Today, I’m blogging about Vice Chancellor Laster’s post-trial decision in In re Columbia Pipeline Group Merger Litigation. This is a fascinating case for many reasons, starting with its procedural history.
The sum is, TransCanada bought Columbia Pipeline in 2016, and shareholders have been suing about it ever since.
First, there was a fiduciary claim against the Columbia Pipeline directors, which was dismissed on the pleadings. Then, there was a securities action in federal court alleging disclosure failures in the merger proxy, which was also dismissed on the pleadings. Then, there was an appraisal action, which resulted in a judgment that the deal price was equal to the fair value. And then, finally, there was the second fiduciary action – this action, which made it to trial – and which Laster refused to dismiss on the pleadings in March 2021. The plaintiffs brought claims against Robert Skaggs, the CEO and Chair, and Stephen Smith, the CFO and Executive VP. They also sued TransCanada as an aider and abetter of Skaggs’s and Smith’s fiduciary breaches.
On the motion to dismiss back in 2021, no one claimed that the first fiduciary action – where the plaintiffs had not even sought books and records – was preclusive of the second one, but the defendants did argue that the earlier securities action and the appraisal action precluded – through estoppel, or as precedent, or as persuasive legal authority – the second fiduciary action.
Laster rejected both arguments. For the earlier securities action, he spent some time on the difference between federal and Delaware’s pleading standards, but his reasoning carries a whiff of disdain for federal courts’ understanding of materiality in the merger context.
As for the appraisal action, he held that it was asking a different legal question than the fiduciary action, namely, whether the deal price represented fair value, not whether Skaggs and Smith breached their fiduciary duties by failing to obtain the best value for the stockholders.
The upshot of all of this was that Laster permitted a fiduciary claim to proceed against Skaggs, Smith, and TransCanada. After the Skaggs and Smith settled, the claims against TransCanada proceeded to trial, and that was the decision issued earlier this week, where Laster found that TransCanada did, in fact, aid and abet breaches of fiduciary duty.
Several things to talk about here, so behind a cut it all goes.
Let’s start with: for an aiding claim, the key question is whether there was an underlying fiduciary breach, and whether the defendant knowingly participated in the breach.
So, was there a breach? Laster divides the issues into two: the sales process claim, and the disclosure claim arising out of omissions in the proxy. The disclosure claim was less complex, so I’ll focus on sales process.
Laster begins with an extensive discussion of standards of review. Obviously, there’s the most lenient, business judgment. Next, there’s entire fairness, which is the most exacting standard reserved for transactions involving an uncleansed conflict of interest. And then, in the middle, there is enhanced scrutiny. At this point, Laster undertakes the somewhat ambitious task of unifying a bunch of different lines of caselaw as coming under the rubric of “enhanced scrutiny,” relying in part on the Delaware Supreme Court’s recent opinion in Coster v. UIP Cos. (which I blogged about here), and which combined Blasius and Unocal. Revlon, of course, is another form of enhanced scrutiny, and he puts Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), in the enhanced scrutiny bucket as well. The theme, he writes – and I think this mirrors a point he’s made in earlier cases – is that certain recurring scenarios present structural conflicts that warrant a greater degree of suspicion from reviewing courts. As he puts it:
there is an identifiable decision-making context where the realities of the situation can subtly undermine the decisions of even independent and disinterested directors. Inherent in these situations are subtle structural and situational conflicts that do not rise to a level sufficient to trigger entire fairness review, but also do not comfortably permit expansive judicial deference under the business judgment rule. Second, the decision under review involves the fiduciary intruding into a space where stockholders possess rights of their own. The fiduciary’s exercise of corporate power therefore raises questions about the allocation of authority within the entity and, from a theoretical perspective, implicates the principal-agent problem…
(citations, alterations, and quotations omitted. In my day, there was no such thing as a “cleaned up” signal.)
He also writes that all of these forms of enhanced scrutiny boil down to asking whether directors “(i) acted for a proper purpose and (ii) selected an appropriate means of achieving that purpose.”
Okay. Stop there.
I don’t disagree with any of these conclusions, but they do raise the question: If enhanced scrutiny is appropriate in these situations presenting structural conflicts that intrude on shareholder rights, should we have it in other situations? Such as, most obviously, when directors unilaterally pass a bylaw that limits litigation against them, or, in a particular case, refuse to waive such a bylaw? Why wouldn’t we use Zapata review for demand excused/demand refusal even when the board is majority independent/disinterested, on the theory that even a majority-unconflicted board still won’t be thrilled about suing their fellow, minority board members? Certainly, I assume, future advance notice bylaw cases should receive Unocal review with the new Blasius twist.
That’s what occurs to me off the top of my head – there may be other situations that, under Laster’s taxonomy, should receive enhanced scrutiny.
