Important Ruling: Delaware Court of Chancery Recognizes Officer Disclosure Duty in Squeeze-Out Transaction Involving Neither Minority Vote Nor Appraisal Rights
October 9, 2023
Types : Alerts
Delaware Vice Chancellor J. Travis Laster’s recent opinion in Cygnus Opportunity Fund, LLC v. Washington Prime Group, LLC, C.A. No. 2022-0718-JTL (Del. Ch. Aug. 9, 2023) further fleshes out the highly contextual duties owed by officers, holding that officers may owe disclosure duties in squeeze-out transactions, even where the transaction was not subject to a minority unitholder vote and did not implicate appraisal rights. This decision, like the one (also by Vice Chancellor Laster) earlier this year delineating officer oversight duties, is enormously important to officers and their advisors, especially when navigating an extraordinary event or transaction.
Disclosure Duties Pre-Cygnus
Disclosure obligations are a context-specific subsidiary of the primary duties of care and loyalty. Under Delaware law, if directors place a matter before the stockholders for a vote, for example, then the directors have a duty to disclose all information material to that vote. Likewise, if directors propose a transaction that presents stockholders with an investment decision, such as a self-tender offer by the corporation or an affiliate, then the directors have a duty to disclose all information material to that investment decision. Cygnus refers to these transactions as “stockholder-action” transactions and the attendant disclosure duties as the “stockholder-action duty.”
Likewise, Delaware recognizes a disclosure obligation where a board chooses to speak, namely, that it do so candidly and completely. In other words, even where the board may have no underlying obligation to convey information to shareholders, the board has a duty to refrain from furnishing misleading or materially incomplete information once it elects to be heard.
That’s the board; what about officers? In the stockholder-action context, Delaware Chancery Court precedent has extended disclosure duties to officers where the officer was involved in the drafting of a disclosure document (such as a proxy statement), the officer took responsibility for the disclosure document by signing it, or the disclosure violation otherwise fell within the officer’s particular area of responsibility.
No decision, however, appears to have recognized an officer disclosure duty outside the discrete circumstances described immediately above and, moreover, outside the stockholder-action context. Until now.
The Cygnus Case
The factual matrix in Cygnus is both complex and nuanced. Germane to this report, the transactions challenged in Cygnus included a post-bankruptcy tender offer followed by a squeeze-out merger, each initiated by the company’s controlling shareholder (Strategic Value Partners, LLC (“SVP”)). Cygnus’ operating agreement created an internal structure akin to a corporation, with a “board” of managers, officers, and membership units denominated “shares.”1
SVP launched a two-tiered, front-loaded tender offer less than three weeks after the company emerged from bankruptcy. Minority shareholders who tendered before a specified date would receive a cash payment of $25.75 per share, and after $25.00 a share. While advising that the offer price may not reflect fair value, no financial information was provided by SVP or the Cygnus board. The tender offer closed in December 2021. Fewer shares were tendered than hoped or expected.
In June 2022, Cygnus issued a disclosure advising the remaining minority shareholders that each of their shares had been converted into the right to receive $27.25 in cash, without interest and no right of appraisal. The disclosure consisted of a 3-page cover letter and an anemic 5-page information statement that conveyed that the board had convened a special committee to consider a squeeze-out merger proposal submitted by SVP in February 2022. The disclosure did not identify the committee’s legal and financial advisors, describe the negotiations, or attach or summarize the fairness opinion obtained by the committee. Shareholder requests for information following the disclosure were met with unresponsive answers or rejected altogether.
A multi-count action alleging that the squeeze-out merger significantly undervalued the shares was filed in October 2022. Count I of the complaint, relevant here, was directed to the Cygnus officers (who, unlike the members of the board, were not protected by a fiduciary exclusion provision in the operating agreement). It alleged breaches of fiduciary duty for, among other things, failing to provide information to the minority shareholders in connection with both the tender offer and the squeeze-out merger. The officer defendants moved to dismiss Count I, contending in part that they did not owe disclosure duties.
The Vice Chancellor rejected this argument: “I personally am not prepared to rule as a matter of law that a fiduciary can take the property of its beneficiary without some level of disclosure, even in the absence of any request for action. To the contrary, basic fiduciary principles suggests that a fiduciary cannot do that.”
Contours of Officer Disclosure Duty
The duty of disclosure is not a separate duty but rather a contextual manifestation of the duties of care and loyalty. Because the duty of disclosure arises situationally, its scope requires a context-specific analysis to determine the source of the duty, its parameters, and any remedies for breach.
The Vice Chancellor referred to the law of trusts, under which the duty to keep beneficiaries informed imposes “an affirmative requirement that, if and as circumstances warrant over the course of administration, the trustee inform fairly representative beneficiaries of important developments and information that appear reasonably necessary for the beneficiaries to be aware of in order to protect their interests.” Critically, the disclosure obligations of trustees do not depend on the existence of a veto right.
In a commercial enterprise like Cygnus, the Vice Chancellor noted, the duty to inform is obviously more limited in that it does not create a regular reporting obligation. It could, however, mandate disclosure about extraordinary events.
Cygnus, of course, presents a transaction in which fiduciaries unilaterally eliminated the investors from the enterprise. In that setting, the duty of loyalty could manifest as an obligation to disclose the material facts surrounding the transaction, regardless of whether or not the investors’ approval is required. Because Cygnus was decided under the forgiving “reasonable conceivability” standard of a Rule 12 motion to dismiss, more detailed findings regarding whether officer-level disclosures should have been made and, if so, what they should have entailed are left for another day.
1The particular minority shareholder units implicated by the transactions were “stapled units,” each comprising one Series A-1 Share, one Series B-1 Share, and one Series C-1 Share. For simplicity, the stapled units are referred to simply as “shares.”
- While broadly held to owe the same fiduciary duties as directors, the context-specific duties owed by officers have been considerably clarified in opinions this year. Officers were brought within the ambit of exculpatory protection through last year’s amendment to 8 Del. C. §102(b)(7), but recent case law likewise makes clear that they share some of the obligations (i.e., oversight and disclosure obligations) previously discussed only in relation to the board.
- Officers and their legal advisors must make every effort to stay abreast of this emerging jurisprudence. Where an extraordinary transaction is in the offing, the particular circumstances may trigger nuanced but very important officer-level fiduciary obligations.
- These obligations may exist even outside the realm of stockholder-action transactions (where the officer may have helped prepare disclosures, signed the disclosures, or the information provided otherwise implicates matters within the officer’s sphere of responsibility). In fact, Cygnus cautions that a squeeze-out merger is such a transaction in which officer-level disclosure obligations may exist, regardless of the absence of minority shareholder approval requirements or appraisal rights.
- There is ample room for further clarification regarding the parameters of officer disclosure duty. For example, Vice Chancellor Laster notes the “conundrum” created by the tension between a potential duty to disclose and the officers’ duty of obedience to the board. At some point, as in Cygnus, these obligations may be in conflict, such as to require careful balancing.
This alert was authored by R. Montgomery Donaldson, partner in Montgomery McCracken’s Delaware office and Chair of the Business Litigation Practice Group. R. Montgomery can be reached at 302-504-7840 or email@example.com.