In re Xura, Inc. Stockholder Litigation: Fiduciary Duties of Officers, Ratification, and the Limitations of Corwin
In In re Xura, Inc. Stockholder Litigation, Consol. C.A. No. 12698-VCS, 2018 WL 6498677 (Del. Ch. Dec. 10, 2018) (Slights, V.C.), the Delaware Court of Chancery recently made significant rulings concerning the fiduciary duties of an officer negotiating a merger. Denying a motion to dismiss, the Court held that: (1) the Plaintiff had pled sufficient facts to state a claim that Philippe Tartavull, the CEO of Xura Inc. (“Xura”), and the only director or officer named as a defendant, had breached his fiduciary duties while negotiating a merger between Xura and Siris Capital Group, LLC (“Siris”); (2) the approval of the merger by a majority of disinterested and independent directors who were unaware of Tartavull’s wrongful actions did not operate to ratify or cleanse the breach; and (3) the approval of the merger by a majority of Xura’s stockholders who were not informed about Tartavull’s conflict of interest and wrongful actions could not trigger business judgment review under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015).
Xura is significant for at least four reasons. First, it identifies conduct by an officer negotiating a merger that can constitute a breach of fiduciary duty even where the merger is approved by a disinterested and independent board. Second, it intimates that a board could possibly “ratify” (and thereby cleanse) conduct by officers in breach of their fiduciary duties, but the decision leaves open questions about the scope of such ratification. Third, it underscores the limitations of the Corwin doctrine as a defense where the wrongful conduct that underlies the claim is not disclosed to the stockholders. Finally, because the undisclosed conduct in Xura never would have been unearthed but for discovery in a related appraisal action, Xura highlights a concern that Corwin might operate unfairly in cases where stockholders do not have a mechanism to learn (and plead) material facts that were not disclosed.
In Xura, the Plaintiff claimed that Tartavull had breached his fiduciary duties as an officer and, in that capacity, was ineligible for exculpation under a charter provision pursuant to Section 102(b)(7) of the Delaware General Corporation Law, because Tartavull (i) had a disqualifying conflict, and (ii) exceeded his authority as Xura’s chief negotiator of the deal. To support its assertion, the Plaintiff pled several facts, not typically occurring in most mergers.
To begin with, negotiations actually resulted in the offering price being lowered. After Siris’s offer of $30-32 per share was rejected by Xura’s board, Siris raised it to $35, but subsequently reduced it to $28 and then to $24.75, with the merger ultimately closing at $25 per share. Moreover, Tartavull also had a unique conflict of interest. Not only did Tartavull and Siris expect that he would continue as CEO of the combined entity if the merger succeeded, but Tartavull also faced the risk of termination from Xura if the transaction did not close. Thus, Tartavull was incentivized to reach a deal – any deal – to save his job.
Tartavull also exceeded his authority as Xura’s sole negotiator. Although Xura’s board designated him as the person with whom Siris would communicate, the board also engaged Goldman Sachs & Co. as its financial advisor and created a Strategic Committee (consisting of Tartavull and two other directors) “to review, evaluate and negotiate the terms of a potential transaction with Siris and to make certain decisions between meetings of the board of directors.” But Tartavull rarely involved Goldman Sachs in, or informed Goldman Sachs about, the communications between himself and Siris. The Strategic Committee’s only activity was to receive updates from Tartavull.
Against this backdrop, the Court highlighted several serious procedural missteps by Tartavull that led it to conclude that the complaint stated a claim against him for breach of fiduciary duty. Specifically, (i) when Siris told Tartavull that it intended to reduce its offer from $35 to $27 per share, Tartavull unilaterally (i.e., without consulting the Strategic Committee or Goldman Sachs) suggested and “agreed” to a price of $28; (ii) Tartavull never informed Goldman Sachs or Xura’s board about that meeting or his agreement to the $28 price; moreover, it appeared that Tartavull attempted to conceal those facts during discovery in the companion appraisal proceeding; (iii) when Siris formally communicated its second reduction in the offering price, Goldman Sachs and Xura’s board decided the appropriate response was “radio silence,” yet in violation of that directive, Tartavull unilaterally contacted Siris directly to discuss “next steps”; and (iv) in communicating with Siris, Tartavull undermined the authority and disparaged the competency of Xura’s CFO, causing Siris to question the information provided to it by Xura and its CFO. Additionally, a potential acquiror that might have engaged in competitive bidding with Siris became, instead, a co-investor with Siris on the “buy-side” of the transaction.
