United States: Chancery Court Denies Motion To Dismiss Fiduciary Duty Claims Where Directors Approved Merger That Extinguished Threatened Derivative Claims

Last Updated: September 5 2016
Article by Jason M. Halper and Gregory Beaman

On July 28, 2016, the Delaware Court of Chancery held that stockholders of Riverstone National, Inc. had adequately stated a breach of fiduciary duty claim against the company's directors who approved a merger that extinguished threatened derivative claims against them.  See In re Riverstone Nat'l, Inc. S'holder Litig., C.A. No. 9796-VCG (Del. Ch. July 28, 2016).  The court concluded that the plaintiffs had sufficiently rebutted the business judgment rule and stated claims under "entire fairness" review because they alleged that a majority of Riverstone's directors had usurped a corporate opportunity by personally investing $4.65 million in other companies operating in Riverstone's general line of business, knew that Riverstone's shareholders were investigating potential derivative claims against them in connection with those investments, and nonetheless proceeded to negotiate a sale of the company for $94 million to an acquirer that agreed not to pursue any litigation against them, including, by implication, the threatened usurpation claims.  In re Riverstone is a cautionary reminder to directors that self-interested motives for negotiating mergers and other transactions will be subject to enhanced scrutiny, and may even lead to personal liability in the event directors are found to have acted disloyally to their shareholders. 

Background

In 2008, Riverstone—then a multi-family property management company—became interested in the single family home rental business.  At the time of the transaction at issue, Riverstone's majority stockholder was CAS Capital Limited, a company controlled by two of Riverstone's five directors, Nicholas and Peter Gould.  In March 2012, Riverstone formed an investment fund, which it pitched to institutional investors, including Blackstone Group LP.  Blackstone, in turn, agreed to "help execute" Riverstone's business plan, including by forming a limited partnership known as Invitation Homes.  Riverstone was allegedly integral to Invitation Homes's business, serving as property manager of its properties and advancing significant funds to develop the company.  Riverstone also assisted Blackstone in its development of another company, B2R, which provided residential buy-to-rent mortgages for large scale single family portfolio investors.  Even though Riverstone never received an ownership interest in Invitation Homes, all but one of its directors were given the opportunity to, and did, acquire a stake in the company.  In addition, the Goulds were offered ownership interests in B2R, and the Goulds and another Riverstone director were also offered, and took, executive positions at Invitation Homes and B2R.

On May 20, 2014, two of Riverstone's stockholders informed Riverstone that its directors and officers breached their fiduciary duties by usurping Riverstone's corporate opportunity to invest in Invitation Homes and demanded that all their equity interests in Invitation Homes be transferred to Riverstone.  The stockholders also sent two books and records demands to investigate this issue, and, after those demands were rebuffed, the stockholders filed suit in the Chancery Court under 8 Del. C. § 220.  That same day, Riverstone executed a merger agreement with Greystar Real Estate Partners, LLC, which had been approved by CAS, pursuant to which Riverstone's stockholders would receive cash equal to their pro rata share of the total $94 million purchase price, less certain adjustments based on Riverstone's debt at closing.  The merger agreement provided, inter alia, that Greystar would not pursue litigation against the directors, including, implicitly, any derivative claims arising out of their alleged usurpation of the Invitation Homes opportunity. 

The same stockholders that had brought the records demands then filed suit against Riverstone's officers and directors, alleging that they breached their fiduciary duties by, inter alia, usurping a corporate opportunity owed to Riverstone by investing in Invitation Homes.  The stockholders also alleged that CAS breached its fiduciary duties as Riverstone's controlling stockholder when, inter alia, it failed to obtain any value from the company for the usurpation of the Invitation Homes opportunity.  Finally, the stockholders alleged that Riverstone's directors and CAS breached their fiduciary duties because they intentionally misclassified $20 million in capital contributions from CAS as "debt due to affiliates" instead of equity in order to reduce the amount paid to Riverstone's stockholders in connection with the merger.  Vice Chancellor Glasscock held that the plaintiffs had alleged sufficient facts to rebut the business judgment rule and trigger "entire fairness" review, and held that the plaintiffs had adequately stated a breach of fiduciary duty claim against Riverstone's directors.  The Vice Chancellor did not address the claims against CAS because CAS did not move to dismiss the plaintiffs' claims.

