Delaware Quarterly. Recent Developments in Delaware Business and Securities Law DQ HIGHLIGHTS. July - September 2013 Volume 2, Number 3

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1 Recent Developments in Delaware Business and Securities Law July - September 2013 Volume 2, Number 3 The Delaware Supreme Court and Delaware Court of Chancery are generally regarded as the country s premier business courts, and their decisions carry significant influence over matters of corporate law throughout the country, both because of the courts reputation for unsurpassed expertise in the field and because the vast majority of public companies in the United States are incorporated in Delaware and, thus, governed by its substantive law. Accordingly, Delaware s corporate jurisprudence provides critical guidance to corporations, alternative entities and practitioners in evaluating corporate governance issues and related matters. Each calendar quarter, the Delaware Quarterly analyzes and summarizes key decisions of the Delaware courts on corporate and commercial issues, along with other significant developments in Delaware corporate law. The Delaware Quarterly is a source of general information for clients and friends of Winston & Strawn, LLP, which is also contemporaneously published in the Bank and Corporate Governance Law Reporter. It should not be construed as legal advice or the opinion of the Firm. For further information about this edition of the Delaware Quarterly, readers may contact the Editors, the Authors, or any member of the Advisory Board listed at the end of this publication, as well as their regular Winston & Strawn contact. EDITORS Jonathan W. Miller jwmiller@winston.com +1 (212) James P. Smith III jpsmith@winston.com +1 (212) Matthew L. DiRisio mdirisio@winston.com +1 (212) DQ HIGHLIGHTS Delaware Quarterly: July 2013 September In re Trados Incorporated Shareholder Litigation... 2 Southeastern Pennsylvania Transportation Authority v. Volgenau... 6 Additional Developments In Delaware Business And Securities Law Alternative Entities...10 Appraisals Arbitration Books and Records Class Actions...14 Contracts...14 Corporate Governance Derivative Actions Expedited Proceedings Fiduciary Duties Fraud Indemnification...18 Jurisdiction...18 Practice and Procedure...18 Privileges...20 Settlement Proceedings... 21

2 Winston & Strawn LLP 2 Delaware Quarterly: July 2013 September 2013 By Jonathan W. Miller, Matthew L. DiRisio, Corinne D. Levy, Jill K. Freedman, Ian C. Eisner, Anthony J. Ford, Lee A. Pepper, Allison G. Castillo and Shawn R. Obi Among other decisions of note this quarter, the Delaware Court of Chancery issued a pair of potentially wide-ranging opinions in the context of mergers and acquisitions litigation. First, the court entered its post-trial opinion in the long-running entire fairness case In re Trados Incorporated Shareholder Litigation, granting judgment to defendant directors against claims that they breached their fiduciary duties by approving a merger in which the deal consideration was usurped almost entirely to fund preferred stockholders liquidation preference. The court ruled in defendants favor notwithstanding that (i) the common stockholders received no consideration for their shares, and (ii) the court found the board s sale process unsatisfactory under the entire fairness standard, primarily based on its conclusion that the fair value of the company s common stock at the time of the merger was zero. The court s holding thus suggests that the fair price prong of the entire fairness test can trump the fair process element, at least after a trial on the merits. Second, the court continued its recent focus on going-private transactions involving controlling stockholders in Southeastern Pennsylvania Transportation Authority v. Volgenau. On the heels of its recent landmark opinion in In re MFW Shareholders Litigation, which held that a statutory freezeout merger effected by a controlling stockholder can earn business judgment rule protection where it is conditioned on the front end on the approval of both (i) a fully empowered, independent special committee and (ii) a nonwaivable, fully-informed majority vote of uncontrolled shares, the court in Volgenau confirmed that the same protections will justify business judgment review of a take-private transaction involving the sale of a controlled company to a third-party buyer, even where the controller will roll over a portion of its equity interest in the surviving entity. Each of these matters is discussed in greater detail below, followed by synopses of the quarter s other Delaware decisions across a range of topics, including: alternative entities; appraisals; books and record actions; class actions; contract interpretation; corporate governance issues; derivative actions; expedited proceedings; fiduciary duties; fraud; indemnification; jurisdiction; privileges; settlements; and other matters of Delaware practice and procedure. In re Trados Incorporated Shareholder Litigation The Court of Chancery recently issued its post-trial opinion in In re Trados Incorporated Shareholder Litigation, a long-running shareholder suit seeking appraisal and alleging breaches of fiduciary duty by the directors of TRADOS Inc. ( Trados ) in connection with its sale to SDL plc for $60 million in July The company s common stockholders received none of the merger consideration, which went primarily to the preferred stockholders (Trados venture capital investors). In 2009, then-chancellor Chandler declined to dismiss the fiduciary duty claim, holding that directors could breach their fiduciary duties by favoring the interests of preferred stockholders over those of common stockholders where those interests diverge. Revisiting that issue, Vice Chancellor Laster s post-trial decision found that, while Trados s board failed to follow a fair process in selling the company by improperly favoring the interests of the preferred stockholders, there was ultimately no breach of fiduciary duty because the common stockholders received a fair price for their shares namely, nothing. Background Trados is a Delaware corporation that originally developed desktop translation software. 2 In the late 1990s, the company sought to grow by entering the enterprise software market and attracting large corporations and government entities as customers. 3 It then sought venture capital funding and set its sights on an eventual IPO. 4 Throughout the early 2000s, Trados received multiple rounds of funding from several venture capital firms. Those firms received various classes of preferred stock and the right to designate directors on the Trados board. 5 The preferred stock carried a liquidation preference, a standard feature of venture capital funding that provides 1 C.A. No VCL, 2013 WL (Del. Ch. Aug. 16, 2013). 2 Id. at *2. 3 Id. 4 Id. 5 See id. at *2-4.

