In a recent decision, the Delaware Court of Chancery found that the board omitted material information from its proxy statement recommending stockholders vote in favor of an all-cash acquisition of the company, and thus “Corwin cleansing” did not apply. Nonetheless, the court dismissed all claims against the directors because the complaint failed to adequately allege that they acted in bad faith, as required by the company’s Section 102(b)(7) exculpation provision. See In re USG Corp. S’holder Litig., Consol. C.A. No. 2018-0602-SG (Del. Ch. Aug. 31, 2020).
This decision provides helpful guidance regarding the kind of information that should be included in a merger proxy statement. It also provides a reminder that Corwin is not the only defense available to directors at the motion to dismiss stage. In particular, Section 102(b)(7) remains a powerful tool to support dismissal of stockholder claims against directors, even in cases where the proxy omits material information and/or the transaction is subject to “Revlon duties.”
USG Corporation (“USG”) was a public building materials company best known for manufacturing and selling Sheetrock brand drywall and wall products. Gebr. Knauf KG and certain of its affiliates (“Knauf”) owned 10.6% of USG’s common stock. In March 2017, Knauf (through its financial advisor) reached out to Berkshire Hathaway Inc. (“Berkshire Hathaway”), which owned 31.1% of USG’s common stock, regarding a potential acquisition of USG. Following discussions, Knauf and Berkshire Hathaway agreed in principle to a price of $40 per share.
Following these discussions with Berkshire Hathaway, on November 29, 2017, Knauf presented USG with an indicative and non-binding proposal to acquire USG for $40.10 per share in cash. USG’s board, however, determined that the offer was inadequate. In March 2018, Knauf raised its offer to $42 per share, and threatened that it would approach USG’s stockholders directly if USG’s board did not “play ball.” The board again determined the offer was inadequate.
On March 26, 2018, Berkshire Hathaway amended its Schedule 13D to disclose that Berkshire Hathaway had offered Knauf an option to buy the USG shares owned by Berkshire Hathaway for $42 per share. On the same day, USG’s board issued a press release disclosing that it had rejected Knauf’s $42-per-share offer as inadequate.
From there, Knauf ratcheted up the pressure on USG’s board. On April 10, 2018, Knauf publicly announced a “withhold campaign” to solicit proxies from USG’s stockholders against USG’s four director nominees in connection with the upcoming 2018 annual stockholders’ meeting. Two days later, Berkshire Hathaway publicly communicated its intent to support Knauf and vote against the board’s nominees.
At an April 25, 2018 board meeting, the USG board was told by management that it was likely that the board’s nominees would not receive a majority of the votes cast at the upcoming stockholders’ meeting. The board considered providing its view that USG’s intrinsic value was approximately $50 per share to the public, but decided against doing so at that time. (The board continued to consider such an announcement on several occasions thereafter, but each time decided against doing so.)
Meanwhile, during April 2018, USG received interest from other potential buyers, but after preliminary discussions, each indicated it was unwilling or unable to pursue a transaction at that time. At the board’s April 30, 2018 meeting, the USG board decided to authorize management to begin negotiations with Knauf within a range of $48 to $51 per share, and on May 8, 2018, USG made a counter-offer to Knauf at $50 per share.
USG’s annual stockholders’ meeting was held on May 9, 2018. At the meeting, approximately 75% of shares voted were cast against each of USG’s director nominees. The three existing directors were thus not duly re-elected, but continued to serve as holdover directors.
In the meantime, Knauf and USG entered into a four-month standstill agreement and continued to negotiate. On June 5, 2018, Knauf delivered a “best and final” offer of $44 per share. On June 10, 2018, the board unanimously approved the merger at that price and Berkshire Hathaway signed a voting agreement promising to vote its shares in favor of the deal.
On August 13, 2018, stockholder litigation was filed seeking to enjoin the acquisition, including on grounds that the proxy omitted material facts concerning Berkshire Hathaway’s role in the transaction. On September 25, 2018, the Court denied the preliminary injunction motion, finding that the proxy adequately disclosed Berkshire Hathaway’s role. At a special meeting the next day, the stockholders voted to approve the acquisition, which then closed on April 24, 2019.
After closing, plaintiffs filed an amended complaint alleging that the USG directors breached their fiduciary duties in failing to achieve “the highest available value” for stockholders, and seeking “quasi-appraisal” damages. Defendants moved to dismiss the complaint for failure to state a claim.
The court first addressed defendants’ Corwin defense. At the threshold, the court rejected plaintiffs’ argument that Knauf was a controlling stockholder of USG (which, because of Knauf’s conflict as the buyer, would have made Corwin inapplicable). While acknowledging the possibility that a stockholder with less than 50% voting power could be considered to exercise control, including as to the specific transaction at issue, the court rejected plaintiffs’ arguments (i) that Knauf and Berkshire Hathaway had formed a “control group” (noting their interests as buyer and seller in the transaction diverged), and (ii) that Knauf had the ability to take “retributive action” if the board rejected Knauf’s overtures (noting that any stockholder could wage a “withhold campaign”; its success would only be the result of other stockholders agreeing to vote against the board, not because Knauf itself had control).
