United States: Delaware Chancery Court Finds That Director Defendants Can Not "Merge Their Way Out Of" Breach Of Fiduciary Claims

Last Updated: August 9 2016
Article by Jennifer Poer, M. Todd Scott and Robert P. Varian

On July 28, 2016, the Delaware Chancery Court allowed claims of unfair dealing against the Board of property management company Riverstone National Inc. to survive where the directors facilitated a merger that forestalled a derivative suit against them. The court held that by orchestrating a merger that extinguished a possible derivative action, the director defendants obtained a special benefit for themselves. As a result, the directors were interested in the transaction, thereby rebutting the presumption of the business judgment rule, and triggering application of the "entire fairness" doctrine.

Prior to the filing of the unfair dealing suit, stockholders Michael C. Halpin and Michael Christian claimed that Riverstone's directors usurped corporate opportunities in breach of the duty of loyalty by taking for themselves opportunities properly belonging to Riverstone. Specifically, the shareholders accused the directors of individually investing in a multi-billion dollar home rental company that Riverstone helped to cultivate – Invitation Homes – without pursuing investment options for Riverstone.

Stockholders Halpin and Christian informed Riverstone of their concern that Riverstone's directors had breached their fiduciary duties by improperly depriving Riverstone of the opportunity to invest in Invitation Homes, and demanded that all equity interests in Invitation Homes owned by Riverstone directors be assigned and transferred to Riverstone. The stockholders also demanded that they be allowed to inspect Rivestone's books and records. After the company refused to make its books and records available, Halpin and Christian filed suit under Delaware General Corporate Law ("DGCL") Section 220 to compel Riverstone to provide the requested documents. That same day, Riverstone approved a $94 million merger deal with Greystar Real Estate Partners LLC. According to the shareholders, the merger agreement provided that the acquirers would release Plaintiffs' claims regarding the usurpation of corporate opportunities.

Halpin and Christian then filed the instant action, asserting claims of breach of fiduciary duties in connection with the merger. Among other things, Plaintiffs alleged that Riverstone's directors violated their fiduciary duties when they failed to obtain consideration for the value of the usurpation claims, which were assertable against the defendants derivatively prior to the merger, and extinguished pursuant to the merger agreement. According to Plaintiffs, the value of the usurpation claim was material in the context of the merger, and thus the merger price was unfair. The defendants moved to dismiss.

In his 46-page opinion, Vice Chancellor Glasscock first examined whether a majority of Riverstone's directors were interested, and therefore whether the complaint was sufficient to rebut the business judgment rule. The court found that Plaintiffs had plead particularized facts showing that the usurpation claims were viable and would have survived a motion to dismiss if brought against the directors prior to the merger. This finding was based on evidence that Riverstone was financially capable of investing in Invitation Homes, that the investment was within Riverstone's line of business, and that the company had missed a valuable opportunity due to the directors' actions. The court also found that there was evidence that Riverstone had an expectation that it would obtain an ownership stake in Invitation Homes in light of the significant time and resources Riverstone had dedicated to Invitation Homes' formation and development.

In considering director interestedness, the court further concluded that the directors knew that they were potentially liable for the usurpation claims when negotiating and recommending the merger; that the potential for liability was material to the directors; and that the directors approved a merger which precluded prosecution of the usurpation claims derivatively. In light of these facts, the court held that the company's right to sue "was not sold, but was obliterated, and the directors received a special benefit by the sale: relief from potential liability. Thus, according to the Complaint, the Director Defendants are not disinterested actors in the merger, and they are not entitled to the business judgment presumption."

Having found that Plaintiffs had adequately overcome the business judgment presumption, the court then considered whether defendants had established that the merger was the product of both fair dealing and fair price pursuant to the "entire fairness" doctrine. The directors argued that even if the merger price did not include value for the foregone derivative claims, those claims were not material. The court looked to the fact that the investment made by the directors in Invitation Homes totaled roughly $4.65 million as indicia of the value of the usurpation claims. Finding that the directors' investments represented roughly 5% of the gross merger consideration, the court found it reasonably conceivable that the usurpation claims were material and that the merger was not entirely fair. Therefore, Plaintiffs' complaint was sufficient to withstand the defendants' motions to dismiss.

The court's ruling serves as a warning about the dangers of attempting to expunge derivative claims in a merger agreement. However, shareholder plaintiffs should pay close attention to the facts of their case before using In re Riverstone National Inc. as a roadmap. Vice Chancellor Glasscock was careful to note that his ruling was based on the particularized and detailed facts pled by Plaintiffs in this case, and recognized that "[i]f a conclusory allegation – that a potential derivative suit against directors existed, but was extinguished by a merger – was sufficient to show that directors were interested in the merger, much ground for strike suits and other mischief would be possible."

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Jennifer Poer
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