3 Winston & Strawn LLP 3 for preferred stockholders to be paid first in any liquidation event, such as a sale or wind-down of the company. 6 By 2002, five of Trados s directors were venture capital designees. 7 By 2004, Trados had grown steadily, but more slowly than its venture capital backers had hoped, 8 and the investors began resigning themselves to a best-case scenario of simply recovering the amount of their original investments. When Trados s growth faltered in early 2004, the board replaced the CEO and engaged an investment bank to begin exploring in earnest the possibility of a sale of the company. 9 The only offer that process produced was a $40 million bid from SDL, a global technology firm. 10 The board rejected that offer and the new CEO began focusing on shoring up Trados s cash position and revenue to increase its attractiveness in a potential sale. 11 The venture capital investors declined to contribute any additional capital. 12 Under the leadership of its new CEO, Trados position improved through SDL continued to express interest in acquiring Trados. 14 To incentivize senior management to pursue a sale, the board unanimously voted to adopt a management incentive plan ( MIP ) that would provide senior executives with a percentage of the sale proceeds in the event Trados was sold. 15 Importantly, the MIP included a cutback feature that would reduce recipients MIP payout by the amount of any consideration they received as equity holders, thus focusing their interests exclusively on the MIP proceeds rather than any proceeds received by virtue of their common stock. 16 In early 2005, board discussions returned to potential exit scenarios, focusing on a handful of parties as possible acquirors, including SDL. 17 The board settled on $60 million as the target price, as one of its venture capital investors refused to sell for any less. 18 Amid solid quarterly results, Trados s CEO presented the $60 million price to SDL, which agreed to acquire Trados at that price. 19 In June 2005, the Trados board 6 See id. at * See id. at * See id. at * See id. at * See id. at * See id. at * Id. at *8. 13 Id. at *9. 14 See id. at * Id. at *7, * Id. at * See id. at * Id. at * Id. at *13. approved the merger. 20 At that time, the board consisted of Trados CEO and CFO and five venture capital designees. 21 Given that Trados s preferred stockholders had the right to vote on an as-converted basis with common stockholders, between Trados venture capital investors and other stockholders friendly to management, there were sufficient votes to obtain the necessary approval of both preferred and common stockholders. 22 Under the MIP, the first 13% of the $60 million merger consideration ($7.8 million) went to senior management. 23 As the total liquidation preference on the preferred stock at the time of the merger was $57.9 million, the entirety of the remaining $52.2 million went to the preferred stockholders, leaving nothing for the common stockholders. 24 The Proceedings In July 2005, a holder of 5% of Trados s common stock filed an appraisal action in the Court of Chancery. 25 In 2008, based on discovery obtained in the appraisal proceeding, the plaintiff filed a class action against Trados and its former directors in the Court of Chancery, alleging that the former directors had breached their fiduciary duties by approving the merger 26 and the two actions were consolidated before then-chancellor Chandler. Defendants motion to dismiss was denied in significant part on the grounds that in circumstances where the interests of the common stockholders diverge from those of the preferred stockholders, it is possible that a director could breach her duty by improperly favoring the interests of the preferred stockholders over those of the common stockholders. 27 After the Chancellor s retirement, the action was reassigned to Vice Chancellor Laster. Following defendants unsuccessful motion for summary judgment, the case proceeded to trial. The Court s Analysis The Standard In its post-trial decision, the court began by noting that while the Trados directors obviously owed fiduciary duties to the 20 Id. at * See id. at *21-23, * See id. at * See id. at * Id. at * Id. at * Id. 27 In re Trados Inc. S holder Litig., C.A. No CC, 2009 WL , at *7 (Del. Ch. Jul. 24, 2009).

