This newsletter is our ninth annual review of significant state court decisions relevant for private company M&A transactions and related governance matters and disputes.
* Esther Ju contributed to this Advisory. Ms. Ju is a graduate of the University of Illinois College of Law and is employed at Arnold & Porter's New York office as an Associate. Ms. Ju is admitted only in Illinois. She is not admitted to the practice of law in New York.
Manti Holdings, LLC v. Carlyle Grp. Inc., C.A. No. 2020-0657-SG, 2022 WL 444272 (Del. Ch. Feb. 14, 2022)
Summary
In a case involving a challenge to an alleged contractual waiver in a stockholders agreement of breaches of corporate directors' and controllers' fiduciary duties of loyalty, the Delaware Chancery Court held that the disputed language in the stockholders agreement did not satisfy the exacting standards under Delaware law to constitute a waiver of fiduciary duties. In dictum, the court also raised significant doubt that a corporate director's fiduciary duty of loyalty could properly be waived by contract in advance.
Background
The plaintiffs, former stockholders of Authentix Acquisition Company, Inc. (Authentix), brought a post-closing damages action challenging alleged breaches of fiduciary duty by the defendants in connection with the sale of Authentix in 2017 (the Sale). The defendants were preferred stockholders of Authentix and affiliated entities, who were alleged to be controllers of Authentix, and three alleged associated persons who were former directors and officers of Authentix. The Sale was opposed by the plaintiffs on the basis that it was prompted not by a desire to realize value for the common stockholders of Authentix, but instead by the strong desire of the defendants to cash out their preferred stock investment prior to a self-imposed deadline in September 2017.
The plaintiffs sued the defendants for breach of fiduciary duties and certain related claims. The defendants moved to dismiss the plaintiffs' claims, based in part on plaintiffs having alleged waived their rights to challenge the Sale pursuant to a stockholders agreement that pre-dated the Sale. Specifically, the defendants relied on the following provision of the stockholders agreement:
"In the event that . . . a Company Sale is approved by the Board and . . . the holders of at least fifty percent (50%) of the then-outstanding Shares . . . each Other Holder shall consent to and raise no objections against such transaction. . ."1
The Court's Decision
Noting that the court had held in a prior stage of the litigation that the Sale constituted a "Company Sale" as referred to in the above-quoted provision of the stockholders agreement, and further noting that there was no dispute among the litigants that the Sale had been approved by the board and at least 50 percent of the then-outstanding shares or that the plaintiffs were "Other Holders" as defined by the stockholders agreement, the court's opinion stated that the pertinent question was whether the plaintiffs' post-closing damages action breached their obligation under the stockholders agreement to "consent to and raise no objections against" the transaction.2 The court held that it did not because the disputed language in the stockholders agreement did not constitute a waiver of rights to seek damages for breaches of fiduciary duty. In this connection, the court noted that under Delaware law "waiver is the intentional relinquishment of a known right,"3 that the facts relied upon to prove a waiver must be "unequivocal"4 and that the purported waiver must be "clear and unambiguous."5 Further, as Delaware courts have noted with respect to fiduciary duty waivers in the limited liability company context (in which fiduciary duty waivers are specifically permitted by the applicable statute), drafters must "make their intent to eliminate fiduciary duties plain and unambiguous for such waivers to be effective."6
In its analysis, the court pointed out that the Authentix stockholders agreement made no reference to fiduciary duties, while it did specifically prohibit the plaintiffs from voting against the transaction, asserting appraisal rights, or refusing to execute certain transaction documents. The court said that a more reasonable interpretation of the disputed language (than it being an attempt to waive the possibility of redress for duty of loyalty breaches) is that the language was intended solely to preclude the plaintiff stockholders from taking actions that would impede or delay the closing of the transaction, such as voting against a transaction, refusing to execute transaction documents, or asserting rights that would arise from any company sale transaction. In other words, the language was intended to waive objections to the transaction itself, rather than waiving objections to fiduciary duty breaches arising in connection with the transaction. As characterized by the court, the plaintiffs were not objecting to the Sale; they were instead seeking redress for purported breaches of fiduciary duty that led to the Sale.
