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June 15, 2022

Goldstein v. Denner: Delaware’s Latest Guidance for When a Fund’s Representative on the Board Seeks to Force Through a Quick Sale

Advisory

Goldstein v. Denner1 involved a motion to dismiss in a breach of fiduciary duty lawsuit against officers and directors of Bioverativ, Inc. (Company), and investment fund Sarissa Capital Management and its affiliates (Sarissa) controlled by one of the directors, Alex Denner, stemming from the sale of Bioverativ, Inc. to Sanofi S.A. In denying the motion to dismiss based on the plaintiff-friendly standards under Rule 12(b)(6),2 the court noted plaintiff’s allegations of multiple serious process and disclosure issues, including the existence and concealment of large stock purchases by Mr. Denner and Sarissa in violation of the Company’s insider trading policy, and manipulation of the sale process so they could obtain a quick profit. The decision provides important guidance for officers, directors, investment funds and practitioners in connection with sale transactions.

The Allegations

The Company was spun off from another company in February 2017. In May 2017, Sanofi approached two of the Company’s directors, Alex Denner and Brian Posner, about a potential acquisition of the Company. They indicated the Company was not for sale, but didn’t inform the other board members about the communication. Days later, Mr. Denner and Sarissa purchased more than one million shares of the Company’s common stock, octupling Sarissa’s holdings, without informing Company management or other board members and in apparent violation of the Company’s insider trading policy. Sanofi approached Messrs. Denner and Posner again in June, September and October 2017, and on this last occasion, Mr. Denner invited Sanofi to make an offer in a single bidder process, again apparently without consulting with or informing the other directors. The court noted that Mr. Denner’s change of heart appears to have been timed so that a sale transaction would not trigger the six-month short swing profit recapture rules under Section 16 of the Securities Exchange Act for the shares Mr. Denner and Sarissa purchased after Sanofi’s initial approach.

In early November 2017, Sanofi offered to acquire the Company for $98.50 per share. This was the first time that the other members of the board learned of Sanofi’s interest. The offer price was considerably lower than the approximately $150 per share valuation derived by Company management and the Company’s financial advisors from updated management projections based on the Company’s 2017 annual plan (November Projections), which were presented at a late November 2017 board meeting discussing the Sanofi proposal. As part of the board’s discussion at that meeting, it was noted that under the terms of the Company’s spin off, the Company could not engage for two years after the spinoff with any bidders who had expressed an interest in acquiring the Company prior to that transactions, as it could jeopardize the tax-free nature of the spinoff and potentially obligate the Company to indemnify for massive tax liabilities. It was also noted that this restriction would end in January 2019, increasing the field of potential bidders. The Company rejected Sanofi’s initial bid.

In December, management presented the board with the Company’s 2018 annual plan, which incorporated the November Projections with slight modifications. Separately Sanofi countered with a $101.50 per share offer. At an early January board meeting, the board was presented with a $158 per share valuation of the Company, based on management’s 2018 annual plan. After a subsequent board meeting, the board countered with a $105 per share proposal, which Sanofi accepted.

In an apparent effort to help its financial advisors with their fairness analysis, Company management then significantly cut back the November Projections, notwithstanding no negative change in the Company’s business. The Company’s financial advisors, Guggenheim and JP Morgan, delivered fairness opinions based on these lowered projections (Final Projections) at a board meeting on January 21, 2018, and the board approved the deal. The merger agreement, providing for a two-step tender offer, was signed the same day. The transaction closed on March 7, 2018.

After bringing a books and records action under Section 220 of the Delaware General Corporation Law, the plaintiff brought a lawsuit alleging (i) breach of fiduciary duty by all directors based on misstatements and omissions in the Schedule 14D-9, and for failing to obtain the highest value reasonable available for stockholders, (ii) breach of fiduciary duty by the CEO, the CFO and the Chief Legal Officer for disclosure violations in the Schedule 14D-9, and for falsifying the record in the Schedule 14D-9 and the board minutes, (iii) breach of fiduciary duty against Mr. Denner for insider trading, and (iv) aiding and abetting by Sarissa.3