4 Winston & Strawn LLP 4 corporation and its stockholders, 28 they did not owe such duties to the preferred stockholders with respect to their preferred rights since, as then-chancellor Chandler recognized in his decision on the motion to dismiss, the rights of preferred stockholders are contractual in nature. Common stockholders, on the other hand, provide the corporation s equity capital and are residual claimants, requiring directors to maximize the value of the corporation for their ultimate benefit. 29 Generally, therefore, it will be the duty of the board to prefer the interests of the common stock to the interests created by the special rights, preferences, etc. of preferred stock. 30 Next, the court held that, because the Trados board lacked a majority of disinterested and independent directors, the applicable standard of review was entire fairness, rather than the deferential business judgment rule or some intermediate level of enhanced scrutiny. 31 The court found that plaintiffs had proven at trial that six of the seven directors had conflicts of interest with respect to the sale of Trados. 32 Specifically, two of the directors (the CEO and CFO) received significant payments under the MIP and were offered employment by SDL following the merger, while three other directors were fiduciaries of venture capital firms that received significant payments under the preferred stock s liquidation preference. 33 A sixth director, the plaintiffs proved, had a strong relationship with one of Trados s venture capital investors which compromised his independence, and, as a preferred stockholder, he received a modest but material payment under the liquidation preference. 34 Under entire fairness, the defendants must, of course, establish that the transaction was the product of both fair dealing and fair price. 35 But at the same time, the court observed, the entire fairness test is not bifurcated between fair dealing and fair price; rather, [a]ll aspects of the issue must be examined as a whole since the question is one of entire fairness. 36 Fair Dealing First taking up the issue of fair dealing, the court found that WL , at * See id. at * Id. at *19 (quoting Equity Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1042 (Del. Ch. 1997)). 31 See 2013 WL , at * See id. at * Id. at * Id. at * Id. at *21 (quoting Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1163 (Del. 1995)) WL , at *30 (quoting Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983)). plaintiffs had proven at trial that the directors had not dealt fairly with the common stockholders. 37 The defendants produced no evidence indicating that the directors sought to protect the interests of common stockholders throughout the sale process. 38 Rather, the court found, the venture capital directors decided to pursue a sale so that their firms could exit Trados, recoup their invested capital (through their preferred stock liquidation preference), and free up their resources for more promising ventures. 39 In short, the venture capital directors pursued the merger to take advantage of the preferred stockholders special cash-flow rights, which diverged from the interest of common stockholders. 40 The court likewise found the structure of the transaction to be indicative of unfair dealing toward the common stockholders, 41 because the MIP was disproportionately funded by common stockholders and therefore favored the preferred. 42 Had the board not adopted the MIP, $57.9 million of the $60 million merger consideration would have gone to preferred stockholders to satisfy the entire liquidation preference, leaving $2.1 million for distribution to the common stockholders. Under the MIP, on the other hand, the first $7.8 million went to management, with preferred stockholders receiving all of the remaining $52.2 million in partial satisfaction of the liquidation preference. Accordingly, the common stockholders in effect contributed all of their merger proceeds to the MIP, while preferred stockholders contributed only about 10% ($5.7 million of the $57.9 million liquidation preference). There was no evidence at trial that the board considered how to fairly allocate the consideration remaining after the liquidation preference or whether it could obtain a higher price such that common stockholders would receive some value in the transaction. 43 The MIP also skewed the incentives of the management directors. As holders of options and common stock, the interests of Trados s CEO and CFO were initially aligned with common stockholders, 44 but the MIP provided them with substantial direct payments in the event of a sale and its cutback feature, which reduced management s MIP payouts by the amount of any consideration received as equity holders and ensured that they had no incentive to maximize value for 37 See 2013 WL , at * See id. 39 See id. 40 See id. at * Id. at * See id. at * See id. at * See id.

5 Winston & Strawn LLP 5 common stockholders by seeking a higher price. 45 Thus, the court found, [t]he MIP converted the management team from holders of equity interests aligned with the common stock to claimants whose return profile and incentives closely resembled those of the preferred. 46 Finally, the manner in which the board approved the transaction evidenced unfair dealing toward common stockholders insofar as [t]he defendants in this case did not understand that their job was to maximize the value of the corporation for the benefit of the common stockholders, and they refused to recognize the conflicts they faced. 47 The court noted that there were no board minutes evidencing consideration of the interests of common stockholders and no director who testified at trial could recall any specific discussions to that effect. 48 Faced with the reality of the divergent interests between the preferred and common stockholders, the board could have formed a special committee or obtained a fairness opinion, but did neither. 49 (Indeed, the court noted, use of a special committee could actually have resulted in application of the business judgment rule rather than entire fairness review.) 50 Fair Price Turning to fair price, the court considered the valuations and testimony of each of the parties expert witnesses. While rejecting the defendants theory that Trados was a failing business that would have entered bankruptcy if not for the merger, the court ultimately found their expert s discounted cash flow analysis credible. 51 Specifically, even though that analysis employed reasonable, plaintiff-friendly assumptions, it still resulted in a present value of only $51.9 million for Trados at the time of the merger significantly less than the $60 million merger consideration. 52 Reviewing all of the evidence, the court went on to conclude that the value of the common stock at the time of the merger was zero, as Trados simply would not have been able to grow at a rate that would have yielded value for common stockholders. 53 This was because the preferred stock s large liquidation preference and cumulative dividend created a gravitational pull that Trados would not have been able 45 See id. at * Id. 47 Id. at * Id. at * Id. at * Id. at *37 n See id. at * See id. at * See id. at * to escape, even had it been able to continue operating with modest growth. 54 Each common stockholder thus receive[d] the substantial equivalent in value of what he had before nothing in satisfaction of the fairness test. 55 In short, even though the directors did not deal fairly with the common stockholders, their fiduciary duties were not ultimately breached because, as they successfully proved at trial, the transaction which gave nothing to common stockholders whose interests were worth nothing was entirely fair. 56 Takeaways While the facts of Trados may in some respects be specific to the venture capital context, certain more broadly applicable corporate governance takeaways are apparent. First, while Vice Chancellor Laster held that the price rendered the transaction entirely fair under the circumstances even though the board did not deal fairly with common stockholders, it remains to be seen to what extent this reasoning will be followed by other members of the Court of Chancery. After all, established Delaware Supreme Court precedent holds that, under entire fairness, defendants must establish to the court s satisfaction that the transaction was the product of both fair dealing and fair price. 57 Second, as the court noted, a director s failure to fully understand his or her duties and recognize conflicts is indicative of unfair dealing. (Such conflicts may arise from the special rights of preferred stock (as here) or any other circumstance where directors receive payments or benefits from a transaction that are not shared with common stockholders.) Accordingly, directors must recognize that they have a duty to maximize value for the common stockholders and take appropriate steps to ensure that result, including, first and foremost, express consideration of the interests of the common stockholders and identification of potential conflicts, appropriately memorialized in board minutes. Finally, as the court explicitly noted here, and as other recent decisions of the Court of Chancery make abundantly clear, protective procedural measures such as forming a special committee, obtaining a fairness opinion, or requiring approval of a majority of disinterested common stockholders may be critical to ensuring a fair process, particularly when a 54 Id. at * Id. (quoting Sterling v. Mayflower Hotel Corp., 93 A.2d 107, 114 (Del. 1952)). 56 See 2013 WL , at * Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1163 (Del. 1995).

