Tuesday, April 04, 2017

Saba stockholders’ uninformed, coerced vote didn’t cleanse Vector merger

By Anne Sherry, J.D.

A company’s failure to file restated financials was shrouded in such mystery that it deprived its board of the business judgment presumption. Saba Software, Inc., was required to file a restatement due to fraud. It repeatedly failed to do so, and the SEC deregistered its stock just before stockholders voted to sell the company to Vector Capital Management. This vote did not cleanse the merger under Corwin because stockholders were not fully informed and were coerced into accepting the deal (In re Saba Software, Inc. Stockholder Litigation, March 31, 2017, Slights, J.).

The cleansing doctrine stems from Corwin v. KKR Financial Holdings (Del. 2015), which held that when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of disinterested stockholders, the business judgment rule applies. If the vote cleansed the merger, only a waste claim would remain, and the defendant directors would prevail on their motion to dismiss. But the plaintiff challenging the Saba merger pointed to four alleged categories of disclosure deficiencies that made the proxy misleading. Although the court rejected two of the categories as classic “tell me more” disclosure claims, the other two categories held up.

Why did Saba fail to restate its financials? One of these categories was the proxy’s omission of the circumstances surrounding the company’s failure to complete the restatement. The court noted that the plaintiff was not questioning a decision made by the board. Rather, the board’s failure to complete a restatement was “a factual development that spurred the sales process and, if not likely correctible, would materially affect the standalone value of Saba going forward.” Without this information, stockholders were unable to evaluate the likelihood that Saba would ever complete the restatement. And that, in turn, meant they could not make an informed choice between accepting merger consideration that reflected the depressed value caused by the company’s regulatory noncompliance or rejecting the merger in hopes that the company might return to good standing with the SEC.

This information also bore on the credibility of the management projections. The projections assumed the company would complete the restatement at some point in the future. Without the ability to test that assumption by examining the circumstances surrounding the company’s past failures to deliver restated financials, stockholders had no basis to conclude whether or not the projections made sense.

What other options did the company have? Finally, the plaintiff identified one omission within the proxy’s description of the events leading up to the merger that a reasonable shareholder would have deemed important when deciding how to vote. The proxy omitted to discuss the post-deregistration options available to Saba, as discussed by an ad hoc committee. In a typical case, Delaware law does not require management to discuss all possible alternatives to the course of action it is proposing. But the SEC’s deregistration of Saba’s shares just prior to the vote made this an atypical case. The deregistration fundamentally changed the nature and value of the stockholders’ equity stake and dramatically affected the environment in which the board conducted the sales process and the stockholders were asked to vote. “The board needed to take extra care to account for this dynamic in its disclosures to stockholders,” the court wrote.

Shareholders were coerced. The plaintiff thus adequately pleaded that the stockholder vote was not fully informed, undermining the cleansing effect under Corwin. The decision also directs the court to consider whether the complaint supports a reasonable inference that the stockholder vote was coerced. The determination of coercion is a relationship-driven inquiry informed by the fact that directors are fiduciaries. In the deal context, an uncoerced vote must be structured in such a way that gives stockholders a free choice between maintaining their current status or accepting the proposed deal. Saba stockholders’ choice was between keeping their recently deregistered—and thus illiquid—stock or accepting a depressed merger price.

“This Hobson’s choice was hoisted upon the stockholders because the Board was hell-bent on selling Saba in the midst of its regulatory chaos,” the court wrote. “Yet the Board elected to send stockholders a Proxy that said nothing about the circumstances that were preventing the Company from filing its restatements and therefore offered no basis for stockholders to assess whether the choice of rejecting the Merger and staying the course made any sense.” The complaint also made the case for inequitable coercion, which can exist in the absence of an affirmative wrongdoing when the fiduciary knows he has a duty to act but fails to do so.

Other defenses fail. After determining that the merger is subject to enhanced scrutiny under Revlon, the court addressed the defendants’ two other arguments: (1) that the allegations regarding the failure to complete the restatement were derivative claims that were extinguished in the merger; and (2) that any remaining direct claims were exculpated in Saba’s certificate of incorporation. The court found that the plaintiff’s claims were direct and that the plaintiff had pleaded non-exculpated claims of bad faith and breach of the duty of loyalty. Aiding and abetting claims against Vector were dismissed, however, because the complaint failed to plead Vector’s knowing participation in the board’s breach of fiduciary duty.

The case is No. 10697-VCS.

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