Monday, November 02, 2015

Merrill Lynch Escapes Claim After Court Admits ‘Material Misapprehension’ of Law

By Matthew Garza, J.D.

A claim against Merrill Lynch for aiding and abetting a breach of duty by directors of Zale Corporation was dismissed after the Delaware Court of Chancery accepted that it had misinterpreted the correct standard to apply to the underlying breach-of-duty claim. Merrill Lynch’s reversal of fortune originated one day after the Chancery Court first refused to dismiss the aiding and abetting claim, when the Delaware Supreme Court issued an opinion in a case involving KKR Financial Holdings LLC. That opinion convinced Chancellor Parsons that he had incorrectly applied an enhanced Revlon standard of review instead of the proper business judgment rule standard to the claim against Zale directors (In re Zale Corporation Stockholders Litigation, October 29, 2015, Parsons, D.).

Merger. The dispute arose from a 2013 merger between two jewelry companies, Signet and Zale. Merrill Lynch advised Zale on the merger and represented that it had “limited prior relationships and no conflicts with Signet,” when in fact it had received $2 million in fees from the company and just one month previously had made a presentation to Signet regarding a possible acquisition of Zale. The merger was approved in February 2014 by a slim majority of Zale stockholders. Holders of Zale common stock then filed suit charging the Zale directors with breaching their fiduciary duties of loyalty and care, and Signet and Merrill Lynch with aiding and abetting those breaches.

Zale’s directors were insulated from the claims through an exculpatory provision in its corporate charter, even though a breach of the duty of care was found to be sufficiently pleaded by the court under the Revlon standard. Signet was let off the hook because it was not shown to have known about Merrill Lynch’s disclosure failure, but Merrill Lynch was unable to shake the aiding and abetting claim because investors pleaded that its representative consciously chose not to disclose the conflict.

Clarifying holding. The Delaware Supreme Court affirmed in the KKR Financial Holdings LLC case that the fully informed vote of a majority of disinterested stockholders invokes a business judgment rule review in cases in which Revlon otherwise would apply. The court found that the Zale-Signet merger was approved by a majority of disinterested stockholders in a fully informed vote, but despite this, Chancellor Parsons said “I declined to follow this Court’s holding in that case because I interpreted the Supreme Court’s decision in Gantler v. Stephens as holding that ‘an enhanced standard of review cannot be pared down to the business judgment rule as a result of a statutorily required stockholder vote, even one rendered by a fully informed, disinterested majority of stockholders.’”

Gantler, however, was a narrow decision focused on defining the term “ratification,” wrote the Chancellor, and he misapprehended the law regarding the cleansing effect of a fully informed, statutorily required vote by a disinterested majority of stockholders, as was the case in the Zale matter.

After determining that the business judgment rule was in fact the appropriate standard, the court found that the plaintiffs could not show that the Zale board’s acceptance of the offer after a fully informed vote of shareholders met the standard for waste under Delaware law. The court also found that it was not reasonably conceivable that the Zale directors were grossly negligent as to their engagement of Merrill Lynch. Merrill Lynch’s belated disclosure of its earlier involvement with Signet was “troubling,” said the court, and the Zale board could have done more to probe their advisor’s independence, but the conduct did not amount to “reckless indifference or a gross abuse of discretion,” found the court. There was therefore no predicate fiduciary duty breach and the aiding and abetting claim against Merrill Lynch was dismissed.

The case is C.A. No. 9388-VCP.

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