6 Winston & Strawn LLP 6 majority of directors face potential conflicts. Indeed, as the court observed, the formation of an independent and disinterested special committee could actually result in the application of the deferential business judgment rule rather than entire fairness review a difference that could very well prove dispositive. Southeastern Pennsylvania Transportation Authority v. Volgenau 58 In recent years, the Delaware Court of Chancery has consistently chipped away at the Delaware Supreme Court s broad edict in Kahn v. Lynch Communication Systems, Inc. 59 that a freeze-out merger between a controlling stockholder and the controlled company must be scrutinized under the stringent entire fairness standard of judicial review, given the inherent potential for controller exploitation of minority stockholders. 60 A few months ago, in its most aggressive step away from Kahn to date, the Court of Chancery held in In re MFW Shareholders Litigation 61 that a statutory merger between a controlling stockholder and its subsidiary could escape entire fairness review in favor of the deferential business judgment standard if, in principal part, the controlling stockholder at the outset of the sale process conditions the transaction on the approval of both (i) an independent and fully empowered special committee and (ii) a non-waivable, fully-informed and uncoerced vote of a majority of the minority stockholders. What has remained unanswered, at least directly, is the related but separate issue of the standard of review applicable to the sale of a company with a controlling stockholder to a third party, as opposed to a transaction directly between a controller and the controlled company. The court touched upon that issue in In re John Q. Hammons Hotels Inc. Shareholder Litigation, where it applied the entire fairness standard in analyzing a third-party sale of a controlled company, but suggested that such transactions could garner protection under the business judgment rule in the presence of sufficient procedural protection for the minority stockholders C.A. No VCN, 2013 WL (Del. Ch. Aug. 5, 2013) A.2d 1110, 1117 (Del. 1994). 60 Among other things, the Court of Chancery has distinguished statutory mergers effected by a controller, as in Kahn, from tender offers conducted by controllers, finding that the latter structure which affords minority stockholders the freedom to tender into the offer or not might avoid entire fairness review by implementing certain procedural protections designed to protect minority stockholders from coercion. See, e.g., In re CNX Gas Corp. S holders Litig., 4 A.3d 397 (Del. Ch. 2010); In re Pure Res., Inc., S holders Litig., 808 A.2d 421 (Del. Ch. 2002) A.3d 496 (Del. Ch. 2013) WL , at *2, *10 (Del. Ch. Oct. 2, 2009). In Southeastern Pennsylvania Transportation Authority v. Volgenau, Vice Chancellor Noble confirmed what then-chancellor Chandler presaged in Hammons: the sale of a controlled company to a third-party buyer can warrant business judgment review even where a controlling stockholder retains an equity interest in the surviving company if proper procedural mechanisms are utilized (i.e., approval by an independent special committee and a nonwaivable, fully-informed majority vote of minority stockholders). Background Volgenau arose from a take-private transaction of SRA International, Inc. ( SRA ), a leading provider of technology solutions and professional services founded in 1978 by Ernst Volgenau, the controlling stockholder of SRA since its inception and a member of its board of directors. SRA had two classes of common stock: Class A, entitled to one vote per share; and Class B, entitled to ten votes per share. Through his Class B ownership, Volgenau held approximately 71.8% of SRA s stockholder voting power. Under the terms of SRA s charter, the holders of Class A and Class B common stock were required to be treated equally in the event of a merger. In 2010, amid declining growth rates, lower profit margins and poorly performing acquisitions, Volgenau became interested in a leveraged buy-out ( LBO ), which would, in theory, provide stockholders with a substantial premium while simultaneously preserving SRA s values and culture a primary concern for Volgenau that, at least initially, soured him on the idea of a strategic acquisition. In the spring of 2010, Providence Equity Partners LLC and its affiliates (collectively, Providence ) contacted and met with Volgenau (and, subsequently, other SRA management) about a possible LBO and received proprietary information about the company pursuant to a confidentiality agreement. After considering various alternatives which included a failed effort to acquire another technology services company SRA turned its attention to Providence. 63 To that end, the SRA board formed a special committee comprised of five directors, with Michael Klein serving as Chair. The special committee retained Houlihan Lokey ( Houlihan ) 64 as its financial advisor and Kirkland & Ellis ( Kirkland ) as its legal 63 In this time frame, the SRA board formed a study team to consider the company s strategic alternatives. The study team retained financial advisor CitiGroup, who concluded that a significant acquisition of another company in the technology services sector would best allow SRA to maximize its long-term value WL at *5. 64 Houlihan Lokey was represented in this litigation by attorneys at Winston & Strawn LLP.

7 Winston & Strawn LLP 7 counsel. At a November 22, 2010 meeting with Providence representatives, Klein, on behalf of the committee, informed Providence that (i) SRA had decided not to undertake a formal sale process and (ii) Providence s initial $28 per share expression of interest was insufficient to commence formal discussions. Consequently, Klein permitted Providence additional diligence, but rejected its request for exclusivity. On December 1, 2010, Serco, a strategic competitor of SRA, made an unsolicited proposal to acquire SRA at a price range of $29-$31 per share, which Klein promptly shared with Providence, purportedly in an effort to evoke a higher offer. 65 When Providence instead responded by lowering its offer price from $28.00 to $27.25 per share, the special committee decided to open up the process and explore additional third-party interest. Over the next six months, the special committee, through Houlihan, conducted a sale process that ultimately included six financial buyers (including Providence and Veritas Capital ( Veritas )) and four strategic buyers who signed confidentiality agreements and conducted diligence. 66 Notably, the process was bifurcated Volgenau was allowed to meet with strategic acquirers to discuss his humanistic concerns for the company, while the special committee handled all negotiation of deal terms. To that end, the special committee expressly instructed Volgenau not to have any communications with potential bidders without special committee authorization. The sale process culminated in only two formal offers, from Providence and Veritas. After a multi-round bidding contest between the two firms, the special committee eventually decided to accept Providence s final offer: $31.25 per share of common stock (those held by Volgenau and by minority stockholders), conditioned upon Volgenau rolling over $150 million of his ownership stake and agreeing to use a portion of it to fund a $30 million non-recourse loan to Providence (to be repaid only if SRA realized certain profit thresholds 65 While plaintiff highlighted Klein s transmission of the proposal to Providence in which he indicated that SRA intended to fend[] off Serco s overture pending receipt of Providence s proposal as indicia of his effort to improperly steer the deal, the court ultimately characterized the message as a negotiation tactic. Id. at *6. 66 The special committee declined to initially solicit other strategic buyers beyond Serco in order to safeguard confidential and proprietary information and avoid leaks into the marketplace. Id. at *6-7. By mid-january, however, the markets began to speculate that SRA had received acquisition proposals. As a result of the speculation, (i) Serco withdrew its preliminary offer and terminated discussions and (ii) the special committee opened the process up to potential strategic acquirers. Id. at *7. from the sale of two subsidiaries). Based on, inter alia, the special committee s unanimous recommendation and Houlihan s opinion that the consideration was fair, the board (absent Volgenau, who abstained) unanimously approved the merger. In its final form, the merger was subject to: (i) a 30- day go-shop provision; (ii) a two-tiered breakup fee $28.2 million during the go-shop and $47 million afterwards; (iii) a reverse breakup fee of $112.9 million; and (iv) a non-waivable affirmative vote by a majority of SRA stock not owned or controlled by Volgenau. The go-shop period, during which Houlihan solicited 50 potential bidders, including 29 strategic buyers and 21 financial sponsors, yielded no additional interest, and, on July 15, 2011, 81.3% of the total outstanding shares not owned or controlled by Volgenau voted in favor of the merger, which closed on July 20, Stockholders received a 52.8% premium over SRA s closing stock price on the last unaffected trading day. Southeastern Pennsylvania Transportation Authority ( SEP- TA ) filed suit shortly thereafter, asserting claims for: (i) breach of fiduciary duty against the SRA board for approving the merger pursuant to an inadequate process and for an unfair price; (ii) breach of fiduciary duty against Volgenau and Stanton Sloane, the former CEO of SRA, for engaging in self-dealing; (iii) breach of fiduciary duty against the SRA board for approving the merger in violation of the equal treatment provision in SRA s charter; and (iv) aiding and abetting the board s breach of fiduciary duty against Providence. Defendants moved for summary judgment. The Court s Analysis The Standard of Review The court began its analysis by distinguishing the recent MFW case, where it recognized an exception to the traditional rule that freeze-out transactions with a controlling stockholder on both sides are necessarily subject to entire fairness review where the controller, on the front end, conditions the transaction on the approval of both an independent and fully empowered special committee and a non-waivable, fully-informed and uncoerced vote of a majority of the minority stockholders. 67 Here, by contrast, the sale was not to the controller itself but to a third party. Moreover, the court found that Volgenau s planned equity rollover, pursuant to which he would retain an interest in the surviving entity, did not by itself place him on both sides of the deal. Under Delaware 67 Id. at *10, citing MFW, 67 A.3d at ,

