In re Massey Energy Company Derivative and Class Action Litigation: Court of Chancery Discusses Valuation of Potential Derivative Claims and Declines to Enjoin Merger
August 1, 2011
In In re Massey Energy Company Derivative and Class Action Litigation, C.A. No. 5430-VCS (Del. Ch. May 31, 2011), the Delaware Court of Chancery declined to preliminarily enjoin a merger between Massey Energy Company (“Massey”) and Alpha Natural Resources, Inc. (“Alpha”). The Court, in its denial of the requested injunction, discussed extensively the value of potential derivative claims against Massey directors and officers (the “Derivative Claims”) in the context of the merger.
Massey is a coal mining corporation with a history of subpar safety practices. In April 2010, a massive explosion occurred at one of Massey’s mines, killing 29 miners. At least one subsequent governmental investigation attributed the explosion to Massey’s failure to comply with critical safety procedures. Massey’s stock price plummeted and stockholders filed the Derivative Claims against Massey’s directors and officers seeking to recover for Massey’s losses flowing from the mine explosion. Following the disaster, Massey began to explore strategic alternatives and ultimately entered into a merger agreement with Alpha pursuant to which the Massey stockholders would become stockholders of Alpha. The merger consideration reflected a 27% premium to Massey’s stock price immediately prior to the mine explosion. While negotiating the transaction with Alpha, the Massey board did not attempt to value separately the Derivative Claims, but instead assumed, based on advice from counsel, that the Derivative Claims would survive the merger and transfer to Alpha. Following the announcement of the transaction, certain Massey stockholders filed suit to enjoin the transaction on the basis that the Massey board did not attempt to value the Derivative Claims and only entered into the merger agreement to limit the board’s exposure to those claims.
The Court began its analysis by acknowledging that the Derivative Claims likely stated a claim for director oversight liability due to a failure of certain Massey directors to ensure Massey’s compliance with applicable safety laws. The Court, however, rejected plaintiffs’ valuation approach to the Derivative Claims. Plaintiffs had asserted that the Derivative Claims were worth between $900 million and $1.4 billion. In support of their valuation, plaintiffs submitted an expert report that equated the value of the Derivative Claims with the aggregate financial harm resulting from the mine disaster. Reasoning that the Derivative Claims were not an independent asset but at best a way for Massey to mitigate its potential monetary liability flowing from the mine disaster, the Court determined the value of the Derivative Claims and the harm resulting from the mine explosion were not equal. Furthermore, Alpha’s incentive to pursue the Derivative Claims to reduce its potential liability resulting from the mine disaster undermined the plaintiffs’ argument that the Massey board entered into the merger agreement to limit its exposure to the Derivative Claims.
In rejecting plaintiffs’ valuation approach, the Court identified several additional flaws in plaintiffs’ case. First, based on the business judgment rule and Massey’s exculpatory charter provision, plaintiffs would have to prove that the Massey directors and officers acted knowingly in order to receive a money judgment against them. The uncertainty of plaintiffs’ ability to meet such a high burden decreased the value of the Derivative Claims. Second, if the Derivative Claims were proven, Massey could be exposed, and thereby its stockholders could be exposed, to severe financial harm in the form of judgments, fines and even punitive damages. Third, the value of any judgment on the Derivative Claims would be limited to the amount that could be collected from defendants. In this instance, the maximum coverage of the defendants’ D&O insurance policy was $95 million, an immaterial amount in the context of an $8.5 billion merger. Furthermore, the insurance likely would not cover acts involving knowledge, which here would have to be proved to impose monetary liability. Finally, the fact that no other bidder made a topping bid evidences the public’s view that Alpha did not undervalue the Derivative Claims.
The Court found that plaintiffs would not suffer irreparable injury without an injunction because they had other remedies at their disposal, such as appraisal, a direct action against the Massey directors for breach of fiduciary duty, a double-derivative action, or a continued pursuit of the Derivative Claims (in limited circumstances). Also, the Court noted that the stockholders could vote against the merger. All of these factors led the Court to conclude that plaintiffs’ valuation of the Derivative Claims was faulty and that the likely actual value of those claims was not material to the value of the merger. Although the Court acknowledged that the Massey board’s failure to value the Derivative Claims in connection with its evaluation of a deal with Alpha may be characterized as a breach of the duty of care, the Court ultimately declined to issue a preliminary injunction since the record before the Court did not support a conclusion that the Massey directors entered into the transaction with Alpha in order to diminish their exposure to liability for the Derivative Claims. The day after the Court’s decision, the Massey’s stockholders approved the merger.