Among the most important recent developments in Delaware corporate law is the establishment (or re-establishment) of the potentially case-dispositive impact of an affirmative stockholder vote in M&A litigation. The Supreme Court of Delaware’s 2015 decision in Corwin v. KKR Financial Holdings LLC held that a fully informed vote in favor of a transaction by disinterested stockholders invokes the application of the business judgment standard of review. Given that application of the deferential business judgment standard of review renders the challenged transaction almost certainly immune from further judicial scrutiny, it is difficult to overstate Corwin’s impact. Few cases survive Corwin’s application, an unsurprising result given that a faithful application of the doctrine places a significant burden on a stockholder plaintiff to allege, without the aid of discovery, a material omission or misstatement in connection with a stockholder vote. Due to this trend, the Delaware Supreme Court’s decision in Morrison v. Berry, which reversed a Court of Chancery decision dismissing a merger challenge based on Corwin, presents an important step in the continued development of the Corwin doctrine. As discussed below, it is apparent that Delaware’s high court expects the Court of Chancery to apply Corwin in a careful, searching manner that is consistent with the plaintiff-friendly motion to dismiss standard. Indeed, Morrison is the second of two recent Delaware Supreme Court cases (the first being Appel v. Berkman) that stress the careful application of Corwin.
The Corwin Decisions
Stockholders of KKR Financial Holdings LLC (KKR Financial) challenged its acquisition by KKR & Co., L.P. (KKR), alleging breaches of fiduciary duty against KKR, as controlling stockholder, and KKR Financial’s board. In opposing the defendants’ motion to dismiss, the plaintiffs argued that the entire fairness standard of review should apply because KKR was allegedly a controlling stockholder of KKR Financial and because, with respect to the claim against KKR Financial’s board, the complaint contained sufficient allegations to rebut the business judgment standard of review.
The Court of Chancery granted the defendants’ motion in full. Regarding plaintiffs’ claim against KKR, the court held that KKR was not a controlling stockholder and therefore owed no fiduciary duties to KKR Financial or its stockholders. As to the claims against KKR Financial’s board, the court first held that the complaint failed to allege facts sufficient to rebut the business judgment rule. Although the court could have ended its decision there, it went on to hold that, even if the complaint had adequately alleged such facts, “business judgment review would still apply because the merger was approved by a majority of disinterested stockholders in a fully-informed vote.” The Supreme Court of Delaware affirmed, likewise holding that “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.”
Fully Informed Stockholder Vote
Given that the plaintiffs in Corwin did not allege that the merger-related disclosures were deficient or contest the defendants’ argument that the business judgment rule was invoked by virtue of the affirmative stockholder vote, the Corwin decisions did not discuss what constitutes a “fully informed” stockholder vote sufficient to invoke the business judgment standard of review. In subsequent decisions by the Court of Chancery, the court has looked to the existing standards under Delaware law in the context of disclosure-based fiduciary duty claims regarding what is or is not material to the stockholders’ decision-making. Where a plaintiff adequately alleges that the merger disclosures were materially incomplete or misleading, the court has found that the stockholder vote was not fully informed.
Morrison v. Berry
The action relates to the 2016 acquisition of The Fresh Market (the Company) by Apollo Global Management LLC (Apollo) through a tender offer. Apollo submitted an unsolicited offer to acquire the Company in October 2015, noting that it had discussed the proposal with Ray Berry, the Company’s founder and a member of the board who, together with his son Brett, owned 9.8 percent of the Company’s outstanding stock. After a five-month process, a special committee of the board and the board recommended a transaction with Apollo that involved a tender offer and an equity rollover by Ray and Brett Berry. The tender offer closed in April 2016 with over 68 percent of outstanding shares validly tendered.
Following the announcement of the tender offer, a stockholder of the Company demanded books and records under section 220 of the Delaware General Corporation Law, through which she received “several key documents,” including board minutes and e-mails between Ray Berry’s counsel and Company counsel. The stockholder then filed suit alleging breaches of fiduciary duty against the board and a claim for aiding and abetting breaches of fiduciary duty against Brett Berry. The defendants moved to dismiss under Corwin, which had been applied to tender offers in an earlier Court of Chancery decision captioned In re Volcano Corp. Stockholder Litigation. The stockholder plaintiff argued that Corwin did not apply because the Company failed to disclose all material facts in its Schedule 14D-9; therefore, the stockholders’ decision to accept the tender offer was not fully informed. In a short letter opinion, the Court of Chancery granted the motion to dismiss, ruling that the alleged disclosure issues were immaterial and that the action was “an exemplary case of the utility of th[e] ratification doctrine, as set forth in Corwin and Volcano.”