In advocating dismissal, Tartavull argued that even if those facts were enough to support a breach of fiduciary duty claim, the claim was not actionable because the merger had been approved in good faith by a disinterested and independent majority of Xura’s board. Moreover, Tartavull argued, Corwin required application of the business judgment standard and dismissal of the claim, because a majority of Xura’s stockholders had approved the merger. The Court rejected both arguments, holding that the pled facts permitted the inference that the board and the stockholders were unaware of Tartavull’s conduct. Framing the issue as whether the board had “ratified” Tartavull’s conduct, the Court concluded that “there is no basis to invoke Board ratification as a defense at the pleading stage, even assuming that board ratification would be a defense to a CEO’s alleged breach of fiduciary duty.” Similarly, the Court held Corwin inapplicable because the stockholders were not informed of Tartavull’s conduct when they voted to approve the merger, and also because the proxy had credited the moribund Strategic Committee with efforts in negotiating the merger that never occurred.
Insights and Remaining Questions
Xura provides insight into, and raises additional questions about, four issues.
First, Xura identifies specific instances of negotiation conduct by an officer that could support a claim for breach of fiduciary duty. A complicating factor is that the Court based its decision on a combination of circumstances viewed collectively. It is fair to ask if the Court would have reached the same conclusion if one or more of those facts were absent. For example, although the Complaint disclosed some explanations for the reduction in the merger price unrelated to any flaws in the negotiations, the reduction still may have influenced the Court’s decision. Would the same flaws in the negotiation process have been deemed actionable had there been no merger price reduction?
Second, the decision seems to suggest that an officer’s wrongful conduct with respect to a transaction might be “ratified” by a fully-informed, disinterested and independent board, thereby extinguishing any claim based on that conduct. If such a “ratification” defense is available, its scope is unclear. Had the board known of Tartavull’s conduct before it approved the merger, would that knowledge render Tartavull’s conduct no longer actionable even if his conduct had prejudiced Xura’s position in the merger negotiations and ultimately caused harm to the stockholders?
Third, although Xura demonstrates the limits of the Corwin standard-shifting doctrine in cases where stockholders are inadequately informed before casting their approving vote, it leaves open the question how much stockholders must be told about the wrongful conduct to trigger business judgment review. The Court concluded that Xura’s stockholders were “entirely ignorant” of Tartavull’s wrongful conduct. But suppose the proxy had disclosed Tartavull’s conflict plus some – but not all – of that conduct? Perhaps that issue could be resolved under a materiality analysis. But must there be disclosure of Tartavull’s subjective state of mind? If a fiduciary's conduct and conflict are fully disclosed, but no disclosure is made with respect to his or her actual state of mind, would Corwin nonetheless operate to extinguish the claim? Put differently, can stockholders cleanse a fiduciary’s bad faith absent some measure of “self-flagellation”, distinct from the conduct and conflicts that might evidence or motivate the bad faith? Perhaps the answer is that subjective bad faith can be inferred from the conflict and “bad conduct” disclosures, but that question must await further litigation.
Lastly, Xura highlights a potential problem of practicality and fairness with the Corwin doctrine. But for the appraisal action that uncovered Tartavull’s conflict and missteps, the Plaintiff’s claim likely would have been extinguished under Corwin. But, in most breach of fiduciary duty actions, the plaintiff will not obtain discovery before the Corwin defense is resolved at a preliminary stage. Unless the actionable conduct has been disclosed before any discovery occurs, the plaintiff will not know of its existence, or of the failure to disclose that conduct to shareholders, and will therefore be unable to adequately plead that the stockholder vote was uninformed. It is therefore possible that Corwin may extinguish meritorious claims in cases where the supportive facts are not disclosed and where the means of uncovering those facts are not readily available before the Corwin issue is presented for decision.
This is not to suggest that Corwin should be overturned; the doctrine undoubtedly extinguishes more non-meritorious claims than meritorious ones. But there should be alternative and economical means to obtain information for a full and fair Corwin inquiry. At the least, Corwin should be applied cautiously in situations that facially trigger some level of suspicion, especially when the claim involves allegations of breach of the duty of loyalty. An action for books and records might serve as a vehicle to unearth the critical facts, but for that process to succeed, a plaintiff must already know enough to show that there is a credible basis to find probable wrongdoing relating to the merger negotiation, Sec. First Corp. v. U.S. Die Casting & Dev. Co., 687 A.2d 563, 565 (Del. 1997), and the plaintiff must file the action before the merger closes and he or she loses standing, see Weingarten v. Monster Worldwide, Inc., C.A. No. 12931-VCG, 2017 WL 752179, at *5 (Del. Ch. Feb. 27, 2017). In Xura, the appraisal served as the mechanism for obtaining information, but not every breach of fiduciary duty action will be preceded or accompanied by an appraisal. A third possibility may be to permit some form of limited discovery at the pleadings stage where Corwin will be advanced as a basis for dismissal. Hopefully, this issue will be resolved in future cases.