United States: Delaware Court Of Chancery Underscores Heightened Pleading Standard Necessary To Support A Claim For Breach Of Fiduciary Duty In Connection With A Merger

In Houseman v. Sagerman, C.A. No. 8898-VCG, 2014 WL 1478511 (Del. Ch. Apr. 16, 2014), the Delaware Court of Chancery (Glasscock, V.C.) granted, in part, a motion to dismiss filed by certain directors and the financial advisor of Universata, Inc. ("Universata" or the "Company") arising out of the Company's merger with HealthPort Technologies, LLC ("HealthPort").  The Court's analysis serves as a reminder that a stockholder plaintiff must plead an "extreme set of facts" to support a claim for breach of fiduciary duty against a corporation's directors arising out of allegations that the directors breached their duty of loyalty as a result of the process used to approve a strategic transaction.  Although the allegations suggested that Universata's board of directors (the "Board") did not conduct a "perfect" process, plaintiffs did not plead facts sufficient to show that the Board "utterly failed to undertake any action to obtain the best price for stockholders."  As a result, the Court dismissed plaintiffs' claim for breach of fiduciary duty.

Universata was a Delaware corporation focused on providing services with respect to medical records for hospitals and clinics.  In 2006, plaintiffs sold a previous business known as Med-Legal, Inc. to Universata and obtained shares in the Company and put rights to those shares whereby a director of the Company, Thomas Whittington, committed to repurchase plaintiffs' shares pursuant to the put rights.

In 2010, HealthPort approached Universata regarding a potential acquisition.  In response to HealthPort's indication of interest, the Board consulted with its legal advisors and with KeyBanc Capital Markets, Inc. ("KeyBanc"), which it hired as its financial advisor.  Due to expense, the Board limited KeyBanc's engagement to assisting in diligence and identifying additional parties with an interest in acquiring the Company.  Notably, the Board did not request that KeyBanc prepare a fairness opinion on the proposed transaction.

In May 2011, the Board approved an Agreement and Plan of Merger between Universata and HealthPort.  As a result of the merger, the stockholders of Universata would receive $1.02 per share.  In addition the stockholders of Universata would receive stock in a new corporation known as "TechCo" created to hold a patent previously held by Universata.  At the meeting approving the merger, KeyBanc advisors informally gave the opinion that the merger price was within the range of reasonableness.  Because the directors who approved the merger collectively held a majority ownership interest in the Company, the Board did not solicit a stockholder vote to approve the transaction.  Nevertheless, at the same time as the Board approved the merger, it amended a previous equity incentive plan to treat all outstanding stock options like outstanding shares upon a change in control.  In addition, the Board voted to vest all outstanding "in the money" warrants for the purchase of shares in the Company.

Plaintiffs, who were a director of the Company and his wife, approved the letter of intent with HealthPort, but did not vote or execute a consent in favor of the merger.  Two years after the merger closed, plaintiffs filed a verified complaint against certain directors of Universata and against KeyBanc asserting causes of action for (i) breach of fiduciary duty against the director defendants; (ii) an accounting against director Whittington; (iii) quasi-appraisal against Universata and the director defendants; (iv) aiding and abetting a breach of fiduciary duty against KeyBanc; and (v) for failing to obtain consideration for alleged "litigation assets."  Defendants moved to dismiss.

The Chancery Court denied defendants' motion to dismiss the accounting claim.  With respect to the other claims, the Court granted, in part, and denied, in part, defendants' motion to dismiss.

Plaintiffs' breach of fiduciary duty claim was premised on the allegation that the director defendants acted in bad faith by "knowingly and completely fail[ing] to undertake their responsibilities" to maximize shareholder value.  Nevertheless, the Court noted that the directors satisfied their duty of loyalty by acting on the advice of legal counsel and hiring KeyBanc as their financial advisor.  Moreover, the directors were entitled to decide that the expense of obtaining a fairness opinion outweighed its benefits.  The allegations in the complaint showed that Board considered bids from several interested parties, negotiated with HealthPort regarding the deal terms, and ultimately obtained from HealthPort "everything that [the Board] felt [it] could get."  Plaintiffs failed to allege any facts to show that the directors had a motive to act in "bad faith."  To the contrary, the Court observed, the directors had a personal financial interest in obtaining the best deal possible, in alignment with the company's public stockholders.  Accordingly, the Court granted defendants' motion to dismiss plaintiffs' cause of action for breach of fiduciary duty.

The Court also dismissed the cause of action for aiding and abetting breach of fiduciary duty against KeyBanc.  It found that there were no allegations that KeyBanc actively concealed information from the Board.  In addition, KeyBanc did not aid or abet the Board's alleged breach of fiduciary duty as a result of providing "limited services."  Boiled to its essence, plaintiffs were arguing that "an investment bank must provide all or none of the financial services it offers in valuing and marketing a company."  The Court disagreed and recognized that "Revlon makes clear that there is no single way to sell a company — no single financial service is required."  Accordingly, the Court dismissed plaintiffs' aiding and abetting a breach of fiduciary duty claim.

The decision in Houseman confirms that stockholders face a high pleading burden when challenging a disinterested board's decision to approve a strategic transaction.  Although the Court recognized that the Board's process was "less than optimal," plaintiffs' allegations could state a claim only for a violation of the fiduciary duty of care.  The board's decision to proceed with the transaction despite several procedural deficiencies did not amount to an "extreme set of facts" sufficient to support a claim for breach of the duty of loyalty.

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