IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

Transcription

1 IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE JOANNA SWOMLEY and LAWRENCE : BROCCHINI, : : Plaintiffs, : : v. : Civil Action : No. -VCL MARTIN SCHLECHT, JOSEPH MARTIN, : KENNETH BRADLEY and SYNQOR HOLDINGS, : LLC, : : Defendants. : Chancery Courtroom No. C New Castle County Courthouse 00 North King Street Wilmington, Delaware Wednesday, August, 0 : a.m BEFORE: HON. J. TRAVIS LASTER, Vice Chancellor THE COURT'S RULING ON DEFENDANTS' MOTION TO DISMISS North King Street Wilmington, Delaware 0 (0) -0

2 APPEARANCES: STEPHEN E. JENKINS, ESQ. CATHERINE A. GAUL, ESQ. ANDREW D. CORDO, ESQ. Ashby & Geddes, P.A. for Plaintiffs JOHN M. SEAMAN, ESQ. Abrams & Bayliss LLP for Defendants

3 0 0 THE COURT: Welcome back, everyone. Please take your seats. Thanks for giving me some time to collect my thoughts on this. I am going to give you a ruling now. I am going to grant the motion to dismiss. The purpose of this hearing is to consider the defendants' motion to dismiss the complaint challenging a cash-out merger involving Synqor, a privately held Delaware corporation. Upon closing of the merger, the non-continuing holders of the company's common stock had their shares converted into the right to receive $. per share in cash. The counterparty to the merger was a management group comprising Dr. Martin Schlecht and other members of the senior management team of the company. Collectively, they owned approximately percent of all the outstanding stock on a fully diluted basis. Dr. Schlecht himself held approximately percent. The board at the time of the transaction comprised Dr. Schlecht, who is president and CEO, and two outside directors, Joseph Martin and Kenneth Bradley. The defendants structured the

4 0 0 transaction to comply with the requirements for business judgment review set out by the Delaware Supreme Court in Kahn versus M&F Worldwide Corporation, A.d, from 0. The question at this point of the case is whether the plaintiffs have called into question whether the requirements were met such that they can proceed beyond the pleading stage. The Kahn case states that -- and I'm going to quote -- "In controller buyouts, the business judgment standard of review will be applied if and only if: the controller conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders; the special committee is independent; the special committee is empowered to freely select its own advisors and to say no definitively; the special committee meets its duty of care in negotiating a fair price; the vote of the minority is informed; and there is no coercion of the minority." Those are essentially the six factors. There is a threshold question that I raised with counsel. Historically, MFW has only been discussed in the public company context. Here it's being applied in the private company context. I agree

5 0 0 with Mr. Jenkins that I don't believe that Delaware law would make a distinction. Historically, we haven't made any distinctions between public companies and private companies. Nixon v. Blackwell holds that the same rules apply to Delaware corporations regardless of whether they're public or private. I do think that the non-public company overlay might be taken into account as a factor, but I don't think that it prevents the application of the Kahn-MFW test. The next question is whether this standard can be applied at the pleading stage. As I understand the development and thrust of the standard, dating back to Cox Communications, the whole point of encouraging this structure was to create a situation where defendants could effectively structure a transaction so that they could obtain a pleading-stage dismissal against breach of fiduciary duty claims. In Cox Communications, which is the case that originally discussed what became the MFW standard, the Court talks at length about the problems created by a legal regime where any claim inherently has litigation value and, hence, settlement value. So the MFW standard was born with the goal of establishing a technique, a practice, a

6 0 0 structure, where, at the pleading stage, defendants could show that they were not subject to a breach of fiduciary duty challenge. The defendants here explain how that approach fits nicely within an aspect of our law that has been unfulfilled. And that's, namely, the promise of Weinberger and Rabkin that there would be a way for the Court of Chancery to distinguish between cases that actually raised breach of fiduciary duty claims and those cases that only challenged judgmental factors of valuation. As a series of Court of Chancery cases observed around 000, and I'm thinking of Andra and Best Lock and decisions like that, the way precedent had developed in the entire fairness context, it really wasn't possible to make that distinction, and any controlling stockholder squeezeout was subject to a breach of fiduciary duty claim such that the promise of Weinberger that there would be a distinction and some claims would be channeled solely to an appraisal had really never been fulfilled. I think it's a good point that the defendants make that the combination of the MFW standard works nicely with Weinberger and Rabkin to

