Delaware Supreme Court Provides M&A Disclosure Guidance

In the seminal 2014 Kahn v. M&F Worldwide Corp. (“MFW”) decision, the Delaware Supreme Court provided a framework by which controller freeze-out mergers may be reviewed using the deferential business judgment standard. In short, a court will apply the business judgment rule if the transaction was conditioned at the outset on (i) approval by a special committee of independent directors and (ii) approval of a fully informed and uncoerced majority of the minority stockholders. In City of Dearborn Police and Fire Revised Ret. Sys. (Chapter 23) v. Brookfield Asset Management,¹ the Supreme Court reviewed the Court of Chancery’s decision to apply MFW to a squeeze-out transaction. Focusing on the disclosures relating to certain advisor conflicts to determine that the transaction did not satisfy the requirements of MFW, the Court reversed the Court of Chancery’s dismissal of the action, and remanded the case for further proceedings.

Background Facts

Brookfield Asset Management (“Brookfield”), acting through a subsidiary, made an offer to acquire all outstanding equity of TerraForm Power, Inc. (“TerraForm”) not already owned by Brookfield in exchange for stock of the subsidiary. At the time of the offer, Brookfield owned approximately 61.5% of TerraForm’s equity securities. In keeping with MFW and its progeny, the offer was conditioned from the outset on approval by an independent special committee and a majority-of-the-minority vote. TerraForm established a special committee (the “Committee”) consisting of independent directors to evaluate the offer, and authorized the Committee to retain independent advisors. Following the formation of the Committee, the Committee met and began its process by interviewing and retaining two financial advisors and two legal advisors. When determining whether to engage the advisors, no conflicts disclosure letters were provided by the advisors. Although one of the financial advisors did not have any active engagements with Brookfield, it had received between $65 million and $90 million in fees from Brookfield in the two years prior to the Committee engagement and held a collective stake of $470 million in Brookfield-related entities. In addition, that advisor had received $5 million to $15 million in fees from Terraform in the same period. One of the law firms had previously advised Brookfield-related entities and was concurrently advising Brookfield on an unrelated transaction. With advisors engaged, the Committee proceeded to negotiate with Brookfield and the merger closed in the summer of 2020.

Court of Chancery Proceedings

Plaintiffs challenged the merger in 2022, alleging that the Committee was not fully empowered and argued that Brookfield engaged in coercive conduct by refusing to consider alternative transactions and by providing a “threatening” set of financial projections that assumed no growth at TerraForm, suggesting that Brookfield would prevent TerraForm’s growth if the Committee rejected the offer. Plaintiffs also alleged that the Committee failed to satisfy its duty of care by, among other things, selecting conflicted advisors, and that the disclosures were sufficiently flawed to render the stockholder vote uninformed. The Court of Chancery granted Brookfield’s motion to dismiss the action, finding that (i) the alleged coercive conduct failed to rise to the level seen in In re Dell and was therefore not sufficient to sustain a coercion claim, (ii) despite a “discomfort with the facts” of the advisor conflicts, the conflicts were not material to the advisors because of the relatively low fees and the fact that the financial advisor’s investment position in Brookfield-related entities represented less than 0.1% of the firm’s total investment portfolio and thus the allegations were not sufficient to allege that the Committee was grossly negligent in engaging its advisors, and (iii) by finding no violation of the Committee’s duty of care, a majority of the alleged disclosure claims were mooted, the expected increase in management fees for Brookfield as a result of the merger had been sufficiently disclosed, and the remainder of the alleged disclosure violations were immaterial or would not otherwise assist stockholders in making an informed vote. Because the transaction satisfied the MFW conditions, the Court of Chancery applied the business judgment rule and dismissed the action. Plaintiffs appealed the Court’s coercion and disclosures rulings.

