Board Did Not Have Fiduciary Duty to Maximize Shareholder Benefit in Merger Where There was No Change of Control or Break-up

On January 13, 2014, Justice Friedman of the New York County Commercial Division issued a decision in Badowski v. Carrao, 2014 NY Slip Op. 50042(U), dismissing breach of fiduciary claims relating to a merger.

In Badowski, the class action plaintiff alleged that the

individual defendants, the former directors and officers of Vertro, Inc. (Vertro), breached their fiduciary duties to Vertro's former shareholders by failing to maximize shareholder value, acting in their own interest, and failing to disclose material information in connection with Vertro's merger with Inuvo, Inc. (Inuvo). Plaintiff further alleges that corporate defendants Vertro, Inuvo, and Anhinga Merger Subsidiary, Inc. (Anhinga) aided and abetted those breaches. Plaintiff seeks rescission of the merger of the two companies, which was completed on March 1, 2012, or, in the alternative, rescissory damages. Defendants move to dismiss the Second Amended Complaint in its entirety for failure to state a claim, pursuant to CPLR 3211(a)(7).

The Badowski decision addresses several interesting issues of Delaware corporate law; we suggest that you read the entire decision. This post addresses only the issue of the duty to maximize shareholder value.

The court held that the actions of the individual defendants were not subject to the heightened Revlon standard of maximizing shareholder value, and instead that it would examine their actions under the business judgment rule. The court explained:

In Revlon, a case involving a hostile take-over, the Court held that once it became apparent that the break-up of the company was inevitable or that the company was for sale, the duty of the board changed from the preservation of the company to the maximization of the company's value at a sale for the stockholders' benefit.

As subsequently refined by the Delaware Courts, the Revlon requirement that the directors seek the best value reasonably available to shareholders applies in at least the following three scenarios: (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder's offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control. The Courts have further clarified that the Revlon duty of value maximization is triggered only when a company embarks on a transaction — on its own initiative or in response to an unsolicited offer — that will result in a change of control. In the context of a stock-for-stock merger, a change of control for Revlon purposes can be triggered if the target's shareholders are relegated to a minority in the resulting entity, and the resulting entity has a controlling stockholder or stockholder group. Where, however, ownership of the merged company will remain in a large, fluid, changeable and changing market, Revlon is not implicated.

(Internal quotations and citations omitted) (emphasis added).

The court held that the Revlon factors had not been adequately alleged, including that there was no allegation that "the shares of the resulting entity will not be freely traded in the marketplace or that the former Vertro shareholders will be subjected to a controlling shareholder or block of shareholders," that the sale would not result in a break-up of the company and that triggering "change-in-control provisions contained in contracts of Vertro's officers and directors" did not "establish change of control for Revlon purposes."

While there are many take-aways from this decision, one is the importance of transactional counsel to help guide a board through the myriad requirements of Delaware law affecting mergers.