8 Winston & Strawn LLP 8 law, [w]hen a corporation with a controlling stockholder merges with an unaffiliated company, the minority stockholders of the controlled corporation are cashed-out, and the controlling stockholder receives a minority interest in the surviving company, the controlling stockholder does not stand on both sides of the merger. 68 Accordingly, the court found its decision in Hammons, which addressed third party acquisitions of controlled companies, to be the applicable precedent. In Hammons, the court reasoned that a third-party transaction involving a controlling stockholder should qualify for business judgment review where: (i) it is recommended by a disinterested and independent special committee with sufficient authority and opportunity to bargain on behalf of minority stockholders, including the ability to hire independent legal and financial advisors ; (ii) it must be (and is) approved by a non-waivable majority vote of the minority stockholders; and (iii) the stockholder vote is fully informed and free of coercion. 69 Special Committee Independence. The court agreed with the defendants that the special committee was disinterested and independent. Most notably, the court found that Klein s request to the board for a $1.3 million bonus for his service on the committee did not impugn his independence, because the payment would be made in the form of donations to two charities with which Klein was affiliated. Since the compensation would go to charity, and not Klein personally, the court found that he did not have a material conflict of interest in the merger. The court likewise found that neither Klein nor Volgenau dominated the special committee, concluding based on record evidence that: (i) all special committee members were involved in the sale process and deliberations; (ii) the special committee opened the bidding process to strategic buyers despite Volgenau s initial desire to limit the process to financial sponsors; and (iii) the special committee bargained hard against Providence and Veritas, ultimately prompting a $4 increase in merger consideration. Majority-Of-The-Minority Provision. Plaintiff did not dispute that the merger was subject to a non-waivable majority of the minority vote, but argued that the vote was not fully informed. Specifically, plaintiff challenged the omission of information regarding: (i) the exploratory meetings between the SRA board of 68 Frank v. Elgamal, , at *7 (Del. Ch. Mar. 30, 2012) (internal quotations omitted). 69 Hammons, 2009 WL , at *12. directors and Providence; (ii) Klein s wishful thinking regarding his request for the charitable contribution; (iii) Kirkland s compensation, which was partially contingent on a deal being undertaken; (iv) why Veritas withdrew from the auction process; (v) how the SRA board of directors determined that the merger conformed with the equal treatment requirement in SRA s charter; and (vi) CitiGroup s previous work for SRA and relationship with Providence. The court disagreed, reciting the familiar maxim that Delaware law does not require that companies bury the shareholders in an avalanche of trivial information, 70 or provide a play-by-play description of every consideration or action taken by a Board. 71 Ultimately, the court found that plaintiff had failed to meet its burden of showing that the omitted facts would have significantly altered the total mix of information available to stockholders. 72 In sum, given the bona fides of the special committee and majority-of-the-minority provision, the court determined that the applicable standard of review was business judgment, under which directors decisions are entitled to great deference and will not be second-guessed or examined for reasonableness where they can be attributed to any rational business purpose. 73 Unfair Price and Process The court rejected plaintiff s contention that the SRA directors breached their fiduciary duties by approving a merger at an inadequate price and pursuant to a flawed sale process. In doing so, the court emphasized that the $31.25 per share merger price marked the highest price any party was willing to pay after a six-month public sale process and a thirty-day go-shop, and constituted a 52.8% premium over SRA s unaffected stock price. Additionally, the court noted Houlihan s opinion that the merger consideration was fair, from a financial standpoint, to minority stockholders, and, indeed, that the merger was approved by 81.3% of the total outstanding shares not owned or controlled by Volgenau. On these bases, the court concluded that there was no triable issue of material fact that a rational mind could have considered the merger price fair. The court similarly dismissed plaintiff s process-based claims, noting, among other things, that the board 70 Volgenau, Op. at 49 (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, (1976)) WL at *19 (quoting In re Cogent, Inc. S holder Litig., 7 A.3d 487, (Del. Ch. 2010)). 72 Id. at * Id. at *21(quoting Paramount Commc ns Inc. v. QVC Network, Inc., 637 A.2d 34, 45 n. 17 (Del. 1994)) (internal quotations omitted).