Analysis

  • "Entire Fairness" review will likely apply where there are particularized allegations that a majority of directors negotiated a merger in order to extinguish threatened derivative claims against them.  The court agreed that the plaintiffs' allegations adequately rebutted the business judgment rule—and triggered "entire fairness" review—because they alleged that a majority of Riverstone's directors were not disinterested, as they orchestrated the merger with Greystone that extinguished a possible derivative action belonging to the company against them for usurpation, and thereby obtained a special benefit for themselves: relief from potential liability.
  • But Delaware courts will be wary of generalized allegations that directors entered into a merger to extinguish potential derivative claims against them.  Conclusory statements of such a motive will not suffice.  Rather, particularized allegations will be necessary to rebut the application of the business judgment rule.  The court explained 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."  However, the court found that the Riverstone plaintiffs' allegations were sufficiently particularized to overcome the business judgment rule because: (i) they alleged sufficient facts to support a derivative claim for usurpation that would have survived a motion to dismiss; (ii) they alleged that the directors were aware, at the time they negotiated the Greystone deal, of the potential derivative action against them for usurpation given the plaintiffs' books and records demands; (iii) they alleged that the potential for liability was material to the directors; and (iv) they alleged that the directors nonetheless recommended an agreement that extinguished the potential claims against them by contract. 
  • Even where "entire fairness" review applies because the merger is alleged to have been entered into for the purpose of extinguishing derivative claims against the selling company's directors, stockholders will still have to allege sufficient facts tending to show that the transaction was not entirely fair in order to defeat a motion to dismiss.  The Riverstone plaintiffs alleged that the merger was not entirely fair because the $94 million sale price did not include the value of the extinguished derivative claims against Riverstone's directors, which the plaintiffs alleged were material.  The court found that this allegation was sufficient to plead that the merger was not entirely fair because the value of the extinguished usurpation claims—which were premised on the directors' investments in Invitation Homes totaling $4.65 million—was material given that it represented approximately 10% of the gross merger consideration net of post-closing adjustments.
  • The corporation itself is not a proper defendant on a fiduciary duty claim.  The plaintiffs named Riverstone as a nominal defendant because, even though they were not seeking to impose liability upon the company, they argued that inclusion of Riverstone as a defendant was necessary to ensure that complete relief was afforded, and, in any event, they wanted discovery from Riverstone.  The court dismissed the claims against Riverstone because, "[u]nder Delaware law, fiduciary duties are owed by the directors and officers of a corporation and not by the corporation itself," and therefore "Riverstone cannot be held liable for any of the claims pled by the Plaintiffs based in breach of fiduciary duty."

Breach of fiduciary duty claims based on alleged misclassification of company funds in connection with a merger are likely to fail absent coherent allegations that the classifications were inconsistent with historical practice and actually made in light of the merger. 

The plaintiffs alleged that Riverstone misclassified CAS's capital contributions as "debts due to affiliates" when they should have been classified as equity, and that Riverstone's directors were motivated to engage in this misclassification because the base purchase price for the merger was reduced by Riverstone's outstanding indebtedness at the time of closing.  The court rejected these allegations because, among other things, "[a]bsent from the Complaint are facts indicating when the alleged Contributions were made; and whether the accounting treatment changed between the times the Contributions were made and the time of the Merger, or whether the change was made in light of the Merger."  The court also observed that the plaintiffs had failed to plausibly allege how they were harmed by the alleged misclassifications because, if the contributions had been classified as equity (as the plaintiffs contended they should have been), then CAS would have received stock, and it was "unclear, based on the facts alleged, that the Plaintiffs' share of the additional $20 million in merger consideration would have outweighed the dilution of the Plaintiffs' interest."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Events from this Firm
26 Sep 2018, Seminar, Tokyo, Japan

Orrick’s Global Japan Practice is hosting a series of “Orrick Library” seminars to explore legal issues in various fields in Japan as well as the United States, Asia and Europe

26 Sep 2018, Conference, New York, United States

Employment Partner, Mandy Perry and Chair of Orrick's Global Employment Law Practice, Mike Delikat will be participating in the Global Business Protections 2018: International Restrictive Covenants and Confidential Information Conference.

10 Oct 2018, Conference, Florida, United States
Julie Totten is Program Chair of this year’s conference, Lynne Hermle is speaking on women in the courtroom, boardroom, and c-suite, and Erin Connell is speaking on pay equity and pay transparency.

Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions