Three Recent Delaware Decisions Highlight The Importance Of Director Independence And Risks For M&A Financial Advisors

On September 28 and October 1, 2015, the Delaware Court of Chancery issued decisions in Caspian Select Credit Master Fund Limited v. Gohl, C.A. No. 10244-VCN and In re Zale Corporation Stockholders Litigation, C.A. No. 9388-VCP. On October 2, 2015, the Delaware Supreme Court decided Delaware County Employees Retirement Fund v. Sanchez, No. 702. The outcome for the director defendants in each case differed: the claims against the Zale directors were dismissed, the claims against directors in Caspian largely survived at the pleading stage, and the claims against the directors in Sanchez, where the Chancery Court had granted the defendants' motion to dismiss, were reinstated when the Supreme Court reversed. These contrasting results largely are attributable to the existence in Zale of an independent board of directors, whereas the pleadings in Caspian and Sanchez sufficiently alleged that a majority of the boards of the companies at issue lacked independence. In addition, the Zale decision underscores again the risks confronting financial advisors to sellers in merger transactions, since the aiding and abetting fiduciary breach claim against the board's financial advisor survived even though the fiduciary duty claims against the directors themselves were dismissed.

Caspian Background

Key Plastics Corporation, a global supplier of automotive components, emerged from Chapter 11 bankruptcy with two controlling stockholders: Wayzata Opportunities Fund II, L.P. and Wayzata Opportunities Fund Offshore, II, L.P., which together owned 91.5% of Key Plastics' stock. The Wayzata funds were managed and controlled by Wayzata Investment Partners LLC.

As part of its Chapter 11 reorganization plan in early 2009, Key Plastics obtained a two-year, $25 million loan from Wayzata Opportunities at an interest rate of LIBOR plus 11%. Between 2010 and 2013, the parties modified the loan five times, ultimately increasing the total commitment to nearly $80 million at a minimum interest rate of 20%. Key Plastics' minority stockholders alleged that the modifications were designed to benefit the Wayzata entities at the minority stockholders' expense, and that the board hastily agreed to these changes because it was beholden to the Wayzata Funds, including because the Wayzata Funds had appointed a majority of Key Plastics' directors to the boards of Key Plastics and numerous other companies in which the Funds held a significant stake.

In January 2015, Key Plastics' minority stockholders brought claims for breach of fiduciary duty against the company's directors and certain executives, as well as the Wayzata Funds and Wayzata Partners. The defendants jointly sought dismissal of the plaintiffs' claims on the grounds that they had failed to adequately plead that demand on the board was futile or the elements of a fiduciary duty claim. On September 28, 2015, Vice Chancellor Noble denied the motion to dismiss as to all directors except the one who had not been appointed to the board by the Wayzata Funds.

Caspian Takeaways

It is critical that a board have the ability to form—and then to follow through on the formation of—a special committee of disinterested and independent directors to evaluate any transaction with a controlling stockholder. Vice Chancellor Noble excused the demand requirement ordinarily imposed upon plaintiffs asserting derivative claims under Chancery Court Rule 23.1 because there was reason to doubt the independence of a majority of Key Plastics' board, and no special committee of independent directors was formed to address that conflict. (It also is unclear whether the Key Plastics board could have formed an independent committee, since only one board member was not beholden to the controlling entities and Delaware courts disfavor one-person committees. See Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1146 n.101 (Del. Ch. 2006).) Key Plastics' CEO, who was also a member of the board, had been appointed to his position by the Wayzata Funds. The Wayzata Funds had also appointed three other members of Key Plastics' five-member board, including one director who was a principal of Wayzata Partners and one who was the CEO of a consulting firm that obtained substantial revenues from Wayzata Partners. Both had also been appointed by Wayzata to the boards of numerous other companies in which the Wayzata Funds held a significant stake. Directors will find it difficult to satisfy a burden of proving the "entire fairness" of a controlling stockholder transaction not approved by independent directors where the board does not retain independent legal and...