9 Winston & Strawn LLP 9 formed a special committee of independent and disinterested directors which retained its own independent financial and legal advisors, and, pursuant to the record evidence, fully exercised its obligation of due care in approving the merger. Therefore, the court found that there was no triable issue of material fact that the decisions made by the special committee and the board of directors were attributable to a rational business purpose, and the court refused to substitute its judgment for that of the SRA directors. Self-Dealing Plaintiff s self-dealing claims against Volgenau and Sloane alleged that Volgenau wrongfully steered the sale process toward Providence, his preferred bidder, and that Sloane sought to facilitate that transaction in order to receive a bonus. The court found each claim unavailing under the business judgment standard. First, the court noted that, while Volgenau was initially (and admittedly) wary of strategic transactions out of concern for company culture, he eventually grew comfortable with the idea of selling his shares to a strategic buyer, once he became familiar with them and their plans for the company going forward. Second, the court found no evidence that Volgenau orchestrated a preordained deal with Providence that the Special Committee merely rubber-stamped, or that any strategic buyer was dissuaded from bidding because of Volgenau s emphasis on culture and values. Finally, the court held that Volgenau did not receive more consideration for his shares than minority stockholders by virtue of his rollover equity interest. On the contrary, by agreeing to a risky $30 million non-recourse promissory note to Providence, the repayment of which was contingent on future earnings of SRA subsidiaries, Volgenau actually sacrificed his economic position for the minority stockholders. 74 The Equal Treatment Charter Provision Vice Chancellor Noble then turned to plaintiff s claim that the SRA board breached its fiduciary duties by approving a merger that, by granting Volgenau a rollover equity interest in the surviving company, violated the equal treatment provision in SRA s charter by apportioning greater consideration to Volgenau than to the public stockholders. The court rejected these allegations, holding that the plain language of the equal treatment clause plainly permits differing forms of consideration. 75 Although the court recognized that the precise value of Volgenau s consideration might be a material issue of fact, it was undisputed that the board, including Volgenau, 74 Id. at * Id. at *25. believed that the consideration being received by Volgenau was equal to or less than that received by minority stockholders, and came to that conclusion rationally after valuing the various forms of consideration. Finally, the court noted any breach of the charter provision would constitute a duty of care violation, for which the directors would be exculpated from liability under the company s 8 Del. C. 102(b)(7) provision in SRA s charter. Conclusion Once the court (i) found no genuine issue of material fact as to whether Volgenau [stood] on both sides of the transaction, 76 and (ii) determined that the special committee process and majority-of-the-minority provision complied with the strictures of Hammons necessary to invoke business judgment protection, it was a short jump to uphold the merger as attributable to a rational business purpose and grant judgment to the defendants. Takeaways First, the Volgenau decision confirms what was largely preordained by the Hammons and MFW decisions: the sale of a company with a controlling stockholder to a third party can secure business judgment protection where it is (i) recommended by a disinterested and independent special committee and (ii) approved by a nonwaivable majority vote of minority shares. Most significantly, the court held that a rollover equity interest for the controller common in take-private transactions of controlled companies does not render the controller impermissibly conflicted such that he or she necessarily stands on both sides of the deal. In that regard, one interesting question in the wake of Volgenau is how the court will analyze a third-party sale where the controller receives exactly the same consideration as minority stockholders. The court has suggested in the past and in its recent decision in In re Morton s Restaurant Group, Inc. Shareholders Litigation that such equal treatment would provide a safe harbor for a sell-side board to invoke business judgment review without even reaching the Hammons analysis. 77 Second, notwithstanding the road map Volgenau provides, it is not clear whether the incidence of nonwaivable majority-of-the-minority provisions will increase in any material way, given the deal risk the provisions pose to controlling 76 Id. at * C.A. No CS (Del. Ch. Jul. 23, 2013) (finding that a 27.7% stockholder was not a controller for purposes of judicial scrutiny, but that even if he was, fact that he was receiving the same consideration as minority stockholders means it was not a conflict transaction).

10 Winston & Strawn LLP 10 stockholders and the other options available. Among other things, structuring a deal as a tender offer rather than a statutory merger might allow a controller to evade entire fairness review without an iron-clad majority-of-the-minority provision. As the court noted in MFW, several Delaware cases have maintained the analytical dichotomy between mergers and tender offers and suggest that controllers in the latter framework do not have the same equitable duties to minority stockholders as those in the former. Third, it bears emphasizing that the Volgenau case was decided on summary judgment, and it is unclear how the holding will translate to the pleading stage of merger litigation. Indeed, the court relied on record evidence in determining, among other things, that the special committee was intimately involved in deliberations and that the board s belief that Volgenau was not receiving greater consideration than minority stockholders was reasonable. In that regard, Volgenau serves as another reminder of the importance of documenting a robust sale process. Of note here, the defendants contention that Volgenau did not dominate the process was bolstered considerably by special committee minutes reflecting an explicit instruction prohibiting Volgenau from communicating with bidders absent special committee authorization. Additional Developments In Delaware Business And Securities Law Beyond those topics addressed above, the Delaware courts also issued noteworthy decisions in the following areas of law during the past quarter. Alternative Entities Attorneys Fees In ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member LLC, 78 Vice Chancellor Laster granted a partial award of attorneys fees and expenses to plaintiffs after they had prevailed in an action against defendants to reform three joint venture agreements. Plaintiffs argued that they were entitled to attorneys fees and expenses as a matter of equity because defendants conduct giving rise to, and during the litigation involved bad faith and fraud. Specifically, plaintiffs asserted that one of defendants principals discovered a scrivener s error in one of the joint venture agreements during the drafting process. But rather than alert plaintiffs of the mistake, defendants attempted to benefit from the error 78 C.A.5843-VCL, 2013 WL (Sept. 16, 2013) after the agreement had been executed by exercising a put right. The court found that while this pre-litigation conduct was regrettable, it did not support a bad faith fee award. The court did, however, find that defendants conduct during the litigation, including their knowing reliance on unfounded expert testimony and decision to file three lawsuits against ASB in three different jurisdictions to drive up litigation costs, constituted bad faith conduct warranting an order granting plaintiffs fees and expenses incurred as a result of defendants misconduct. Breach of Contract In Stewart v. BF Bolthouse Holdco, LLC, 79 Vice Chancellor Parsons denied in part and granted in part defendants motion to dismiss certain breach of contract claims brought by former employees of a Delaware LLC against the company and its board of managers. The dispute arose out of BF Bolthouse Holdco, LLC s ( Bolthouse ) repurchase of the former employees membership units. Plaintiffs alleged that Bolthouse and its managers breached both the contract that governed the terms of the repurchase transaction and the terms of the company s LLC agreement by valuing the membership units at $0.00 in bad faith. The court found that plaintiffs sufficiently stated a claim that the fair market value of the units was greater than $0.00 and that defendants acted in bad faith in valuing the units. The court applied the standard articulated in Clean Harbors, Inc. v. Safety-Kleen, Inc., 80 which requires a plaintiff to allege sufficient facts related to the alleged act taken in bad faith, and a plausible motivation for it. 81 The court found that, while none of the allegations of bad faith were sufficient on their own, taken together, it was reasonably conceivable that defendants failed to act in good faith when valuing the units. The court also found that plaintiffs sufficiently alleged a plausible motivation for defendants bad faith conduct. However, the court dismissed plaintiffs claims for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing, finding that these claims were foreclosed by, and duplicative of, the breach of contract claims. 79 C.A. No VCP, 2013 WL (Aug. 30, 2013) WL (Del. Ch. Dec. 9, 2011). 81 Id.