Based on its reading of the disputed stockholder agreement language, the court concluded that it did not need to rule on the question of whether contractual waivers of breaches of fiduciary duty are permissible under Delaware corporate law. The court nonetheless stated in footnote 45 to its opinion that finding such waivers to be effective "would blur the line between LLCs and the corporate form and represent a departure from norms of corporate governance . . ."7
Additional Guidance in Subsequent Decisions
In Totta v. CCSB Fin'l Corp., issued a few months later and described elsewhere in this Advisory, the Court of Chancery considered whether a charter provision that empowered a board of directors to interpret and enforce a 10 percent vote limitation and that purported to make the board's decision "conclusive and binding," foreclosed judicial review for breach of fiduciary duties.8 The court noted that fiduciary duties arise in equity, that the Delaware legislature could replace equity standards with statutory law, and that "Delaware corporations may not . . . default fiduciary obligations unless authorized to do so by statute."9 The court held that in contrast to alternative entities, such as limited liability companies and limited partnerships, Delaware corporations only have very limited ability to modify or eliminate fiduciary duties, such as the ability under DGCL Section 102(b)(7) to eliminate monetary damages for breach of the duty of care. Totta therefore appears to answer in the negative the question left open in Manti Holdings regarding whether corporate directors' and controllers' fiduciary duties of loyalty may be waived in advance by contract.
Support for that conclusion is also found in Delman v. Gigacquisitions3, LLC,10 a case against a SPAC sponsor and board members alleging breach of fiduciary duties in connection with a value-destructive de-SPAC transaction. The defendants in that case argued that the plaintiff could not bring a fiduciary duty claim because the plaintiff had implicitly agreed to the conflicts of interest inherent in the SPAC structure and disclosed in the IPO prospectus when he invested in the IPO and again in the proxy statement provided to stockholders in connection with the solicitation of their approval of the de-SPAC transaction. The court rejected that argument, holding that it was inconsistent with the fundamental principles of Delaware law and that "Delaware corporate law does not allow for a waiver of the directors' duty of loyalty."11
Takeaways
As implied in Manti and stated more directly by the courts in Totta and Delman, advance contractual waivers of the fiduciary duty of loyalty of Delaware corporate directors and controllers are unlikely to be enforceable. One of the situations where this frequently arises is exit transactions. Controlling investors should assume that they cannot rely on pre-existing drag-along provisions or redemption provisions in stockholders agreements or corporate documents to override fiduciary challenges to mergers or other corporate transactions. Accordingly, controlling investors and board members should be conscious of structuring exit transactions in a way that complies with their fiduciary duties, particularly transactions where the holders of common stock receive little or no value and may therefore be predisposed to initiate fiduciary duty challenges.
Click here to continue reading...
Footnotes
1 Id. at *3.
2 Id.
3 Id. at *2 (citing Minna v. Energy Coal S.p.A., 984 A.2d 1210, 1214 (Del. Nov. 16, 2009)).
4 Id. (citing Bantum v. New Castle Cnty. Vo-Tech Educ. Ass'n, 21 A.3d 55, 50 (Del. May 18, 2011)).
5 Id.
6 Id. (citing Bay Ctr. Apartments Owner, LLC v. Emery Bay PKI, LLC, C.A. No. 3658-VCS, 2009 WL 1124451 at *9 (Del. Ch. Apr. 20, 2009)).
7 Id. at *4 n.45.
8 Totta v. CCSB Financial Corp., C.A. No. 2021-0173-KSJM, 2022 WL 1751741 at *14 (Del. Ch. May 31, 2022).
9 Id. at *16.
10 Delman v. GigAcquisitions3, LLC, C.A. No. 2021-0679-LWW, 2023 WL 29325 (Del. Ch. Jan. 4, 2023).
11 Id. at *1.
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.