Anyway, unsurprisingly, Laster reviewed the conduct of Skaggs and Smith under the Revlon enhanced scrutiny standard and concluded they had, in fact, breached their duties. The opinion paints a compelling picture that Skaggs and Smith had decided they wanted to retire, sell their stock, and get their extremely generous change of control benefits, and the only way to do that was to accept a cut-rate price in order to push a deal through. Parts of the opinion are genuinely hilarious, such as when Smith, an inexperienced negotiator, physically hands over his talking point notes to TransCanada’s representative rather than discussing them, which was among several moves that left TransCanada absolutely baffled (“Smith’s behavior during that period seemed so accommodating that Poirier [TransCanada’s rep] was puzzled and found himself pondering what Smith might be trying to do”). Skaggs and Smith repeatedly favored TransCanada in negotiations, including letting them violate the don’t-ask-don’t-waive and openly telling TransCanada that the board was “freaking out” over a leak and would do “whatever it takes” to close the deal.
Ultimately, TransCanada realized that Columbia Pipeline’s representatives were – I swear to god, these are Laster’s words – “acting like a bunch of noobs who didn’t know how to play the game,” pressed its advantage, and managed to get a price below what it would have otherwise been willing to pay (as well as getting a jump on competing acquirers).
All of this was an unreasonable sales process, undertaken out of bad faith motivation by Skaggs and Smith, and they also misled the board and generally contributed to the board’s breach of their care duties. Everybody’s in breach.
Did TransCanada aid?
This is where Laster realizes he’s on novel ground. It’s one thing if a fiduciary (like a board member) or someone working for the target (like a financial advisor) sabotages the process. The target is relying on those actors to act on its behalf. And it’s certainly aiding and abetting if the acquirer actually creates a conflict of interest on the board, like by going out and bribing the CEO personally to get the deal done.
But if an arm’s length counterparty like an acquirer does not create a conflict, but merely notices an existing one and exploits it to gain a bargaining advantage – what’s the line between sharp dealing and aiding and abetting a fiduciary breach?
That’s the problem Laster was confronted with in Columbia Pipeline, and he clearly recognized he had a difficult issue, because he spent pages and pages justifying his conclusion (expert testimony on bargaining tactics was even involved). Laster’s main takeaway was that TransCanada was on actual or constructive notice that Skaggs and Smith were compromised, and took advantage of that fact in various ways, partly by socially cultivating Smith, but mainly by breaching the standstill/NDA it had signed. It repeatedly violated the don’t-ask-don’t-waive provisions, and in violation of its NDA, it threatened to publicly announce the failure of talks unless Columbia Pipeline accepted a deal price lower than one that had previously been agreed upon. Laster concluded this threat was coercive: the lower price was not, in fact, TransCanada’s best offer, it was simply what it thought it could get away with given Skaggs and Smith’s behavior, and was issued in violation of TransCanada’s contractual obligations.
This combination of factors pushed TransCanada’s behavior over the line to aiding and abetting. Laster in particular emphasized that to hold otherwise would give acquirers incentives to keep pushing the boundaries of contractual agreements with targets, knowing that targets will have to make hard choices when deciding whether to enforce them. Treating the violation of preliminary contractual agreements as potential factors in an aiding and abetting claim would, Laster concluded, create better incentives.
Couple things.
First, as I said, Laster recognized the delicacy of the inquiry here, and he began by looking at prior caselaw. And, I gotta say, he used a bit of retconning in his interpretation. He started with C & J Energy Servs., Inc. v. Mia. Gen. Empls.’ Ret. Tr., 107 A.3d 1049 (Del. 2014), a relatively recent case that held that courts should not use preliminary injunctions to bar enforcement of merger agreements unless the acquirer aided and abetted a target’s breach. He then went back in time, to look at earlier cases where preliminary injunctions had issued, and concluded those cases must illustrate what aiding and abetting by a counterparty looks like, even though no court had ever so held. So, he concluded, Revlon, and Mills Acq. Co. v. Macmillan, Inc., 559 A.2d 1261 (Del. 1989), were in fact aiding-and-abetting cases, and he used the facts of those cases to illustrate how sharp dealing differs from knowingly participating in a breach.
Well, you know, I’d argue that C&J changed the law, it did not restate it – and if that’s right, then Revlon and Mills don’t tell us anything about what aiding and abetting looks like from counterparties. In that sense, should TransCanada seek to appeal, Laster’s reasoning offers something of a dare to the Delaware Supreme Court: Admit that C&J represented a break from prior law, or accept a rather broad view of aiding and abetting that includes the conduct in Revlon and Mills?
Beyond that, Laster doesn’t identify any precedent where an arm’s length counterparty – not in cahoots with someone working for target, as occurred in In re Del Monte Foods Co. S’holders Litig., 25 A.3d 813 (Del. Ch. 2011) – was found to aid and abet because it breached a preliminary contract in response to vulnerable/weak negotiators. There is a danger here, that contractual obligations will be converted into fiduciary obligations, which is usually, you know, bad.
