In Elizabeth Morrison v. Ray Berry et. al., (dated July 9, 2018), the Delaware Supreme Court reversed the Delaware Chancery Court’s dismissal of deal litigation based on obtaining a cleansing vote under Corwin/Volcano because the defendants failed to show “as required under Corwin” that the vote was fully informed. The deal litigation arose from the sale of The Fresh Market to a private equity buyer through a cash tender offer that involved The Fresh Market’s founder and his son, who owned collectively 9.8% of The Fresh Market shares, rolling over their equity. The plaintiffs contend that the founder and his son teamed up with the private equity buyer to purchase The Fresh Market at a discount by inducing the board to run a process that gave the private equity buyer an improper bidding advantage. The plaintiffs used a Delaware General Corporation Law Section 220 books-and-records demand and then Section 220 litigation to seek and obtain board minutes and emails with the founder’s counsel that the plaintiffs then used as evidence in the post-closing fiduciary duty case. The Delaware Supreme Court found that a reasonable stockholder would find the following information that was not included in the Schedule 14D-9 to be material, and therefore, the tender was not fully informed and the business judgment rule was not invoked:

  1. The 14D-9 did not disclose that the private equity buyer’s counsel had sent an email to the founder’s counsel that referred to an agreement that the founder had reached with the private equity buyer before the sale process commenced, and the founder had previously disclosed to the board that no such agreement existed.
  1. The 14D-9 did not disclose that the founder had a clear preference for a rollover transaction and that the founder was reluctant to engage in a rollover transaction with any other bidder because the founder did not consider other private equity funds to have adequate experience in the food retail industry. The founder’s counsel had indicated in an email that the founder viewed the private equity buyer as “uniquely qualified” because of its recent success with the acquisition of Sprouts. The 14D-9 stated that the founder was willing to consider a rollover with another bidder without mentioning the caveats on his support.
  1. The 14D-9 did not disclose that the founder threatened to sell his equity stake if the company remained public.
  1. The 14D-9 mislead the stockholders about the reasons for formation of a special committee of the board. The 14D-9 stated that the committee was formed because the company “could become the subject of shareholder pressure and communications and potentially additional unsolicited acquisition proposals in light of TFM’s recent stock pressure,” but failed to mention that the company was already subject to activist stockholder pressure when it decided to form the committee.

Key Takeaways:

Savvy plaintiffs’ counsel are likely to continue to make Section 220 books-and-records demands prior to closing in order to obtain discovery that can be used to challenge Corwin votes and support post-closing deal litigation.

In preparing the Background and the Reasons sections of Schedule14D-9/Proxy Statements, we need to scrutinize minutes and email communications during the process and consider disclosing information that may suggest that the process was less than ideal in order to have a record that enables dismissal of post-closing deal litigation based on a valid cleansing vote.

Transactions involving stockholders who receive different consideration or otherwise affect the pre-signing process (even if they are not controlling stockholders) are likely to get more scrutiny on the review of the record to determine whether the vote was fully informed.

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