The Court’s Decision

Whether Corwin Applies

The court first considered whether the fiduciary duty claims should be dismissed under Corwin4 because stockholders holding a majority of disinterested shares approved the deal by tendering into the tender offer. The court noted that under Corwin, if a transaction that is subject to enhanced scrutiny under Revlon is approved by “by a fully informed, uncoerced vote of the disinterested stockholders,”5 the business judgment standard of review applies. Director conflicts, if fully disclosed to stockholders, will not serve as a basis for rebutting the business judgment rule. The court held that in this case, for purposes of the review standard on a motion to dismiss, the complaint invoked sufficient disclosure flaws to prevent the Corwin protections from applying. The court noted omissions and inaccurate disclosures in the Schedule 14D-9 in connection with meetings involving Messrs. Denner and Posner, and Sanofi or Sanofi’s financial advisor, Lazard, which appeared intended to obscure the fact that the board was not informed of those meetings or of the stock purchases in violation of the Company’s insider trading rules, and to cover up the insider trading. The court noted that statements in the Schedule 14D-9 that the board was informed of some of these meetings, and of directions to management on how to respond to Sanofi, were not supported by board minutes and email records produced in the Section 220 proceeding.

The court held that several other misstatements and omissions in the Schedule 14D-9 also rendered Corwin inapplicable:

  • The schedule 14D-9 failed to reference the purchase by Mr. Denner and Sarissa of over one million shares after Sanofi’s initial approach about an offer in the range of $90 per share.
  • The Schedule 14D-9 noted the existence of an indemnification obligation under a Tax Matters Agreement if the Company took or failed to take “certain action” that would cause the Company’s spin-off from to lose its tax-free status. But the Schedule 14D-9 did not disclose the practical implication that any party that had engaged with the Company's parent about an acquisition of the Company prior to the spin-off (which could include the most likely bidders for the Company) would not want to engage in acquisition discussions with the Company before February 1, 2019, for fear of triggering the tax indemnity.
  • The November Projections were reliable, and should have been disclosed in the Schedule 14D-9, because they were detailed bottoms-up projections, they were the only projections the board had when it made a $105 per share counter-offer to Sanofi, and they were used by the Company’s financial advisors for valuation presentations to the board in excess of $150 per share. The court held that it was reasonable to infer that a description of both sets of projections should have been included in the Schedule 14D-9 so that stockholders could “readily track the changes and reasonably infer the rationale that went into the changes from one scenario to another.”6

Fiduciary Duty Claims Under Enhanced Scrutiny

Analyzing under the enhanced scrutiny standard of review applicable to cash sales, the court held that it was reasonably conceivable that Mr. Denner’s conflicts caused the sale not to achieve the best price reasonable available. The complaint alleged that Mr. Denner was conflicted because he wanted a quick sale “as part of his activist playbook”. The court noted that the complaint detailed the way Mr. Denner had operated on multiple occasions in the past, including use or threat of proxy contests to get on the board, recruitment of other supporting directors, and then a short term exit, usually a company sale. According to the court, Mr. Denner’s purchase of stock, the addition of two individuals to the board who had reason to be loyal to Mr. Denner, and Mr. Denner’s role in the negotiations with Sanofi and orchestrating a single bidder process, which culminated in a sale in which Sarissa made a profit of $49.7 million, were in accordance with this playbook. The court held that at the motion to dismiss stage, plaintiff was entitled to an inference that Mr. Denner was following his playbook.

The court held that it was “reasonably conceivable that Mr. Denner’s conflicts tainted the sale process.” The court noted that had Mr. Denner disclosed his conflicts, the board “might well have approached the prospect of a near-term sale with greater skepticism” and may have determined that it was better to remain independent at that time, particularly given that the Company’s stock price didn’t appear to reflect what the board understood to be the Company’s full value, and the limitation on the field of potential acquirors due to the Tax Matters Agreement.

