Houseman v. Sagerman: Court of Chancery Concludes that Failure to Obtain a Fairness Opinion Does Not Necessarily Constitute Bad Faith
June 12, 2014
In Houseman v. Sagerman, C.A. No. 8897-VCG, 2014 WL 1600724 (Del. Ch. Apr. 16, 2014), the Court of Chancery, by Vice Chancellor Glasscock, in addressing defendants’ motion to dismiss claims related to the 2011 acquisition of Universata, Inc. (“Universata”) by HealthPort Technologies, LLC (“HealthPort”), held that the failure to obtain a fairness opinion in connection with the acquisition did not rise to the level of bad faith on the part of the board of directors of Universata (the “Board”) and did not support an aiding and abetting claim against the Board’s financial advisor.
In 2006, plaintiffs (husband and wife) sold their business to Universata for a seven-year stream of payments totaling $9 million. Several years later, in 2009, when Universata had difficulty satisfying its payment obligations, plaintiffs agreed to convert some of their debt into shares of Universata common stock. As part of the transaction, Thomas Whittington, a director and stockholder of Universata, granted plaintiffs a put right obligating Whittington, under certain circumstances, to pay plaintiffs $2.10 for each share of plaintiffs’ common stock (the “Put Contract”). In late 2010, HealthPort, and at least one other party, indicated an interest in acquiring Universata. At the suggestion of its legal counsel, Universata hired KeyBanc Capital Markets, Inc. (“KeyBanc”), an investment bank familiar with Universata’s business, to assist the Board in conducting due diligence and identifying potential buyers. After considering the relative costs involved, the Board decided not to obtain a fairness opinion in connection with the merger, but did receive an informal recommendation from KeyBanc as to whether the merger consideration was within a range of reasonableness. On May 10, 2011, the Board approved a merger with HealthPort for consideration substantially less than the $2.10 per share that plaintiffs were, under certain circumstances, entitled to under the Put Contract.
After the merger closed, plaintiffs filed a lawsuit in Minnesota state court against Whittington for breach of the Put Contract. The Minnesota court dismissed the case with prejudice, finding that, upon the merger with HealthPort, the shares of Universata common stock ceased to exist, and thus the Put Contract was no longer enforceable. Unsatisfied with the result, plaintiffs brought an action in the Delaware Court of Chancery attempting to re-litigate their claims related to the Put Contact and also alleging, among other things, breach of fiduciary duty for approving the merger and for failing to obtain consideration in the merger for certain “litigation assets” against the Board, and aiding and abetting breach of fiduciary duty against KeyBanc. The Court held, however, that the doctrine of issue preclusion prevented the re-litigation of the Put Contract claims and, accordingly, dismissed those claims.
In addressing plaintiffs’ breach of fiduciary duty claim, the Court noted that because Universata’s charter contained a Section 102(b)(7) provision exculpating the directors for breaches of the duty of care and because it was undisputed that a majority of directors were disinterested in the merger, plaintiffs were required to allege facts sufficient to show that a majority of the directors acted in bad faith in approving the merger. Plaintiffs pled that the Board acted in bad faith by “knowingly and completely” failing to undertake its responsibilities in connection with the merger. While acknowledging that the Board “did not conduct a perfect sales process,” the Court found that the Board did not “utterly fail to undertake any action to obtain the best price for stockholders” by undertaking “some process,” including (i) consulting with legal counsel, (ii) hiring KeyBanc to assist in shopping Universata and to provide an informal recommendation that the consideration was in a range of reasonableness, (iii) considering and deciding, due to the costs, not to obtain a fairness opinion, (iv) considering offers from various bidders, and (v) negotiating with HealthPort. Thus, the Court dismissed the breach of fiduciary claims against the Board.
The Court then turned to the aiding and abetting breach of fiduciary duty claim against KeyBanc. Relying on In re Rural Metro Corp., 88 A.3d 54 (Del. Ch. 2014), the Court held that the Section 102(b)(7) provision did not protect KeyBanc against claims for aiding and abetting breaches of fiduciary duty by the Board. However, the Court determined that plaintiffs had failed to allege that KeyBanc “knowingly participated” in any breach of duty. The Court distinguished Rural Metro, finding that plaintiffs had failed to allege that KeyBanc “actively concealed information to which it knew the Board lacked access, or promoted the failure of a required disclosure by the Board,” or that KeyBanc had misled the Board or created an “informational vacuum” sufficient to support a finding that KeyBanc knowingly participated in a breach of fiduciary duty. The Court also rejected a claim that the limited services provided by KeyBanc supported an inference that KeyBanc knew of a breach by the Board. Again distinguishing Rural Metro, the Court found that the evidence suggested that it was the Company’s interest, not KeyBanc’s, that drove the structure of the financial services provided in connection with the merger. Accordingly, the Court dismissed plaintiffs’ aiding and abetting claims against KeyBanc.
The Court then addressed plaintiffs’ claim that the Board failed to obtain consideration for certain “litigation assets” under In re Primedia, Inc. Shareholders Litigation, 67 A.3d 455 (Del. Ch. 2013). According to plaintiffs, the “litigation assets” included, among other things, latent derivative claims based on the Board’s decisions, on the day the merger was approved, to amend Universata’s equity incentive plan to treat all employee stock options like outstanding shares of common stock in the merger and to vest certain warrants (including those that plaintiffs alleged were invalidly issued to certain directors). The Court noted that as a threshold matter, under Primedia, plaintiffs were required to plead that a derivative claim existed at the time Universata and HealthPort negotiated the merger price. Because the Court found that the alleged derivative claims came into existence, if at all, on the day the merger was approved, the Board could not have negotiated a merger price that considered those claims. However, the Court determined that plaintiffs stated a claim for diversion of assets under Golaine v. Edwards, 1999 WL 1271882 (Del. Ch. Dec. 21, 1999), by pleading facts supporting an inference that the Board’s actions “represented an improper diversion and that, absent the impropriety, the consideration would have gone to the stockholders.”