One of today’s more widely debated issues in the M&A space concerns the precise scope, application and boundaries of the Delaware Supreme Court’s decision in Corwin v. KKR Fin. Holdings, 125 A.3d 304 (Del. 2015). Corwin held that a post-closing claim for damages arising out of a merger not governed ab initio by the entire fairness standard will be reviewed under the business judgment rule, if the merger was “approved by a fully informed, uncoerced majority of the disinterested stockholders.” A line of post-Corwin Court of Chancery decisions has confronted different aspects of that issue,1 but it has yet to come to rest and is still a work in progress. The latest, and highly significant, contribution to that doctrinal issue is Chancellor Andre Bouchard’s May 4, 2017 decision in In re Massey Energy Co. Derivative & Class Action Litig., No. 5430-CB, 2017 WL 1739201 (Del. Ch. May 4, 2017).
The ‘Massey’ Decision
Non-’Corwin’ Aspects of the Ruling.Massey was one of several litigations, including civil, criminal and regulatory proceedings, growing out of an April 2010 explosion at a Massey Energy Company coal mine in West Virginia. The explosion, which killed 29 miners and was the deadliest mining disaster in the United States in 40 years, was the direct result of worn cutting equipment and the mine’s failure to maintain adequate ventilation and water spraying systems. Massey and its CEO, Donald Blankenship, had a history of flouting safety regulations and misleading regulators by manipulating compliance data in favor of maximizing coal production. Massey also had a practice of retaliating against employees who raised concerns about mine safety. This disaster led to Massey having to pay significant civil damages, criminal fines and penalties, and in the criminal conviction of CEO Blankenship. Ultimately, Massey was acquired in a merger by Alpha Natural Resources, which later filed for bankruptcy in 2015.
The Delaware Court of Chancery action involved two identical counts, one styled as derivative and the other as a direct class action on behalf of former (pre-merger) stockholders of Massey. The plaintiffs sought damages against Massey’s former directors and officers, claiming that the defendants had willfully failed to make good faith efforts to assure that Massey complied with mine safety regulations. After the Chancellor denied a motion for a preliminary injunction halting the merger with Alpha, the action was stayed until after the conclusion of the criminal investigation and (thereafter) the Alpha bankruptcy. After the stay was lifted, the defendants moved to dismiss on various grounds, including failure to satisfy the “continuous ownership” requirement under which the derivative plaintiffs must hold their shares continuously throughout the litigation or lose standing to maintain the action. The defendants argued that because the plaintiffs’ shareholder interests were eliminated in the merger wherein Alpha succeeded to Massey’s fiduciary claims, the plaintiffs lacked standing to maintain the action because the claims being asserted were derivative.
Chancellor Bouchard dismissed the complaint on that ground. The derivative count, he ruled, would have stated a viable derivative Caremark claim were it not for the fact that the company (and derivatively its shareholders) had been divested of that claim in the merger. To salvage their direct claim, which was not barred by the continuous ownership requirement, the plaintiffs urged that the direct claim alleged “inseparable fraud” under Countrywide II,2 whereby fiduciaries employ a merger to eliminate their exposure to liability for prior fiduciary misconduct that depleted the corporation’s value such that a merger became inevitable. The Chancellor rejected that argument on the basis that “inseparable fraud” required allegations of misconduct that independently would constitute a direct claim. In Massey, however, the pre-merger conduct—an alleged “business plan” to disregard safety regulations—alleged merely a form of mismanagement that implicated the directors’ duty to the corporation to manage its business with due care and loyalty. That claim, properly understood, was classically derivative.
‘Corwin’ Aspect of the Ruling. Although the opinion could have concluded at that point, Chancellor Bouchard nonetheless proceeded to address the defendants’ separate argument for dismissal, which was that even if the plaintiffs continued to have standing to prosecute their pre-merger mismanagement claims, those claims were extinguished under Corwin. The argument ran as follows: The disinterested stockholders of Massey had cast a fully informed vote to approve the merger. As a consequence, that vote “ratified” the defendant’s pre-merger conduct, thereby extinguishing plaintiffs’ fiduciary claims. The court’s response to this argument, although technically dictum, is important dictum that will afford the M&A bar valuable guidance.
Describing the Corwin argument as “mystifying,” the Chancellor rejected it out of hand. The policy underlying Corwin is to avoid judicial second-guessing after disinterested stockholders have made an informed decision on the economic merits of a transaction. Here, the Massey stockholders voted solely on the Massey-Alpha merger, not on the board’s decision-making process or the fiduciary conduct leading up to that transaction. Indeed, the fiduciary misconduct alleged—a business plan to consciously disregard safety laws—preceded the merger by several years. As the Chancellor aptly put it, Corwin “was never intended to serve as a massive eraser, exonerating corporate fiduciaries for … actions preceding their decision to undertake a transaction.” And, moreover, the stockholders were never asked to approve a release of the defendants for pre-merger mismanagement. “In order to invoke the cleansing effect of a stockholder vote under Corwin [the Chancellor concluded] … there logically must be a far more proximate relationship … between the transaction or issue for which stockholder approval is sought and the nature of the claims to be ‘cleansed’ as a result of a fully-informed vote.”
Some Brief Observations
One may fairly ask whether the Chancellor’s “proximate relationship” limitation on the reach of Corwin represents a doctrinally new development. Even if that were fairly debatable, we view the court’s chosen expression only as reaffirming a long-established principle, but couched in different terms. As a matter of common sense, shareholders who vote for a transaction, but who were not asked to approve pre-transaction fiduciary conduct, should not be deemed to have approved anything other than the transaction itself. The Delaware Supreme Court so recognized in In re Santa Fe Pacific S’holder Litig., 669 A.2d 59, 68 (Del. 1995) (“Since the stockholders of Santa Fe merely voted in favor of the merger and not the [pre-merger] defensive measures, we decline to find ratification in this instance.”) and in Gantler v. Stephens, 965 A.2d 695 (Del. 2009) (“[T]he only director action or conduct that can be ratified is that which shareholders are specifically asked to approve.”). As thus viewed, the Massey court’s gloss on Corwin broke no new doctrinal ground. Only if the Massey court intended to articulate a different concept, would his “proximate relationship” expression raise doctrinal implications. Any clearer answer must await post-Massey case law development.
1. See generally “Difficult in Delaware to Challenge Transactions That Have Been Approved by Disinterested and Fully-Informed Stockholders,” SIDLEY PERSP. ON M&A & CORP. GOVERNANCE (Sidley Austin, Chi.), Feb. 2017, at 7; “Delaware Again Underscores the ‘Cleansing’ Effect of Approval by Disinterested and Fully Informed Stockholders,” SIDLEY PERSP. ON M&A & CORP. GOVERNANCE (Sidley Austin, Chi.), April 2017, at 8.
2. Ark. Teacher Ret. Sys. v. Countrywide Fin., 75 A.3d 888 (Del. 2013).