Attorney: Matthew C. Moehlman
Pomerantz Monitor November/December 2015
On October 29, 2015, Vice Chancellor Parsons of the Delaware Court of Chancery dismissed the sole remaining claim in In re Zale Corporation Stockholder Litigation, the shareholder suit arising from Zale’s 2014 merger with Signet Jewelers Ltd. The Zale opinion, in which Parsons reversed his own earlier ruling in light of binding new precedent from the Delaware Supreme Court, serves as a blunt reminder to investors that Delaware courts are highly reluctant to meddle with the decisions of corporate boards.
In the suit, the Zale plaintiffs had alleged that they were cashed out of their investment at an unreasonably low price due to the involvement of a conflicted financial advisor, Bank of America Merrill Lynch. Zale’s Board of Directors retained Merrill Lynch to advise it as to the financial fairness of the merger. In accepting the engagement, Merrill Lynch failed to inform the Board that it had recently met with Signet to pitch an acquisition of Zale. Notably, the same Merrill Lynch investment banker who led the team advising Zale’s Board had also led the team that pitched to Signet. Further, in the pitch meeting, Merrill Lynch had suggested that Zale pay no more than $21 per share for Zale, and ultimately, the merger was approved by Zale’s Board for an acquisition price of $21 per share. Finally, while Merrill Lynch ultimately informed the Board of its meeting with Signet, it waited to do so until after the merger was announced.
On those allegations, the plaintiffs asserted a claim for breach of fiduciary duty against the Board for insufficiently vetting Merrill Lynch for potential conflicts of interest, and against Merrill Lynch for aiding and abetting the Board’s breach by concealing the conflict from it. Plaintiffs sued Merrill Lynch as aiders and abettors because the bankers owed no fiduciary duties to shareholders.
Initially, Vice Chancellor Parsons found that the plaintiffs had plausibly alleged that Zale’s Board had breached its duty of care to shareholders by not ferreting out Merrill Lynch’s conflict. Parsons noted that Zale had “rather quickly decided to use Merrill Lynch, the only candidate they considered,” and did not ask probing questions designed to detect conflicts of interest, such as whether the bank had made any presentations regarding Zale to prospective buyers within the last six months. Nevertheless, Parsons dismissed the Board from the suit due to an exculpatory charter provision—a protection permitted by Delaware statute that insulates directors from damage claims based on breach of their duty of care. But Parsons sustained the aiding and abetting claim against Merrill Lynch for failing to promptly disclose its meeting with Signet to the Board, which potentially allowed Signet to have the upper hand in negotiations.
However, the day after Parsons issued his opinion, the Delaware Supreme Court undercut it. Specifically, in Corwin v. KKR Financial Holdings LLC, the high court held that a fully-informed vote by an uncoerced majority of disinterested stockholders invoked the deferential “business judgment” standard of review. Practically speaking, business judgment review precludes second guessing of Board decisions, and its application is typically outcome-determinative against shareholder plaintiffs.
The Zales-Signet merger had been approved by 53% of Zale’s shareholders. Accordingly, under Corwin, Parsons should have evaluated the Board’s conduct in vetting Merrill Lynch under the business judgment standard. Parsons had instead applied the stricter “enhanced scrutiny” standard of review. Parsons held that enhanced scrutiny was appropriate under the Delaware Supreme Court’s 2009 decision in Gantler v. Stephens, which he found did not mandate business judgment review where a shareholder vote was statutorily required. Corwin clarified that Parsons had misread Gantler. Corwin said where the approving shareholders were disinterested, fully-informed and uncoerced, it did not matter whether their vote was required or purely voluntary—business judgment was the standard of review. Corwin thus made it exceptionally difficult to find that Zale’s Board had breached its duty of care to shareholders. And because Merrill Lynch’s liability as an aider and abettor was predicated on the Board’s duty breach, the Corwin holding benefitted it as well.
So, after politely holding off for three days —no doubt to give the Zale plaintiffs time to wind up their affairs and come to terms with the inevitable—Merrill Lynch moved for reargument in light of the holding in Corwin. Parsons saved Merrill Lynch the trouble, reconsidering his earlier ruling and dismissing the bank from the case. Perhaps showing his ambivalence at the result, he observed that, “The conduct of Merrill Lynch in this case is troubling, and it was disclosed only belatedly to the Zale Board.”
In a broad sense, the Zale opinions, and the holding in Corwin, illustrate the substantial protections that Delaware continues to afford the directors of companies incorporated there—estimated to be 50% of all U.S. public corporations. By clarifying that banker conflicts may be scrutinized less after a merger receives shareholder approval, it also marks an important qualification to the series of scathing banker conflict opinions that have boiled out of the Court of Chancery in recent years.
For example, in In re Del Monte Foods Co. Shareholders Litigation, Vice Chancellor J. Travis Laster found that Del Monte’s financial advisor Barclays PLC had “secretly and selfishly manipulated the sales process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees.” Likewise, in In re El Paso Corporation Shareholder Litigation, former Chancellor, now Chief Justice of the Delaware Supreme Court, Leo Strine skewered El Paso Board advisor Goldman Sachs for “troubling” conduct that led him to conclude that the transaction was “tainted by disloyalty.” And in In re Rural/Metro Corporation Stockholders Litigation, Vice Chancellor Laster took aim at RBC Capital for steering Rural/Metro’s Board to consummate a deal with an acquirer that RBC secretly hoped would hire it to provide financing for the transaction.
Such rulings are salutary because they recognize that bankers wield considerable influence in merger transactions, and that a self-interested sell-side banker can prevent shareholders from realizing maximum value when cashed out of their investments. As the outcome in Zale shows, Corwin makes it that much more difficult to show director liability after a merger has been consummated. The further rub for investors is that, after Corwin, bankers enjoy more flexibility to act selfishly and against shareholders’ interests —so long as they make the perfunctory disclosures, the deal gets done, and the merger is approved.