Charles Almond v. Glenhill Advisors LLC
Opinion
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE CHARLES ALMOND AS TRUSTEE ) FOR THE ALMOND FAMILY 2001 ) TRUST, ALMOND INVESTMENT ) FUND LLC, CHARLES ALMOND, and ) ANDREW FRANKLIN, )
)
Plaintiffs, )
v. ) C.A. No. 10477-CB )
GLENHILL ADVISORS LLC, )
GLENHILL CAPITAL LP, GLENHILL )
CAPITAL MANAGEMENT LLC, )
GLENHILL CONCENTRATED LONG )
MASTER FUND LLC, GLENHILL )
SPECIAL OPPORTUNITIES MASTER )
FUND LLC, JOHN EDELMAN, )
GLENN KREVLIN, JOHN MCPHEE, )
WILLIAM SWEEDLER,WINDSONG )
DB DWR II, LLC, WINDSONG DWR, )
LLC, WINDSONG BRANDS, LLC, )
HERMAN MILLER, INC. and HM )
CATALYST, INC., )
Defendants, )
)
and )
)
DESIGN WITHIN REACH, INC., )
)
Intervenor and )
Counterclaim-Petitioner. )
MEMORANDUM OPINION
Date Submitted: May 31, 2018 Date Decided: August 17, 2018
Peter B. Ladig of BAYARD, P.A., Wilmington, Delaware; David H. Wollmuth and Michael C. Ledley of WOLLMUTH MAHER & DEUTSCH LLP, New York, New York. Attorneys for Plaintiffs Charles Almond as Trustee for the Almond Family 2001 Trust, Almond Investment Fund LLC, and Charles Almond.
Norman M. Monhait and P. Bradford deLeeuw of ROSENTHAL MONHAIT & GODDESS, P.A., Wilmington, Delaware; Scott J. Watnik of WILK AUSLANDER LLP, New York, New York; Thomas A. Brown of MOREA SCHWARTZ BRADHAM FRIEDMAN & BROWN LLP, New York, New York. Attorneys for Plaintiff Andrew Franklin.
Andrew D. Cordo and F. Troupe Mickler IV of ASHBY & GEDDES, Wilmington, Delaware; Adrienne M. Ward and Brian Katz of OLSHAN FROME WOLOSKY LLP, New York, New York; John B. Horgan of ELLENOFF GROSSMAN & SCHOLE LLP, New York, New York. Attorneys for Glenhill Advisors LLC, Glenhill Capital LP, Glenhill Capital Management LLC, Glenhill Concentrated Long Master Fund LLC, Glenhill Special Opportunities Master Fund LLC, Glenn Krevlin, William Sweedler, Windsong DB DWR II, LLC, and Windsong DWR LLC.
Douglas D. Herrmann of PEPPER HAMILTON LLP, Wilmington, Delaware; Paul B. Carberry, Joshua Weedman, and Erin Smith of WHITE & CASE LLP, New York, New York. Attorneys for John Edelman and John McPhee.
Frederick B. Rosner, Scott J. Leonhardt, and Jason A. Gibson of THE ROSNER LAW GROUP LLC, Wilmington, Delaware; S. Preston Ricardo of Golenbock Eiseman Assor Bell & Peskoe LLP, New York, New York. Attorneys for Windsong Brands, LLC.
John D. Hendershot, Susan M. Hannigan, and Brian F. Morris of RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Bryan B. House of FOLEY & LARDNER LLP, Milwaukee, Wisconsin. Attorneys for Defendants, Counterclaim Petitioners Herman Miller Inc. and HM Catalyst, and Intervenor and Counterclaim Petitioner Design Within Reach, Inc.
BOUCHARD, C.
In July 2014, Herman Miller, Inc. acquired Design Within Reach, Inc.
(“DWR” or the “Company”), a retailer of modern furniture, for approximately $170 million in a third-party merger transaction. The merger was the culmination of a dramatic turnaround of the Company that began in August 2009, when a group of funds known as Glenhill invested $15 million in the Company and became its controlling stockholder, holding a 92.8% equity interest. A new management team was put in place later that year, and the Company’s fortunes improved steadily over the next few years.
After the merger closed, two former stockholders filed suit against Glenhill and the Company’s directors who oversaw its turnaround. Plaintiffs have never challenged the fairness of the merger consideration, which by all accounts was an outstanding result. Instead, plaintiffs’ core strategy has been to secure a larger portion of the merger consideration for themselves by challenging transactions that occurred before the merger.
In this post-trial decision, the court enters judgment in defendants’ favor on all of plaintiffs’ twelve claims for relief. Two rulings concerning two different categories of claims largely drive this result.
The first category consists of claims relating to a 50-to-1 reverse stock split that the Company implemented in 2010 on both its common stock and its Series A preferred stock, which Glenhill had purchased in 2009. Unknown to anyone at the
time, the reverse stock splits were implemented in a defective manner that had the effect of diluting the number of shares of common stock into which the Series A preferred stock could be converted by a factor of 2500-to-1, instead of the intended result of a 50-to-1 adjustment. This defect remained unknown in 2013, when the Series A preferred stock was converted into common stock, and in 2014, when the merger occurred.
Over one year after the merger closed, plaintiffs amended their complaint after discovering the defect, adding Herman Miller as a party and asserting that the merger was void. This action prompted Herman Miller to ratify certain defective corporate acts under 8 Del. C. § 204 relating to the implementation of the reverse stock splits and the subsequent conversion of the Series A preferred stock, and to file a counterclaim asking the court to validate those acts under 8 Del. C. § 205. For the reasons explained below, all of the equitable considerations identified in Section 205 overwhelmingly favor judicial validation, which the court grants.
The second category consists of claims challenging various transactions through which some or all of the Company’s board members or their affiliates received additional equity in the Company before the merger. All of these claims are concededly derivative in nature and, thus, a threshold issue is whether plaintiffs’ standing to maintain these claims was extinguished as a result of the merger.
Plaintiffs advance a novel “control group” argument in an effort to fit these claims into the transactional paradigm our Supreme Court recognized in Gentile v. Rosette for “a species of corporate overpayment claim” that can be both derivative and direct when a transaction results in an improper transfer of economic value and voting power from the minority stockholders to the controlling stockholder. 1 That argument fails, however, because it is clear from the record that Glenhill was DWR’s controlling stockholder by itself (and not as part of the group plaintiffs suggest) at all relevant times and that each of the challenged transactions did not increase—but actually reduced—its economic stake and voting power in the Company.
Based on these two rulings, and for other reasons explained below with respect to plaintiffs’ remaining claims, judgment will be entered in defendants’ favor and against plaintiffs on all claims. I. BACKGROUND The facts recited in this opinion are my findings based on the testimony and documentary evidence submitted during a five-day trial held in November 2017. The record includes stipulations of fact in the Pre-Trial Stipulation and Order (“PTO”), over 500 trial exhibits, nine depositions, and the live testimony of eight fact and two expert witnesses.
1 906 A.2d 91, 99 (Del. 2006).
A. The Parties and Relevant Non-Parties Design Within Reach, Inc. is a Delaware corporation with its principal place of business in Stamford, Connecticut. It is in the business of selling modern design furnishings and accessories.2 DWR was the surviving corporation of a merger with defendant HM Catalyst, Inc., a wholly-owned indirect subsidiary of defendant Herman Miller, Inc., that closed on July 28, 2014 (the “Merger”).3 Herman Miller is a Delaware corporation with its principal place of business in Zeeland, Michigan that produces office furniture, equipment, and home furnishings.4 Plaintiffs were stockholders of DWR at the time of the Merger. Plaintiff Charles Almond, individually or through the Almond Investment Fund, LLC and the Almond Family 2001 Trust, owned approximately 9.6% of DWR common stock in August 2009, and continued to acquire additional DWR shares until July 2014.5 The Almond plaintiffs tendered their shares for the Merger consideration on August 21, 2014.6 Plaintiff Andrew Franklin owned DWR common stock in 2009 and sold
2 PTO ¶ 1.
3 PTO ¶¶ 3, 63.
4 PTO ¶ 2.
5 PTO ¶ 11.
6 PTO ¶ 11.
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IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE CHARLES ALMOND AS TRUSTEE ) FOR THE ALMOND FAMILY 2001 ) TRUST, ALMOND INVESTMENT ) FUND LLC, CHARLES ALMOND, and ) ANDREW FRANKLIN, )
)
Plaintiffs, )
v. ) C.A. No. 10477-CB )
GLENHILL ADVISORS LLC, )
GLENHILL CAPITAL LP, GLENHILL )
CAPITAL MANAGEMENT LLC, )
GLENHILL CONCENTRATED LONG )
MASTER FUND LLC, GLENHILL )
SPECIAL OPPORTUNITIES MASTER )
FUND LLC, JOHN EDELMAN, )
GLENN KREVLIN, JOHN MCPHEE, )
WILLIAM SWEEDLER,WINDSONG )
DB DWR II, LLC, WINDSONG DWR, )
LLC, WINDSONG BRANDS, LLC, )
HERMAN MILLER, INC. and HM )
CATALYST, INC., )
Defendants, )
)
and )
)
DESIGN WITHIN REACH, INC., )
)
Intervenor and )
Counterclaim-Petitioner. )
MEMORANDUM OPINION
Date Submitted: May 31, 2018 Date Decided: August 17, 2018
Peter B. Ladig of BAYARD, P.A., Wilmington, Delaware; David H. Wollmuth and Michael C. Ledley of WOLLMUTH MAHER & DEUTSCH LLP, New York, New York. Attorneys for Plaintiffs Charles Almond as Trustee for the Almond Family 2001 Trust, Almond Investment Fund LLC, and Charles Almond.
Norman M. Monhait and P. Bradford deLeeuw of ROSENTHAL MONHAIT & GODDESS, P.A., Wilmington, Delaware; Scott J. Watnik of WILK AUSLANDER LLP, New York, New York; Thomas A. Brown of MOREA SCHWARTZ BRADHAM FRIEDMAN & BROWN LLP, New York, New York. Attorneys for Plaintiff Andrew Franklin.
Andrew D. Cordo and F. Troupe Mickler IV of ASHBY & GEDDES, Wilmington, Delaware; Adrienne M. Ward and Brian Katz of OLSHAN FROME WOLOSKY LLP, New York, New York; John B. Horgan of ELLENOFF GROSSMAN & SCHOLE LLP, New York, New York. Attorneys for Glenhill Advisors LLC, Glenhill Capital LP, Glenhill Capital Management LLC, Glenhill Concentrated Long Master Fund LLC, Glenhill Special Opportunities Master Fund LLC, Glenn Krevlin, William Sweedler, Windsong DB DWR II, LLC, and Windsong DWR LLC.
Douglas D. Herrmann of PEPPER HAMILTON LLP, Wilmington, Delaware; Paul B. Carberry, Joshua Weedman, and Erin Smith of WHITE & CASE LLP, New York, New York. Attorneys for John Edelman and John McPhee.
Frederick B. Rosner, Scott J. Leonhardt, and Jason A. Gibson of THE ROSNER LAW GROUP LLC, Wilmington, Delaware; S. Preston Ricardo of Golenbock Eiseman Assor Bell & Peskoe LLP, New York, New York. Attorneys for Windsong Brands, LLC.
John D. Hendershot, Susan M. Hannigan, and Brian F. Morris of RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Bryan B. House of FOLEY & LARDNER LLP, Milwaukee, Wisconsin. Attorneys for Defendants, Counterclaim Petitioners Herman Miller Inc. and HM Catalyst, and Intervenor and Counterclaim Petitioner Design Within Reach, Inc.
BOUCHARD, C.
In July 2014, Herman Miller, Inc. acquired Design Within Reach, Inc.
(“DWR” or the “Company”), a retailer of modern furniture, for approximately $170 million in a third-party merger transaction. The merger was the culmination of a dramatic turnaround of the Company that began in August 2009, when a group of funds known as Glenhill invested $15 million in the Company and became its controlling stockholder, holding a 92.8% equity interest. A new management team was put in place later that year, and the Company’s fortunes improved steadily over the next few years.
After the merger closed, two former stockholders filed suit against Glenhill and the Company’s directors who oversaw its turnaround. Plaintiffs have never challenged the fairness of the merger consideration, which by all accounts was an outstanding result. Instead, plaintiffs’ core strategy has been to secure a larger portion of the merger consideration for themselves by challenging transactions that occurred before the merger.
In this post-trial decision, the court enters judgment in defendants’ favor on all of plaintiffs’ twelve claims for relief. Two rulings concerning two different categories of claims largely drive this result.
The first category consists of claims relating to a 50-to-1 reverse stock split that the Company implemented in 2010 on both its common stock and its Series A preferred stock, which Glenhill had purchased in 2009. Unknown to anyone at the
time, the reverse stock splits were implemented in a defective manner that had the effect of diluting the number of shares of common stock into which the Series A preferred stock could be converted by a factor of 2500-to-1, instead of the intended result of a 50-to-1 adjustment. This defect remained unknown in 2013, when the Series A preferred stock was converted into common stock, and in 2014, when the merger occurred.
Over one year after the merger closed, plaintiffs amended their complaint after discovering the defect, adding Herman Miller as a party and asserting that the merger was void. This action prompted Herman Miller to ratify certain defective corporate acts under 8 Del. C. § 204 relating to the implementation of the reverse stock splits and the subsequent conversion of the Series A preferred stock, and to file a counterclaim asking the court to validate those acts under 8 Del. C. § 205. For the reasons explained below, all of the equitable considerations identified in Section 205 overwhelmingly favor judicial validation, which the court grants.
The second category consists of claims challenging various transactions through which some or all of the Company’s board members or their affiliates received additional equity in the Company before the merger. All of these claims are concededly derivative in nature and, thus, a threshold issue is whether plaintiffs’ standing to maintain these claims was extinguished as a result of the merger.
Plaintiffs advance a novel “control group” argument in an effort to fit these claims into the transactional paradigm our Supreme Court recognized in Gentile v. Rosette for “a species of corporate overpayment claim” that can be both derivative and direct when a transaction results in an improper transfer of economic value and voting power from the minority stockholders to the controlling stockholder. 1 That argument fails, however, because it is clear from the record that Glenhill was DWR’s controlling stockholder by itself (and not as part of the group plaintiffs suggest) at all relevant times and that each of the challenged transactions did not increase—but actually reduced—its economic stake and voting power in the Company.
Based on these two rulings, and for other reasons explained below with respect to plaintiffs’ remaining claims, judgment will be entered in defendants’ favor and against plaintiffs on all claims. I. BACKGROUND The facts recited in this opinion are my findings based on the testimony and documentary evidence submitted during a five-day trial held in November 2017. The record includes stipulations of fact in the Pre-Trial Stipulation and Order (“PTO”), over 500 trial exhibits, nine depositions, and the live testimony of eight fact and two expert witnesses.