On the other hand. Skaggs and Smith were acting as agents of TransCanada. In the general common law of agency, if an agent acts outside the scope of his authority, his actions still bind the principal vis a vis third parties on a theory of apparent authority, unless the third party knows the agent does not have the authority he claims. Can that situation present something of an analogy here? If Smith and Skaggs were so obviously compromised that TransCanada was aware they were not, in fact, representing Columbia Pipeline’s interests – and certainly if TransCanada had any reason to suspect the board was not fully informed – then perhaps TransCanada really did aid their breach by continuing to deal with them, and expecting to hold Columbia Pipeline bound to the merger contract that resulted.
But there’s more!
Laster concluded that TransCanada aided two distinct breaches of duty: the Revlon failure of sales process, and the omissions from the proxy materials. That meant he had to assess damages.
For the sales process claim, the damages were equivalent to what TransCanada had originally agreed to pay, before it coerced Columbia Pipeline into a lower price by threatening to publicly end negotiations. That by itself is interesting mainly by comparison to the earlier appraisal action, where he only awarded the deal price. The two cases had some different evidence, but the reason for the distinction was, of course, that fiduciary actions are different than appraisal. As Laster put it:
For purposes of the Sale Process Claim, TransCanada is liable to the class in the amount of $1.00 per share. This award necessarily results in the plaintiffs in this case receiving more than the fair value of their shares, which the Appraisal Decision determined to be $25.50 per share. That is because an appraisal measures the value of the corporation as a standalone entity, as if the merger giving rise to appraisal rights never happened. An appraisal does not take into account other injuries, such as the possibility that sell-side fiduciaries could breach their fiduciary duties by failing to obtain a higher-valued transaction.
Appraisal excludes synergies; by contrast, the best price available in a Revlon compliant sales process may include them. In this case, that turned out to be $1 per share.
Then there was the disclosure claim. The ultimate holding was that the disclosure damages were duplicative with sales process damages, not cumulative, so they ultimately didn’t add anything, but the number – and how he reached it – was interesting.
He held that while plaintiffs would ordinarily need to prove reliance, reliance in this case would have been presumed – if plaintiffs had made any arguments about it. They didn’t, though, which meant there was a failure of proof on the issue of reliance, leading him to award only what he called “nominal” damages on the disclosure claim of 50 cents per share. He went through a number of calculations to show that 50 cents was at the low end of what the shareholders lost as a result of the faulty process (not unlike the sales process claim).
But! As a backup calculation to demonstrate the propriety of 50 cents per share, he also did a cross check regarding the value of voting rights in general, on the theory that the disclosure breaches of duty represented an impairment to shareholders’ voting rights. He invoked academic studies demonstrating how investors value voting rights, by comparing the pricing of voting shares to nonvoting shares, and the pricing of large blocks of shares to the pricing of individual ones. Those studies confirmed that the 50 cents per share award was within the range of how votes are valued in the market.
So let me explain why this intrigues me. A few weeks ago, I posted about the Ninth Circuit’s en banc decision in Lee v. Fisher. There, the Ninth Circuit allowed a Delaware corporation to adopt a litigation-limiting bylaw that functionally eliminated Section 14(a) derivative claims by requiring them all to be heard in Delaware Chancery, which has no jurisdiction to hear Section 14(a) claims. I argued in that post that the decision could significantly impact shareholder rights, because there are many Section 14(a) claims where the only economic harm is to the company, and so a direct claim – which the Ninth Circuit left intact – would not yield any damages. In support, I cited Delaware decisions where that exact thing had occurred.
Which makes me wonder whether Laster’s opinion here might offer a method for valuing voting rights in future Section 14(a) cases brought as direct claims, where the only measurable economic injury is to the company itself.
That’s not what Laster was doing in Columbia Pipeline, of course. Laster actually goes out of his way to make clear that his award of damages on the disclosure claim is based on the actual economic injury to shareholders from the transaction; the separate voting rights calculation is only a backup. And, when he held that the 50 cents per share based on disclosure violations would not be added to the $1 per share on the sales process claim – the two were not cumulative – he explained:
Delaware courts have generally calculated damages for breach of the duty of disclosure using the value of the underlying economic rights harmed by the breach…In theory, there could be an award of damages for the loss of voting rights that is separate from and additive to the economic loss…But Delaware decisions have never calculated damages that way. Delaware courts have only awarded damages based on the economic harm. In a disclosure case warranting a quasi-appraisal remedy, the plaintiff receives only its pro rata share of the value of the company as if it had remained a standalone entity. The plaintiff does not receive that value plus an additional measure of damages tied to the lost voting right. Likewise, cases that have found a sale-process injury and a disclosure-based injury have only awarded a singular recovery tied to the economic harm.
But still, it raises the question whether his method could be used in cases where there is no direct economic injury to the shareholders at all, other than the disclosure violations.
Whew. Okay, I’m done now.