Important Ruling: Delaware Court of Chancery Declines to Extend Corwin Protection to Post-Closing Unocal Claims for Injunctive Relief

Types : Alerts

In May this year, Delaware Vice Chancellor Morgan T. Zurn issued an opinion declining to extend the protections of the Corwin Doctrine to post-closing Unocal claims for injunctive relief. In re Edgio, Inc. Stockholders Litigation^[1] [view opinion here]. Edgio thus presents a potentially significant limitation to the cleansing effect of a stockholder vote, at least with respect to whether a post-closing claim seeking to enjoin defensive measures may withstand a motion to dismiss. This has potentially significant implications for investment agreements with substantial stockholders, and the directors and counsel who negotiate them.

The Corwin Doctrine Generally

Corwin v. KKR Financial Holdings LLC,^[2] decided by the Delaware Supreme Court in 2015, was and remains a Delaware corporate law milestone: Under Corwin (and what has become known as “the Corwin Doctrine”), a non-controlling stockholder transaction otherwise subject to heightened judicial scrutiny may be protected by the business judgment rule in an action seeking money damages if approved by a fully-informed, uncoerced vote of the disinterested stockholders. Such a vote essentially eliminates any agency problem and requires that the reviewing court defer to the uncoerced and informed approval of the stockholders. When Corwin cleansing applies, claims seeking money damages are subject to dismissal.

Until Edgio, no Delaware Chancery or Supreme Court decision explicitly addressed Corwin’s application to post-closing claims for injunctive relief against defensive measures under Unocal.^[3]

In re Edgio, Inc. Stockholders Litigation

The transaction: After a period of financial underperformance and unsuccessful turnaround initiatives, and amidst speculation that it may be a target for activist investors, Limelight Networks, Inc. (now Edgio, Inc.) (the “Company”)^[4] acquired a portfolio company (Edgecast, Inc., the parent of which was College Parent, L.P.) of Apollo Global Management, Inc. in exchange for newly issued Company stock. Apollo had a 90% ownership interest in College Parent, and the acquisition gave College Parent a 35% post-closing interest in the Company. In connection with the acquisition, the parties negotiated a Stockholder Agreement to govern College Parent’s investment. Among other things, the Stockholder Agreement contained: (1) a director voting provision, obligating Apollo to vote in favor of a director only if the nominee were recommended by the board; (2) a vote neutralization provision concerning non-routine matters, directing Apollo to vote in favor of the board’s recommendations or pro rata with the rest of the stockholders; and (3) a transfer restriction provision, imposing a two-year restriction on the transfer or sale of shares except in a board-approved transaction, and a supplemental restriction on the sale the third year post-closing to any investor then on the “SharkWatch 50” (a list of the 50 investors most likely to launch an activist campaign). These are the three provisions later challenged by two dissenting stockholders as improper director entrenchment vehicles.

The stockholder vote: Nasdaq listing rules required that Limelight obtain stockholder approval for the issuance of stock to be used for the acquisition. The proxy statement preceding the vote disclosed the terms of the Stockholder Agreement (which was also publicly filed), including the terms later challenged in litigation. The Company’s stockholders voted overwhelmingly in support of the stock issuance, and the acquisition closed a week later.

The litigation and motion to dismiss: Two Company stockholders filed suit in the Delaware Court of Chancery alleging that the Stockholder Agreement’s provisions created an enduring and significant stockholder block designed to entrench the board and insulate it from stockholder activism. As such, the plaintiffs argued, they were subject to enhanced scrutiny under Unocal, and their enforcement should be enjoined. The defendants moved to dismiss, arguing that the stockholder vote cleansed the transaction under Corwin and that business judgment deference rather than Unocal enhanced scrutiny applied.

The decision: The motion to dismiss was denied, the court noting that whether Corwin could apply to a claim seeking injunctive relief had not yet been definitively resolved.

Citing language in Corwin itself and a subsequent Delaware Supreme Court opinion,^[5] the court observed that the holding in Corwin was explicitly limited to post-closing damages. The court likewise noted that Corwin apparently left in place earlier Delaware Supreme Court precedent^[6] holding that a stockholder vote cannot eliminate claims for injunctive relief under Unocal. And finally, the court found that applying Corwin to claims for injunctive relief would not advance Corwin’s policy objective of permitting stockholders to make free and informed choices based on the economic merits of a transaction.

