Thursday, September 02, 2021

Proxy’s omission of talks between merger parties precluded Corwin cleansing

By Anne Sherry, J.D.

The Delaware Court of Chancery allowed some aspects of a merger challenge to proceed against Zayo Group Holdings CEO Dan Caruso. The former stockholders’ complaint did not support a reasonable inference that Caruso corrupted the sale process or that the Zayo board did not manage Caruso’s conflict of interest. However, the plaintiffs did identify a discussion between Caruso and representatives of the acquiror that the merger proxy did not disclose, which constituted a material omission and precluded cleansing of the transaction under Corwin (Teamsters Local 2 37 Additional Security Benefit Fund v. Caruso, August 31, 2021, Fioravanti, P.).

In March 2020 a consortium of equity investors acquired Zayo in a $14.3 billion deal. Each share of Zayo common stock was converted into the right to receive $35 in cash. While there had been two key bidders, the company had also met with activist investors urging the company to sell. The merger received the overwhelming support of stockholders, with over 183 million votes in favor, compared to 150,000 against and 140,000 abstentions.

Advancing a single count for breach of fiduciary duty against Caruso, the plaintiffs alleged that under the threat of removal by the activist stockholders, Caruso steered the sale process toward the ultimate acquiror so that he could remain as CEO post-merger and roll over his stock. They also alleged that the Zayo board did not sufficiently oversee and manage Caruso’s conduct despite knowing that he was conflicted. Finally, the complaint identified a discussion between Caruso and a representative of the acquiror that was omitted from the proxy, which disclosed other, similar communications between the parties.

The court first dispensed with the idea that the merger is subject to entire fairness review, rather than the more deferential business judgment review, because Caruso had a conflict of interest. While the court allowed that the complaint created a pleading-stage inference that Caruso had personal interests that conflicted with those of the public stockholders, it did not draw an inference that the activist stockholder pressure raised a conflict. Under Delaware law, the mere threat of a proxy contest does not render a director conflicted. Furthermore, the complaint did not adequately allege that a majority of the board was not independent, much less under Caruso’s control. Accordingly, entire fairness review was not appropriate.

In the alternative, the plaintiffs alleged that Caruso breached his fiduciary duties because the board’s process did not satisfy enhanced scrutiny under Revlon. However, while the complaint raised an inference of a conflict, it lacked allegations supporting a reasonable inference that Zayo’s board did not act in a manner reasonably designed to manage the conflict or maximize value. The complaint also lacked well-pleaded allegations supporting a reasonable inference that Caruso disabled the Board by failing to inform it about critical events or by acting unilaterally without the Board’s knowledge.

However, the complaint survived Caruso’s motion to dismiss as to its allegations that Caruso breached his fiduciary duty by approving a materially misleading proxy statement. The complaint alleged that Caruso played an integral role in the merger negotiations and signed the proxy in his capacity as CEO, permitting the court to infer that he was involved in preparing the proxy’s disclosures. While rejecting some of the identified representations as immaterial, the court agreed with the plaintiffs that the proxy should have disclosed some of the communications between Caruso and the acquiror. While the proxy recounted the negotiation process and the range of prices the bidders were willing to accept, it omitted a representative’s statement to Caruso that the consortium had "price enthusiasm" in the range of $34 to $36 and Caruso’s reply that the board would not go below $35. As a result, the complaint alleged a claim that Caruso breached his duty as an officer, for which he was not entitled to exculpation.

In turn, the material omission meant that Caruso was not entitled to rely on the cleansing doctrine of Corwin v. KKR Financial Holdings LLC (Del. 2015). The material omission meant that the stockholder vote approving the merger was not fully informed, precluding application of Corwin.

The case is No. 2020-0620-PAF.