committee communicated the corporate misconduct to the Board, and how the Board responded to the information provided to them. . . . 

The court, however, relied on cases that were not on point.  The case law in this area has generally involved committees that consist entirely of directors.  Efforts have been made to attribute knowledge to these directors solely because they serve on the audit or risk committee.  Courts, however, have declined to accept this reasoning and have instead required that plaintiffs produce evidence suggesting that the relevant information was actually communicated to these directors.

In this case, however, plaintiffs were essentially asserting that officers on the committee were aware of the investigation (presumably by virtue of their position) and that the information was conveyed to the directors as part of the function of the committee.   Thus, the issue was not whether knowledge could be attributed to directors solely because they served on a committee.  The issue was whether plaintiffs had adequately alleged knowledge of the developments by some on the committee and whether plaintiffs had sufficiently alleged that the information had been conveyed to the directors on the committee.  The court did not really address this issue.

For primary materials on this case, go to the DU Corporate Governance web site.

The two main components of the analysis is knowledge of the concern and an intentional decision not to act.  Because shareholders usually bring these cases in instances where the board did not act, the salient issue is typically whether the board knew about the problem.  The rubric here is whether the board was aware of sufficient red flags to be on notice of the problem.

Finding a potential breach of good faith is significant.  With waiver of liability provisions ubiquitous (see Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom) it is significant that the provisions do not extend to violations of good faith. 

A recent case that looked to New Jersey law but in actuality applied Delaware law, see In re Johnson & Johnson Derivative Litigation, 2011 US Dist. Lexis 112292 (D NJ Sept. 29, 2011) (noting that court "draw[ing] on case law from Delaware”), shows how far the courts have gone to exonerate directors from any oversight responsibility. 

The case turned on the application of the Rales variation of the Aronson test.  To get past the pleading threshold, plaintiffs had to show the absence of a disinerested and independent board.  One way to do so was to show that a majority of the board faced a "substantial likelihood' of personal liability".

Such an approach requires the court to assess the strength of plaintiffs' claim for breach of fiduciary duty.  This in turn requires the court to determine whether in fact the plaintiffs have sufficiently alleged that the board knew of "red flags" concerning corporate misconduct.  We'll look at these "red flags" in the next few posts.  

For primary materials on this case, go to the DU Corporate Governance web site.

The sale process began on July 16, 2010, when to Citi Venture Capital International (“CVCI”) made an unsolicited bid to acquire Ness Technologies, Inc. (“Ness”).   A special board committee that excluded the one director “appointed” by CVCI was created to deal with the offer.  The four disinterested directors also relied on legal and financial advisors, specifically Ropes & Gray LLP as legal advisor and Jefferies & Co. as the financial advisor.  . 

The special committee attempted to negotiate a higher price with CVCI but negotiations ended in September 2010.  After the negotiations ended, the special committee contacted a total of 27 strategic and financial buyers and obtained confidentiality agreements from  three additional potential buyers. 

The three buyers offered between $6.40 and $6.70 per share to acquire Ness. In January 2011, a fourth bidder (“Bidder D”) entered the scene offering between $6.50 and $7.00 per share.  On March 16, 2011, following Bidder D’s increased bid of $7.40 per share, Ness and Bidder D entered into an exclusivity agreement.  On March 31, 2011, CVCI returned with an unsolicited expression of interest in acquiring Ness at $7.75 per share.  When Bidder D’s exclusivity agreement expired on May 20, 2011, Bidder D lowered its bid to $7.00 per share.  CVCI confirmed the offer of $7.75 per share and the parties entered into a confidentiality agreement on May 25, 2011.  Ness and CVCI announced their merger agreement on June 10, 2011. 

Plaintiff sought expedited discovery.  The court first addressed the plaintiff’s “concerns” over the sale process but concluded that the allegations had not sufficiently shown a colorable claim that the price or the process were unfair to the shareholders.  As the court noted:

This sale process lasted eleven months, involved approximately thirty potential bidders, and resulted in a sale price that is $2.00 per share higher than the price at which CVCI originally expressed its interest in acquiring Ness, higher by at least $0.65 per share than any other bidder was willing to pay, and 68% higher than Ness's stock price on day before potential acquirors' interest in Ness became public. There is little in the Plaintiffs' allegations to suggest that either the price of, or the process leading up to, the Proposed Transaction were unfair to Ness's shareholders.

Plaintiff also alleged a possible conflict of interest between the financial advisor used by the special committee and CVCI.  Specifically, Jefferies and its affiliates allegedly provided “financial advisory and financing services” for CVCI and related companies.  The court conceded  that “if the amount of business involved would be material to either of the advisors, the Plaintiffs might have a colorable claim” and therefore granted the right to expedited discovery to determine whether the past, present, or future dealings between the advisors and CVCI created a conflict of interest. To the extent the relationships were material, a disclosure issue could exist.

The plaintiff’s requests for additional detail regarding Ness’ continued performance, additional detail regarding the financial advisors selection of comparable companies, and a detailed description of the sale process were dismissed by the court.  The court determined that the “shareholders are not entitled to a ‘play-by-play’ description of the merger negotiations.”  Based on the foregoing reasons, the court granted the Plaintiff’s Motion for Expedited Proceedings limited to whether the advisors to the board and special committee were conflicted because of their relations with CVCI.       

