In re Saba Software, Inc. S’holder Litig.: Court of Chancery Declines to Find Stockholder Ratification under Corwin
May 25, 2017
In In re Saba Software, Inc. Stockholder Litigation, 2017 WL 1201108 (Del. Ch. Mar. 31, 2017), the Court of Chancery refused for the first time to apply the cleansing effect available under Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015), to a stockholder vote approving a merger, finding that plaintiff pled sufficient facts alleging that the stockholder vote was neither fully informed nor uncoerced.
The Court’s determination was based on a unique set of facts. As uncovered by the Securities and Exchange Commission (the “SEC”), Saba Software, Inc. (“Saba” or the “Company”) had engaged in financial fraud between 2008 and 2012, overstating its pretax earnings during that period by $70 million. Saba repeatedly and publicly provided assurances that it would restate and correct its financials, but never did. On April 9, 2013, because of Saba’s failure to correct its financial statements, NASDAQ suspended trading of Saba’s stock. On June 12, 2013, NASDAQ delisted Saba, and Saba’s common stock began trading over-the-counter. The SEC filed a complaint against Saba in early September 2014. On September 24, 2014, Saba announced that it had reached a settlement with the SEC regarding the allegations of financial fraud. The settlement required, among other things, that the Company restate its financials by February 15, 2015, or the SEC would deregister Saba’s common stock.
Saba had been exploring strategic alternatives for several years before these events. At a board meeting on November 19, 2014, the board formed a committee comprised of three members to direct a sales process (the “Ad Hoc Committee”). In early December 2014, the Ad Hoc Committee was advised that the restatement of Saba’s financials was unlikely to be completed on time. At that point, Saba was progressing towards a transaction with a private equity firm from which it had received its only indication of interest.
On December 15, 2014, Saba announced that it would not be able to complete the required restatement of its financials by the February 15, 2015 deadline and that it was evaluating strategic alternatives. This news caused Saba’s stock price to fall from its post-settlement high of $14.08 to $8.75 per share. Nonetheless, a group of analysts set a price target for Saba stock of $17 per share and gave it a “Buy” rating, and the board doubled down on its efforts to consummate a sale of the Company.
In early 2015, Saba received several communications from companies interested in purchasing Saba, including Vector Capital Management, L.P. (“Vector”), one of Saba’s former lenders. On January 20, 2015, Saba announced its intention to enter into a definitive acquisition agreement prior to the restatement deadline if the board determined that a sale was in the best interests of the Company. Vector resubmitted its indication of interest to acquire Saba at $9.00 per share on February 2, 2015. The same day, the closing price for Saba’s stock was $9.45. The Ad Hoc Committee met the next day to consider Vector’s offer.
Despite the fact that several potential bidders had signed non-disclosure agreements and the Company continued to receive new indications of interest, on February 9, 2015, Saba’s board approved, and the next day announced, a merger with an affiliate of Vector for $9.00 per share. One day before agreeing to the merger, the board had awarded itself equity awards that would convert into cash upon a change in control. The SEC deregistered Saba’s stock nine days after the announcement of the merger. Plaintiff, a former Saba stockholder, then brought suit against the individual members of Saba’s board alleging breach of fiduciary duty. On March 26, 2015, Saba’s stockholders voted to approve the merger.
The Court found that plaintiff had pled facts suggesting that the stockholder vote was neither fully informed nor uncoerced, and that these alleged facts undermined the cleansing effect of the stockholder vote under Corwin. The Court held that plaintiff had pled two reasonably conceivable material omissions from the Company’s proxy statement. First, the Court concluded that Saba’s stockholders could not have made a fully informed decision without an explanation for Saba’s repeated failure to restate its financials. This omission was material because, according to the Court, Saba’s failure to restate its financials “spurred the sales process” and “materially affect[ed] the standalone value of Saba going forward.” Without knowing why Saba had repeatedly failed to restate its financials or whether there was any likelihood of Saba restating its financials and becoming reregistered with the SEC, stockholders could not make an informed decision whether to support the merger. Second, the Court agreed that the proxy statement failed to disclose adequately the range of post-deregistration options potentially available to Saba. Although Delaware law does not normally require disclosure of alternatives to a given transaction, the Court determined that the dynamic of the deregistration, which “dramatically affected the environment in which the Board conducted the sales process,” required the board to disclose the Company’s other prospects.
The Court also held that the Corwin cleansing effect did not apply because the pleadings supported a reasonable inference that the stockholder vote was coerced. The Court found the board’s failure to act to restate its financials in the face of a known duty to act led to “situational coercion” and “may have wrongfully induced the Saba stockholders to vote in favor of the Merger for reasons other than the economic merits of the transaction,” because Saba’s stockholders found themselves in the precarious position of choosing between holding on to “recently-deregistered illiquid stock or accepting the Merger price of $9 per share, consideration that was depressed by the Company’s nearly contemporaneous failure once again to complete the restatement of its financials.” The Court determined that Saba’s stockholders were left with “no practical alternative but to vote in favor of the Merger.”
Because the stockholder vote did not cleanse the merger under Corwin and because the challenged transaction involved a change in control, the Court determined that the Revlon enhanced scrutiny standard would apply.
Saba’s directors further argued that the claims should be dismissed because (i) plaintiff lacked standing to bring what defendants argued were derivative claims once the merger was consummated, and (ii) the directors were exculpated from any monetary liability by the Section 102(b)(7) provision in Saba’s certificate of incorporation.
The Court concluded that plaintiff’s claims were direct because the complaint challenged the directors’ actions during the merger process. The Court also determined that the facts pled concerning Saba’s repeated failure to restate its financials and the rushed, forced stockholder vote that followed justified a pleading-stage inference of bad faith, and the late-stage equity awards to the directors prior to the transaction supported an inference that the board members had breached their duty of loyalty, stating non-exculpated claims.