The Supreme Court’s Decision

The Supreme Court ruled that the coercion claim had been properly dismissed, holding that the coercive nature of the communication by Brookfield was too attenuated to rise to the level set in Dell. However, the Court determined that the disclosures were deficient in several respects sufficient to render the stockholder vote uninformed. First, the advisor conflicts were not adequately disclosed. Drawing a distinction between the Committee’s duty of care in selecting advisors and the Committee’s duty of disclosure in providing stockholders with information regarding potential conflicts, the Court explained that a conclusion that the plaintiff had not adequately pled that the Committee breached its duty of care by acting grossly negligent did not also provide the answer as to whether the directors satisfied their duty of disclosure. That duty requires providing all material information to the stockholders and requires a separate analysis “assessed from the viewpoint of the reasonable stockholder.”

The Supreme Court believed it was reasonably conceivable that the financial advisor’s nearly half-billion-dollar stake in affiliates of the controller would be material in the eyes of a stockholder in assessing the financial advisor’s objectivity.

Distinguishing the facts at bar from In re Micromet, Inc. S’holders Litig.,² where the allegedly conflicted financial advisor held a large position in both the target and the controller on behalf of its clients, the Court held that the failure of the proxy to disclose the financial advisor’s position, which was held for its own benefit rather than simply of record, was material. Further, the fact that the disclosure used the word “may” in addressing the financial advisor’s holdings rendered the disclosure misleading. Following the same logic, the Court determined that it was “reasonably conceivable” that the legal advisor’s conflicts, particularly the concurrent conflict, were material facts for the stockholders that required disclosure because an ongoing relationship with Brookfield raised the question of whether the legal advisor would want to push Brookfield too hard in the negotiations.

Additionally, the Court ruled that the increased management fees that would be paid to Brookfield following the transaction were not adequately disclosed. While the proxy set forth the “complex” formula that would be used to calculate the management fee and indicated that an increased fee would be owed, the Court noted that disclosures to stockholders must be “clear and transparent.” The Court explained that the proxy’s failure to set forth all of the variables needed to actually apply the management fee formula would not necessarily equate to a disclosure violation but the fact that the parties had already determined that the projected increase in fees was $130 million and failed to disclose that amount rendered the disclosure deficient. On the other hand, the Court determined that vague descriptions of certain debt refinancings available to Brookfield as a result of the transaction were adequate given the “speculative” nature of the benefits conferred. The Court also held that a general warning that dividends could not be guaranteed post-merger combined with the disclosed financial forecasts provided sufficient information for a “skilled reader” to determine the merger’s dilutive effect on TerraForm dividends.

Finally, the Court reinforced prior case law that disclosures do not have to include a “play-by-play description of every consideration or action taken” and that Boards (and committees) do not have to “engage in self-flagellation” in disclosures. Accordingly, failure to disclose certain considerations put forth by one of the financial advisors in an initial pitch was not fatal to the adequacy of the disclosures.

Ultimately, the failure to adequately disclose the advisor conflicts and the management fee increase rendered the disclosures defective for the purposes of obtaining the protections of MFW. Because the majority-of-the-minority vote was not fully informed, the Court of Chancery erred in applying the business judgment rule and granting Brookfield’s motion to dismiss. The Court remanded the case back to the Court of Chancery for further proceedings.

Conclusion

Brookfield illustrates the importance of proper disclosures for obtaining pleadings stage dismissal after conditioning a transaction on MFW. That said, its disclosure teachings go beyond that setting because a plaintiff could make the same disclosure arguments to defeat a Corwin defense concerning the informed vote of stockholders. In challenging disclosures after the fact, in both the Corwin and MFW settings, stockholder plaintiffs are likely to go over corporate books and records they obtain with a fine tooth comb, looking for something that was not disclosed that could be painted as material to stockholders. For fiduciaries and their financial and legal advisors, Brookfield teaches that it is important to disclose information beyond the green light/red light distinction of the existence of a conflict, and to provide information about relationships to allow fiduciaries and stockholders to make their own informed decisions.

Footnotes

^{1  City of Dearborn Police and Fire Revised Retirement System v. Brookfield Asset Management Inc., 2024 WL 1244032 (Del. 2024).}

^{2  In re Micromet, Inc. Shareholders Litigation, 2012 WL 681785 (Del. Ch. 2012).}

The article was originally published in the May 2024 issue of The M&A Lawyer, a Westlaw publication.

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