In Salladay v. Lev, 2020 Westlaw 954032 (Del. Ch. Feb. 27, 2020), the Court of Chancery clarified certain timing and procedural requirements necessary for special committees comprised of disinterested directors to cleanse a transaction involving a board consisting of a majority of conflicted directors.  Salladay involved a former stockholder of Intersections Inc. (“Intersections”) challenging a going-private transaction approved by a special committee comprised of disinterested directors (the “Committee”). Intersections’ directors believed that the Committee’s formation, structure, and actions cleansed the transaction, thereby restoring review under the business judgment rule, not the rigorous entire fairness standard.

Salladay involved the following facts.  The Committee was originally formed in early 2018 to explore possible financing options with third parties.  The Committee was subsequently abandoned prior to consideration of the going-private transaction.  Later in 2018, the CEO and chairman of Intersections’ board was approached by a third-party acquirer in connection with the going-private transaction.  That meeting occurred before the Committee was reconstituted.  The CEO allegedly told the prospective acquirer a range of prices for Intersections’ shares that Intersections’ board would likely consider favorably.  The Committee was reconstituted after those discussions and later approved the going-private transaction at a share price within the range discussed by the CEO and acquirer.  After reviewing Intersections’ proxy statement, the plaintiff sued under theories of various breaches of fiduciary duties.  In response, the directors filed a motion to dismiss.

The directors’ main argument was that the Committee was properly constituted and authorized to enter into the transaction, thereby cleansing the conflicted transaction under the rationale noted in In re Trados Inc. Shareholder Litigation (“Trados II”).[1]  The Court was not receptive to this argument.  The Court held that the Committee did not successfully cleanse the transaction because it was not sufficiently constituted and authorized ab initio, which was a theory previously applied by Delaware courts in controlling-stockholder transactions.[2]  A special committee can therefore cleanse a conflicted board transaction if it is empowered before “substantive economic negotiations” occur.  Substantive economic negotiations include valuation and price discussions if such discussions “set the field of play for the economic negotiations to come.”[3]  Because the discussions between the CEO and the acquirer regarding the potential price range that might be acceptable to the board occurred before the Committee was reconstituted, those discussions plausibly created a price collar upon which future negotiations would build.  In other words, the CEO’s discussions rose to the level of substantive economic discussions, which meant that the Committee could not replicate an arms’ length transaction free of those pre-negotiated deal parameters.

Because Intersections did not have a conflicted controlling shareholder, an alternative  method to cleanse the transaction would be approval by a fully informed, un-coerced vote of disinterested stockholders.  However, the plaintiff alleged that Intersection’s proxy statement omitted several potentially material facts.  The proxy disclosed that a separate agreement executed in addition to the going-private merger agreements gave the acquirer the contractual right to appoint a majority of the board if the merger agreements were terminated.  This was subject to NASDAQ Rule 5640 which generally prohibits a company from allowing an investor to designate directors at a level that is disproportionately greater than its aggregate ownership position.  The Court stated that factually, even though the acquirer had the contractual right to appoint a majority of directors, Rule 5640 would have only allowed it to exercise that right commensurate with its ownership percentage of 33.54 percent.  The proxy provided enough information to reach that conclusion through very diligent analysis, but did not actually outright disclose the acquirer’s ownership percentage.  The issue before the Court was whether that disclosure scheme was adequate to disclose all material facts upon which stockholders would rely.  The Court found that director appointment was an issue “fundamental to a stockholder” and the disclosures related to the acquirer’s appointment rights were “presented in an ambiguous, incomplete, or misleading manner, [and] is not sufficient to meet a fiduciary’s disclosure obligations.”   Finally, the proxy did not disclose why a reputable financial advisor hired to evaluate the deal voluntarily walked away from a “fully formed transaction”.  The advisor was replaced a few days later by a new financial advisor who completed the engagement on a tight schedule.  The Court found that those disclosure omissions were material because a reasonable board, the new financial advisor, and Intersections’ stockholders would want to why a well-known financial advisor would terminate an engagement at that point.  Based on those findings, the court found that the entire fairness review was appropriate.

[1] In re Trados Inc. S’holder Litig., 73 A.3d 17 (Del. Ch. 2013).

[2] See, e.g., Kahn v. M&F Worldwide Corp., 88 A.3d 635, 644 (Del. 2014).

[3] The Court’s analysis incorporated timing elements presented in Olenik v. Lodzinski, 208 A.3d 704 (Del. 2019) and Flood v. Synutra Int’l, Inc., 195 A.3d 754 (Del. 2018).

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Photo of David R. Earhart David R. Earhart

Leader of the Capital Markets and Securities Practice Group, David’s practice covers all areas of corporate, transactional and securities law, everything from complex mergers, acquisitions and dispositions to representation of both issuers and underwriters in all types of public and private offerings of…

Leader of the Capital Markets and Securities Practice Group, David’s practice covers all areas of corporate, transactional and securities law, everything from complex mergers, acquisitions and dispositions to representation of both issuers and underwriters in all types of public and private offerings of debt and equity.

Photo of Brian Clark Brian Clark

As a business lawyer and CPA, Brian  advises clients on the federal income tax consequences of a variety of transactions, including the acquisition and disposition of businesses and assets, structuring joint ventures and partnerships, and business succession planning.