In determining that the claims supported enhanced scrutiny under Unocal, the court determined that it was reasonable at the pleading stage to infer a subjective entrenchment motivation from the Company’s financial underperformance, market speculation about activist investors, the timing of the transaction, and the terms of the protective provisions themselves.

Important Aspects of the Decision That May Bear Upon Future Treatment of the Issue

1. Procedural posture of the case: The court was called upon to evaluate the claims under the forgiving lens of a Rule 12(b)(6) challenge, requiring a high level of deference to well-pleaded allegations and that the plaintiffs be given the benefit of all inferences reasonably drawn from them (the “reasonably conceivable” standard). A Unocal challenge not involving a poison pill implicates the subjective intent of the board with respect to the enactment of defensive measures. Later, the evidentiary record in Edgio may reveal that the board acted in what it perceived to be the best interest of the Company by guarding against stockholder activism at a critical time in the Company’s efforts to integrate an acquired company and regain traction in the market. The record likewise may show that stockholder approval of the stock issuance was predicated in part on concerns at the stockholder level that an activist interloper may bring with it objectives misaligned with the expectations and value set of the existing stockholders – that is, improper bundling (here, packaging arguably favorable economic terms with unfavorable entrenchment features) is at best inferred.^[7] So, while the Unocal claims survived a motion to dismiss, there is no basis on which to assume that they will carry the day on the merits.
2. Not a blanket condemnation of measures guarding against investor activism: Hand in hand with this, Edgio should not be read as damning protections against investor activism to the losing side of judicial scrutiny. Such protections may be eminently reasonable where the board reasonably and in good faith determines that such protections advance the best interest of the firm and its stockholders. In this regard, a robust and carefully crafted deliberative record may go a long way. Additionally, the circumstances surrounding the challenged provisions rather than the provisions alone appear to have prompted enhanced scrutiny in Edgio, the court noting in dicta that “it is unlikely that the nature of the Challenged Provisions alone would be sufficient to trigger Unocal.”
3. The conflicting authority: The court considered itself bound by the Delaware Supreme Court’s decisions in Corwin (explicitly approving the earlier decision in Santa Fe) and Morrison, concluding that they implicitly overruled two pre-Corwin decisions: Stroud v. Grace^[8] and Williams v. Geier,^[9] each holding that a stockholder vote can lower the standard of review from enhanced scrutiny to business judgment with respect to claims seeking to enjoin defensive measures. Further analysis of the seemingly conflicting pre-Corwin decisions may be anticipated. Santa Fe (unlike Edgio) declined to find ratification since the stockholders there voted on the economic merits of a merger and not the defensive measures in isolation; Stroud and Williams, by contrast, involved charter amendments (each subject to an independent stockholder vote) that effectively entrenched existing management. When challenged by dissenting stockholders, the Court in both Stroud and Williams held that the stockholder votes supporting the amendments did ratify the challenged provisions. So there remains a degree of misalignment among the pre-Corwin cases that invites judicial clarification.

^[1] In re Edgio, Inc. Stockholders Litigation, C.A. No. 2022-0624-MTZ (Del. Ch. May 1, 2023).

^[2] 125 A.3d 304 (Del. 2015).

^[3] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

^[4] Limelight provided network service for the delivery of digital media content and software.

^[5]  Morrison v. Berry, 191 A.3d 268 (Del. 2018).

^[6] In re Santa Fe Pacific Corp. Shareholder Litigation, 669 A.2d 59 (Del. 1995).

^[7] It is interesting to speculate as to whether separate, stand-alone votes for the share issuance and defensive terms in the Stockholder Agreement would have prompted the court to reach a different result.

^[8] 606 A.2d 75 (Del. 1995).

^[9]  671 A.2d 1368 (Del. 1996).

This article is co-authored by Partner R. Montgomery Donaldson, and Associate Stefania Rosca. Please reach out to R. Montgomery or Stefania for further questions or more information.