The court also held that it was “reasonably conceivable that Mr. Denner’s conflicts affected the price negotiations with Sanofi,” where Mr. Denner was central to the negotiation process, and he led the counteroffer that resulted in a $105 per share deal price when Company information supported a valuation of over $150 per share. The court rejected defendants’ justification of the deal price based on Sanofi having raised its offer price twice, and the final deal price represented a 64% premium over the market price. The court held that deal premium does not support the price as being the best price reasonably available where, as here, the complaint alleged that the market did not fully value the Company. Similarly, the court rejected defendants’ justification of the deal price on the absence of a topping bid, noting that the argument was premised on potential acquirors recognizing the true value of the Company despite not having access to non-public information. Defendants’ argument also ignored the fact that some entities may have been precluded from bidding because of the tax indemnity.

The court held that the last minute preparation of the Final Projections with significant downwards adjustments, which appeared intended to support the fairness analysis of the deal price, supported an inference, for purposes of the motion to dismiss, that the management defendants acted in bad faith.

Non-Exculpated Claims Against Director Defendants

The court held that in light of the exculpation provision in the Company’s charter, to survive a motion to dismiss, claims against directors must be based on allegations the directors were “interested in the [t]ransaction, lacked independence, or acted in bad faith.”7

The court held that plaintiff’s allegations were adequate to support non-exculpated claims against all of the directors other than Paglia, through the following inferences:

  • It was reasonably conceivable Mr. Denner acted in bad faith through purchasing shares in violation of the insider trading policy, concealing the illicit stock purchases and discussions with Sanofi and Lazard from the board, and manipulating the sale process to obtain a quick personal gain.
  • It was reasonably conceivable Mr. Cox was interested as a result of the $72.3 million severance payment he would receive, when compared to his $11.6 million average annual compensation.8
  • It was reasonably conceivable Mr. Posner acted in bad faith as a result of having concealed his early discussions with Sanofi from the board.
  • While a close call, it was reasonably conceivable Ms. Protopapas acted in bad faith as a result of a combination of factors relating to her ties to Mr. Denner and flaws in the Company’s sale process. The court noted that academic papers showed that obtaining board seats can be material to individuals, and thus cultivating a relationship with someone like Mr. Denner, who through his fund gets to appoint individuals to boards on a frequent basis, can develop significant loyalty. The complaint alleged that Mr. Denner nominated Ms. Protopapas to serve on the board of another company, Ariad Pharmaceuticals, Inc., which was sold less than two years later, resulting in Protopapas receiving $2.2 million for her shares and options. Less than two weeks later, Mr. Denner appointed Ms. Protopapas to the Company’s board. Ms. Protopapas was also the President and CEO of Mersana Therapeutics, Inc., a company in which Sarissa was one of the three largest stockholders.
  • While a close call, it was reasonably conceivable Mr. Germano acted in bad faith for similar reasons to those for Mr. Protopapas. Mr. Germano was unemployed at the time that Mr. Denner secured his appointment to the Company’s board, and thus likely to be appreciative to Mr. Denner for his appointment. In November 2017, Mr. Denner also secured a seat for Mr. Germano at another company in which Sarissa was invested, which resulted in Mr. Germano receiving $3 million for his equity awards when that company was sold less than two years later.

The court held that there was no showing that Mr. Denner had played any role in Mr. Paglia’s appointment to the Company’s board. The court held that Mr. Denner’s appointment of Mr. Paglia to the board of a special purpose acquisition corporation after the Company’s sale to Sanofi was insufficient to show Mr. Paglia lacked independence.

Claims Against Officer Defendants

The court held that the complaint sufficiently alleged that Messrs. Cox and Greene acted disloyally, in their capacities as CEO and CFO, respectively, by failing to disclose Sarissa’s share purchases to the board and by participating in creation of the Final Projections, so that they could each receive significant payouts in the deal. Mr. Greene was eligible to receive more than $18.4 million in severance and accelerated equity awards in the deal, which was more than four times his annual compensation.9

The court held that the complaint sufficiently alleged that the Company’s chief legal officer breached her duty of loyalty given that her payout from severance and accelerated equity awards was more than four times her annual compensation, and that the complaint alleged she fabricated part of the legal record in order to enable the transaction to close. The complaint alleged several inconsistencies between the board minutes and emails obtained in the Section 220 action. In particular, the plaintiff alleged that it did not make sense for several emails on January 4th involving board members and the Company’s financial advisors to have been sent if the board meeting on that date had transpired as the minutes described.