The primary materials for this case may be found on the DU Corporate Governance website

• It appears that counsel for the Board was so influenced by the fact that a majority of the Board were defendants in the Derivative Claims that counsel essentially told the Board not to give any weight to the pendency of those Claims in determining whether to do a deal with Alpha. Although the record is not clear, the plaintiffs themselves embrace the notion that the Board was told that the Claims would survive the Merger but that control over the Claims would pass to Alpha. The defendants also admit that the Board did not value the Derivative Claims and that the Advisory Committee set up to investigate whether Massey should pursue those Claims stopped its work when the Merger negotiations got serious.  As a result, one cannot conclude that the Massey Board was presented with a reasoned analysis of the “value” of the Derivative Claims.

The court went on to list "the better practice" that the board could have used in considering the derivative claims. 

• No doubt the better practice would have been to have had the Advisory Committee, whose members are not defendants in the actions based on the Derivative Claims, consider the extent to which the Derivative Claims were an economic asset (even in the sense of arguing to Alpha that its concerns about ongoing liability were overstated because of the possibility to shift costs to the derivative action defendants), with the advice of the Advisory Committee’s own advisors, who were not in the awkward position of also representing Massey Board members in the Derivative Claims, like Cravath.

But in the end, the consequences of this criticism and failure to engage in the better practices was the court's determination that it should withhold its "applause" from the board.  See Id.  ("In acknowledging what seems to me to be an economic reality, I do not mean to applaud how the Massey Board dealt with the Derivative Claims in considering whether to sell the company.").  It is a price many companies will be willing to incur.

Primary materials in this case can be found at the DU Corporate Governance web site.

This case addresses to some degree the possibility of mismanagement by officers and directors.  The court, however, puts at least some of the blame on shareholders.  As a result to the extent that shareholders are not made whole, this may well be an example of "justice."  Why?  Because in effect they encouraged the alleged misdeeds of the board.

• Remember that to the extent that Massey kept costs lower and exposed miners and the environment to excess dangers, Massey’s stockholders enjoyed the short-term benefits in the form of higher profits.  The very reason for laws protecting other constituencies is that those who own businesses stand to gain more if they can keep the operation’s profits and externalize the costs. Thus, the stockholders of corporations, especially given the short-term nature of holding periods that now predominate in our markets, have poor incentives to monitor corporate compliance with laws protecting society as a whole and may well put strong pressures on corporate management to produce immediate profits. . . . Stockholder pressure to produce profits might increase the already well-known risk that profit-seeking entities have incentives to take the profits of their operations for themselves and externalize the risk of operations to others, be it to their workers or society as a whole in the form of environmental degradation.

In other words, the court is effectively saying that shareholders pressured management into cutting corners because of the need for short term profits.  So, when the cost cutting results in harm, shareholders should harness some of the blame and not be made whole.  Justice is in fact done.

The conclusion is driven by the observation that short term holdings "predominate."  This is an unsupported assertion.  But it is the view of the Chancery Court.  The approach allows the court to blame shareholders for board misbehavior.  Shareholders collectively want short term profits and will pressure management to get them.  Management that then cuts corners to obtain short term profits is really only doing what shareholders have pressured them to do.   

The view is wrong for many many reasons.  It ignores the fact that management benefits from short term profits through increases in compensation.  It ignores the fact that many institutional investors are in for the long term.  The "justice" of not making shareholders whole, therefore, is extended not only to the short term investors who are blamed for the cost cutting but the long term investors who are not. 

It ignores the fact that even the investors motivated by profit maximization in the short term would not favor cost cutting that could lead to substantial liability.  While they may benefit if they happen to invest when the cost cutting is taking place, they will be harmed if they own shares when the liability is uncovered.  In effect, the court is attributing to investors a goal of short term profit maximization that results in a form of Russian roulette.

There is no question that management must keep an eye on profits.  But this does not mean that any action that increases profits in the short term is appropriate or favored by shareholders, even those with a short term horizon.  Yet that is, apparently, the view of the Delaware courts.   

Primary materials in this case can be found at the DU Corporate Governance web site.

But of course this is largely a mythical power.  Shareholders have little actual ability to remove directors from office.  The plurality system of voting dictates that management's slate will invariably be elected, even if shareholders have considerable concern over the board's performance.  Indeed, the fact that shareholders can withhold their vote (the equivalent of a no vote) is only because it is a requirement of federal, not state law. 

And while majority vote provisions have become popular, they do not give shareholders any meaningful say in board membership.  In Delaware, they result in a letter of resignation that give the board, not shareholders, the authority to decide the membership issue.  Efforts to increase shareholder authority in this area through access to the proxy statement has been vigorously opposed by the state of Delaware.

In other words, the authority doesn't exist yet it is trotted out as an appropriate remedy for shareholders.  It ought to be an appropriate remedy but in Delaware it is not. 

Primary materials in this case can be found at the DU Corporate Governance web site.