CURRENT MONTH (March 2024)
Business Litigation
Delaware Supreme Court Denies MFW Protection Due to Committee’s Financial and Legal Advisors’ Undisclosed Ties with Controlling Stockholder
By K. Tyler O’Connell, Morris James LLP
Under Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) and its progeny, controlling stockholder squeeze-out acquisitions may be subject to deferential review under the business judgment rule if they are approved by a special committee of independent directors and a majority of the minority stockholders. In City of Dearborn Police and Fire Revised Ret. Sys. (Chapter 23) v. Brookfield Asset Mgmt., Inc., __ A.3d __, 2024 WL 1244032 (Del. Mar. 25, 2024), the Delaware Supreme Court considered en banc a stockholder challenge to Brookfield’s 2020 squeeze-out merger of TerraForm Power, Inc., and reversed a Court of Chancery decision granting the defendants’ motion to dismiss under MFW. While the Supreme Court rejected many of the plaintiffs’ grounds for appeal, it found that the proxy statement soliciting stockholder approval was materially misleading for failing to disclose that one of the special committee’s two financial advisors, Morgan Stanley, had invested $470 million in Brookfield and its affiliates. While the amount at issue (comprising roughly 0.1 percent of Morgan Stanley’s total investment portfolio) was not material to Morgan Stanley, and thus would not support a claim that the committee failed to exercise due care (i.e., was “grossly negligent”) in hiring Morgan Stanley, the Supreme Court reasoned the fact was material for purposes of disclosure obligations to stockholders. This was particularly so in light of the proxy statement’s disclosure that Morgan Stanley “may” have had unspecified investments in Brookfield. The Supreme Court similarly concluded that the proxy statement omitted material facts that the law firm representing the special committee had previously represented Brookfield in unrelated matters and was representing Brookfield in a current unrelated matter. The Supreme Court explained that, while it was not a breach of the duty of care for the special committee to hire the firm, an advisor’s “concurrent engagement with a transaction counterparty can present legitimate concerns” in the mind of a reasonable stockholder, particularly given the firm’s simultaneous duty to zealously represent Brookfield in the unrelated matter. Finally, the Supreme Court found the proxy statement was deficient for failure to disclose that, among other benefits from the transaction, Brookfield expected to receive an additional $130 million in management fees over the next five years. While the proxy statement accurately stated the formula for management fees, it did not disclose the inputs a reasonable stockholder would need to derive the expected gain. Accordingly, because disclosure violations undermined the cleansing effect of the stockholders’ majority of the minority vote for MFW purposes, the Supreme Court reversed the Court of Chancery’s decision dismissing the action and remanded the matter for further proceedings.
Tyler O’Connell is a Partner at Morris James LLP in Wilmington, Delaware. Any views expressed herein are not necessarily those of the firm or any of its clients.
Delaware Court of Chancery Grants Zapata Special Litigation Committee’s Motion to Dismiss Claims against Carvana’s Controlling Stockholders
By K. Tyler O’Connell, Morris James LLP
In In re Carvana Co. S’holders Litig., ___ A.3d ___, 2024 WL 1300199 (Del. Ch. Mar. 27, 2024), the Delaware Court of Chancery granted a motion to dismiss filed by a special litigation committee formed under Zapata Corp. v. Maldanado, 430 A.2d 779 (Del. 1981), which had concluded that derivative claims arising from Carvana’s controlling stockholders’ participation in a direct offering were not worth pursuing. In early 2020, Carvana’s board of directors explored options for an equity financing and began to negotiate a non–pro rata direct offering with an initial group of twenty-four large stockholders. A large third-party institutional investor led the buy-side negotiations. It was understood that Carvana’s controlling stockholders would also participate up to $50 million. After price negotiations, the parties agreed to a purchase of up to $600 million shares at $45 per share, which represented an 8.2 percent discount to the stock’s unaffected market price. The offer was oversubscribed. When stockholder-plaintiffs filed derivative claims, the Court of Chancery denied the defendants’ motion to dismiss, because the plaintiffs adequately alleged that three of Carvana’s six directors were either interested in the transaction or lacked independence from the controlling stockholders. Following that decision, Carvana’s board of directors formed a two-member Zapata special litigation committee (“SLC”) to investigate the claims and determine whether they should be pursued. The special committee retained independent legal and financial advisors, conducted its investigation, and then moved to dismiss the claims.