Disclosure Claims

The court held that in addition to the fiduciary duty claims above regarding the sales process, plaintiff had adequately alleged breach of the duty to “disclose fully and fairly all material information with the board’s control when it seeks shareholder action.”10 The court held that plaintiff had adequately pleaded damages, by alleging that they equaled the difference between the deal value and the value implied by the November Projections.

Takeaways

This decision by Vice Chancellor Laster is similar in many respects to his earlier decision in In re PLX Technologies Inc. S’holder Litig.11 Both concerned board breaches of fiduciary duty when an activist fund’s board representative allegedly manipulated a sale process, including by withholding material information from other directors, to force through an expedited sale that appeared to be contrary to the best interests of the stockholders as a whole. Both cases involved an enhanced scrutiny standard of review, given disclosure violations that prevented application of the business judgement standard under Corwin. Both cases involved allegations that the defendant fund’s investment strategy and its principal’s actions created a conflict of interest vis-à-vis other stockholders. As stated in PLX, “particular types of investors may espouse short-term investment strategies and structure their affairs to benefit economically from those strategies, thereby creating a divergent interest in pursuing short-term performance at the expense of long-term wealth.” In both cases, projections were revised downwards after the deal price had been agreed to, but prior to board approval of the deal, in order to support the deal valuation.

But there are also significant differences between the two decision. In Goldstein, the existence of purchases by the activist in violation of the Company’s insider trading policy, and the failure to disclose them to the other board members or in the Schedule 14D-9, suggest a more flagrant breach of fiduciary duties. In Goldstein, the other board members appear to have had greater conflicts, and were more beholden to the activist’s board representative, than in PLX. But perhaps the biggest difference is the potential damages award. In PLX, where there had been a lengthy auction process, the court held that the per share deal price was the best measure of fair value, and thus plaintiffs had not suffered any damages. Goldstein involves the polar opposite. There was a single-bidder sale process, the market seemed to undervalue the Company’s stock, and a tax indemnity may have prevented some of the more serious bidders from being interested in discussing an acquisition of the Company prior to February 2019. The court appeared receptive to arguments that the November Projections, which yielded a price per share of over $150, were more representative of fair value than the deal price. Assuming that is the case, based on the number of shares outstanding at the time of the transaction, damages could be of the order of several billions of dollars. Obviously facts could develop differently as the litigation progresses, but this provides a useful illustration of why the structure and conduct of the sale process is critical, particularly in situations with board members representing investment funds or other stakeholders with divergent incentives and interests.

This point has wider applicability beyond classic activist funds, and is potentially applicable to investment funds of all stripes.12 The court held that fiduciary duty claims against two of the directors in Goldstein were non-exculpated in significant part because of their roles at other companies with which Sarissa was involved. Investment funds and their portfolio companies should be mindful that a fund’s appointment of an individual to serial boards, or the expectation of such appointments, can create conflicts that cause fiduciary duty claims against the directors to lose the benefit of exculpation.

This is also a concern for the individuals selected by funds for board appointments. Non-exculpated fiduciary duty claims expose them to personal loss, unless those losses are covered by D&O insurance or indemnification. Such individuals should remain cognizant that their fiduciary duties are owed to the corporation on whose boards they sit, and to the corporation’s stockholders as a whole. They should make sure to avoid the types of bad facts alleged in Goldstein, such as failing to disclose material information to other board members, signing off on stockholder information documents that contain material inaccuracies or omissions, and signing off on last minute material downward adjustments to projections.

And investment funds should be mindful that their investment strategy and thesis concerning a particular company, if capable of being presented as short-term in nature, may be used under this line of cases to allege a conflict with the interests of other investors. This supposed divergence of interest can help support an inference that the fund’s board representative is a conflicted fiduciary, raising the legal stakes under enhanced scrutiny.

Goldstein also serves a warning to inside and outside deal counsel about the importance of accurate board minutes. For several meetings, the minutes did not reference that Messrs. Denner or Posner had updated the directors about discussions with Sanofi or Lazard. If they had provided such an update, it would have been important to include that in the minutes. Equally important, the minutes for the January 4th board meeting appeared to be materially inconsistent with contemporaneous emails. Accurate board minutes could make the difference between whether or not directors and officers prevail on a motion to dismiss.