7 0 0 show that there is a structure that one can put into place where one is not forced, necessarily, to confront an entire fairness challenge and that this Court can determine, as Weinberger and Rabkin seem to have contemplated, that certain claims can be channeled to appraisal. So I do believe that this standard can be applied at the pleading stage. Next is the question of how I apply the pleading standard. The plaintiffs, naturally, take the view that their complaint is what I look at and, because the conditions for MFW are things that, really, the defendants should have to establish, it's effectively unfair, it's procedurally inappropriate, to accept those as reality for purposes of their claim and then force them to plead around them. The plaintiffs point out that, particularly in a private company context, they really don't have any way to test statements that are made in disclosures or the substance of board resolutions. I think in my colloquy with counsel, we explored whether 0 would be an avenue around that. And I think at least as the law currently stands, it's not at all clear that a stockholder plaintiff could maintain a 0 action post-close such that the stockholder could,

8 0 0 prior to the pleading stage, obtain the information necessary to be able to plead challenges to the disclosures and the minutes. But, again, I come back to the point that this is what MFW contemplates. MFW contemplates that one can establish a structure where, at the pleading stage, it would stand up, and the plaintiff would have the burden to attack it by pleading facts that would undermine each of its elements. I, therefore, believe that in considering the six elements of the Delaware Supreme Court's test for purposes of today, my job is to consider whether the plaintiffs have pled facts sufficient to call into question the existence of those elements, at least when those elements have been described in a public way suitable for judicial notice, such as board resolutions and a proxy statement, as was done here. I also believe that the plaintiff essentially has to come forward with some reason why each of these standards hasn't been met and isn't simply allowed to say, "Well, we don't know today whether it was met." In other words, to meet the reasonably conceivable standard, it seems like the

9 0 0 plaintiff should have to plead some type of facts that would call these into question. I'm now going to go through the six elements of the MFW test and see if they were met. The first one is whether the deal was conditioned on both the approval of a special committee and a majority-of-the-minority vote of the disinterested stockholders. Here, the plaintiffs have not called into question that both conditions were met. It is true that the controller's initial proposal hedged on whether the majority-of-the-minority condition would be waivable or not, but from the first meeting, the board resolved that any deal would require both the approval of a special committee and a majority-of- the-minority vote. The controller, or the lead guy, Dr. Schlecht, was part of the board that made those determinations. I don't think that the plaintiffs have legitimately called into question or raised a debate about the existence of that first factor. All this went down before any negotiations took place, even before anything really started. The next issue under the MFW test is whether the special committee is independent. The

10 0 0 0 plaintiffs haven't advanced any allegations that would call into question from a traditional standpoint either the disinterestedness or independence of either member of the special committee. The claim is made that they were historically elected by the founder group, but under Aronson, that's not enough. They did receive a payment of $0,000 for service on the committee. That was established up front. It was not contingent. And that is not something that our law has viewed as disqualifying. There are a number of atmospheric factors that Mr. Jenkins ably stitches together, such as the directors' involvement historically with the company and essentially having never put out information or having a stockholder meeting. Those aren't the type of factors that at least Chancellor Strine considered in MFW when evaluating the independence of the special committee. He really looked at traditional independence and interestedness factors; and so I will follow his lead. Consequently, I don't believe that the plaintiffs have pled a reason to call into question the independence of the special committee. The next element is whether the

11 0 0 special committee was empowered to freely select its own advisors and to say no definitively. It was so empowered and it did hire both an independent legal advisor and an independent financial advisor, or at least no challenge, no pleading-stage challenge, has been made to either of those folks. And the special committee -- really, it's a similar analysis to item one -- it had the ability to say no in that the deal was conditioned upon its approval. The next element is one of the more interesting ones. This is the question of whether the special committee met its duty of care in negotiating a fair price. As Mr. Jenkins points out, this was the element of the MFW standard that was added by the Delaware Supreme Court in Kahn and was not part of Chancellor Strine's formulation in this court. I think it's important to note that the question is whether the special committee meets its duty of care. Duty of care is measured by a gross negligence standard. Our cases teach that gross negligence is only satisfied by conduct that really requires recklessness. There are even some cases that analogize it to statutes contemplating wanton conduct. So gross negligence is a very tough standard to

12 satisfy. 0 0 Here, the committee negotiated improvements in the merger price from an initial offer of $.0 to a final offer of $.. There are certainly potential bases to disagree with the committee's strategy or tactics. One might say, as Mr. Jenkins argues, that they should have insisted on some type of contingent payout for the '0 case. Certainly there are reasons proffered why they didn't. But that's a debatable choice. One could debate that. They might have said something like, "Hey, you guys put million of the company's money into this. We ought to at least get something for it" or "that ought to be backed out of the price." I mean, who knows. Somebody could have negotiated that differently, but that seems to me to be a matter of strategy and tactics that's debatable and isn't a duty of care violation. Likewise, in terms of valuing the patent portfolio as opposed to proceeding with more traditional valuation methodologies in reliance on the expert that they chose, as long as the standard is traditional duty of care and traditional gross negligence, that strikes me as things that don't plead

