In an important decision for M&A professionals and other board advisors, the Delaware Court of Chancery addressed a stockholder plaintiff’s claims that the target board’s financial advisor and law firm, as well as the private equity buyer, aided and abetted a breach of fiduciary duty by the target board in connection with a take-private merger. See Morrison v. Berry, C.A. No. 12808-VCG (Del. Ch. June 1, 2020). While the claim against the financial advisor was allowed to proceed, the claims against the law firm and buyer were dismissed. These diverging results provide early guidance as to when the Delaware courts will (and when they will not) dismiss aiding and abetting claims. In many cases, the determining factor will be whether the complaint pleads facts raising a reasonably conceivable inference that the advisor, buyer, or other third party knew the board was engaging in a breach of its fiduciary duty. This has important implications for the way board advisors and M&A buyers should approach a situation in which they become aware that the board of a target company is unaware of some material fact that could conceivably affect its ability to fulfill its fiduciary duties.
This case concerns a two-step going-private transaction in which an affiliate of a private equity sponsor (“Buyer”) acquired The Fresh Market (“Fresh Market” or “the Company”), a specialty grocery chain. In July 2015, Buyer reached out to Ray Berry, chairman of Fresh Market’s board and a significant minority stockholder, indicating Buyer’s interest in taking Fresh Market private. After further communications in which Berry reached an oral agreement to roll over his equity in a transaction with Buyer, which he did not disclose to the Company’s board, the board instituted a public bidding process. During this process, Fresh Market’s financial advisor allegedly provided “inside information” about the bidding process to Buyer, which allegedly was a large client of the financial advisor. The complaint alleged that these communications may have impacted the bidding process, but were not disclosed to the Fresh Market board. Although there were multiple expressions of interest, the bidding process yielded only one definitive bid—from Buyer, on March 8, 2016, for $27.25 per share. After the board determined the same day that the offer was insufficient, Buyer submitted a revised offer of $28.50 per share on March 9. On March 11, the board accepted the offer and approved the merger. On March 25, Fresh Market publicly filed its solicitation/recommendation statement on Schedule 14D-9 (“14D-9”), which omitted certain facts about Buyer’s discussions with Berry and the Company’s financial advisor. The two-step merger closed on April 22, 2016.
This case initially drew attention two years ago when the Delaware Supreme Court ruled that “Corwin cleansing” did not apply, reversing the Court of Chancery’s dismissal of the case. See Morrison v. Berry, 191 A.3d 268 (Del. 2018). The Supreme Court held that undisclosed facts concerning Berry’s communications with Buyer would have been important to a reasonable stockholder in deciding whether to approve the merger, and thus their omission precluded a finding that the stockholders’ approval of the merger was sufficiently informed to extinguish merger claims under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015).
On remand, the Court of Chancery therefore considered the merits of the plaintiff’s claims that the directors engaged in a bad-faith “sham sale” in order to avoid activist pressure and a potential proxy contest. On December 31, 2019, the Court of Chancery dismissed the claims against the Company’s directors, other than Berry, for failure to plead a non-exculpated claim. See Morrison v. Berry, 2019 WL 7369431 (Del. Ch. Dec. 31, 2019). Of note, while the court found that the board was unaware of the Buyer’s alleged back-channeling with the financial advisor during the bidding process, the court rejected the plaintiff’s theory that the board’s failure to inquire further into the financial advisor’s alleged conflicts vis-a-vis the Buyer was an intentional dereliction of duty. The court also rejected the claim that the board intentionally allowed what the court concluded was a misleading 14D-9 to be filed. The court reserved decision and requested supplemental briefing on the aiding and abetting claims.
The court decided the aiding and abetting claims in its decision last week, denying the financial advisor’s motion to dismiss, but granting the motions of the law firm and buyer. The court began by reciting the elements of an aiding and abetting claim: a plaintiff must allege (and ultimately prove) an underlying breach of fiduciary duty, plus “knowing participation” in that breach by a third party. “Knowing participation” requires that the third party “advocated or assisted” conduct on the part of the board that the third party knew constitutes a breach of fiduciary duty. While noting that the underlying fiduciary duty claims against the directors had been dismissed, the court explained that was not fatal to the aiding and abetting claims under RBC Capital Markets, LLC v. Jervis, 129 A.3d 816 (Del. 2015). In that case, the Delaware Supreme Court held that an advisor who creates an “informational vacuum” that results in the board failing to satisfy its Revlon duties may be liable for aiding and abetting the board’s breach of fiduciary duty even if the directors themselves would be exculpated from any liability for that underlying breach of fiduciary duty (as was the case here). Applying that standard:
- The court found that it was reasonably conceivable that the financial advisor knew its failure to disclose the back-channeling between Buyer and the financial advisor impacted the Fresh Market board’s ability to carry out its Revlon duties. In particular, the court found that—on a motion to dismiss, drawing all inferences in plaintiff’s favor based on the allegations in the complaint—it was reasonably conceivable that Buyer may have “gained insight and favorable treatment” from its communications with the financial advisor that “it may have used . . . to its advantage, depriving the Plaintiff of value in the transaction.” Critically, the court also found that, based on plaintiff’s allegations, it was reasonable to infer that the financial advisor “intentionally disguised its communications with [Buyer] and thus knowingly deceived the Board about its ongoing conflicts.”
- By contrast, the court found that, while the law firm was the principal drafter of the 14D-9 that omitted disclosure of the alleged back-channeling, there were no well-pled facts showing that the law firm knowingly concealed that information, and it was not enough that the law firm could (or even should) have discovered it through further diligence. The court also found the allegation that the law firm intentionally hid these facts in drafting the 14D-9 in order to collect a transaction fee to be insufficient.
- Similarly, the aiding and abetting claim against Buyer was dismissed because there were no well-pled allegations that it knew the financial advisor and chairman failed to disclose its discussions to the board. In fact, just the opposite, in its communications with Fresh Market, Buyer was upfront about its discussions and relationship with Berry. That Buyer participated in the back-channeling with the financial advisor, therefore, was not enough to sustain an aiding and abetting claim against it.
- While it is important to emphasize that the decision was based on the allegations of the complaint and the court’s ruling was limited to determining whether the claims were adequately pleaded and could proceed to discovery, this case serves as a reminder that board advisors should be careful to ensure that the board is fully informed, including about any conflicts (potential or actual) those advisors may have and about any discussions between those advisors and others involved in the transaction that could conceivably affect the board’s process.
- That said, board advisors need not worry that they will be liable for breaches of fiduciary duty by the board of which they are unaware. As the court noted, the knowledge requirement of an aiding and abetting claim provides board advisors with “effective immunity from due-care liability.” There is thus no duty of board advisors to diligence the board’s process outside of their own participation in that process.
- If, however, a board advisor becomes aware of facts that it suspects are not known to the board and that may have an impact on the board’s exercise of its fiduciary duties, such advisor should promptly ensure the board becomes aware of those facts and takes appropriate action.
- The same principles apply to M&A buyers. While there is no duty to ensure the target board is complying with its fiduciary duties (including no duty to ensure the target board is fully informed), if the buyer becomes aware that the target board is unaware of some material fact that could conceivably impact its ability to carry out its fiduciary duties, it may be advisable for the buyer to itself inform the target board of such facts in order to ensure it is not knowingly participating in a fiduciary duty breach.