Goldstein also reinforces some of the lessons from PLX. It is critical that directors fully disclose to other board members any discussions they hold with potential acquirors. It is important that boards do an evaluation at the outset regarding potential conflicts of interest of the board members, and put in place a process so as to minimize the impact of any conflicts. Having the board member with the most significant conflicts have such a central position in the sale process was problematic in both Goldstein and PLX. Another problem in Goldstein was Mr. Denner’s concealment of his and Sarissa’s share purchases, particularly given that shareholder ownership was discussed at one board meeting. While those purchases were concealed from the other directors, it would presumably have been simple to have directors expressly confirm the accuracy of the share ownership information in connection with setting up and maintaining the board sale process. Another lesson common to both cases was the apparent acceptance of management’s original, higher financial projections by the board without significant challenge, and the problem of lowering projections in a way that appeared intended to justify the deal price. The importance of solid, realistic projections, including regular updates to those projections as needed, cannot be overstated, even in the absence of any planned sale process. Deal counsel should inquire as to the existence and status of projections at the outset. If internal non-deal projections are overly optimistic, a documented process should be implemented to prepare revised projections early in the process, preferably in connection with the initial valuation work conducted by financial advisors and in any event in advance of price discussions. 

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. C.A. No. 2020-1061-JTL (Del. Ch. May 26, 2022).

  2. For purposes of the motion to dismiss, the court noted that the complaint’s allegations were assumed to be true, and plaintiff received the benefit of all reasonable inferences. The court also noted that the motion was made under Court of Chancery Rule 12(b)(6), which “imposes a lower pleading standard than a motion to dismiss under Court of Chancery Rule 23.1.”

  3. The court’s decision to which this summary relates only addressed the first two claims. The third (Brophy) claim, and aiding and abetting by Sarissa, were addressed in another decision by the court on June 2, 2022.

  4. Corwin v. KKR Fin. Hldgs. LLC, 125 A.2d 304 (Del. 2015).

  5. Corwin v. KKR Fin. Hldgs. LLC, 125 A.2d 304 (Del. 2015).

  6. Citing In re Saba Software, Inc. S’holder Litig., 2017 WL 1201108 (Del. Ch. Mar. 31, 2017).

  7. Quoting In re Cornerstone Therapeutics Inc. S’holder Litig., 115 A.3d 1173, 1179-80 (Del. 2015).

  8. The court noted that the Chancery court had previously found severance equal to twice annual salary was sufficiently material to support an inference that the individual was interested. The court held that to the extent prior case law indicated that severance could not be deemed material if it was pursuant to existing agreements, such an interpretation of case law was incorrect.

  9. In addressing the defendants’ argument that the November Projections were lowered “in response to board dialogue”, the court held that even if the Board had instructed Mr. Greene “to slash the projections, Mr. Greene did not have a duty to comply if it would have caused him to breach his fiduciary duties.”

  10. Quoting Stroud v. Grace, 606 A.2d 75, 84 (del. 1992).

  11.  2018 WL 5018535 (Del. Ch. Oct. 16, 2018). PLX involved a post-trial decision on the merits. By the time of the decision, all of the defendant directors had settled, and the decision just involved an aiding and abetting claim against the activist. A summary of PLX, begins on p. 25 of this Arnold & Porter newsletter.

  12. Sarissa is not a dedicated activist fund, but often acts more like a sophistical life sciences private equity fund. Mr. Denner did not seem to have joined the Company’s board in an activist capacity. He appears to have joined the Company’s board because he was on the board of the Company’s parent entity before the spin-off. Mr. Denner was on that company’s board not because of activism by Sarissa, but because he was appointed to the board as a designee of Carl Icahn, when he worked at Icahn’s fund prior to forming Sarissa. That is what created some of the bad facts in this case: Sarissa did not have a significant ownership stake in the Company because Mr. Denner was not involved with the Company in an activist capacity. When Mr. Denner learned of potential interest by Sanofi, the complaint alleges he rushed to cause Sarissa to buy shares, in violation of the Company’s insider trading rules, so that he could profit from an eventual sale.