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Chancery Finds General Counsel Potentially Liable for Misleading Tender Offer Documents

By | January 3, 2020

Morrison v. Berry considers Plaintiff’s claims for damages following the purchase of a grocery-store chain, The Fresh Market, Inc. (“Fresh Market” or the “Company”) by Apollo investment entities. The Plaintiff was a former stockholder of the Company, purportedly acting on behalf of the stockholder class. She alleges that certain Fresh Market fiduciaries breached their duties in negotiating the sale and in obtaining the assent of the stockholders. The matter was previously the subject of a motion to dismiss, which was granted based on the fact of the approval of the merger by a majority of disinterested stockholders.    The Plaintiff appealed that decision, and the Supreme Court reversed and remanded, finding that the Defendants failed to show the stockholder vote was fully informed, and thus the business judgment rule did not apply under Corwin.  The Complaint was amended and the matter was again before the Court on additional motions to dismiss, alleging failure to state a claim under Chancery Court Rule 12(b)(6).

While the Court’s opinion is wide ranging and considers a number of issues, it addresses Scott Duggan’s, the General Counsel of Fresh Market, motion to dismiss for the claims against him.  As an officer of Fresh Market, Duggan was not exculpated by the Company’s 102(b)(7) provision.  The Court noted Plaintiff must plead either a breach of the duty of loyalty or care to overcome Duggan’s motion to dismiss.

To state a claim for breach of the duty of loyalty the Plaintiff must plead Duggan was interested in the transaction, lacked independence, or acted in bad faith.  To state a claim for bad faith conduct, the Plaintiff must allege Duggan knowingly and completely failed to undertake his responsibilities.

A breach of the duty of care exists if Duggan acted with gross negligence. Gross negligence involves more than simple carelessness. To plead gross negligence, a plaintiff must allege “conduct that constitutes reckless indifference or actions that are without the bounds of reason.”

Change-in-Control Benefits

The Court noted the Plaintiff did not plead a claim for breach of the duty of loyalty related to change-in-control benefits.  The Court primarily based this conclusion on the fact that  change-in-control benefits arising out of a pre-existing employment contract do not create a conflict.  Nothing in the alleged facts suggests Duggan’s single-trigger bonus was unique or specially negotiated in anticipation of the Apollo transaction. The change-in-control benefit was not exclusive to a purchase by Apollo, and would not predispose Duggan to encourage a sale to Apollo exclusively, nor a sale at an unfair price.

Alleged Knowledge of Wrongdoing

The Court noted as a general rule, an officer does not have a duty to probe into wrongdoing unless he has reasonable suspicion that such activity is afoot. According to the alleged facts, Duggan first received news of Apollo’s interest from Ray Berry, Fresh Market’s Chairman of the Board and former CEO, and a few days later from  Apollo. Thus, Duggan knew that Berry and Apollo had communicated and that Apollo’s bid was forthcoming.  When that bid arrived, it stated as fact that Berry and Apollo were in an exclusive relationship. At that point, Duggan went to Berry and asked him about this purported relationship, and Berry denied it. Duggan reported Berry’s version to the Board, which declined further inquiries. When Berry later made a contrary disclosure, Duggan reported it in full to the Board.  The Court found it may have been wise to explore further, but that the pleaded facts did not support gross negligence.

Process Related to Revised Projections

Plaintiff also alleged Duggan breached his fiduciary duties by organizing a scheme to obtain downward revised projections from the Company’s financial adviser without allowing input from Richard Noll, a Board member and a member of the Strategic Transaction Committee. Duggan’s motive, according to the Plaintiff, was to create a lower price range that would justify the Board’s decision to sell, thus completing a sham process. In the Plaintiff’s scenario, Duggan’s behavior was intentional and implicated a breach of loyalty. The Court discounted the allegations, noting that Noll was travelling on business during a Committee meeting in question.  Communications indicated that Duggan intended to share all materials and plans with Noll.

The Court found Duggan’s process did not evince a breach of loyalty or bad faith. Nor were there sufficient allegations from which to infer gross negligence. Suggesting additional financial scenarios to prepare the Board for bids—particularly when the last projections were three months old—reasonably suggests Duggan was fulfilling his duties on behalf of the Company, not acting outside the bounds of reason.

Disclosures in Schedule 14D-9

The Delaware Supreme Court found four omissions in the Schedule 14D-9 to be material.  The Plaintiff argued that the omissions suggested that Duggan intended to disguise his disloyal actions.  However, the allegations related to Duggan’s conduct in the sales process, as noted above, did not adequately plead disloyalty on Duggan’s part.

Turning to the claim of gross negligence, the Court noted “Because fiduciaries . . . must take risks and make difficult decisions about what is material to disclose, they are exposed to liability for breach of fiduciary duty only if their breach of the duty of care is extreme.” Given the omissions noted by the Supreme Court, the Court observed the Schedule 14D-9 offers stockholders a version of events that left them lacking information material to a decision. Such a distortion of events creates a reasonable inference for the Plaintiff at this stage that Duggan conceivably acted with gross negligence in his role as Fresh Market’s General Counsel with regard to the 14D-9.  Given Duggan’s role as General Counsel, and given the sales process as pled, the Court stated it inferred that the omitted facts were omitted with Duggan’s knowledge. According to the Court it is reasonably conceivable that crafting such a narrative to stockholders, while possessed of the information evincing its inadequacy, represents gross negligence on Duggan’s part.

The Court concluded noting another reasonable interpretation is that the Schedule 14D-9 represents a good faith but failed effort to make reasonable disclosures, but given the pleading stage, the Court must choose the inference favoring the Plaintiff. Therefore, the motion to dismiss was denied.

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