11 Winston & Strawn LLP 11 Contract Interpretation In Natural Energy Development, Inc. v. Shakespeare- One Limited Partnership, 82 Chancellor Strine, in a memorandum opinion, held that plaintiff, the former general partner of Shakespeare-One L.P. ( Shakespeare- One ), had a vested right to a general partnership interest, thereby granting plaintiff a portion of Shakespeare- One s profits. Defendants had conceded that plaintiff had not been properly removed from the position of general managing partner of Shakespeare-One, but subsequently amended the partnership agreement to provide that if plaintiff resigned or was removed as managing general partner, then plaintiff would forfeit the general partner interest. The court analyzed the terms of the partnership agreement in which plaintiff was clearly named managing general partner even though plaintiff had not been acting as such for a period of time. The court found that the agreement vested plaintiff with the general partner interest based on plaintiff s prior services to Shakespeare-One. Plaintiff also sought a declaration that it was not the managing general partner of Shakespeare-One, which defendants did not oppose. The court granted plaintiff s request, finding that it would have been inequitable to require plaintiff be the general partner against its will. The court declined to grant plaintiff s request for attorneys fees. Fiduciary Duties In Allen v. Encore Energy Partners, L.P., 83 the Delaware Supreme Court affirmed the dismissal of a class action complaint challenging the merger of a limited partnership with its general partner s controller. The Court held that the plaintiff did not raise a reasonable inference that defendants breached their duty of subjective good faith under the limited partnership agreement when approving the merger and, in so holding, confirmed that where contractual language modifies default common law fiduciary duties, the Court will enforce the contract. Plaintiff, a limited partner of Encore Energy Partners, LP ( Encore ), alleged that the general partner, its controller, and its board of directors violated duties imposed upon them under the limited partnership agreement in connection with the merger. Recognizing that the Delaware Revised Uniform Limited Partnership Act was intended to give maximum effect to the principle of freedom of contract, the Supreme Court found that the 82 C.A. No CS, 2013 WL (Del. Ch. Jul. 22, 2013). 83 C.A. No. 534, 72 A.3d 93 (Del. Jul. 22, 2013). partnership agreement eliminated common law fiduciary duties and only required that defendants act in good faith with regards to Encore. Under the agreement, good faith required a subjective belief that actions taken would be in the best interests of Encore. Thus, to adequately plead a breach of the good faith standard, plaintiff needed to show either that the independent directors: (i) consciously disregarded their contractual duty to form a subjective belief that the merger was in Encore s best interest; or (ii) believed that they were acting against Encore s best interests in approving the merger. The Court found that plaintiff failed to meet these burdens, noting that it would take an extraordinary set of facts to do so. In Grove v. Brown, 84 Vice Chancellor Glasscock, in a post-trial memorandum opinion, held that Marlene Grove and Larry Grove, two members of Heartfelt Home Health, LLC ( Heartfelt ), a home health care agency, breached their fiduciary duty of loyalty by forming competing health care agencies without informing the other two members of Heartfelt, Melba Brown and Hubert Brown. The court also rejected an attempt by the Browns to merge Heartfelt into a new entity solely owned by the Browns. While the operating agreement provided that each member owned 25% of Heartfelt, the Browns alleged that because the Groves had not paid the full amount of their required capital contributions, the Browns owned 63% of Heartfelt and thus had the authority to effectuate the merger. The court disagreed, finding that the operating agreement did not provide that a member s failure to make the required capital contribution would divest that member of his or her share of the company. Indemnification In Costantini v. Swiss Farm Stores Acquisition LLC, 85 Vice Chancellor Glasscock, in a letter opinion, held that Edmond D. Costantini ( Costantini ), a former managing member of Swiss Farm Stores Acquisition LLC ( Swiss Farm ), was entitled to indemnification, but that James Kahn ( Kahn ), a partner of a managing member of Swiss Farm, was not. Both Costantini and 84 C.A. No VCG, 2013 WL (Del. Ch. Aug. 8, 2013). 85 C.A. No VCG, 2013 WL (Del. Ch. Sept. 5, 2013). On September 13, 2013 Vice Chancellor Glasscock noted that the court had mistakenly overlooked Khan s alternative argument that he was an agent of Swiss Farm. Because briefing and oral argument did not fully address this issue, the court requested additional submissions to be completed by September 25, 2013.