Wilmington, Del. (November 18, 2024) - A recent Delaware Court of Chancery opinion addressed the not infrequent situation where a distressed company is sold or merged but only the preferred stockholders receive consideration — and the common stockholders receive nothing. In Jacobs v. Akademos, Inc., Del. Ch., C.A. No. 2021-0346-JTL (Del. Ch. Oct. 30, 2024), the court conducts an analysis of the fiduciary duties of the directors who approved the deal.
Brief Factual Background
The first three pages of the decision provide a pithy overview of the key factual circumstances, including that the challenged transaction was not conditioned on the twin MFW requirements — approval from both an independent special committee and a majority of the unaffiliated stockholders — because the company was in such a distressed financial situation that it lacked the funds to support a full-blown MFW process.
A group of common stockholders led by the company's founder sought appraisal rights and also asserted plenary claims for breach of fiduciary duty against the directors challenging the deal on the basis that the common stockholders did not receive any consideration. The first 33 pages or so of the decision provide an exhaustive recitation of factual details with credibility determinations.
The company involved had not made a profit in its 20-year history. An investor continued to provide necessary working capital and in exchange received preferred stock and other preferential rights upon sale or liquidation.
Summary of Holding
The court determined that the plaintiffs did not present a credible valuation, and the defendants at trial presented a convincing case that the fair value of the common shares at the time of the merger was zero. Regarding the plenary claims, the defendants bore the burden of proving that the challenged transactions were entirely fair, and they carried that burden. The court also noted, as an aside, that the net loss from the transaction to the primary investor with the preferred stock was $18 million.
Highlights
- The court provides a primer on principles of Delaware appraisal
law, as well as a critique of competing reports of valuation
experts. The court explained: (i) why the court gave no weight to a
Rule 409A valuation, and (ii) why it did not rely on deal price.
Slip op. at 35 to 56.
- The court addressed the analysis of the fair value of the
minority interest by assessing the value attributable to the shares
as a going-concern. Slip op. at 56 to 66. Notably, the court
observed that in appraisal actions in Delaware, there is no
minority discount imposed. Slip op. at 58 to 59.
- The court described the two elements of a breach of fiduciary
duty as: first, establishing that a fiduciary duty existed, and
then, establishing that the defendant breached that duty. Slip op.
at 67. The court observed that establishing the first element was
easily satisfied in this matter, but the second element in this
case was more complex.
- The court distinguished between the standard of
conduct and the standard of review when determining
whether corporate fiduciaries breached their duties when approving
a transaction.
- The standard of conduct describes what those with
fiduciary duties are expected to do, and is defined by the content
of the duties of loyalty and care. Slip op. at 68.
- The standard of review arises in the context of
litigation, when instead of using the standard of conduct,
the courts in Delaware use three tiers of review for evaluating
director decision-making: (i) the business judgment rule; (ii)
enhanced scrutiny; and (iii) entire fairness. Slip op. at 68.
- The entire fairness standard of review applied in this case and
the two dimensions include: (1) substantive fairness (fair price);
and (2) procedural fairness (fair dealing). Id.
- The court underscored the distinction between "fair
price" for purposes of appraisal, as compared to satisfying
the entire fairness standard in connection with a breach of
fiduciary duty claim: (i) the appraisal statute requires that the
court determine an estimate for fair value using the special
valuation standards in the statute. (ii) by contrast, the fair
price aspect of the entire fairness test is the standard of review
to identify a fiduciary breach, and instead of picking a single
number, the task of the court is to determine whether the
transaction price falls within a range of fairness. Slip op. at 69
to 70 and 72 to 73.
- The court elaborated on the fair price and fair dealing
components of the entire fairness test. Slip op. at 69 to 72.
- My favorite quote from the case is the following:
"Ultimately, fairness is not a technical concept. 'No
litmus paper can be found or Geiger-counter invented that will make
determinations of fairness objective.' A judgment concerning
fairness 'will inevitably constitute a judicial judgment that
in some respects is reflective of subjective reactions to the facts
of a case.'" Slip op. at 72.
- The court also observed that in an appraisal proceeding the
going-concern standard looks to the value of the corporation
without considering issues of control. By contrast, a claim for
breach of fiduciary duty that challenges the fairness of a
squeeze-out transaction must account for the implications of
control. Slip op. at 72-73.
- The court provided a detailed analysis to apply the standards
of fair price and fair dealing to the facts of this case. Slip op.
at 72-85.
- The court concluded that the preferred stockholders proved that the fair value of the common stock for purposes of appraisal was zero, and they proved that the other challenges to the transaction satisfy the entire fairness test, and therefore, did not breach any fiduciary duty.
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.