While theoretically available, the court nonetheless found the directors’ Corwin defense failed in this case because the stockholder vote was not fully informed. In particular, the court credited plaintiffs’ allegation that the undisclosed fact that the board believed USG’s intrinsic value was $50 per share (approximately 15% higher than the merger price) was material in light of the number of times (fifteen, by the court’s count) that the proxy statement itself referenced the board’s view of USG’s intrinsic value. In these circumstances, the court rejected defendants’ argument that intrinsic value is necessarily subjective and not a material “fact,” because the proxy statement itself repeatedly implied that the board had a belief as to the “precise intrinsic value of USG” but made a conscious decision not to disclose it. The court also rejected defendants’ argument that stockholders were sufficiently apprised of the board’s view of intrinsic value because the fact that the board authorized management negotiations within a range of $48 to $51 per share was disclosed, noting that negotiating prices are not necessarily indicative of the board’s view of intrinsic value.
Rejecting plaintiffs’ argument that the defendants’ failure to invoke Corwin cleansing was dispositive of their motion to dismiss, the court then addressed plaintiffs’ breach of fiduciary claim on its merits. In light of the Section 102(b)(7) exculpation provision in USG’s charter, the court explained that in this post-closing damages action against the directors, plaintiffs were required to plead facts (i) “supporting a rational inference that the director[s] harbored self-interest adverse to the stockholders’ interests,” (ii) “acted to advance the self-interest of an interested party from whom they could not be presumed to act independently,” or (iii) “acted in bad faith.” The court found plaintiffs’ claim did not satisfy any of these prongs.
First, the court rejected plaintiffs’ argument that the USG directors were “interested” by virtue of their “fear” of the withhold campaign, and alleged desire to avoid the potentially negative career ramifications that might follow a proxy contest loss. Without ruling out the possibility that such concerns could lead to a reasonable inference that directors approved a transaction to advance their self-interest at the expense of the stockholders, the court noted such an inference was not reasonably conceivable here because the board opposed the transaction while the withhold campaign was ongoing, and then only approved the transaction after the board had already lost the proxy contest when it was clear a majority of the stockholders were committed to the Knauf acquisition.
Second, the court rejected plaintiffs’ argument that the USG directors lacked independence from Knauf. While acknowledging that the test to determine independence is whether “a director’s decision is based on the corporate merits of the subject . . . rather than extraneous considerations or influences,” the court reasoned that the board’s “fear” of a takeover by Knauf after the latter won the withhold campaign was “a nod to reality, not a disabling extraneous influence.”
Finally, the court rejected plaintiffs’ two theories as to how the directors acted in bad faith. A bad faith claim requires that plaintiffs plead facts supporting a rational inference that a director intentionally or consciously breached her or his fiduciary duties. First, despite having found that the proxy statement omitted a material fact (that the board’s view of USG’s intrinsic value was $50), the court found it was not reasonably conceivable that the board (which the court had found was independent and disinterested) had intentionally omitted such fact to convince stockholders to approve a transaction they knew to be unfair.
Second, the court rejected plaintiffs’ argument that pleading a “Revlon claim” (that directors, having made a decision to sell, failed to take reasonable steps to achieve the best price) is sufficient, by itself, to demonstrate bad faith. As the court explained, Revlon duties are most salient at the pre-closing preliminary injunction stage, when money damages (and therefore exculpation provisions) are not relevant. In the context of a post-closing damages action where plaintiffs must plead a non-exculpated claim, however, an allegation showing that a defendant failed to satisfy Revlon is insufficient absent some allegation that such failure was tainted by bad faith. The court found that even if it were true that the USG board “negotiated poorly, perhaps unreasonably,” the allegations were insufficient to show bad faith.
- Although Corwin cleansing does not apply when a controlling stockholder is the buyer, the mere fact that a stockholder succeeds in influencing the board to pursue a transaction through a proxy contest does not raise a reasonable inference that such stockholder exercises “control” over the corporation.
- In certain narrow circumstances, it may be necessary for the board to disclose its view of the company’s intrinsic value. In particular, when the board repeatedly implies in the merger proxy statement that it has a specific view as to intrinsic value, and that view materially differs from the price ultimately agreed in the transaction, the court may find the board’s view of intrinsic value to be material. In most cases, however, the board’s view of intrinsic value (which the court acknowledged is usually an “amorphous” and “subjective” concept) will not be material and needs not be disclosed.
- When considering information to be disclosed in a merger proxy statement, it is important to bear in mind not only that a fully informed stockholder vote will “cleanse” fiduciary duty claims under Corwin, but also that stockholder plaintiffs are frequently being granted access to board documents (and even, in some cases, emails and other electronic communications) under 8 Del C. 220 that they can use to craft a complaint that pleads around the board’s Corwin defense. Accordingly, it is in the board’s interest to ensure that all material information that could be found in such documents is included in the proxy statement.
- That said, the In re USG decision provides a reminder that Corwin is not the only defense available to directors in M&A litigation at the motion to dismiss stage. Exculpation under Section 102(b)(7) provisions remains a powerful tool that will result in dismissal of breach of fiduciary duty claims against directors unless the complaint pleads facts showing that the directors were interested in the transaction, were not independent of someone interested in the transaction, or acted in bad faith.
- In order to plead a bad faith claim against directors, it is not sufficient for plaintiffs to allege simply that directors failed to take reasonable steps to achieve the best price in violation of their Revlon duties, or that directors negligently omitted a material fact from the proxy statement. In either case, plaintiffs must plead facts showing that the directors intentionally or consciously breached their fiduciary duties.
 See Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015) (holding that business judgment protection applies to mergers that are not subject to entire fairness review and are approved by a fully informed and uncoerced vote of a majority of disinterested shareholders).
 See Revlon, Inc. v. MacAndrews & Forbes Holdings, 506 A.2d 173 (Del. 1986).