CURRENT MONTH (November 2024)
Delaware Chancery Court Answers Whether Directors of a Corporation Breached Their Fiduciary Duties by Approving a Cash-Out Merger That Rendered Common Stock Valueless
By Shawn Garrett, Founding Attorney, Garrett, PLLC
On October 30, 2024, the Delaware Chancery Court issued its opinion in Jacobs, et al. v. Akademos, Inc., et al., a suit concerning a merger that rendered the common stock of the target company, Akademos, Inc.(hereinafter “Corporation”), valueless. The Corporation, which served as an outsourced online bookstore for educational institutions, had multiple early investors who received common stock for their investments. The Corporation later received an injection of capital from a venture capital fund, which received preferred stock and promissory notes in exchange for its investment.
Facing challenges with growth, the Corporation attempted to attract additional investors with no success. The fund offered to acquire the Corporation in a cash-out merger scenario, wherein the equity interest holders would receive cash for their equity. Due to the liquidation preferences associated with the fund’s preferred stock and the repayment premiums associated with the Corporation’s debt, the deal would require the Corporation to achieve a valuation of $40 million prior to the common stockholders receiving anything for their equity interest; the contemplated merger was only valued at $12.5 million. The fund conditioned the merger on a passing vote of the Corporation’s three unaffiliated directors as well as a three-week go-shop period, allowing the Corporation to shop the offer freely. The directors voted in favor of the merger 2 to 1, and the go-shop period expired without the Corporation receiving a matching or competing offer. A group of common stockholders filed suit challenging the merger.
At trial, the plaintiffs argued that the directors of the Corporation breached their fiduciary duties by agreeing to the merger. The Court determined that a claim for breach of fiduciary duty against a director requires proof of two elements: (a) that a fiduciary duty existed and (b) that the director breached that duty. The Court held that the first prong was easily met, as courts have routinely held the fiduciary duty of directors as “axiomatic,” and determined this prong was met without question. As to the second prong, the Court noted that Delaware has three tiers of review for evaluating director decision-making: the business judgment rule, enhanced scrutiny, and entire fairness. The Court applied the entire fairness standard in this case. Utilizing this standard, the Court assessed the economic and financial merits of the transaction, considering all relevant factors, including whether the purchase price was fair, whether the dealings were conducted fairly, and whether the transaction was fair overall based on the factors presented at trial. In its analysis, the Court pointed to the reality that no competing offers had existed at multiple stages of the Corporation’s life cycle that would have brought value to the common stockholders. Both the Corporation’s valuation and history proved that the common stock would not realistically receive value in any scenario. The Court held that the defendants proved that their conduct was entirely fair, and judgment was entered in their favor on the breach of fiduciary duty claims.