On appeal, the Delaware Supreme Court reversed, finding that the stockholder plaintiff alleged four disclosure deficiencies that rendered the 14D-9 materially incomplete and misleading.
First, the Supreme Court concluded that the complaint adequately alleged that the 14D-9 omitted material information about Ray Berry’s agreement with Apollo and his representations to the board about the agreement. After withdrawing its initial offer, Apollo renewed its offer on November 25, 2015. A November 28, 2015 e-mail from Berry’s counsel to Company counsel read that Berry had one conversation with Apollo in the interim, during which “he agreed, as he did in October” to roll over his equity if Apollo reached an agreement with the Company. The 14D-9 did not include any reference to an agreement between Berry and Apollo in October. Whereas the Court of Chancery determined that this information was not material because Berry’s “position as of the time of the auction process and go-shop—that is, at the time material to stockholders—was adequately disclosed,” the Supreme Court determined that this information was material, especially in light of the 14D-9’s disclosure that Berry stated during an October 15 board meeting that he had not committed to a transaction with Apollo. The Supreme Court held that a reasonable stockholder would want to know both about Berry’s “level of commitment” to Apollo in October and that Berry was not forthcoming with the board about that commitment.
Second, the Supreme Court held that the 14D-9 was materially misleading because it included statements that Berry was open to considering other bidders and rolling over his equity in such transactions. The minutes from the board’s October 15 board meeting indicated, however, that Berry only committed to rolling over his equity if he was confident in the purchaser’s experience in the retail food industry, and he stated that Apollo was “uniquely qualified” in that respect. Without specifically addressing this alleged disclosure deficiency, the Court of Chancery held that Berry’s involvement with and commitment to Apollo was adequately disclosed. In contrast, the Supreme Court reasoned that stockholders would want to know facts suggesting that Berry preferred Apollo because these facts concern “the openness of the sale process.”
Third, the Supreme Court focused on statements in the November 28 e-mail from Berry’s counsel to Company counsel that Berry believed the board should pursue a sale of the Company “at this time,” and that he would sell his shares if the board failed to act. The Court of Chancery concluded that the omission of these facts from the 14D-9 was not material because “it would not have made investors less likely to tender.” The Supreme Court emphasized that the materiality standard considers whether there is a substantial likelihood that a reasonable stockholder would have considered the omitted fact important—not whether it would have caused the stockholder to change his or her vote. To this end, the Supreme Court held that stockholders “would want to know the rationale that Ray Berry gave the Board in encouraging it to pursue the sale, as well as his communication of his intent to sell his shares if such a transaction were not consummated.” In so reasoning, the Supreme Court cited to the decision it issued earlier this year in Appel v. Berkman, which held that the Schedule 14D-9 issued by Diamond Resorts International was materially misleading because it omitted information about why the company’s founder, chairman, and largest stockholder abstained from voting on proceeding with merger discussions. The company’s founder abstained because he thought mismanagement of the company had depressed the sale price and it was the wrong time to sell the company—facts the Supreme Court concluded would have been of interest to stockholders. Likewise, in Morrison, the Supreme Court held that stockholders would have been interested to know Berry’s rationale for pursuing the Apollo transaction.
Finally, the Supreme Court held that the 14D-9 was materially misleading in that it stated the Company created a special committee in October 2015 because it “could become the subject of shareholder pressure,” when in fact the contemporaneous board minutes reflected that the Company had already encountered “a significant amount” of stockholder pressure. The Supreme Court reasoned that, because the Company chose to address why the special committee was created, “stockholders were entitled to know the depth and breadth of the pressure confronting the Company” and that “it already existed.”
Because the 14D-9 was materially incomplete and misleading, the Supreme Court concluded that the stockholders’ decision to tender their shares was not fully informed, and the business judgment standard did not apply under Corwin. In so holding, the court warned directors and the attorneys who advise them to avoid “partial and elliptical disclosures,” which “cannot facilitate the protection of the business judgment rule under the Corwin doctrine.”
- Morrison demonstrates the Supreme Court’s willingness to closely scrutinize a company’s contemporaneous documents to see if they support the facts disclosed to stockholders. The court’s apparent willingness to so scrutinize the underlying record appears motivated by its recognition that “[c]areful application of Corwin is important due to its potentially case-dispositive impact.”
- In light of the court’s willingness to carefully examine the underlying record, Morrison reminds practitioners of the importance of full and accurate disclosures. This is especially so considering stockholder plaintiffs’ growing reliance on section 220 of the Delaware General Corporation Law as a means of avoiding dismissal by showing discrepancies between the record and the disclosures.
- Particular attention should be given to disclosures relating to the motivations and analysis of key board members and stockholders, given the Supreme Court’s decisions in Morrison and Appel.