In a 94-page opinion issued last Thursday, Vice Chancellor Laster denied defendants’ motion to dismiss in In re Dell Technologies Inc. Class V Stockholders Litigation, finding that the complaint alleged facts that made it “reasonably conceivable” that the safe harbor established by Kahn v. M&F Worldwide Corp. (“MFW”), 88 A.3d 635 (Del. 2014), would not apply and thus that entire fairness could be the operative standard of review, rather than the more favorable business judgment standard. While the facts in Dell are unique, the opinion offers helpful guidance to boards seeking the benefit of MFW, particularly on issues relating to establishment of a special committee, its role in negotiations, potential threats or coercion, and director independence.
In 2016, Dell Technologies (“Dell” or the “Company”) acquired EMC Corporation with a combination of cash and newly-issued shares of Class V stock. A critical feature of the Class V shares was the existence of a conversion right: if the Company listed its Class C shares on a national exchange, then the Company could forcibly convert the Class V shares into Class C shares pursuant to a pricing formula that the Court characterized as “superficially simple” and that commentators had suggested could be influenced to the disadvantage of the Class V stockholders by the existence of the conversion right itself.
In March 2018, after identifying a conflicted member on its existing Capital Stock Committee, Dell’s board of directors established a Special Committee (the “Committee”) to negotiate a redemption of the Class V shares with the Company. Wanting the protection of MFW, the Company conditioned any such negotiated redemption or similar transaction on both committee approval and approval from holders of a majority of the outstanding Class V shares. The Company also, however, reserved the right to instead proceed with a forced conversion without approval of the Committee and, according to the complaint, repeatedly told the Committee that if it did not agree to a negotiated redemption, the Company would proceed with a forced conversion. According to the complaint, the Company also signaled its intent to effect a forced conversion through repeated leaks to the press and statements in Company SEC filings that the Company was exploring a potential listing of the Class C shares, a necessary prerequisite to exercising a forced conversion. In July 2018, the Committee agreed to a negotiated redemption that valued the Class V shares in the aggregate at $21.7 billion.
Large holders of Class V stock objected to this proposal, and, rather than negotiate further with the Committee, Dell began negotiating directly with six large holders of Class V stock (the “Stockholder Volunteers”), at the same time preparing for a forced conversion, if necessary. In November 2018, the Company reached an agreement in principle with the Stockholder Volunteers, which valued the Class V shares at $23.9 billion. On November 14, 2018, the Company informed the Committee of the terms of the stockholder-negotiated redemption. The Committee approved the redemption later that evening.
The operative complaint alleges that the Dell board breached their fiduciary duties by pursuing and approving the stockholder-negotiated redemption, and that Mr. Dell and Silver Lake, as controlling stockholders, breached their fiduciary duties by pursuing and causing the company to enter into the redemption. In their motion to dismiss, the defendants argued that the transaction properly implemented the MFW framework and, thus, the business judgment rule should apply. The Court denied the motion, finding that—viewing the allegations in the light most favorable to plaintiffs and taking all inferences in their favor at the pleading stage—the complaint supported a reasonable inference that the defendants did not satisfy four of the six required MFW conditions.
To invoke MFW and receive the benefit of the business judgment rule, “the controller [must] irrevocably and publicly disable itself from using its control to dictate the outcome of the negotiations and the shareholder vote,” thereby allowing the conflicted transaction to “acquire the shareholder-protective characteristics of third-party, arm’s-length mergers.” The Delaware Supreme Court has articulated six necessary and sufficient conditions for obtaining the MFW benefit:
- the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
- the Special Committee is independent;
- the Special Committee is empowered to freely select its own advisors and to say no definitively;
- the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and
- there is no coercion of the minority.
First, the Court found that the complaint supported a reasonable inference that the transaction was not properly conditioned on approval of the Committee given the Company’s reservation of its right to effect a forced conversion. The Court also found that such an inference arose given that the Company bypassed the Committee and negotiated directly with the Stockholder Volunteers without involvement of the Committee other than ex post approval after a deal had been struck with the Stockholder Volunteers. The Court stressed that, while it was not holding that “a controller loses MFW protection when it improves its offer after reaching agreement with the special committee,” for a defendant to fall within the scope of MFW, “any improvement must result from continued negotiations with the special committee, not a process that bypasses” a committee in favor of direct negotiations with stockholders.
