Delaware Supreme Court Offers a Cautionary Reminder on Disclosure Adequacy
Disclosures to stockholders can be the hobgoblin of M&A transactions. Delaware law requires that disclosures apprise stockholders of all material information and not be materially misleading. What is sufficiently material for disclosure turns on what a reasonable investor would consider important when deciding how to vote on the transaction. The information must be accurate, full, and a fair characterization of events so as not to be deemed materially misleading.
The adequacy of the disclosure plays a critical role under Delaware’s Corwin doctrine, where the deferential business judgment rule often results in dismissal of post-closing damages actions if the transaction was approved by a fully informed, uncoerced majority of the disinterested stockholders and is not otherwise subject to entire fairness review. The July 9, 2018 decision in Morrison v. Berry is a recent pronouncement of the Delaware Supreme Court’s view of disclosure adequacy. The Supreme Court “offers a cautionary reminder to directors and the attorneys who help them craft their disclosures: ‘partial and elliptical disclosures’ cannot facilitate the protection of the business judgment rule under the Corwin doctrine.”
Morrison involved a going-private transaction in which a company had agreed to be acquired by a private equity firm in a transaction in which the founder had agreed to roll over his existing shares into shares of the acquirer, rather than selling his shares alongside other stockholders, pursuant to a cash tender offer by the acquiring private equity firm for the shares of the other stockholders of The Fresh Market. Pursuant to federal securities laws, Fresh Market filed a Schedule 14D-9 articulating the board’s reasons for recommending stockholder acceptance of the tender offer. The Schedule 14D-9 included a narrative of the events leading up to the transaction. The private equity firm filed a Schedule TO that included its own narrative of the transaction background. Such a filing is required of any party who will own more than 5% of a class of the company’s securities after making a tender offer.
Based, in part, upon materials obtained from Fresh Market through a books and records demand under section 220 of the Delaware General Corporation Law, a stockholder identified potential discrepancies between the Schedule 14D-9, the Schedule TO, and the information contained in the company records. More specifically, the stockholder alleged that the disclosures were materially incomplete and misleading because they:
- did not inform the stockholders that the company founder, who controlled 9.8% of the stock, was not candid with his fellow board members when confronted about his relationship with the private equity firm and denied the existence of any pre-existing agreement with the acquirer;
- the Schedule 14D-9 did not disclose the company founder’s pre-existing agreement with the acquirer to roll over his equity interest if the acquirer reached a deal with the board;
- improperly suggested that the founder would participate in an equity rollover with any buyer, whereas in actuality he expressed to the board that he was only doing so if the private equity firm was the buyer;
- did not disclose the founder’s “threat” to sell his interest in the company if the board did not engage in a sale process; and
- mischaracterized that the board formed a Strategic Transaction Committee to explore a sale process because the company could become the subject of shareholder pressure, when in fact the company was already subject to such pressure.
The tender offer by the private equity firm closed with 68.2% of the outstanding shares validly tendered. The stockholder then pursued a breach of fiduciary duty claim against the board, in part contending that the disclosure deficiencies prevented stockholders from making an informed decision about the tender offer. The lawsuit was dismissed at the trial court level based upon reasoning that the amalgamation of information disclosed sufficiently apprised stockholders of the pertinent facts to warrant application of ratification under Corwin (extended to tender offers by In re Volcano Corp.).
Reversing the dismissal, the Supreme Court reminded those tasked with preparing disclosures that failure to include full and complete facts underlying the background narrative is problematic. The Supreme Court stated that whether omitted information is material includes facts that a stockholder would “generally want to know in making a decision, regardless of whether it actually sways a stockholder one way or the other, as a single piece of information rarely drives a stockholder’s vote.” The test is whether there is a substantial likelihood that a reasonable stockholder would have considered the omitted information important when deciding whether to tender shares or seek appraisal.
Although several of the facts identified by the stockholder were arguably covered by the Schedule TO, the Supreme Court’s decision implies that neither incorporation by reference of the Schedule TO nor the fact that the Schedule TO was also available to the stockholder and provided certain omitted information will cure deficiencies in the Schedule 14D-9. To the extent possible, effort should be made to coordinate the narratives disclosed by the parties. Ratification under Corwin can be a powerful tool for heading off stockholder challenges, but only when care is taken to fully inform the stockholders of all material information in a manner that is not misleading. Directors should retain legal counsel familiar with Delaware disclosure requirements to best position for a Corwin defense.
 The business judgment rule is generally the default standard applied in determining if a board acted properly in accordance with its fiduciary duties in approving a transaction. Such a standard protects the board from second-guessing by the courts. However, the presumption that the board acted properly can be rebutted if stockholders can establish that the board was either interested in the transaction or lacked the independence to consider objectively whether a transaction is in the best interest of the company and its stockholders or where a controlling stockholder is on both sides of a transaction. In such a case, the more onerous entire fairness standard requires that the transaction must be fair as to both process and price. In this case, the founder (a director of the company) had an interest in the transaction.
 In a tender offer, the company that is the subject of the takeover must file with the SEC its response to the tender offer on Schedule 14D-9.