13 0 0 a breach of the duty of care. The next issue is whether the vote of the minority was informed. The transaction certainly received a favorable vote. It received a favorable vote from percent of the unaffiliated shares. The stockholders were provided with a public-company-style proxy statement. After the complaint was filed by the plaintiffs, that proxy statement was supplemented with additional disclosures. In my view the remaining disclosure claims are not well pled. The proxy statement described the '0 case and the fact that no value was being provided for that. The plaintiffs say there should have been more valuation information provided about the '0 case, but I think that the stockholders were in a position to know what they were getting or weren't getting. Likewise, I think there was a fair summary provided of the bankers' work. The plaintiffs have been able to raise a lot of disagreements with the bankers' work and really raise some real questions about some of the techniques that the bankers used, but I think a fair summary of that work, even assuming that there were some questionable decisions made, was

14 provided. 0 0 I don't believe that Dr. Schlecht's compensation was material. It's hard for me to understand how that spins into some effect on the vote. I really just don't get that. I'm not connecting it up in my mind. As for the charter and bylaws, I could understand if the stockholders were going to have a continuing interest in the company why receiving the charter and bylaws would be material. Here, where they are being cashed out, I don't understand why that would be material. The last question is whether there was coercion or retributive threats. I don't think threats were made. I think what stockholders were told was, essentially, "We're going to maintain the status quo." And the status quo is the status quo. The status quo is you haven't been getting dividends; and the status quo is we, not you, have been managing the company and compensating ourselves. The question on coercion is whether you can vote down a deal and keep the status quo. The status quo may not be attractive. Here, it probably wasn't attractive. But the question for coercion is

15 0 0 whether you can return to the status quo. Here, I think the stockholders were able to vote down the transaction and, for better or for worse, return to the status quo. I should have touched on this when I was dealing with the special committee being independent, but the other argument that Mr. Jenkins made when he was stitching together the various factors about the special committee's potential lack of independence was the idea that this valuation is just so darn bad -- and I am not saying that; I am summarizing his characterization -- but there were so many value-depressing steps that were taken, both during the process and then, finally, in the lumping on the 0 percent discount, that you just have to grant an inference here that the committee was trying to achieve something for the controller. I don't think that is an inference that one necessarily can grant. It's not clear to me at the pleading stage that these directors were experts in valuation. It's not clear that there's any reason why they personally should have called into question the nature of the valuation analysis. I understand why a skilled lawyer like

16 0 0 Mr. Jenkins, who has litigated many appraisal cases, is able to spot these issues and raise them and say, Come on, look at this thing." I understand that. But it's not clear to me that that equates to something that supports an inference of lack of independence. So for all these reasons, I think that this is a case where the stockholders' exclusive remedy was to seek an appraisal. That's assuming, of course, that they didn't vote the deal down. As Mr. Seaman mentioned several times, the real remedy is for the stockholders to simply reject the deal. But having not rejected the deal, for any stockholder that chose not to vote against the deal, the remedy was to seek appraisal in this instance. That's my ruling. Let's see. Mr. Seaman, you're the movant. What questions do you have for me? MR. SEAMAN: No questions, Your Honor. I will submit a proposed form of order after consultation with Mr. Jenkins. THE COURT: That's fine. Mr. Jenkins, do you have any questions? MR. JENKINS: No, Your Honor. I'll

17 0 0 raise those to the Supreme Court, and we'll get -- at least this helps clarify and they'll help clarify what was meant by MFW, and we'll find from there. Thank you, Your Honor. I appreciate it. THE COURT: I am by no means of the impression that in this area I am infallible. And while I have tried to interpret these cases as I think they're interpreted, it is certainly possible that I have erred. And I am not offended at all if you turn out to establish that. MR. JENKINS: My view, Your Honor, is we're all going to learn. And I learned something from Your Honor's ruling this morning. Maybe I'll learn something different from the Supreme Court. I don't know. THE COURT: Thank you, everyone, for coming in. I appreciate it. We stand in recess. (Court adjourned at :0 p.m.) - - -

18 CERTIFICATE 0 I, JEANNE CAHILL, RDR, CRR, Official Court Reporter for the Court of Chancery of the State of Delaware, do hereby certify that the foregoing pages numbered through contain a true and correct transcription of the proceedings as stenographically reported by me at the hearing in the above cause before the Vice Chancellor of the State of Delaware, on the date therein indicated. IN WITNESS WHEREOF I have hereunto set my hand at Wilmington, Delaware, this th day of August, 0. /s/ Jeanne Cahill Official Court Reporter of the Chancery Court State of Delaware 0