Second, the Court found that the complaint supported a reasonable inference of coercive conduct, including threats of a forced conversion. Among other things, the Court found that it was reasonably conceivable at the pleading stage that such threat caused the Class V stockholders to approve the redemption “for reasons other than the merits of that transaction,” that disclosures regarding the potential exercise of the conversion right constituted “improper threats” resulting in coercion, and that, by reserving the right to bypass the Committee and engage in a forced conversion, the Company “created a coercive environment that undermined the Special Committee’s ability to bargain effectively.” While Defendants argued that the Company never made a final decision on exercising the forced conversion right, the Court observed that, “In colloquial terms, someone pointing a gun at you may not have decided whether to pull the trigger, but the situation is objectively threatening regardless of the shooter’s subjective intent.”
Third, the Court found that the complaint alleged facts (again, accepted as true at the pleading stage) supporting a reasonable inference that the two Committee members were not independent. For one member, the Court focused not only on his business ties to Mr. Dell and Silver Lake, but also his close social ties to the managing partner of Silver Lake, including their shared exclusive golf memberships, amateur golf tournaments in which they both played, and their shared “platinum” donation status at the University of Georgia. For the second member, the Court noted his thirty-year friendship and business association as a co-CEO with the Company’s “senior advisor” on the transaction and his service as a director of a Dell subsidiary that is commercially dependent on Dell.
Fourth, the Court found that the complaint adequately stated a claim that the proxy statement and supplement did not contain certain material information necessary for the Class V stockholder vote to be “fully informed.” Specifically, the Court pointed to:
- the omission of the specific price of the Committee’s final proposal in November 2018 (after it learned of the negotiations with the Stockholder Volunteers);
- certain information relating to the experience, financial performance, and compensation arrangement of the Committee’s financial advisor; and
- certain statements about the Committee’s knowledge of a prior Deloitte valuation of the Class C stock that was favorable to the Class V stockholders.
The Court’s thorough analysis of the four MFW conditions above provides helpful guidance to boards seeking protection from the MFW safe harbor.
The Dell decision makes clear that a Special Committee needs to remain engaged and active throughout the process, even if its initial work is rejected by stockholders. Negotiations with stockholders can be valuable, but they cannot replace a Special Committee, which owes fiduciary duties. As the Court explained, a Special Committee cannot merely “pass the baton to a handful of stockholder volunteers to negotiate for themselves,” but rather, it must “return to the bargaining table, continue to act in its fiduciary capacity, and seek to extract the best transaction available” if it wants the protections of MFW.
The Court’s discussion of coercion also serves as a warning to boards and controlling stockholders attempting to qualify for the MFW safe harbor. In establishing Special Committees, boards must ensure that Special Committees are given the opportunity to say “no” without the risk of unilateral action by the controlling stockholder undermining the Committee’s ability to do so or otherwise negotiate effectively. Likewise, controlling stockholders and their agents (including the boards, managements and advisors they may be deemed to control) should refrain from making statements that may be perceived as threats by Special Committees or stockholders, including the implicit threat of proceeding unilaterally without committee or stockholder approval. Repeated references to such a reservation, whether to a Special Committee, in disclosures to stockholders, or leaks to the press, can—at the very least—create an inference of coercion at the pleading stage.
Finally, in focusing on the Special Committee members’ indirect business dealings and social relationships, the Court reiterated the “plaintiff-friendly standard” it must apply when considering allegations of director independence, particularly at the pleading stage. Boards and their legal advisors must continue to use the utmost care in identifying independent directors for purposes of Special Committees and should have documentation supporting this analysis, including thorough director questionnaires that touch on business as well as social relationships. The process of determining director independence should also be refreshed regularly to ensure that any potentially disqualifying issues are identified promptly.