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In re Answers: Court of Chancery Denies Motion to Dismiss, Finding Adequate Allegations that Directors Conceivably Could Have Acted in Bad Faith by "Consciously Disregarding" Their Duties in Sale of Company

June 5, 2012

In In re Answers Corporation Shareholders Litigation, Consol. C.A. No. 6170-VCN (Del. Ch. Apr. 11, 2012), the Court of Chancery refused to dismiss breach of fiduciary duty and aiding and abetting claims in connection with the acquisition of Answers Corporation (“Answers”) by Summit Partners, L.P. (“Summit”), a private equity fund. The Court held that the plaintiffs adequately pled that three of Answers’ seven directors were interested in the merger and four conceivably could have acted in bad faith by having known of the other directors’ interest but nevertheless conducting an unnecessarily expedited sales process. The Court had previously refused to enjoin the merger, but at the motion to dismiss stage, the Court did not rely on the factual record developed in connection with the earlier preliminary injunction proceeding.

According to the plaintiffs’ allegations, by early 2010 Redpoint Ventures (“Redpoint”), then a 30 percent stockholder of Answers, wanted to end its investment in Answers. Due to the size of Redpoint’s investment and the fact that Answers’ stock was thinly traded, Redpoint could only monetize its investment if Answers were sold. Two of Answers’ seven directors, who had been appointed to the board by Redpoint, began arranging meetings between Answers’ founder and CEO, also a director, and potential acquirors. Redpoint informed the board that if Answers were not sold in the near future, the entire management team, including the CEO, would be replaced.

In November 2010, Answers and Summit Partners agreed to a price of $10.25 per share, and in response to pressure from Summit Partners, the Answers board agreed to a two-week market check and did not perform any analysis regarding alternatives to the merger. The board allegedly sped up the sales process because Answers’ financial outlook was improving, which could have caused Answers’ stock price to rise above the offer price and placed the merger in jeopardy. Answers persuaded Summit Partners to increase its bid to $10.50 per share, and in February 2011—before Answers was required to report improved results—the Answers board obtained a fairness opinion and approved the merger. Answers’ stockholders voted in favor of the merger in April 2011.

The Court held that the plaintiffs stated a claim against all seven of Answers’ directors for breach of the duty of loyalty. The complaint adequately alleged that Answers’ founder/CEO was interested in the merger because he knew from Redpoint that he would lose his job if he did not sell the company; allegedly, it was his desire to keep his job that caused him to approve the merger. The complaint also adequately alleged that the two directors appointed by Redpoint were interested in the merger because of their desire to achieve liquidity for Redpoint.

Regarding the four remaining outside directors, according to the Court, the complaint adequately alleged that they acted in bad faith because they allegedly knew that the three interested directors wanted to enter into the merger before Answers’ stock price rose above Summit Partner’s offer price, but nevertheless agreed to expedite the sales process. The Court stated: “In other words, the Complaint alleges that [the four outside directors] agreed to manipulate the sales process to enable the Board to enter quickly into the Merger Agreement before Answers’ public shareholders appreciated the Company’s favorable prospects. That is a well-pled allegation that those Board members consciously disregarded their duty to seek the highest value reasonably available for Answers’ shareholders.”

The Court also held that the plaintiffs stated a claim against Summit Partners for aiding and abetting breach of fiduciary duties. The plaintiffs alleged that Summit Partners received confidential information showing that Answers’ operating and financial performance was improving and then pressured the Answers board to conduct a flawed, expedited sales process. These allegations, the Court held, were sufficient to constitute the required “knowing participation” in the Answers directors’ alleged breach of fiduciary duties.