Independent Directors, Law Firm and Financial Advisor not Liable for Omissions in Private Tender Offer
R.L. Polk & Co. Inc., a private company, was allegedly more than 90% controlled by the Polk family. The Company was in the consumer marketing business with holdings such as Carfax, Inc. In March 2011, the Company initiated a self-tender to purchase 37,037 shares of its common stock at $810 per share in cash. A financial advisor rendered a fairness opinion to the Company’s Board in connection with the self-tender. Prior to the self-tender, the Company had explored other alternatives, in which the financial advisor participated, such as a reverse merger to reduce the number of stockholders to qualify for Subchapter S status. The reverse merger was never consummated. The financial advisors fees for the abandoned reverse merger alternative were rolled into the Company’s fees for work on the self-tender, allegedly based on the advice of the Company’s law firm.
Fifteen months after the self-tender, the Company engaged a different financial advisor to discuss possible strategic alternatives. The Company was acquired in June 2013 for $2,675 per share, an amount equal to more than three times the offer price in the 2011 self-tender. In addition, the Board had declared special dividends amounting to one third of the self-tender price following completion of the self-tender and prior to completion of the acquisition.
Class action litigation ensued, and the Delaware Court of Chancery rendered its decision on the Defendants’ motion to dismiss in Buttonwood Tree Value Partners, L.P. v R.L. Polk & Co., Inc. et al. The Court declined to dismiss the allegations against three directors that were members of the Polk family. The Court noted the Complaint included minimally sufficient allegations that the Polk family and the Polk directors acted as a controlling block. According to the Court, it was reasonably conceivable the Polk’s stood on both sides of the transaction in an attempt to maintain their control. The entire fairness standard therefore applied at the pleading stage, and the control group has the burden of proving entire fairness. Since it was a motion to dismiss, the Court did not make any factual or other findings of wrong doing or breach of fiduciary duties.
The Court granted the motion to dismiss as to the Company’s directors that were not members of the Polk family. The Plaintiffs failed to plead non-exculpated claims related to the breach of loyalty against these independent directors. The independent directors did not act in bad faith by omitting alleged material disclosures. To do so would require showing an extreme set of facts that the disinterested directors were disregarding their duties or the decision was so far beyond the bounds of reasonable judgement that it was essentially inexplicable on any ground other than bad faith. According to the Court, absent knowledge of a fraudulent scheme, inadequate disclosures related to the background of the self-tender were not the type of omissions that implicated bad faith.
The Plaintiffs also brought aiding and abetting claims against the financial advisor for the self-tender and the Company’s law firm. The Court noted to state a claim for aiding and abetting a breach of fiduciary duty, Plaintiffs must:
Allege facts demonstrating a fiduciary relationship, a breach of the fiduciary’s duty, knowing participation in that breach by the defendants, and damages proximately caused by the breach. The standard for aiding and abetting is a “stringent one, one that turns on proof of scienter of the alleged abettor.” That is, a claim for aiding and abetting often turns on meeting the “knowing participation” element. Therefore, “there must be factual allegations in the complaint from which knowing participation can be reasonably inferred.” “Knowing participation in a board’s fiduciary breach requires that the third party act with the knowledge that the conduct advocated or assisted constitutes such a breach.” Additionally, “the element of knowing participation requires that the secondary actor have provided substantial assistance to the primary violator.”
The Court observed that almost all corporate boards retain law firms to advise them on significant transactions, and that those lawyers are limited by professional responsibilities in their freedom of action concerning information communicated by clients. If pleading a plausible breach of duty on the part of a director or controller is also sufficient to implicate her lawyer as an aider and abettor, a significant and perverse chilling effect on the ability of fiduciaries to obtain legal counsel would result.
Essentially, the Plaintiff’s claim against the law firm boiled down to the law firm’s alleged advice to reallocate the financial advisors fees from the entity involved with the abandoned reverse merger to the Company for the self-tender transaction. According to the Plaintiffs, this was done for the purpose of hiding, from stockholders considering a tender, the fact that the financial advisor had participated in the aborted freeze-out before opining on the fairness of the self-tender, thus facilitating inadequate disclosures on the financial advisor’s role to the stockholders. The Court dismissed the claim against the law firm on the basis that the accounting change recommended by the law firm only appears nefarious if the law firm was privy to a scheme to, shortly after the self-tender, orchestrate a sale at a far higher price. The Court found Plaintiffs failed to allege facts sufficient to infer such knowledge on the law firm’s part.
As to the financial advisor, the Plaintiffs relied on omissions from disclosures regarding the financial advisor’s work on valuation matters related to the reverse merger. According to the Court:
The Complaint lacks sufficient facts from which I may infer that [the financial advisor’s] alleged failure to attempt to correct these omissions results in “knowing participation” in the alleged breach of the Individual Defendants’ fiduciary duties. The Directors were aware of all the facts that the Complaint presumes [the financial advisor] knew. A general duty on third parties to ensure that all material facts are disclosed, by fiduciaries to their principals, is, so far as I am aware, not a duty imposed by law or equity. There is, obviously, no allegation here that [the financial advisor] worked a fraud on the directors, or otherwise caused misrepresentations in connection with the Self-Tender by withholding information from fiduciaries. The Plaintiffs allege only a passive awareness on the part of a non-fiduciary of the omission of material facts in disclosures to the stockholders, made by fiduciaries who themselves were aware of the information. Such passive awareness on the part of [the financial advisor] does not constitute “substantial assistance” to any breach resulting from the Individual Defendants’ failure to disclose the facts.