With respect to the first step of the Zapata inquiry, the Court found there were no material disputes of fact whether the SLC members were independent, or whether they conducted a reasonable investigation with sufficient bases for their conclusions. The plaintiffs failed to provide any information supporting that either committee member had material financial ties to the controller. The Court rejected plaintiffs’ argument that the fact the SLC hired one of two law firms recommended by the general counsel suggested a lack of independence; the Court explained, “Accepting a recommendation from management alone does not evidence a lack of independence . . . .” The fact the SLC members were defendants in two factually unrelated cases concerning Carvana that did not concern the direct offering at issue similarly did not compromise their independence. The Court also explained that an SLC member’s presence on the board when the corporation moves to dismiss derivative claims at the outset of the case does not in itself indicate any pre-judgment of the claims. The Court also found the SLC conducted an unbiased, reasonable investigation. The investigation included counsel’s review of documents, eighteen witness interviews, and nine SLC meetings, culminating in the Committee’s 170-page report. The Court rejected the plaintiffs’ arguments that the SLC’s counsel should not have run the investigation or spent far more time on it than the committee members themselves. One committee member’s statement that his schedule permitted only a “minimal” time commitment did not undermine the investigation, because the subsequent investigation was reasonable. The SLC’s financial advisor also concluded that the direct offering was fair to Carvana, and that if anything the controlling stockholders were worse off from the transaction due to the economic dilution of their holdings. With respect to Zapata’s second step, in which the Court applies its own business judgment to assess the SLC’s recommendation, the Court found that “a disinterested and independent decision-maker for the Company, not acting under any compulsion and with the benefit of the information available to the SLC, could reasonably accept the SLC’s recommendation to dismiss Plaintiffs’ claims.” The Court accordingly granted the SLC’s motion to dismiss.
Tyler O’Connell is a Partner at Morris James LLP in Wilmington, Delaware. Any views expressed herein are not necessarily those of the firm or any of its clients.
Dispute Resolution
The Second Circuit Finds COVID Furlough Suit Not Subject to Arbitration
By Leslie A. Berkoff, Partner and Chair of Dispute Resolution Practice Group, Moritt Hock & Hamroff LLP
In a March 13, 2024, decision in Staley v. Four Seasons Hotels and Resorts, a three-judge panel from the Second Circuit found that a suit brought by several former Four Seasons Hotel (“Hotel”) employees concerning a COVID-related furlough did not fall under the terms of their employment agreements (the “Agreement”) and denied a request by the Hotel to arbitrate the dispute. Staley v. Four Seasons Hotels and Resorts, No. 23-770, No. 23-771, 2024 WL 1090816, at *5 (2d Cir. Mar. 13, 2024). The workers had claimed that the Hotel had violated the federal Worker Adjustment and Retraining Notification (“WARN”) Act, as well as its state counterpart, when it furloughed them indefinitely at the beginning of the pandemic. As a result of the furlough, the workers were prevented from looking for other jobs, as they were told that if they secured other jobs, they would not receive no-fault separation payments from the Hotel.
The Court found that the terms of the Agreement limited arbitration of disputes to employees’ termination or constructive discharge but did not extend to permanent layoffs. The Court rejected an argument that the Agreement’s incorporation of the AAA’s rules—including Rule 6, which provides that “[t]he arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement”—did not by itself allow the arbitrator to make such a determination; rather, the Court held that while parties may contract to have arbitrators (rather than a court) decide whether a particular dispute is to be arbitrated under the terms of the contract, this needs to be done with specificity and clarity. In contrast, where an arbitration agreement contains “exclusionary language suggesting that the parties consented to arbitrate only a limited subset of disputes, incorporation of rules that empower an arbitrator to decide issues of arbitrability [i.e., AAA rule 6], standing alone, does not suffice to establish the requisite clear and unmistakable inference of intent to arbitrate arbitrability” (emphasis added).
The Agreement in question contained an arbitration provision that specifically carved out disputes regarding a “permanent layoff” from the types of claims to be arbitrated and instead was focused on termination or constructive discharge. In fact, the Court pointed to a specific section of the Agreement titled “No-Fault Separation Pay,” which provides that an employee “may not seek . . . arbitration of a permanent lay-off.” Once again, while arbitration is a construct to be supported and given deference, courts will not push this agenda when to do so will fly in the face of specific and contravening language in an agreement.