1 906 A.2d 91, 99 (Del. 2006).
A. The Parties and Relevant Non-Parties Design Within Reach, Inc. is a Delaware corporation with its principal place of business in Stamford, Connecticut. It is in the business of selling modern design furnishings and accessories.2 DWR was the surviving corporation of a merger with defendant HM Catalyst, Inc., a wholly-owned indirect subsidiary of defendant Herman Miller, Inc., that closed on July 28, 2014 (the “Merger”).3 Herman Miller is a Delaware corporation with its principal place of business in Zeeland, Michigan that produces office furniture, equipment, and home furnishings.4 Plaintiffs were stockholders of DWR at the time of the Merger. Plaintiff Charles Almond, individually or through the Almond Investment Fund, LLC and the Almond Family 2001 Trust, owned approximately 9.6% of DWR common stock in August 2009, and continued to acquire additional DWR shares until July 2014.5 The Almond plaintiffs tendered their shares for the Merger consideration on August 21, 2014.6 Plaintiff Andrew Franklin owned DWR common stock in 2009 and sold
2 PTO ¶ 1.
3 PTO ¶¶ 3, 63.
4 PTO ¶ 2.
5 PTO ¶ 11.
6 PTO ¶ 11.
approximately 25% of his shares after the Merger was consummated.7 On August 25, 2014, Franklin tendered his remaining shares for the Merger consideration.8 Defendants Glenhill Advisors, LLC, Glenhill Capital, L.P., Glenhill Capital Management, LLC, Glenhill Concentrated Long Master Fund, LLC (the “Glenhill Long Fund”), and Glenhill Special Opportunities Master Fund LLC (collectively, the “Glenhill Defendants”) are part of a fund complex managed by defendant Glenn Krevlin.9 Non-party Glenhill Capital Overseas Master Fund, L.P. (the “Glenhill Overseas Fund”) is a limited partnership that primarily invests in equity markets and has an investor base of institutional investors, pension plans, foundations, individuals, and family offices.10 The Glenhill Defendants and the Glenhill Overseas Fund are referred to collectively as “Glenhill.”
At all relevant times, Krevlin had sole investment and voting power over all DWR shares held by Glenhill.11 Krevlin also was the largest investor in and the sole portfolio decision maker at all relevant times for the Glenhill Long Fund, which was an investment vehicle primarily for individuals.12
7 PTO ¶ 12.
8 PTO ¶ 12.
9 PTO ¶ 4; Tr. 9 (Krevlin).
10 Tr. 8 (Krevlin); Dkt. 377.
11 PTO ¶ 6.
12 Tr. 9, 104-106 (Krevlin).
Defendant Windsong Brands, LLC (“Windsong Brands”) is an investment and restructuring company.13 Defendant William Sweedler was the managing member of Windsong Brands at all relevant times.
The individual defendants are Krevlin, Sweedler, John Edelman, and John McPhee. From January 2010 until the Merger, the period relevant to plaintiffs’ claims, the Company’s board of directors (the “Board”) consisted of these four individuals (collectively, the “Director Defendants”), with Krevlin serving as Chairman of the Board.14 Krevlin and Sweedler joined the Board in 2009.15 Edelman and McPhee joined the Board in January 2010, when they were hired to serve as the Company’s CEO and COO, respectively.16 Defendants Windsong DWR, LLC (“Windsong I”) and Windsong DB DWR II, LLC (“Windsong II”) are special purpose vehicles that were formed in May 2010 and July 2012, respectively, for the purpose of investing in DWR.17
13 PTO ¶ 7.
14 PTO ¶ 10.
15 PTO ¶ 18.
16 PTO ¶ 9.
17 PTO ¶ 8.
B. Events Preceding the 2009 Transaction In 2004, DWR went public and listed its common stock on NASDAQ.18 From 2005 to 2007, the Company’s revenues grew, but it continued to operate at a loss.19 On February 2, 2007, the Company entered into a Loan Guaranty and Security Agreement with Wells Fargo Retail Finance, LLC that provided the Company with a revolving credit line that was secured by substantially all of the Company’s assets, except for certain intellectual property.20 In 2008, with the collapse of the housing market, DWR’s revenues dropped by $15 million, and the Company incurred $14.6 million in losses.21 In May 2009, Wells Fargo informed the Company that it needed to make a capital infusion of $10 million to $15 million to maintain its line of credit.22 On May 29, 2009, DWR sought a financial viability exception from NASDAQ to allow a contemplated transaction to close without stockholder approval.23 After NASDAQ denied that request, DWR delisted its stock from NASDAQ effective July 16, 2009.24 It is in this context that a special committee of the Board pursued a private
18 PTO ¶ 1.
19 PTO ¶ 1.
20 PTO ¶ 21; JX 2 at 2.
21 PTO ¶ 1.
22 JX 10; JX 529 at 40.
23 PTO ¶ 14.
24 PTO ¶¶ 14-15.
placement with Glenhill, which held approximately 2.5 million shares or 17.2% of the Company’s common stock and had no Board representation at the time.25 C. The 2009 Transaction On July 20, 2009, DWR and Glenhill entered into a Securities Purchase Agreement pursuant to which Glenhill26 acquired a 91.33% ownership stake in DWR for $15 million in the form of 15.4 million shares of DWR common stock for $0.15 per share and 1 million shares of Series A 9% Convertible Preferred Stock (the “Series A Preferred”) for $12.69 per share (the “2009 Transaction”).27 The 2009 Transaction closed on August 3, 2009, at which point Glenhill became the Company’s majority stockholder with a total equity ownership interest of 92.8%, including the shares it held before the 2009 Transaction.28 The 2009 Transaction is not the subject of any challenge in this action.
25 PTO ¶ 4.
26 Glenhill Special Opportunities Master Fund LLC was the counterparty to the Securities Purchase Agreement, but the purchased shares were issued to the Glenhill Long Fund (8.34%), Glenhill Capital LP (51.33%), and the Glenhill Overseas Fund (40.33%), which were the three owners of the Glenhill Special Opportunities Master Fund LLC. Dkt. 377; JX 22 at GH/WS 0000204. 27 PTO ¶¶ 16, 18; JX 22 at GH/WS 0000038-74; JX 111 at DWR_EM_0000481. The Pre- Trial Order states that the Series A Preferred was issued at $12.89 per share (PTO ¶ 18), but this appears to be a typographical error. The Securities Purchase Agreement states that the Series A Preferred was issued at $12.69 per share, which is its “Stated Value.” JX 22 at GH/WS 0000038; JX 23 § 2. 28 PTO ¶ 5; JX 111 at DWR_EM_0000455; JX 513 ¶ 24.
The terms of the Series A Preferred were governed by the Certificate of Designation of Preferences, Rights and Limitations of Series A 9% Convertible Preferred Stock of Design Within Reach, Inc. (the “Series A COD”).29 Four features of the Series A Preferred relevant to this case are its (i) voting rights; (ii) paid-in- kind dividend; (iii) conversion formula; and (iv) adjustment provision.
Voting Rights. The Series A Preferred shares (i) had voting rights equal to the number of shares of common stock into which the Series A Preferred could convert, on an “as-converted” basis; and (ii) voted together with the common stock as one class on all matters.30 PIK Dividend. Series A Preferred holders had the right to receive cumulative dividends at the rate of 9% per year, compounding annually to be paid-in-kind in the form of additional shares of Series A Preferred (the “PIK Dividend”), with the option to let the PIK Dividend (i) accrue to the next “Dividend Payment Date” or (ii) to accrete to and increase the Stated Value:
Holders shall be entitled to receive, and the Corporation shall pay, cumulative dividends at the rate per share (as a percentage of the Stated Value per share) of 9.0% per annum (compounding annually . . .), payable annually in arrears, beginning on the first such date after the Original Issue Date and on each Conversion Date . . . in duly authorized, validly issued, fully paid and non-assessable shares of Preferred Stock (the “Dividend Share Amount”). At the option of the Holder, such
29 PTO ¶ 18; JX 23.
30 JX 23 § 4.
dividends shall accrue to the next Dividend Payment Date or shall be accreted to, and increase, the outstanding Stated Value.31
Conversion Formula. Series A Preferred holders had the right to convert their shares into shares of common stock in certain specified circumstances. Upon conversion, the holder was entitled to receive a number of common shares determined by multiplying the number of Series A Preferred shares to be converted by a “Stated Value” and then dividing by a “Conversion Price” (the “Conversion Formula”).32 The initial Stated Value was $12.69, and the Conversion Price was $0.09235.33 To “effect conversions,” a Series A Preferred holder had to provide the Company with a completed “Notice of Conversion” in the form attached as “Annex A” to the Series A COD.34 Adjustment Provision. Section 7 of the Series A COD contains a number of terms to adjust the Conversion Formula for the Series A Preferred in the event of certain types of transactions, such as stock dividends, stock splits, and subsequent equity sales of common stock.35 Relevant here, Section 7(a) adjusted the Conversion
31 JX 23 § 3(a); see also JX 14 at GH/WS 0000103.
32 JX 23 § 6(a).
33 JX 23 §§ 2, 6(b).
34 JX 23 § 6(a).
35 JX 23 § 7.
Price of the Series A Preferred in the event of a reverse split of the common stock as follows:
If the Corporation, at any time while this Preferred Stock is outstanding:
. . . (iii) combines (including by way of a reverse stock split)
outstanding shares of Common Stock into a smaller number of shares . . . then the Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock . . .
outstanding immediately before such event, and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event.36
In simple terms, under Section 7(a), a reverse split of the common stock would increase the Conversion Price of the Series A Preferred, which, in turn, would decrease in a proportional manner the number of common shares into which a share of Series A Preferred was convertible through operation of the Conversion Formula. As such, the provision was intended to operate so that, all else being equal, a Series A Preferred holder would receive the equivalent economic benefit upon a conversion of the Series A Preferred after a reverse split of common stock as it would have received upon a conversion before the split.
To be clear, the preceding discussion concerns how a reverse split of the common stock affects the Series A Preferred. As becomes important in this case, the Series A COD did not provide for any adjustment to the Conversion Formula for the Series A Preferred in the event of a reverse split of the Series A Preferred itself.
36 JX 23 § 7(a).
D. The Brands Grant As part of the 2009 Transaction, the Company agreed that Glenhill would have three Board designees. Glenhill initially designated Krevlin, Sweedler, and David Rockwell, who joined then-CEO Ray Brunner and Peter Lynch.37 The new Board met on August 20, 2009.38 After the meeting, DWR’s CFO Ted Upland raised concerns that the business plan Brunner introduced did not include “the real numbers.”39 According to Stuart Jamieson of Windsong Brands, the projections were “really unrealistic.”40 At the Board’s request, Windsong Brands put together a team to investigate, sending Jamieson, Ken Ragland, and Sweedler to DWR’s headquarters in San Francisco.41 In late August 2009, after discovering that Brunner had engaged in misconduct, Jamieson and Ragland “walked [Brunner] out of the building” and “took over” the Company, with Jamieson as acting CEO.42 On October 16, 2009, the Board terminated Brunner from his CEO position for cause based on various alleged acts of misconduct.43
37 PTO ¶ 18; JX 27 at 1.
38 JX 27 at 1.
39 Tr. 25-26 (Krevlin).
40 Tr. 688-89 (Jamieson).
41 Tr. 689-90 (Jamieson).
42 Tr. 692-93 (Jamieson).
43 See JX 47 at GH_WS0045704-5.
From late August 2009 until early 2010, Windsong Brands acted as interim management, performing a top-to-bottom review of DWR’s business and evaluating how to “cut the costs as much as possible,” given that the Company was losing $1 million to $2 million per month.44 Windsong Brands oversaw a reduction of 20% to 30% of DWR’s staff and the implementation of other cost-cutting measures to “stop[] the bleeding,” including changing the Company’s medical plan for employees and shutting down the development of new products.45 On October 16, 2009, the Company terminated the registration of its common stock to save the expense of maintaining public company filings.46 By the end of 2009, Windsong Brands had reduced the Company’s expense structure by 20% or approximately $11.4 million,47 but the Company’s pre-tax losses still increased to $24.9 million.48 At some point after Brunner was terminated as CEO in October 2009, the Board considered filing for bankruptcy.49 Before performing its restructuring and consulting work, Windsong Brands did not reach an agreement with the Company on compensation.50 In early 2010,
44 Tr. 691-96 (Jamieson); Tr. 919-20 (Sweedler); see also JX 28.
45 Tr. 693-95 (Jamieson).
46 PTO ¶ 19; Tr. 31 (Krevlin).
47 JX 99 at GH_WS0040041-42.
48 JX 99 at GH_WS0040038.
49 Tr. 113 (Krevlin); see also Tr. 576-78 (McPhee); Tr. 873-74 (Sweedler).
50 Tr. 29-30 (Krevlin); Tr. 865-66 (Sweedler).
Sweedler began compensation negotiations with Krevlin, seeking a 10% equity interest in the Company, which he believed was “commonplace” for this type of work.51 After a “long, drawn-out negotiation,” Sweedler ultimately agreed to accept a 1.5% interest in the Company.52 On September 28, 2011, the Company granted 54,796 shares of restricted stock to Windsong Brands that would vest only if a change of control occurred before March 22, 2016 (the “Brands Grant”).53 The stock grant provided that “Windsong shall have all rights of a stockholder (including, without limitation, the right to receive all dividends and distributions and voting rights) with respect to the shares of Common Stock comprising the Award.”54 The stock grant did not state that Windsong Brands would receive anti-dilution protection.
E. DWR Hires Edelman and McPhee In the fall of 2009, Sweedler introduced Krevlin to Edelman and McPhee, who had recently sold their business to one of DWR’s competitors.55 Edelman and McPhee had worked together successfully in other ventures and were “a package
51 Tr. 866-69 (Sweedler); Tr. 698-99 (Jamieson).
52 Tr. 866-68 (Sweedler); JX 79; JX 89.
53 JX 180 at GH_WS0013913.
54 JX 180 at GH_WS0013913.
55 Tr. 33 (Krevlin); Tr. 443-44 (Edelman).
deal,” with McPhee focused on operations and Edelman focused on sales and design.56 On December 14, 2009, the Company entered into employment agreements with Edelman and McPhee, hiring them to serve as CEO and COO, respectively, beginning in January 2010.57 Those agreements provided Edelman and McPhee options to purchase 4% and 3% of the Company’s equity, respectively.58 The agreements did not state that Edelman or McPhee would receive anti-dilution protection. In January 2010, Edelman and McPhee joined Krevlin and Sweedler on the Company’s Board.59 These four individuals comprised DWR’s entire Board from this point in time until the Merger.
F. The Windsong Note In 2010, DWR was “continuing to not do well.”60 By the end of the first quarter of 2010, net product revenues were down 23.6% from the year before, first
56 Tr. 34 (Krevlin).
57 PTO ¶¶ 9, 20.
58 JX 49 at DWR_EM_0001471 (Edelman), 85 (McPhee).
59 PTO ¶ 9. By this date, Brunner, Rockwell, and Lynch all had left the Board. See Tr. 32- 33 (Krevlin). 60 Tr. 44 (Krevlin).
quarter income was negative, and EBITDA was lower than the year before.61 The Company was “losing about [$]1 to $2 million a month, and [was] out of money.”62 Shortly after McPhee and Edelman joined the Company in January 2010, the Board began to consider a capital raise.63 On February 12, 2010, Krevlin emailed Edelman: “Would be great to raise only 5mil[.] Sounds like we can round that up [b]etween you john and friends.”64 That month, Edelman contacted four potential investors: “one of [his] relationships,” his co-investor in another project, his brother, and another contact, but “didn’t really go through [the investment with them] at length.”65 Sweedler testified that he had discussions with a potential Canadian investor (Knightsbridge Capital), but it wanted terms that were more dilutive than the 2009 Transaction and a higher interest rate.66 On March 11, 2010, Seth Shapiro, a senior analyst at Glenhill,67 emailed Krevlin that the Company was “[n]ot in a real rush” to raise capital, “given [Edelman and McPhee] cant close until early April and we don’t have cash need before then.”68
61 Tr. 192-94 (Shapiro); JX 95; see also JX 556 at 9.
62 Tr. 44 (Krevlin).
63 Tr. 117-18 (Krevlin).
64 JX 63.
65 Tr. 465-67 (Edelman); JX 64 at GH_WS0038397.
66 Tr. 876 (Sweedler).
67 Tr. 186 (Shapiro).
68 JX 78 at GH_WS0038948.
According to Krevlin, the Board did not seek funding from other potential investors because “it would be extremely difficult to get anyone comfortable with [the Company’s] precarious situation,”69 given the “significant unknown liabilities” in buying out leases for closed and underperforming stores70 and a potential multi- million-dollar liability arising from “wage and hour” claims regarding the classification of sales associates as exempt employees to avoid paying overtime wages.71 The capital raise ultimately took the form of a $5 million loan referred to herein as the “Windsong Note.” The terms of the Windsong Note were the product of a conflicted and deficient process. Shapiro was charged with “negotiating” the transaction on behalf of the Company even though his employer (Glenhill) was to own part of the Windsong Note.72 Across from Shapiro sat Sweedler, who
69 Tr. 46-47 (Krevlin).
70 See JX 99 at GH_WS0040046 (noting that twenty-three studios were deemed impaired “due to the inability of those studios to demonstrate that they could generate future cash flows in excess of operating expenses”); Tr. 573-74, 578-79 (McPhee). 71 See Tr. 44 (Krevlin); Tr. 582-85 (McPhee); see also JX 512 ¶ 53. By April 1, 2010, the Company resolved the wage and hour problem by changing its compensation plan, but it still was exposed to possible litigation given that employees could pursue claims that had statutes of limitations ranging from three to six years. Tr. 583-84 (McPhee). 71 Tr. 576-78 (McPhee); see also Tr. 873-74 (Sweedler).
72 Tr. 199 (Shapiro); see JX 109 (May 18, 2010 email from Sweedler to Krevlin, among others, stating “Glenn, you should know that [Shapiro] fought for EVERY little point for Glenhill!! He did his job AND MORE!!”).
negotiated on behalf of himself, Jamieson, McPhee, Edelman, and (purportedly) the Glenhill Long Fund.73 The Board did not consult with an outside financial advisor.74 Sweedler dictated the terms of the transaction. The loan was secured by a first lien on the Company’s intellectual property, which was the usual structure Windsong Brands used to make investments,75 and his lawyers (White & Case) papered the transaction.76 Ellenoff Grossman & Schole LLP, the law firm that represented Glenhill and the Company, did not participate in any discussions about the legal or economic terms of the Windsong Note.77 Joshua Englard, an Ellenoff Grossman partner, testified that he played no role in negotiating the terms of the Windsong Note, and that the transaction documents were presented to him as a “done document.”78 There were no real price negotiations. The Windsong Note was priced “at the same price as the previous round,” i.e., on the same terms as Glenhill’s initial investment.79 That is, the Windsong Note “was convertible into common stock at the same exchange ratio as the [2009 Transaction] ($4.57 per share on a split-
73 Tr. 199, 292-93 (Shapiro).
74 Tr. 287 (Shapiro).
75 Tr. 721-22 (Jamieson); PTO ¶ 23.
76 See JX 66; Tr. 114 (Krevlin); see also Tr. 124-25 (Krevlin); Tr. 580 (McPhee).
77 See Tr. 292 (Shapiro).
78 JX 495 60-62 (Englard Dep.).
79 See JX 552 at Defs.’ Demonstrative 1; Tr. 53 (Krevlin).
adjusted basis) if converted immediately.”80 As Krevlin testified, “the way this note was set up is that, basically, the conversion would be always tied to the same price of the conversion of the original ‘09 security so that they would move in lockstep in terms of the convertible price.”81 Windsong I, a limited liability company, was formed for the purpose of making the $5 million loan reflected in the Windsong Note, which paid interest at a rate of 5% per year, had a maturity date of October 3, 2012, and contained an option to convert all of the principal and accrued interest into DWR common stock based on a conversion matrix.82 With respect to the 5% cash coupon, Krevlin testified that the original ask was closer to 10%, but the record does not contain any documentary evidence showing that the parties actually negotiated the coupon rate.83 The five members of Windsong I and their capital contributions were as follows: (i) Edelman—$2 million for 40%; (ii) Windsong DB, LLC (an entity associated with Sweedler)84—$1.15 million for 23%; (iii) the Glenhill Long Fund— $1 million for 20%; (iv) McPhee—$750,000 for 15%; and (v) Jamieson Investments,
80 JX 512 ¶ 54.
81 Tr. 53 (Krevlin).
82 JX 105 at SJ_SBPN_0000666; § 5(a). “The conversion matrix resulted in a conversion price that decreased over time,” but “the longer the Windsong Note was outstanding, the greater the number of shares into which the Windsong Note would convert.” JX 513 ¶ 32. 83 Tr. 53 (Krevlin).
84 See JX 107 at GH_WS0036454 (reflecting that Sweedler is the authorized signatory of Windsong DB, LLC).
LLC (owned by Jamieson)—$100,000 for 2%.85 The limited liability company agreement for Windsong I, dated May 18, 2010 (the “LLC Agreement”), provided that any proceeds from the Windsong Note would be distributed to the members in proportion to their percentage ownership of Windsong I.86 The Company and Windsong I entered into a Note Purchase and Security Agreement dated as of May 18, 2010.87 The parties agreed that the Company would adjust the exercise price of the Windsong Note to account for any reverse stock split:
If the Company, at any time while this Note is outstanding . . . combines (including by way of a reverse stock split) outstanding shares of Common Stock into a smaller number of shares . . . then the Conversion Price shall be multiplied by a fraction of which the numerator shall be the number of shares of Common Stock . . . outstanding immediately before such event, and of which the denominator shall be the number of shares of Common Stock outstanding immediately after such event.88
On May 24, 2010, the Company issued a Notice of Annual Meeting of Stockholders, which disclosed that the Company had entered into the Note Purchase and Security Agreement and that Sweedler, Krevlin, Edelman, and McPhee were “affiliated with” Windsong I.89
85 JX 107 at § 3.3, GH_WS0036456.
86 JX 107 §§ 6.1, 6.2.
87 PTO ¶ 22; JX 108.
88 JX 105 at § 6(a); see also JX 108 at GH_WS0036630.
89 PTO ¶ 25; JX 111 at DWR_EM_0000484.
G. The Reverse Stock Splits During the summer of 2010, DWR common stock “became like a penny stock,” trading intermittently and at widely fluctuating prices.90 To address this volatility and save costs, the Board decided to implement a 50-to-1 reverse stock split of both the common stock and the Series A Preferred.91 Specifically, on July 26, 2010, the Board recommended and Glenhill, as the Company’s majority stockholder, approved (i) a 50-to-1 reverse stock split of the Company’s common stock; (ii) a 50-to-1 reverse stock split of the Series A Preferred; and (iii) an amendment to the Company’s certificate of incorporation to reduce the authorized number of shares of common stock from 30 million to 600,000 and the authorized number of shares of Series A Preferred from 1.5 million to 30,000 (the “Reverse Stock Splits”).92 After the Reverse Stock Splits were approved, Krevlin asked Shapiro to work with the Company’s attorneys to effectuate the transaction.93 On August 23, 2010, the Company filed with the Delaware Secretary of State an amendment to its certificate of incorporation stating that the Company was authorized to issue 600,000 shares of common stock and 30,000 shares of preferred
90 Tr. 59-60 (Krevlin); Tr. 586-87 (McPhee).
91 Tr. 59-61 (Krevlin); Tr. 586-87 (McPhee).
92 JX 126; PTO ¶ 28.
93 Tr. 61, 132 (Krevlin); Tr. 211 (Shapiro).
stock.94 On or about August 27, 2010, DWR issued a press release announcing the Reverse Stock Splits, and the Company’s stock transfer agent sent a notice to the Company’s stockholders of record.95 As discussed later in this opinion, although unknown to anyone at the time, there were many flaws in the implementation of the Reverse Stock Splits. Most importantly, instead of reducing by a factor of 50-to-1 the number of shares of common stock into which the Series A Preferred could convert, the transaction mistakenly was structured to reduce by a factor of 2500-to-1 the number of shares of common stock into which the Series A Preferred could convert. I refer to this defect as the “double dilution” problem.
The prospect of double dilution of the Series A Preferred upon conversion arose because of the combined effect of two actions: (i) the 50-to-1 reverse split of the common stock triggered a 50-to-1 reduction in the number of shares of common stock into which each share of Series A Preferred could convert under the adjustment provision in Section 7(a) of the Series A COD, described above; and (ii) the 50-to-1 reverse split of the Series A Preferred itself reduced by 98% the number of shares of Series A Preferred outstanding. With respect to the latter action, as mentioned previously, the Series A COD did not provide for any adjustment to the Conversion
94 PTO ¶ 29; JX 118 at DWR_EM_0000104-5.
95 PTO ¶ 30.
Formula for the Series A Preferred in the event of a reverse split of the Series A Preferred itself.
H. The 2011 Bridge Loan and Herman Miller’s Indication of Interest In 2010, DWR closed nineteen stores, negotiated early terminations for five more leases,96 and reported losses of $15.8 million and EBITDA of negative $3.1 million.97 In 2011, the Company found itself with a large inventory of unsold outdoor product and needed an additional capital infusion until that excess inventory could be sold.98 McPhee and Edelman asked Glenhill to make a bridge loan to the Company “to help [it] get over this problem.”99 On July 21, 2011, the Glenhill Long Fund loaned the Company $2 million, which was repaid in November 2011.100 In late August 2011, DWR received an inquiry from Herman Miller, its largest supplier, about a possible acquisition, which indicated a preliminary total enterprise valuation of the Company in the range of $25 million to $30 million.101 According
96 JX 147 at HMI 0051837.
97 See JX 147 at HMI 0051830; JX 160 at GH_WS0041151.
98 Tr. 65-66 (Krevlin); Tr. 589-92 (McPhee).
99 Tr. 589-90 (McPhee).
100 See JX 167 (July 21, 2011 Board consent granting Glenhill a warrant to purchase 1.5% of the Company’s outstanding common stock if the loan was not repaid in full by January 1, 2012); JX 189 at HMI 0057912. The repayment of the loan in November 2011 obviated the need to issue a warrant to Glenhill for making the loan. Tr. 66 (Krevlin), Tr. 591-92 (McPhee). 101 PTO ¶ 31.
to Krevlin, the Company was “not excited” about the indication of interest, which he thought was “too low.”102 Over the following months, Herman Miller signed a non-disclosure agreement and received access to a due diligence room, but did not make an offer at that time.103 I. The 2012 Financing At the end of 2011, “things were starting to turn positive . . . The company was making money [and] moved from a defensive position to going on offense.”104 Management prepared a budget for 2012 contemplating $3.3 million of capital expenditures.105 As Shapiro explained, “the [C]ompany was not in the same type of distress that it was in 2010 and 2009” and was seeking to raise “offensive capital.”106 During the first half of 2012, the Board discussed a private placement to raise a total of $2.5 million.107 A transaction was consummated on July 19, 2012, when the Company entered into a series of agreements concerning (i) the sale of stock and granting of options to raise up to $2.5 million; (ii) modification of the Windsong Note; and (iii) establishing a date for the conversion of the Series A Preferred.
102 Tr. 150 (Krevlin).
103 PTO ¶ 31.
104 Tr. 594 (McPhee).
105 See JX 188 at GH_WS0010732; Tr. 68-70 (Krevlin).
106 Tr. 230 (Shapiro).
107 PTO ¶ 33; see also JX 186 (November 22, 2011 email from Krevlin to Shapiro stating: “Edelman called they want to put in up to 2mil . . . And others can do up to 3mil?”).
These transactions, which are referred to collectively as the “2012 Financing,”
involved the following components:
The Company entered into a Securities Purchase Agreement with Edelman, McPhee, the Glenhill Long Fund, and Windsong II, an entity affiliated with Sweedler.108 They collectively purchased 401,108 common shares for a total of $1.8 million, or $4.49 per share (the “2012 Stock Sale”) as follows:
Edelman and McPhee each paid $400,000 for 89,135 shares; and the Glenhill Long Fund and Windsong II each paid $500,000 for 111,419 shares.109 Edelman and McPhee also each received an option to acquire up to $350,000 worth of additional shares of common stock at the same per share price of $4.49, which they exercised in December 2012.110 The Company and Windsong I entered into an agreement by which the parties amended the Windsong Note to extend its maturity date by one year to October 3, 2013.111 The PIK Dividend associated with the Series A Preferred continued to accrue until that date.112
108 See JX 246 at DWR_EM_0002233, 2247 (listing Sweedler as “Managing Member” of Windsong II). 109 PTO ¶ 36; JX 246 at DWR_EM_0002234-47.
110 PTO ¶¶ 37, 42; JX 246 at DWR_EM_2240 § 4.3.
111 PTO ¶ 39; JX 246 at DWR_EM_0002217-18.
112 JX 512 ¶ 66; Tr. 75 (Krevlin) (“[W]e would stop the PIKing on October [2013]”). The Letter Agreement does not state that the PIK Dividend will stop accruing before the conversion date but provides that, upon conversion, “the undersigned shall no longer have
The Company, Windsong I, the Glenhill Long Fund, and the Glenhill Overseas Fund entered into a Letter Agreement by which the parties agreed that on October 3, 2013 (i) all outstanding principal of the Windsong Note would be converted into shares of common stock at a conversion price of $3.5339; and (ii) the Glenhill Long Fund and the Glenhill Overseas Fund would convert all of their Series A Preferred shares into common stock (the “2013 Conversions”).113 The parties also agreed that Windsong I’s “rights to any interest on the Note are hereby forfeited and that the sole obligation of the Company with respect to the Note shall be the issuance of the Conversion Shares.”114 In connection with the 2012 Financing, the Company filed an amendment to its certificate of incorporation, increasing the number of authorized shares of common stock from 600,000 to 1.6 million shares.115 Krevlin believed the 2012 Financing was “a home-run transaction.”116 He explained the rationale for the transaction at trial, as follows:
any rights with respect to [the Windsong Note] (other than the issuance by the Company of the Conversion Shares).” JX 246 at DWR_EM0002209. 113 PTO ¶ 40; JX 246 at DWR_EM_0002208-2213.
114 JX 246 at DWR_EM_0002209; see also Tr. 74, 166 (Krevlin).
115 PTO ¶ 35; JX 118 at DWR_EM_0000099-100.
116 Tr. 75 (Krevlin).
[W]e did a holistic solution here which was a negotiation where every party gave up something . . . [Windsong Brands] took the 2012 note and they pushed it out one year to October of 2013 [and] agreed that they would not take any interest . . . which at that point was $600,000 .
. . And they agreed to convert that security, the $5 million security, at the PIK preferred conversion price on October of ‘13. [The Glenhill Overseas Fund said that] we would stop the PIKing on October [2013], so that that would allow everything to collapse into a simplified structure. So by us stop[ping] PIKing, you stop the dilution on the preferred piece. You basically got Windsong to convert their note, give up interest at exactly the same conversion price as the PIK preferred, which I believe was $3.25, and the equity investment was made. So we simplified everything. Windsong gave up a fair amount. We gave up the PIK, and we were able to get . . . management to invest further in the equity.117
As with the Windsong Note, the 2012 Financing was the product of a conflicted and deficient process. There are no minutes reflecting the Board’s consideration of the 2012 Financing, and it never hired an outside financial advisor.118 Shapiro again was tasked by Krevlin to negotiate on behalf of the Company against Sweedler, who represented the Director Defendants, including Krevlin.119 Shapiro and Sweedler did not negotiate vigorously. There is no documentary evidence of price negotiations, and Sweedler admitted that he and Krevlin had “two securities that were bumping up against each other,” i.e. Glenhill’s
117 Tr. 74-75 (Krevlin).
118 Tr. 651 (McPhee).
119 Tr. 78 (Krevlin).
Series A Preferred and the Windsong Note, and “were trying to protect each other’s interest at the end of the day.”120 Krevlin, Shapiro, and Sweedler testified that at least two data points were used to determine the price of the 2012 Financing, which implied a $27 million valuation of the Company:121 (i) the indication of interest from Herman Miller at a $25 million to $30 million enterprise value; and (ii) Glenhill’s internal valuation of the Company indicating a value of $4.41 per share as of December 31, 2011.122 No documents confirm that Shapiro and Sweedler actually used those data points to negotiate the price per share.
J. The Anti-Dilution Grants On July 17, 2012, when the 2012 Financing was under consideration, the Company granted an additional 19,654 restricted shares of common stock to Windsong Brands and awarded Edelman and McPhee 55,459 and 41,594 options to purchase common stock in the Company (the “Anti-Dilution Grants”).123 The restricted stock had the same terms as the restricted stock in the Brands Grant.124
120 JX 487 at 176-77 (Sweedler Dep.); Tr. 913-14 (Sweedler).
121 Tr. 160 (Krevlin).
122 JX 203 at GH_WS11399; Tr. 78 (Krevlin); Tr. 893-94 (Sweedler); Tr. 216-17, 337-40 (Shapiro). 123 PTO ¶ 34; JX 239; JX 235.
124 See JX 240 at SJ_SBPN_0001120 (email from Shapiro to counsel).
McPhee and Shapiro testified that they believed Edelman and McPhee were supposed to receive anti-dilution protection for the options they were granted under their employment agreements,125 but those agreements do not contain that protection.126 Sweedler similarly testified that anti-dilution protection should have been included in the documentation for the Brands Grant,127 but it was not.128 The Anti-Dilution Grants were made to offset the dilution each of them otherwise would have suffered by the PIK Dividend and other dilutive events since the Brands Grant and employment agreements were executed.129 K. The 2013 Conversions On October 8, 2013, Shapiro contacted Englard of Ellenoff Grossman to complete the paperwork to effectuate the 2013 Conversions.130 On October 22, 2013, Ellenoff Grossman delivered to the Company (i) a notice of conversion, dated October 16, 2013, purporting to convert the entire amount of the Windsong Note into 1,414,868 shares of common stock; and (ii) a notice of conversion, dated
125 Tr. 239 (Shapiro); Tr. 560, 599-600 (McPhee); see also Tr. 141 (Krevlin).
126 See JX 49 at DWR_EM_0001471 § 2.3, 001485 § 2.3 (stock option provisions of McPhee’s and Edelman’s employment agreements). 127 Tr. 869-70 (Sweedler).
128 See JX 180.
129 See Tr. 599-602 (McPhee); JX 237 (email from McPhee stating “DWR will be issuing additional options to John & me to cover dilution that has occurred since our options were issued”). 130 Tr. 243-44 (Shapiro); JX 288 at GH_WS0059422.
October 3, 2013, purporting to convert 1,432,397 shares of Series A Preferred held by Glenhill into 3,936,571 shares of common stock.131 The next day, the Company requested that the transfer agent issue the shares requested in the two notices of conversion.132 At the time of the 2013 Conversions, the Company was authorized to issue only 1.6 million shares of common stock,133 but the 2013 Conversions purported to convert the Series A Preferred and Windsong Note into a total of 5,351,439 shares of common stock—1,414,868 shares for the Windsong Note, and 3,936,571 shares for the Series A Preferred.134 On October 28, 2013, after this problem was brought to his attention, Englard sent the Company’s CFO Lorraine DiSanto and Shapiro forms of consent for the Board and majority stockholder to increase the number of authorized shares of common stock to 7.5 million.135 On October 30, 2013, the Company filed with the Delaware Secretary of State an amendment to the Company’s certificate of incorporation stating that the Company was authorized to issue 7.5 million shares of common stock and 30,000
131 PTO ¶¶ 44-45, 47; see also JX 301 at DWR_EM_11984-85 (notices of conversion).
132 PTO ¶ 48.
133 See PTO ¶ 35.
134 PTO ¶¶ 44, 47.
135 PTO ¶ 49; JX 305 at GH_WS0059631.
shares of preferred stock.136 Although Ellenoff Grossman did not deliver the notices of conversion to the Company until October 22, 2013,137 the Board’s written consent approving the 2013 Conversions was dated as of October 3, 2013.138 L. The Merger and the Change of Control Bonuses In November 2013, the Board retained Financo LLC to provide financial advisory services in connection with a potential sale of the Company.139 Financo contacted a number of potential strategic and financial buyers for the Company, which ultimately led to a transaction with Herman Miller.140 In July 2014, Herman Miller agreed to purchase the Company for an enterprise value of $183 million or an estimated equity value of approximately $170.4 million, subject to certain adjustments.141 The transaction contemplated combining DWR with Herman Miller’s consumer business and involved a number of steps. In simplified form: (i) Herman Miller purchased approximately 83% of the Company’s total equity from certain “Selling Stockholders” for $155 million in cash,
136 PTO ¶ 51.
137 PTO ¶¶ 44-45.
138 PTO ¶ 52; see also JX 295 (notice of conversion dated October 3, 2013).
139 PTO ¶ 53; JX 313.
140 See JX 340 at FINANCO0001135.
141 PTO ¶ 60; JX 411 at HMI 0002037.
or $23.9311 per share;142 (ii) Edelman and McPhee exchanged some of their DWR shares (representing approximately 14% of the outstanding shares of the Company) for an 8% interest in HM Springboard, Inc., a newly formed subsidiary of Herman Miller that ultimately would own all of the shares of the Company as well as the shares of a subsidiary of Herman Miller holding its consumer business; and (iii) DWR ended up as the surviving entity of a short-form merger with HM Catalyst, Inc., a wholly owned subsidiary of HM Springboard, in which the remaining stockholders of the Company were cashed out for $23.9311 per share plus a potential amount for a working capital adjustment.143 The Merger closed on July 28, 2014.144 During due diligence for the Merger, DWR’s counsel discovered that a greater number of options had been granted to twelve employees, including Edelman and McPhee, than was authorized under the Company’s 2009 Equity Incentive Award Plan.145 In response to this problem, the Company’s counsel recommended treating the options as bonuses, so that the employees would receive the cash equivalent of
142 The Selling Stockholders were the Glenhill Overseas Fund, the Glenhill Long Fund, Windsong Brands, Windsong DB, LLC, Jamieson Investments, LLC, Edelman, and McPhee. PTO ¶ 60. 143 JX 421 at AF 000011-12; PTO ¶ 64. As part of the transaction, the Selling Stockholders agreed to place $18.5 million of their proceeds into escrow to secure certain contingent liabilities of the Company. No other stockholder contributed to the escrow. PTO ¶ 65. 144 PTO ¶ 63.
145 See JX 363 at Financo_0056244; see also JX 394 at DWR_EM_0006760; JX354, 358, 359, 361.
what they would have received had they exercised their options, as they were entitled to do, upon a change of control (the “Change of Control Bonuses”).146 By letter agreements dated July 21, 2014, the Company agreed to pay the Change of Control Bonuses in lieu of the options. In exchange, the recipients provided general releases and relinquished their ability to roll over their shares.147 In total, $3,858,508 in Change of Control Bonuses were paid, with Edelman receiving $1,143,780, and McPhee receiving $857,819.148 In August 2014, a Notice of Merger and Appraisal Rights (the “Merger Notice”) was mailed to DWR’s stockholders of record.149 The Merger Notice provided background information about the Company, described the Merger, outlined the stockholders’ appraisal rights, and attached copies of three years of the Company’s financial statements and a fairness opinion from Financo.150
M. The Litigation Begins and Herman Miller Becomes Aware of the Defects Concerning the Reverse Stock Splits and 2013 Conversions
On December 19, 2014, plaintiffs filed their initial Verified Complaint, which they amended on March 12, 2015.151 On November 13, 2015, plaintiffs filed their
146 JX 363 at Financo_0056244.
147 PTO ¶ 61; Tr. 620 (McPhee); JX 394 (letter agreements with option holders).
148 PTO ¶ 62. These figures are rounded to the nearest dollar for simplicity.
149 See, e.g. JX 423; JX 424; JX 506.
150 JX 421 at AF000002-20, 26-103.
151 Dkts. 1, 16.
Second Amended Complaint, which added Herman Miller as a defendant and asserted for the first time that the Merger was void. According to plaintiffs, the Selling Stockholders owned only approximately 60% of the Company’s common stock as a result of defects concerning the Reverse Stock Splits and 2013 Conversions, meaning that Herman Miller failed to acquire the 90% ownership interest required to effectuate a short form merger under 8 Del. C. § 253.152 Although Herman Miller, with the assistance of its financial and legal advisors, conducted extensive due diligence in connection with the Merger, it did not become aware of any defects associated with the Reverse Stock Splits and 2013 Conversions until after this litigation began.153 The general counsel of Herman Miller could not explain how his diligence team could have missed those issues.154 N. The Ratification Resolutions Shortly after Herman Miller was added as a defendant, the Company engaged Delaware counsel (Richards, Layton & Finger, P.A.) to review its corporate records
152 Dkt. 61 ¶¶ 96-106.
153 Tr. 789 (Lopez); see also Tr. 737, 771, 780-81, 786-91 (Lopez). Plaintiffs suggested for the first time at post-trial argument that Glenhill recognized the double dilution problem before the Merger closed based on a memorandum attached to a July 11, 2014 email, which stated “[w]hat they really care about is the PIPE and not take risk on the conversion and PIK, etc.” Tr. 185 (May 22, 2018); JX370 at GH_WS0050206. I reject this contention. The cited document is ambiguous on its face, and plaintiffs made no effort during discovery to ask questions about it. Tr. 187-88 (May 22, 2018). Based on the preponderance of the evidence, I find that no one at Glenhill or any of the other defendants was aware of the double dilution problem before the Merger closed. 154 Tr. 760 (Lopez).
“in light of [plaintiffs’] allegations regarding the validity of certain corporate actions of DWR in the Second Amended Verified Complaint.”155 On February 10, 2016, the Company’s Board (then consisting of Edelman, McPhee, Krevlin, Brian Walker, Ben Watson, and Steve Gane) approved under 8 Del. C. § 204 a set of resolutions that, among other things, ratified certain defective corporate acts and putative stock relating to the Reverse Stock Splits and 2013 Conversions (the “Ratification Resolutions”).156 That same day, Herman Miller Consumer Holdings Inc., as the sole stockholder of DWR, approved the Ratification Resolutions in all respects.157 On February 11, 2016, the Company filed with the Delaware Secretary of State four certificates of validation contemplated by the Ratification Resolutions concerning the ratification of the following defective corporate acts:
“a 50-to-1 reverse stock split purportedly effected on August 23, 2010 pursuant to which each fifty (50) shares of Common Stock . . . were reclassified and combined into one (1) share of Common Stock;”
an amendment to the Company’s certificate of incorporation filed with the Delaware Secretary of State “on August 23, 2010 in connection with a 50-
to-1 reverse stock split,” which “reduced the number of shares of the Company’s preferred stock . . . below the number of shares of Preferred Stock designated as Series A Junior Participating Preferred Stock;”
155 JX 449 at HMI 0081976.
156 PTO ¶¶ 67-68; JX 456 Ex. E.
157 PTO ¶¶ 69; JX 456 Ex. F.
“a 50-to-1 reverse stock split purportedly effected on August 23, 2010 pursuant to which each fifty (50) shares of [Series A Preferred] were reclassified and combined into one (1) share of Convertible Preferred Stock;”
an amendment to the Company’s certificate of incorporation filed with the Delaware Secretary of State on August 23, 2010, which “reduced the number of shares of the Company’s preferred stock . . . below the number of shares of Preferred Stock designated as Convertible Preferred Stock;”
“the purported issuance of 3,936,571 shares of Common Stock . . . on October 23, 2013 upon conversion of certain shares of Convertible Preferred Stock;”
“the purported issuance of 5,351,439 shares of Common Stock [on October 23, 2013] consisting of 3,936,571 shares of Common Stock issued upon the purported conversion of certain shares of [Series A Preferred] and 1,414,868 shares of Common Stock issued upon the purported conversion of certain convertible notes of the Company;” and
an amendment to the Company’s certificate of incorporation filed with the Delaware Secretary of State on October 30, 2013 that “increase[d] the number of authorized shares of Common Stock from 1,600,000 shares of Common Stock to 7,500,000 shares of Common Stock.”158
The Ratification Resolutions also recite that, on July 19, 2012, the Company filed an amendment to the Company’s certificate of incorporation that increased the number of authorized common shares from 600,000 to 1.6 million, but the amendment “failed to state that it had been approved by the Company’s stockholders
158 PTO ¶ 70; JX 456 Exs. A-D (certificates of validation) & Ex. E (Board resolutions) at 7-8. The Board also ratified the issuance of “20 shares of Common Stock in connection with the rounding up of fractional shares in the Common Stock Reverse Stock Split.” JX 456 Ex. E at 2-3. The relevant resolution recites that stockholder approval was not required for this action. Id. at 3.
by written consent in lieu of a meeting” and the Company “failed to send the notice required by Section 228(e).”159 The Board determined that this 2012 amendment was not a defective corporate act under Section 204 and did not require ratification, but resolved to file a certificate of correction with respect to the 2012 amendment.160 II. CLAIMS ADJUDICATED AT TRIAL On August 14, 2017, about three months before trial, plaintiffs filed their Fourth Amended Complaint (the “Complaint”).161 It asserted the following twelve claims that were to be presented at trial:
Count I, asserted against all defendants, seeks rescissory damages in connection with the Merger;
Count II, brought against all defendants other than Herman Miller, asserts a claim for breach of fiduciary duty and “unlawfully benefiting” on the theory that “defendants received a far greater portion of the sum Herman Miller paid to acquire DWR than they were entitled to receive;”162
Count III asserts a conversion claim against all defendants on the theory that through the Merger, defendants unlawfully exercised control and dominion over plaintiffs’ shares;
Count IV, brought against the Director Defendants, asserts a claim for breach of fiduciary duty and “unlawfully benefitting” from void acts in connection with the stock sale that occurred as part of the 2012 Financing;
159 JX 456 Ex. E at 6.
160 Id.
161 Dkt. 301.
162 Compl. ¶ 137.
Count V, brought against the Director Defendants, asserts a claim for breach of fiduciary duty and “unlawfully benefiting” from void acts in connection with the Series A Preferred conversion in 2013;
Count VI, brought against the Director Defendants, asserts a claim for breach of fiduciary duty and “unlawfully benefitting” from void acts in connection with the Windsong Note, the modification of the Windsong Note as part of the 2012 Financing, the conversion of the Windsong Note in 2013, the Brands Grant, and the anti-dilution grant to Windsong Brands;
Count VII asserts a breach of fiduciary duty claim against the Glenhill Defendants as controlling stockholders in connection with the Windsong Note, the 2012 Financing, the 2013 Conversions, the Brands Grant, and the anti-dilution grant to Windsong Brands;
Count VIII asserts an unjust enrichment claim against all defendants except Herman Miller;
Count IX, brought against the Director Defendants and the Glenhill Defendants, asserts a breach of the fiduciary duty of disclosure claim based on the Merger Notice;
Count X asserts a breach of the fiduciary duty of loyalty claim against the Director Defendants and the Glenhill Defendants in connection with the Change of Control Bonuses;
Count XI asserts an aiding and abetting claim against Herman Miller; and
Count XII asserts an equitable fraud claim against the Glenhill Defendants, the Director Defendants, and Herman Miller based on alleged material misrepresentations and omissions in the Merger Notice.
On May 31, 2018, after post-trial argument, plaintiffs conceded that Count VIII (Unjust Enrichment) had been waived.163
163 Dtk. 378.
In addition to the claims recited above, the trial addressed a counterclaim filed by Herman Miller, HM Catalyst, Inc., and DWR. The counterclaim asserts a single claim seeking judicial validation under 8 Del. C. § 205 of the defective corporate acts identified in the Ratification Resolutions.164 The analysis of the claims that follows is divided into three parts. Section III analyzes the Section 205 counterclaim and related claims in the Complaint. Section IV analyzes plaintiffs’ claims challenging the Windsong Note, Brands Grant, 2012 Financing, and Anti-Dilution Grants. Section V analyzes plaintiffs’ remaining claims, which relate to the Merger. III. ANALYSIS OF SECTION 205 AND RELATED CLAIMS Under Section 205 of the Delaware General Corporation Law, this court has the authority to “[d]etermine the validity and effectiveness of any defective corporate act ratified pursuant to § 204 of this title;” “[d]etermine the validity and effectiveness of any defective corporate act not ratified or not ratified effectively pursuant to § 204 of this title;” and “[d]etermine the validity of any corporate act.”165 “In connection with an action under [Section 205],” the court may, among other things, “[v]alidate and declare effective any defective corporate act” and “[d]eclare
164 Dkt. 135.
165 8 Del. C. §§ 205(a)(1), (a)(3), (a)(4).
that a defective corporate act validated by the Court shall be effective as of the time of the defective corporate act or at such other time as the Court shall determine.”166 Before deciding whether to exercise its authority under Section 205, “the Court must first determine whether there was a defective corporate act.”167 The court then may consider the factors listed in Section 205(d) in deciding whether to exercise its authority under Section 205 to validate that defective corporate act.
Section 204(h)(1) defines “defective corporate act” as any act or transaction that is void or voidable due to a failure of authorization:
“Defective corporate act” means an overissue, an election or appointment of directors that is void or voidable due to a failure of authorization, or any act or transaction purportedly taken by or on behalf of the corporation that is, and at the time such act or transaction was purportedly taken would have been, within the power of a corporation under subchapter II of this chapter . . . but is void or voidable due to a failure of authorization.168
Section 204(h)(2) defines “failure of authorization” as a failure to effect an act in compliance with a company’s certificate of incorporation to the extent the failure renders the act void or voidable:
“Failure of authorization” means: (i) the failure to authorize or effect an act or transaction in compliance with (A) the provisions of this title, (B) the certificate of incorporation or bylaws of the corporation, or (C)
any plan or agreement to which the corporation is a party, if and to the
166 8 Del. C. §§ 205(b)(2), (b)(8).
167 In re Numoda Corp. S’holders Litig., 2015 WL 402265, at *9 n.99 (Del. Ch. Jan. 30, 2015), aff’d sub nom. In re Numoda Corp., 128 A.3d 991 (Del. 2015). 168 8 Del. C. § 204(h)(1).
extent such failure would render such act or transaction void or voidable.169
“Precisely because [Sections 204 and 205] were intended to cure inequities, ‘failure of authorization’ must be read broadly to allow the Court of Chancery to address any technical defect that would compromise the validity of a corporate action.”170
A. The Acts the Board Ratified in the Ratification Resolutions Constitute Defective Corporate Acts
In the counterclaim, Herman Miller, HM Catalyst, and DWR ask the court to declare under Section 205 that the Merger and the ratification of the seven defective corporate acts identified in the Ratification Resolutions are valid.171 Plaintiffs do not oppose judicial validation of five of these defective corporate acts.172 For example, plaintiffs do not challenge the actions the Company took to remedy the failure to obtain Board and stockholder approval to combine and reclassify the common stock and Series A Preferred on a 50-to-1 basis in connection with the Reverse Stock Splits. Instead, plaintiffs challenge only the Ratification Resolutions insofar as they seek to remedy the double dilution problem arising from the Reverse Stock Splits by validating the following two defective corporate acts:
169 8 Del. C. § 204(h)(2).
170 In re Numoda Corp., 128 A.3d 991, 991 (Del. 2015) (TABLE), 2015 WL 6437252, at *3. 171 Countercl. ¶ 34 (Dkt. 301).
172 Tr. 12-17 (May 1, 2018).
“the purported issuance of 3,936,571 shares of Common Stock . . . on October 23, 2013 upon conversion of certain shares of Convertible Preferred Stock;” and
“the purported issuance of 5,351,439 shares of Common Stock [on October 23, 2013] consisting of 3,936,571 shares of Common Stock issued upon the purported conversion of certain shares of [Series A Preferred] and 1,414,868 shares of Common Stock issued upon the purported conversion of certain convertible notes of the Company.”
To repeat, the double dilution problem occurred because, instead of reducing by a factor of 50-to-1 the number of shares of common stock into which the Series A Preferred could convert upon a conversion event, the Reverse Stock Splits reduced by a factor of 2500-to-1 the number of shares of common stock into which the Series A Preferred could convert. This occurred because of the combined effect of two actions: (i) the 50-to-1 reverse split of the common stock triggered a 50-to-1 reduction in the number of shares of common stock into which each share of Series A Preferred could convert under the adjustment provision in Section 7(a) of the Series A COD; and (ii) the 50-to-1 reverse split of the Series A Preferred itself reduced by 98% the number of shares of Series A Preferred outstanding without providing for an adjustment to the Conversion Formula for the Series A Preferred because the Series A COD did not contain an adjustment provision in the event of a reverse split of the Series A Preferred itself. There is zero evidence in the record that anyone involved intended for the Reverse Stock Splits to cause this double dilution.
The flaws in the implementation of the Reverse Stock Splits in 2010 became a problem in 2013 when the Company purported to convert the Series A Preferred into 3,936,571 common shares, although no one recognized the problem at the time. It is undisputed as a mathematical matter that Glenhill was entitled to receive at least 3,936,571 common shares upon the conversion of its shares of Series A Preferred in October 2013 if the Reverse Stock Splits had been implemented correctly to reduce by a factor of 50-to-1 (and not by 2500-to-1) the number of shares into which the Series A Preferred could convert.173 Because of the defects arising from the implementation of the Reverse Stock Splits, however, the Series A Preferred could not be converted into 3,936,571 common shares at that time but could only be converted into about 1/50th of that figure, i.e., approximately 78,731 common shares. The Ratification Resolutions addressed this plainly unintended consequence by
173 As previously explained, Glenhill had the right under the Series A COD to receive cumulative dividends at the rate of 9% per year compounding annually to be paid in-kind in the form of additional shares of Series A Preferred with the option to let the PIK Dividend (i) accrue to the next “Dividend Payment Date” or (ii) accrete to, and increase, the Stated Value of the Series A Preferred. JX 23 § 3(a). It is undisputed that PIK Dividends were not paid to Glenhill at any time before its shares of Series A Preferred were converted in October 2013. It also has never been disputed as a mathematical matter that, if the PIK Dividends were deemed to accrete to and increase the Stated Value of the Series A Preferred, Glenhill would have been entitled to convert its Series A Preferred shares in October 2013 into approximately 3,956,867 common shares, which is approximately 20,000 more than the number of common shares that Glenhill purportedly received (i.e., 3,936,571) in connection with the 2013 Conversions. See Dkt. 201 at 21-22 (explaining that the Stated Value would have increased from $12.69 to approximately $18.27 on October 23, 2013, the date of conversion, so that 20,000 shares of Series A Preferred would convert into approximately 3,956,687 common shares (20,000 shares X [$18.27/0.09235])).
amending Section 7(a) of the Series A COD to eliminate one of the two actions that caused the double dilution by providing “that no adjustment shall be made pursuant to this Section 7(a) . . . in respect of the 50-to-1 reverse stock split of the Common Stock effected . . . on August 23, 2010.”174 Plaintiffs’ primary point of contention in opposing the counterclaim concerns this amendment to Section 7(a). Specifically, plaintiffs argue that the court should not validate this amendment because defendants “have not identified any [defective corporate act] that was rendered void or voidable by the failure to amend [Section 7(a)].”175 I disagree.
To begin, the issuance of 3,936,571 common shares to Glenhill upon the conversion of its Series A Preferred was void because it violated Section 7(a) of the Series A COD as it existed before that provision was amended as a result of the Ratification Resolutions. “[U]nder Delaware law, a corporate action is void where it violates a statute or a governing instrument such as the certificate of incorporation or the bylaws.”176 The Series A COD was part of the Company’s certificate of
174 See JX 456 Ex. C at 6.
175 Pls.’ Reply Br. at 5-6.
176 Southpaw Credit Opportunity Master Fund, L.P. v. Roma Rest. Hldgs., Inc., 2018 WL 658734, at *5 (Del. Ch. Feb. 1, 2018); see also In re Oxbow Carbon LLC Unitholder Litig., 2018 WL 818760, at *47 (Del. Ch. Feb. 12, 2018) (“Historically, if a corporation failed to follow corporate formalities when issuing shares, then a party challenging the issuance had strong grounds to contend that the issuance was void and could not be validated in equity, whether through the invocation of equitable defenses or otherwise.”).
incorporation,177 and thus a corporate action violating the Series A COD would be a void act. Here, the Company purported to issue Glenhill 3,936,571 common shares as part of the 2013 Conversions but, as the parties agree, Glenhill’s Series A Preferred could not be converted into that many common shares under the original version of Section 7(a) of the Series A COD.178 In other words, the Company issued Glenhill more shares in 2013 than it was entitled to under the original Series A COD, which made that issuance void.
The Company’s failure to amend Section 7(a) is a failure of authorization with respect to the 2013 Conversions because it rendered the issuance of 3,936,571 common shares to Glenhill void.179 As discussed above, Glenhill suffered the prospect of double dilution because of the Reverse Stock Splits, which reduced by a factor of 2500-to-1 the number of common shares into which its Series A Preferred
177 See Elliott Associates, L.P. v. Avatex Corp., 715 A.2d 843, 845, n. 3 (Del. 1998)
(“When certificates of designations become effective, they constitute amendments to the certificate of incorporation.”). 178 See Herman Miller’s Answering Br. at 16-17 (“[T]he failure to amend the certificate of designation at the time of the Reverse Stock Splits in 2010 caused the issuance of common shares to Glenhill upon the Conversion to be a defective corporate act because (assuming away the effect of ratification) Glenhill received 50 times more common shares than the certificate of designation entitled it to.”); Pls.’ Reply Br. at 7 (“Glenhill held only 20,000 Series A, which cannot be converted into 3,936,571 common shares under the original [Series A COD].”). 179 See JX 456 Ex. C at 2 (identifying as a failure of authorization the failure to “include an exception for the Common Stock Reverse Stock Split Amendment from the provisions that would otherwise adjust the number of shares of Common Stock into which [the Series A Preferred] is convertible”).
could be converted. Thus, before Section 7(a) was amended, the Series A Preferred could be converted into only approximately 78,731 common shares. On the other hand, had the Company amended Section 7(a) immediately before the Reverse Stock Splits so that its adjustment provision would not apply to the reverse split of common stock, the Series A Preferred would have been convertible into at least 3,936,571 shares, and the issuance of that amount of shares would not have been void. In sum, the issuance of 3,936,571 shares of common stock in connection with the 2013 Conversions was a defective corporate act because the issuance of that many common shares was void due to the Company’s failure to amend Section 7(a) of the Series A COD before the Reverse Stock Splits in 2010.
Plaintiffs argue, without citing any supporting legal authority, that the “temporal disconnect” between the failure to amend Section 7(a) in 2010 and the 2013 Conversions “demonstrates that the issuance of shares at the time of the Conversion cannot be a [defective corporate act] for which the failure to amend 7(a) is a failure of authorization.”180 I disagree.
The plain language of Section 205 does not contain a temporal limitation on the court’s power to validate defective corporate acts, nor would such a limitation make sense where, as here, the effect of a defective corporate act may not manifest itself until years into the future. As noted previously, our Supreme Court has
180 Pls.’ Reply Br. at 6 (internal quotations omitted).
emphasized the need to “read broadly” the term “failure of authorization” to “cure inequities” and “to address any technical defect that would compromise the validity of a corporate action.”181 My conclusion that the Company’s failure to amend Section 7(a) is a failure of authorization with respect to the 2013 Conversions accords with this approach, particularly given the highly technical nature of the defect and that the equities overwhelmingly support correcting this obviously unintended defect, as discussed below.
As a secondary matter, plaintiffs challenge judicial validation of the purported issuance of 5,351,439 shares of common stock on October 23, 2013, because there were only 1.6 million shares of common stock authorized at that time.182 This is because the amendment to the Company’s certificate of incorporation to increase the authorized number of shares of common stock from 1.6 million to 7.5 million was not approved until one week later, on October 30, 2013.183 The Ratification Resolutions purported to fix this problem by changing the effective date of the amendment to October 22, 2013, before the 2013 Conversions.184
181 In re Numoda Corp., 128 A.3d at 991.
182 See PTO ¶ 35; JX 118 DWR_EM_0000099-100.
183 PTO ¶ 51; JX 308.
184 See JX 456 at Ex. D at 2 (stating that the certificate amendment increasing the number of authorized common shares to 7.5 million “shall be deemed to have become effective as of October 22, 2013”).
Plaintiffs do not dispute that the purported issuance of 5,351,439 shares of common stock in connection with the 2013 Conversions was a defective corporate act.185 Rather, plaintiffs contend that the court “should not permit the Miller Parties to change the effective date and time to the [certificate of incorporation] amendment because [the Company] deliberately and improperly backdated the Amendment and the board resolutions approving it in October 2013,” making it inappropriate for relief under Section 204.186 This argument fails because, even if this defective corporate act was “not ratified effectively pursuant to § 204,” the court still may determine its validity under Section 205187 and, as I discuss below, all of the Section 205(d) factors weigh in favor of judicial validation of this and all of the other defective corporate acts set forth in the Ratification Resolutions.
B. All of the Section 205(d) Factors Support Validating the Defective Corporate Acts Identified in the Ratification Resolutions
I turn now to the question of whether the court should ratify under Section 205 the defective corporate acts identified in the Ratification Resolutions. In making that determination, the court may consider the following factors:
185 See Tr. 55 (May 1, 2018) (“[W]e do not challenge [the certificate amendment increasing the number of authorized shares to 7.5 million] because we believe that you can’t increase the number of shares pursuant to the statute under normal circumstances . . . The reason we challenge that is because they backdated their effort to increase the number of shares, and even in this 204 notice, they continue the fiction that that was done on October 3.”). 186 Pls.’ Reply at 19-20.
187 8 Del. C. § 205(a)(3).
(1) Whether the defective corporate act was originally approved or effectuated with the belief that the approval or effectuation was in compliance with the provisions of this title, the certificate of incorporation or bylaws of the corporation;
(2) Whether the corporation and board of directors has treated the defective corporate act as a valid act or transaction and whether any person has acted in reliance on the public record that such defective corporate act was valid;
(3) Whether any person will be or was harmed by the ratification or validation of the defective corporate act, excluding any harm that would have resulted if the defective corporate act had been valid when approved or effectuated;
(4) Whether any person will be harmed by the failure to ratify or validate the defective corporate act; and
(5) Any other factors or considerations the Court deems just and equitable.188
In my opinion, all of the Section 205(d) factors weigh overwhelmingly in favor of judicial validation of the defective corporate acts identified in the Ratification Resolutions.
First, the record demonstrates that the Board effectuated the Reverse Stock Splits and 2013 Conversions with the reasonable belief that those transactions would be carried out by counsel in compliance with Delaware law and the Company’s
188 8 Del. C. § 205(d); see Cirillo Family Trust v. Moezinia, 2018 WL 3388398, at *8-9 (Del. Ch. July 11, 2018).
certificate of incorporation and bylaws.189 The reality is that counsel tasked with documenting these transactions botched them up unbeknownst to anyone associated with the transactions until after they had been implemented. There is no credible evidence to the contrary. Indeed, given that the implementation of the Reverse Stock Splits, if not corrected, would have gutted the value of Glenhill’s Series A Preferred upon a conversion, it is inconceivable that Krevlin or anyone associated with Glenhill knew about the double dilution problem when the Reverse Stock Splits and the 2013 Conversions were implemented.
Second, the record shows that the Board always treated the defective corporate acts as if they were valid and effective. The Board disclosed the Reverse Stock Splits in a press release190 and to FINRA191 and purported to take official action by signing Board resolutions approving the Reverse Stock Splits and 2013 Conversions192 and by authorizing amendments to the Company’s certificate of incorporation in connection with both transactions.193 Numerous parties relied on
189 Tr. 61-63, 84-85, 133 (Krevlin); Tr. 476-77 (Edelman); Tr. 587-89, 651-52 (McPhee) Tr. 889-90 (Sweedler); see also Tr. 299 (Shapiro). 190 JX 130.
191 JX 125.
192 JX 122; JX 285.
193 PTO ¶¶ 29, 51.
the public record of validity, including those who traded in DWR stock over a four- year period (including both plaintiffs) 194 and Herman Miller.195 Third, no one legitimately will or could claim to be harmed by the ratification of the defective corporate acts. The only conceivable harm is that plaintiffs will lose a large claim for damages. But that is not a cognizable harm under Section 205(d)(3) because plaintiffs would not have suffered that harm had the defective corporate acts been carried out correctly in first instance.196 Indeed, plaintiffs’ selective opposition to validation of the defective corporate acts in the Ratification Resolutions (i.e., not opposing validation of the Reverse Stock Splits but opposing validation of the issuances to preserve the double dilution problem) betrays an intention to obtain a windfall for themselves in this litigation.
194 See Tr. 1143-47 (Franklin) (discussing how Almond purchased DWR stock between 2009 and the Merger); JX 432 (showing that Franklin bought and sold DWR stock in 2014); JX 455 (showing that Almond bought DWR stock between 2010 and 2014). 195 See Tr. 734-37 (Lopez) (explaining that “DWR and its advisors would have loaded up onto a data room all information regarding the shareholdings of the company”); JX 502 at 56-57 (Walker) (testifying that he did not have any concerns about DWR’s capital structure before the closing). Plaintiffs assert that sufficient information was made available to Herman Miller during due diligence for it to detect the defective corporate acts. Even if this is theoretically true, it is of no moment. Herman Miller’s General Counsel, who oversaw the internal personnel and outside advisors responsible for Herman Miller’s due diligence, testified credibly that Herman Miller did not actually become aware of these defects until after the litigation began. Tr. 789 (Lopez). 196 See 8 Del. C. § 205 (d)(3) (excluding from the factors the statute identifies for consideration “any harm that would have resulted if the defective corporate act had been valid when approved or effectuated”).
Fourth, Glenhill and the individual defendants stand to be harmed by the defective corporate acts because plaintiffs seek damages from them (e.g., Counts II, III, and V) for receiving more Merger consideration than they would have received if the defective corporate acts are not validated. Herman Miller and its stockholders similarly stand to be harmed if the defective corporate acts are not ratified because plaintiffs seek damages from them on the theory that “the Merger was void ab initio because it did not comply with Delaware law.”197 Fifth, ratification is clearly the equitable outcome. Defendants are requesting that the court restore the Company and its stockholders to the positions they believed they occupied at all times from the Reverse Stock Splits in 2010 through the Merger in 2014. This is the “preferred remedy.”198 There is no inequitable motivation underlying the Company’s failure to implement and document the Reverse Stock Splits and 2013 Conversions correctly. To the contrary, defendants had nothing to gain but much to lose by the failures, and Herman Miller took action to fix the defective corporate acts promptly after they came to its attention. Plaintiffs, on the
197 Compl. ¶ 141.
198 C. Stephen Bigler & John Mark Zeberkiewicz, Restoring Equity: Delaware's Legislative Cure for Defects in Stock Issuances and Other Corporate Acts, 69 BUS. LAW. 393, 427 (2014) (“The ratification statutes, when effective, will eliminate the uncertainty faced by counsel and courts confronted with defects in stock issuances and other corporate acts by providing a practical and certain path to curing those defects that will result in the corporation and its stockholders being restored to the positions they thought they occupied and having the interests they thought they had before the defects were discovered. In most cases, this will be the preferred remedy.”).
other hand, seek an inequitable windfall for technical defects that DWR, the Board, Glenhill, and Herman Miller had no idea occurred until after the Merger.199
*****
For the reasons discussed above, the court grants the request to validate under Section 205 the defective corporate acts identified in the Ratification Resolutions. Accordingly, judgment will be entered in favor of the Herman Miller, HM Catalyst, and DWR and against plaintiffs on the counterclaim.
Counts II, III, and V of the Complaint all appear to proceed from the premise that one or more of the defendants unlawfully benefited from, or converted to his own benefit, a greater percentage of the Company’s equity in connection with the Merger than he would have received if the defective corporate acts had not been validated.200 Because the defective corporate acts have been validated, these three
199 Plaintiffs argue that the Company’s ratification under Section 204 was approved by a conflicted Board (consisting of Krevlin, Edelman, McPhee, Walker, Watson, and Gane) and does not meet the entire fairness test. No statutory support or precedent is cited in support of this puzzling argument. Putting aside that plaintiffs were not stockholders of the Company when the Board approved the ratifying actions and thus would have no standing to assert a breach of fiduciary duty claim relating thereto, all of the considerations discussed above demonstrating that the Section 205(d) factors overwhelmingly weigh in favor of judicial validation as the only equitable outcome equally support the conclusion that the Board’s ratification under Section 204 was entirely fair. 200 See Compl. ¶¶ 136-39 (Count II: claim for breach of fiduciary duty and “unlawfully benefitting” from “Invalid Transaction”); ¶¶ 140-43 (Count III: conversion claim that “the Merger was void ab initio because it did not comply with Delaware law”); ¶¶ 155-62 (Count V: claim for breach of fiduciary duty and “unlawfully benefitting” from “Void Acts”).
claims necessarily fail. Accordingly, judgment is entered in favor of the relevant defendants and against plaintiffs on Counts II, III, and V. IV. ANALYSIS OF OVERPAYMENT CLAIMS In this section, the court considers plaintiffs’ claims for breach of fiduciary duty relating to four transactions: the (i) Windsong Note; (ii) Brands Grant; (iii) 2012 Financing, including the 2012 Stock Sale and the extension of the Windsong Note; and (iv) Anti-Dilution Grants. I refer to these claims, at times, collectively as the “Overpayment Claims” because they each concern the authorization of transactions that allegedly unfairly benefitted some or all of the Director Defendants or their affiliates through the issuance of additional equity in the Company before or in connection with the Merger. Specifically, taking the four transactions in chronological order, plaintiffs contend that:
All four members of the Board (Krevlin, Sweedler, Edelman, and McPhee)
had a financial interest in and unfairly benefitted from the Windsong Note issued in May 2010, which was structured as a loan convertible into common stock.
Windsong Brands—and thus its principal Sweedler—was overpaid for the restructuring work it performed in 2009 when the Company granted it restricted stock, which would vest only upon a change of control, in September 2011 (i.e., the Brands Grant).
Windsong Brands, Edelman, and McPhee received an unfair benefit in July 2012 when they were awarded restricted stock and stock options (i.e., the Anti-Dilution Grants) to offset dilution they each would have suffered as a result of dilutive events that occurred after Windsong Brands received the Brands Grant and after Edelman and McPhee signed their employment agreements. To be clear, those agreements did not contain anti-dilution protection.
All four members of the Board again had financial interests in and unfairly benefitted from the 2012 Stock Sale and the extension of the Windsong Note that were components of the 2012 Financing approved in July 2012.
With respect to each of the Overpayment Claims, a threshold issue is whether plaintiffs have standing to assert those claims in light of the Merger. It is plaintiffs’ burden to prove they do.201 It is well established under our Supreme Court’s decision in Lewis v. Anderson and its progeny that, as a general matter, a merger extinguishes a plaintiff’s standing to maintain a derivative suit.202 This is because “a derivative claim is a property right owned by the nominal corporate defendant [that] flows to the acquiring
201 El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1260 n. 57 (Del. 2016) (quoting Dover Historical Soc’y v. City of Dover Planning Comm’n., 838 A.2d 1103, 1109 (Del. 2009)). 202 477 A.2d 1040, 1049 (Del. 1984).
corporation by operation of a merger.”203 Delaware law recognizes two circumstances where a merger would not extinguish a stockholder’s standing to maintain a derivative claim,204 but neither is present here, as plaintiffs concede.205 To determine whether a claim is direct or derivative, the court must consider “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?”206 “In the typical corporate overpayment case, a claim against the corporation’s fiduciaries for redress is regarded as exclusively derivative, irrespective of whether the currency or form of overpayment is cash or the corporation’s stock.”207 “The reason is that, in the typical corporate overpayment case, ‘any dilution in value of the corporation’s stock is merely the unavoidable result (from an accounting standpoint) of the reduction in
203 Feldman v. Cutaia, 951 A.2d 727, 731 (Del. 2008).
204 See Lewis, 477 A.2d at 1047, n.10 (“The two recognized exceptions to the rule are: (1) where the merger itself is the subject of a claim of fraud; and (2) where the merger is in reality a reorganization which does not affect plaintiff’s ownership of the business enterprise.”). 205 Tr. 85 (May 1, 2018).
206 Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004).
207 Gentile v. Rossette, 906 A.2d at 99.
the value of the entire corporate entity, of which each share of equity represents an equal fraction.’”208 Consistent with these authorities, plaintiffs concede that all of the Overpayment Claims are derivative claims.209 Plaintiffs nonetheless contend they have standing to maintain these claims under the “transactional paradigm” our Supreme Court recognized in Gentile v. Rosette where “a species of corporate overpayment claim” could be both direct and derivative in nature:
A breach of fiduciary duty claim having this dual character arises where: (1) a stockholder having majority or effective control causes the corporation to issue ‘excessive’ shares of its stock in exchange for assets of the controlling stockholder that have a lesser value; and (2)
the exchange causes an increase in the percentage of the outstanding shares owned by the controlling stockholder, and a corresponding decrease in the share percentage owned by the public (minority)
shareholders.210
Before focusing on plaintiffs’ theory for applying the Gentile framework here, it bears mentioning that our Supreme Court recently construed the doctrine narrowly in the context of an alternative entity dispute in El Paso Pipeline GP Co., L.L.C. v.
208 Sciabacucchi v. Liberty Broadband Corp., 2018 WL 3599997, at *7 (Del. Ch. July 26, 2018) (quoting Gentile, 906 A.2d at 99). 209 Tr. 77 (May 1, 2018).
210 Gentile, 906 A.2d at 99-100.
Brinckerhoff, with our Chief Justice even suggesting that Gentile should be overruled, at least in certain respects.211 In El Paso, a limited partner argued that its claim, which alleged overpayments by the partnership to the controlling general partner, fell within the Gentile framework because the overpayments diluted the minority limited partners’ economic interests but concededly were “not coupled with any voting rights dilution.”212 The Supreme Court refused to apply Gentile to that claim:
Gentile concerned a controlling shareholder and transactions that resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.
[Plaintiff’s] claim does not satisfy the unique circumstances presented by the Gentile species of corporate overpayment claims.213
The Court further explained, “[w]e decline the invitation to further expand the universe of claims that can be asserted ‘dually’ to hold here that the extraction of solely economic value from the minority by a controlling stockholder constitutes direct injury.”214 To do so, the Court reasoned, “would deviate from the
211 See El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1265–66 (Del.
2016) (Strine, C.J., concurring) (“Gentile cannot be reconciled with the strong weight of our precedent and it ought to be overruled, to the extent that it allows for a direct claim in the dilution context when the issuance of stock does not involve subjecting an entity whose voting power was held by a diversified group of public equity holders to the control of a particular interest.”). 212 Id. at 1252-53, 1264.
213 Id. at 1263-64 (emphasis in original) (internal quotations and citations omitted).
214 Id. at 1264.
Tooley framework and largely swallow the rule that claims of corporate overpayment are derivative.”215 The consequence of the Supreme Court’s ruling in El Paso was highly significant. It resulted in the reversal of a $171 million judgment for damages plaintiff had obtained because plaintiff’s standing to maintain a derivative claim was extinguished under Lewis v. Anderson and its progeny when the limited partnership was acquired in a merger “after the trial was completed and before any judicial ruling on the merits” in what the high court described as a “troubling case.”216 In the wake of El Paso, this court has exercised caution in applying the Gentile framework, commenting in one case that “[w]hether Gentile is still good law is debatable”217 and finding in another that “Gentile must be limited to its facts.”218 Whatever the ultimate fate of the Gentile paradigm may be, the current state of the law for the doctrine to apply is that (i) there must be a controlling stockholder or control group; and (ii) the challenged transaction must result “in an improper transfer
215 Id. (internal quotations and citations omitted).
216 Id. at 1250-52.
217 ACP Master Ltd. v. Sprint Corp., 2017 WL 3421142, at *26 n.206 (Del. Ch. July 21, 2017, aff’d, 2018 WL 1905256 (Del. Apr. 23, 2018). 218 Liberty Broadband Corp., 2018 WL 3599997, at *10.
of both economic value and voting power from the minority stockholders to the controlling stockholder.”219 I address each requirement, in turn, below.
A. The Windsong Entities, Edelman, and McPhee Were not Part of a Control Group with Glenhill with Respect to the Overpayment Claims
Plaintiffs’ theory for invoking Gentile proceeds from a novel premise. It is
stipulated that Glenhill became DWR’s majority stockholder when the 2009 Transaction closed, before any of the transactions underlying the Overpayment Claims occurred.220 At that point, Glenhill’s equity ownership in DWR was 92.8%.221 It also is stipulated that Krevlin had the sole investment and voting power over all DWR shares Glenhill held at all relevant times.222 Recognizing the reality that Glenhill was DWR’s controlling stockholder at all relevant times, plaintiffs asserted a claim against “the Glenhill Defendants” with respect to some of the Overpayment Claims for breach of fiduciary duty as the “controlling shareholders of DWR.”223
219 El Paso, 152 A.3d at 1263–64 (emphasis in original).
220 PTO ¶ 5. Technically, the shares were held by multiple Glenhill funds, but I refer to “Glenhill” in the singular for simplicity. 221 JX 111 at DWR_EM_0000455; JX 513 ¶ 24.
222 PTO ¶ 6.
223 Compl. ¶¶ 174-75 (asserting that Glenhill breached its fiduciary duty as a controlling stockholder with respect to the Windsong Note, the extension of the Windsong Note, and the 2012 Stock Sale).
Despite Glenhill’s indisputable status as DWR’s controlling stockholder and the manner in which plaintiffs plead their controlling stockholder claim for breach of fiduciary duty, plaintiffs do not—for reasons that will become obvious—invoke the Gentile framework based on Glenhill’s ownership position alone. Instead, relying on this court’s decision in In re Nine Systems Corporation Shareholders Litigation,224 plaintiffs argue that Edelman, McPhee, and the various Windsong entities (including Sweedler) were part of a control group along with Glenhill.
In Nine Systems, this court found after trial that three stockholders, none of which individually qualified as a controlling stockholder but the three of which collectively held approximately 54% of the company’s equity, functioned as a control group for purposes of Gentile.225 The court framed the analysis to find a control group, as follows:
A group of stockholders, none of whom individually qualifies as a controlling stockholder, may collectively be considered a control group that is analogous, for standard of review purposes, to a controlling stockholder. A control group is accorded controlling stockholder status and, therefore, its members owe fiduciary duties to their fellow shareholders. Proving a control group is not impossible, but it is rarely a successful endeavor because it is a fact-intensive inquiry that requires evidence of more than mere parallel interests. A plaintiff must prove that the group of stockholders was connected in some legally significant way—e.g., by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal. The standard
224 2014 WL 4383127 (Del. Ch. Sept. 4, 2014), aff’d sub nom. Fuchs v. Wren Holdings, LLC, 129 A.3d 882 (Del. 2015). 225 Id. at *2, *24-26.
does not necessarily require control over the day-to-day operations of a corporation; actual control with regard to the particular transaction that is being challenged may suffice.226
This court has applied this form of analysis to determine whether or not a group of stockholders, none of whom individually qualified as a controlling stockholder, constitutes a control group at least one other time for the purpose of determining whether a direct claim exists under the Gentile paradigm,227 and on many occasions for other purposes outside of the Gentile context.228 Particularly instructive is this court’s decision in In re PNB Holding Company Shareholders Litigation, where Chief Justice Strine, writing as a Vice Chancellor, considered after trial whether a group of individuals holding 33.5% of the company’s outstanding shares constituted a control group for purposes of deciding whether to
226 Id. at *24 (internal quotations and citations omitted).
227 See, e.g., Carsanaro v. Bloodhound Techs., Inc., 65 A.3d 618, 659-61 (Del. Ch. 2013).
228 See, e.g., In re Hansen Med., Inc. S’holders Litig., 2018 WL 3030808, at *5 (Del. Ch. June 18, 2018) (finding that “[p]laintiffs have stated a reasonably conceivable claim that the Merger should be considered under the entire fairness standard of review because it was a conflicted transaction involving [a control group]”); Frank v. Elgamal, 2014 WL 957550, at *18-19 (Del. Ch. Mar. 10, 2014) (finding that a group of stockholders did not constitute a control group during the initial part of a sales process but that a genuine issue of fact existed as to whether they did later in the sales process); Zimmerman v. Crothall, 62 A.3d 676, 700 (Del. Ch. 2013) (finding after trial that two stockholders did not constitute a control group for purposes of resolving a loyalty claim); Emerson Radio Corp. v. Int’l Jensen Inc., 1996 WL 483086, at *17 (Del. Ch. Aug. 20, 1996) (finding on a preliminary injunction record that two stockholders did not constitute a control group for purposes of determining the probability of success of a fiduciary duty claim).
review a merger under the entire fairness standard of review.229 In holding that they did not, the court emphasized the lack of any voting agreement or other arrangement impeding each stockholder’s ability to act in his or her own self-interest:
All told, some twenty people (directors, officers, spouses, children, and parents) comprise the supposed controlling stockholder group. The record, though, does not support the proposition that these various director-stockholders and their family members were involved in a blood pact to act together. To that point, there are no voting agreements between directors or family member[s]. Rather, it appears that each had the right to, and every incentive to, act in his or her own self-
interest as a stockholder.230
Here, plaintiffs have identified no case—and the court is aware of none—
where the analysis for determining the existence of a control group has been applied to glom on to a preexisting controlling stockholder additional stockholders to give them the status of a “control group” for Gentile purposes or otherwise. Given that the controller already is the proverbial 800-pound gorilla imbued with fiduciary obligations to guard against acting “selfishly to the detriment of the corporation’s minority stockholders,”231 it is not readily apparent why this scenario would arise. To be sure, one can envision a situation where a controller may have parallel interests
229 2006 WL 2403999, at *9-12 (Del. Ch. Aug. 18, 2006).
230 Id. at *10 (emphasis added).
231 Nine Sys., 2014 WL 4383127, at *24.
with other stockholders in a given transaction, but that is insufficient to create a “control group.”232 In my opinion, in order for a preexisting controlling stockholder to become part of a “control group” with other stockholders, the preexisting controlling stockholder would have to agree to share with other stockholders, or to impose limitations on, its own control power (such as through a voting agreement) for some perceived advantage as part of a legally significant relationship with the other stockholders. In other words, the preexisting controlling stockholder would have to agree to limit its ability to act in its own self-interest as a controller in some material way; otherwise the preexisting controlling stockholder would retain the ability to wield control by itself, and the power of control would not reside in the hands of a “group.” Nothing of this nature exists in the trial record.
With respect to the Brands Grant and the Anti-Dilution Grants, for example, Glenhill entered no arrangements to share its majority voting control with any Windsong entity (in the case of the Brands Grant) or Edelman and McPhee (in the case of the Anti-Dilution Grants), or to otherwise limit its ability to act in its own self-interest as the Company’s majority stockholder. Indeed, Glenhill received no equity or other form of payment in connection with either transaction and actually
232 Id. (citing Williamson v. Cox Commc’ns, Inc., 2006 WL 1586375, at *6 (Del. Ch. June 5, 2006)).
stood on the opposite side of the negotiating table for both transactions, each of which diluted its ownership stake in DWR. Indicative of this misalignment of interest, the record reflects that the negotiations with Windsong Brands over the Brands Grant were vigorous and protracted, extending over an eighteen-month period and resulting in a deal in which Windsong Brands received a 1.5% interest in the Company after initially demanding a 10% interest.
With respect to the Windsong Note, the 2012 Stock Sale, and the extension of the Windsong Note in 2012, the record shows that Glenhill’s interests were, at most, parallel to those of Sweedler (the principal behind Windsong Brands), Edelman, and McPhee. This is because they each held an interest in Windsong I, the entity holding the Windsong Note, and thus each had an apparent interest in procuring the Windsong Note (and extending it) on terms favorable to Windsong I. The same holds true concerning the 2012 Stock Sale, where the purchasers were the Glenhill Long Fund ($500,000), Windsong II, an entity affiliated with Sweedler ($500,000), Edelman ($400,000), and McPhee ($400,000). Critically, however, nothing in the record indicates that Glenhill entered into a voting agreement or any other arrangement imposing limitations on its control power that would have prevented Glenhill from acting in its own self-interest as DWR’s controlling stockholder as a result of any of these transactions.
During post-trial argument, plaintiffs cited as evidence of a control group the fact that Glenhill entered into an LLC Agreement in connection with the Windsong Note, and a Stockholders Agreement in connection with the 2012 Financing.233 As an initial matter, plaintiffs never discussed either of these agreements as evidence of a control group during post-trial briefing, thereby waiving the argument,234 and made no real effort to explain during post-trial argument why entering into either of these agreements supports their control group theory. In any event, based on the court’s own review of the terms of these agreements, neither supports plaintiffs’ position.
Glenhill, Edelman, McPhee, Windsong DB, LLC (an entity affiliated with Sweedler), and Jamieson Investments, LLC entered into the LLC Agreement in connection with Windsong I’s issuance of the Windsong Note to DWR.235 From the court’s review, no provision in that agreement limited in any way Glenhill’s ability to vote any of its shares in the Company as it saw fit so as to prevent it from acting unilaterally in its self-interest as DWR’s majority stockholder. Rather, that agreement appears to address the rights and obligations relating to the members’
233 Tr. 99 (May 1, 2018); Tr. 195-96 (May 22, 2018).
234 See Emerald P'rs v. Berlin, 726 A.2d 1215, 1224 (Del. 1999) (“Issues not briefed are deemed waived.”). 235 JX 107.
respective ownership interests in Windsong I and the terms governing the internal affairs of that entity.236 Glenhill, Edelman, McPhee, and various Windsong entities entered into the Stockholders Agreement for the purpose of setting forth “certain terms and conditions regarding the [2012 Stock Sale] and the ownership of the Equity Securities held by the Stockholders, including certain restrictions on the transfer of such shares.”237 As with the LLC Agreement, the court found no provision in that agreement evidencing that Glenhill limited in any way its ability to vote its shares in the Company as it saw fit. The Stockholders Agreement does contain a provision providing that, subject to various exceptions, “no Stockholder shall Transfer, directly or indirectly, all or any part of its Equity Securities . . . in the Company without the prior approval of the board of directors of the Company,”238 but that provision did not limit Glenhill’s ability to vote its shares in the Company and exercise its majority voting control as it sees fit, including by replacing the members of the Board, or to otherwise act unilaterally in its self-interest as DWR’s majority stockholder.
236 See JX 107 at GH_WS0036423.
237 Tr. 195-196 (May 22, 2018); JX 246 at DWR_EM_0002220.
238 JX 246 at DWR_EM_0002222 § 2.1.
In sum, based on the preponderance of the evidence, I find that Glenhill alone was DWR’s controlling stockholder at all times from the 2009 Transaction until the Merger, and that it did not share or otherwise limit its control power with any Windsong entity, Edelman, or McPhee in such a manner as to make them part of a “control group” along with Glenhill for purposes of applying the Gentile framework.
B. The Transactions Underlying the Overpayment Claims Did Not Result in an Improper Transfer of Either Economic or Voting Power from the Minority Stockholders to Glenhill The harm Gentile seeks to remedy arises “when a controlling stockholder,
with sufficient power to manipulate the corporate processes, engineers a dilutive transaction whereby that stockholder receives an exclusive benefit of increased equity ownership and voting power for inadequate consideration.”239 As such, a transaction does not fit within the Gentile paradigm if the controller itself is diluted by that transaction.240 Having determined that Glenhill alone was DWR’s controlling stockholder at all relevant times, the next question is whether any of the challenged transactions resulted “in an improper transfer of both economic
239 Feldman v. Cutaia, 956 A.2d 644, 657 (Del. Ch. 2007), aff’d, 951 A.2d 727 (Del. 2008).
240 See Dubroff v. Wren Holdings, LLC, 2011 WL 5137175, at *9 (Del. Ch. Oct. 28, 2011) (“[M]inority shareholders may have a direct equity dilution claim when their holdings are diluted, and those of the corporation’s controller are not. In other words, as long as the controller’s holdings are not decreased, and the holdings of the minority shareholders are, the latter may have a direct equity dilution claim.”).
value and voting power from the minority stockholders” to Glenhill.241 The answer is clearly no.
As an initial matter, the parties debate whether the type of securities underlying most of the Overpayment Claims—i.e., a convertible debt instrument, stock options, or restricted stock that vests only on a change-of-control—can form the basis of an improper transfer of economic and voting power under Gentile.242 I need not resolve these technical issues. Even if one assumes for the sake of argument that each of these types of securities could satisfy Gentile, which is debatable,243 none of the transactions challenged here resulted in a disproportionate transfer of economic and voting power to Glenhill.
As a mathematical matter, for a transaction to transfer economic and voting power to Glenhill disproportionately, Glenhill would need to receive in that transaction a percentage of the security to be issued that exceeds the percentage of economic and voting power Glenhill already held in the Company immediately
241 El Paso, 152 A.3d at 1263 (emphasis in original).
242 Glenhill’s Answering Br. at 51-53; Pls’ Reply Br. at 26-27.
243 See, e.g., ACP Master, 2017 WL 3421142, at *26 (concluding that plaintiff did not have standing to assert a direct dilution claim after a merger because “Sprint’s notes were never converted and no additional shares were issued”); Caspian Select Credit Master Fund Ltd. v. Gohl, 2015 WL 5718592, at *5 (Del. Ch. Sept. 28, 2015) (rejecting plaintiffs’ attempt to characterize a term loan facility, which was “facially a debt instrument,” as an equity transaction for purposes of Gentile); Harff v. Kerkorian, 324 A.2d 215, 219 (Del. Ch. 1974), rev’d on other grounds, 347 A.2d 133 (Del. 1975) (“The holder of an option to purchase stock is not an equitable stockholder of the corporation.”).
before that transaction. Otherwise, the transaction either would be dilutive to Glenhill or would maintain its percentage ownership. A simple hypothetical demonstrates the point.
Assume that Glenhill had a pre-issuance equity stake of 90 of 100 shares outstanding, that the Windsong entities, Edelman, and McPhee collectively held five shares, and that the remaining stockholders held five shares. If the Company issued 50 shares in a transaction, Glenhill must receive 90% of those shares to retain its 90% stake in the post-issuance entity:
Now assume that, as part of that 50 share issuance, Glenhill received only ten shares (20% of the issuance) while the Windsong entities, Edelman, and McPhee together received the remaining 40 shares (80% of the issuance). In that scenario, Glenhill’s position would drop below 90%:
Glenhill did not receive any securities in connection with either the Brands Grant or the Anti-Dilution Grants. Thus, by definition, both of these transactions were dilutive to Glenhill and fail to satisfy the second prong of Gentile.
Although Glenhill received a 20% economic interest in the Windsong Note and purchased approximately 28% of the shares issued in connection with the 2012 Stock Sale, both of these transactions also were dilutive to Glenhill and fail to satisfy the second prong of Gentile because Glenhill held at least a majority of the economic and voting power of the Company at all times from the 2009 Transaction until the Merger.244 Plaintiffs do not contend otherwise, which explains why they premised their Gentile argument on a novel “control group” theory instead of focusing on Glenhill’s own control position.
244 According to plaintiffs’ expert, Glenhill held approximately 85% of the Company on a fully diluted basis as of May 18, 2010, when the Windsong Note was issued. JX 513 Ex. E. The math concerning Glenhill’s ownership interest before the 2012 Financing is more complicated, but it plainly exceeded a majority position. See JX 513 Ex. E (calculating Glenhill’s position to be approximately 86% as of October 3, 2012); JX 552 at Defs’ Demonstrative 2 (estimating Glenhill’s position to be approximately 87% as of July 2012).
*****
For the reasons explained above, the Overpayment Claims (which seem to include at least Counts IV, VI, and VII) do not fall within the Gentile paradigm and thus constitute purely derivative claims that were extinguished by the Merger. Accordingly, judgment is entered in defendants’ favor and against plaintiffs with respect to each of those claims.
In reaching this conclusion, I recognize that some of the claims that will be extinguished here involved self-dealing transactions in which all members of the Board were conflicted (e.g., the Windsong Note and the 2012 Financing) and which otherwise would be subject to entire fairness review.245 As the El Paso decision recently reinforced, however, our law only permits purely derivative claims to survive a merger in certain narrowly prescribed circumstances, which simply do not exist here.246 And at least in this case, unlike in El Paso, plaintiffs cannot claim to
245 Krevlin, Sweedler, Edelman, and McPhee all benefited from these transactions by receiving, personally or through affiliated entities, an interest in the Windsong Note or shares of stock or options issued in connection with the 2012 Stock Sale. In Krevlin’s case, these benefits were obtained through his status as the largest holder of the Glenhill Long Fund at all relevant times. See Tr. 105-06 (Krevlin). That is the vehicle through which Glenhill acquired its 20% membership interest in Windsong I (the entity holding the Windsong Note) and purchased approximately 28% of the shares sold in the 2012 Stock Sale. 246 See Lewis, 477 A.2d at 1047, n.10 (“The two recognized exceptions to the rule are: (1) where the merger itself is the subject of a claim of fraud; and (2) where the merger is in reality a reorganization which does not affect plaintiff’s ownership of the business enterprise.”).
have been ambushed. They did not assert any of the Overpayment Claims in real time but chose to file them after the Merger closed, presumably aware of the risk of litigating derivative claims in that context. V. ANALYSIS OF PLAINTIFFS’ REMAINING CLAIMS In this section, the court considers plaintiffs’ remaining claims. Each of these claims, which were litigated seemingly as an afterthought to the claims discussed in Sections III and IV above, relates to the Merger. They are styled as claims for breach of fiduciary duty, equitable fraud, and aiding and abetting, and they concern essentially two subjects: the manner in which the Change of Control Bonuses were paid and certain disclosures in the Merger Notice. Based on these theories, plaintiffs seek, among other relief, rescissory damages.
A. Change of Control Bonuses As previously discussed, during due diligence for the Merger, DWR’s counsel discovered that a greater number of options had been granted to twelve employees than was authorized under the Company’s 2009 Equity Incentive Award Plan. The Company addressed this problem by paying the affected employees Change of Control Bonuses in a cash equivalent to what they would have received had their options been exercised in connection with the Merger. Edelman and McPhee together received approximately $2 million in Change of Control Bonuses.
Plaintiffs assert in Count X that the Board breached its fiduciary duty by having the Company pay the Change of Control Bonuses on the theory that it caused plaintiffs to bear a pro rata portion of the expense.247 This claim fails for two related reasons.
First, the contractual obligation to pay the option holders plainly belonged to the Company as the counterparty to the stock option agreements with its employees.248 That obligation was not owed by the Director Defendants or any subgroup of stockholders, and plaintiffs have offered no logical reason why the Company’s directors would be under a fiduciary obligation to treat the options as anything other than a liability of the Company.
Second, plaintiffs have not established any harm resulting from the Company paying the Change of Control Bonuses. As plaintiffs concede, the Company selected a zero-sum solution where the option holders received exactly the same value they would have received had the options been valid.249 Thus, the Change of Control Bonuses did not reduce the Merger consideration the plaintiffs received. If anything,
247 Pls.’ Opening Br. at 72-73. Count X also was asserted against the Glenhill Defendants (Compl. ¶¶ 190-91), but plaintiffs did not brief and thus waived that aspect of the claim. See Emerald P’rs, 726 A.2d at 1224 (Del. 1999) (“Issues not briefed are deemed waived.”). 248 See JX 394 at DWR_EM_0006761, 6765, 6769, 6773; see also JX 411 (flow of funds memorandum). 249 Pls.’ Opening Br. at 72 (“After discovering that DWR had awarded more options than authorized under its option plan, the Board decided to pay the holders of invalid options the value they would have received in the Merger had the options been valid.”).
the solution was beneficial to the Company (and all of its stockholders) because it eliminated—for no cost—the risk of employees seeking to impede the closing of the Merger to enforce their contractual rights.250 B. The Merger Notice Plaintiffs assert two claims predicated on alleged material misstatements or omissions in the Merger Notice that principally concern the background of the Merger and the circumstances concerning the Change of Control Bonuses:251 breach of fiduciary duty (Count IX) and equitable fraud (Count XII). I address each in turn.
1. Fiduciary Duty of Disclosure “[D]irectors of Delaware corporations are under a fiduciary duty to disclose fully and fairly all material information within the board’s control when it seeks shareholder action.”252 “[T]he duty of disclosure is not an independent duty, but derives from the duties of care and loyalty.”253 To recover damages for a breach of this nature, plaintiffs bear the burden of proving: “(i) a culpable state of mind or
250 See Tr. 500-01 (Edelman).
251 See Pls.’ Opening Br. at 81-82.
252 Stroud v. Grace, 606 A.2d 75, 84 (Del. 1992).
253 Pfeffer v. Redstone, 965 A.2d 676, 684 (Del. 2009) (internal quotations and citations omitted).
non-exculpated gross negligence, (ii) reliance by the stockholders on the information that was not disclosed, and (iii) damages proximately caused by that failure.”254 At the times relevant to this action, DWR’s certificate of incorporation contained a provision, authorized under 8 Del. C. § 102(b)(7), exculpating DWR’s directors from monetary liability for breaches of the duty of care.255 Thus, the Director Defendants only could be liable with respect to the Merger Notice if they breached their duty of loyalty.256 Here, however, plaintiffs have not identified any evidence of disloyalty or bad faith precipitating the contents of the Merger Notice. Indeed, plaintiffs made no effort in their post-trial briefs to discuss Glenhill’s or the directors’ involvement in the Merger Notice’s preparation or approval, or how they were responsible for the contents of any of the alleged misstatements or omissions.257 Plaintiffs’ fiduciary duty claim concerning the Merger Notice also fails because plaintiffs have not adduced any evidence of damages proximately caused by the alleged misstatements or omissions in the Merger Notice. “When seeking post-closing damages for breach of the duty of disclosure, . . . plaintiffs must prove
254 In re Wayport Inc. Litig., 76 A.2d 296, 315 (Del. Ch. 2013) (citing Loudon v. Archer- Daniels-Midland Co., 700 A.2d 135, 146-47 (Del. 1997)). 255 JX 1 at GH/WS 1392 (Ninth Article).
256 In re Transkaryotic Therapies, Inc., 954 A.2d 346, 360-63 (Del. Ch. 2008), as revised (June 24, 2008). 257 See Emerald P’rs, 726 A.2d at 1224 (Del. 1999) (“Issues not briefed are deemed waived.”).
quantifiable damages that are ‘logically and reasonably related to the harm or injury for which compensation is being awarded.’” 258 Plaintiffs have not made such a showing here, nor could they.
The sole question the Merger Notice presented to plaintiffs was whether to accept the Merger consideration or to demand appraisal. Here, however, as Almond and Franklin both testified,259 plaintiffs have never contended—even after full discovery and the retention of experts—that the Merger consideration was unfair. Plaintiffs did not even present an expert to offer an opinion on that subject. Instead, plaintiffs’ consistent strategy throughout this case has been to advance arguments to obtain a larger share of the Merger consideration. They employed this strategy by, among other things, opposing the relief sought under Section 205 to correct the double dilution problem and pressing the purely derivative Overpayment Claims despite their lack of standing to do so. Plaintiffs’ failure to challenge the sufficiency of the Merger consideration is fatal to their claim for damages relating to the Merger Notice.
258 In re Orchard Enters., Inc. S’holder Litig., 88 A.3d 1, 53 (Del. Ch. 2014) (quoting In re J.P. Morgan Chase & Co. S’holder Litig., 906 A.2d 766, 775 (Del. 2006)). 259 Tr. 1192 (Franklin); JX 497 at 264 (Almond Dep.). Given plaintiffs’ admissions that the Merger consideration was fair and the manner in which plaintiffs consistently litigated this case, I do not credit Franklin’s testimony—in response to a leading question from his own counsel—that he would have sought appraisal “if the Merger Notice disclosed everything [he] now know[s] about DWR.” Tr. 1110 (Franklin).
2. Equitable Fraud
To recover on a claim for equitable fraud, plaintiffs must establish “1) a false representation, usually of fact, by defendant; 2) an intent to induce plaintiff to act or to refrain from acting; 3) that plaintiff’s action or inaction was taken in justifiable reliance upon the representation; and 4) damage to plaintiff as a result of such reliance.”260 Plaintiffs’ equitable fraud claim in Count XII is based on the same alleged misstatements and omissions in the Merger Notice as their breach of fiduciary duty claim discussed above. As with that claim, plaintiffs’ equitable fraud claim fails because it is conceded that the Merger consideration was fair. Thus, plaintiffs have not, and cannot, establish damages based on any alleged reliance on the contents of the Merger Notice.
C. Aiding and Abetting Plaintiffs assert in Count XI that Herman Miller aided and abetted breaches of fiduciary duty by the Director Defendants and the Glenhill Defendants with respect to (i) the Change of Control Bonuses (Count X); and (ii) the Merger Notice (Count IX).261 Under Delaware law, to prove a claim for aiding and abetting a breach of fiduciary duty, a plaintiff must establish: “(i) the existence of a fiduciary
260 Shamrock Hldgs. of Cal., Inc. v. Iger, 2005 WL 1377490, at *7 (Del. Ch. June 6, 2005)
(citations omitted). 261 Pls.’ Opening Br. at 82-83.
relationship, (ii) a breach of the fiduciary’s duty, (iii) knowing participation in that breach by the defendants, and (iv) damages proximately caused by the breach.”262 Because plaintiffs have failed to establish a predicate breach of fiduciary duty with respect to the Change of Control Bonuses and the Merger Notice, or any harm resulting therefrom, the aiding and abetting claim against Herman Miller fails for the reasons discussed above.263 Additionally, plaintiffs have failed to prove that Herman Miller knowingly participated in any wrongdoing.
“Knowing participation in a board’s fiduciary breach requires that the third party act with the knowledge that the conduct advocated or assisted constitutes such a breach.”264 In other words, the aider and abettor must act with scienter, meaning that “the aider and abettor must act knowingly, intentionally, or with reckless indifference that is, with an illicit state of mind. To establish scienter, the plaintiff must demonstrate that the aider and abettor had actual or constructive knowledge that their conduct was legally improper.”265 Plaintiffs have not proven that Herman Miller acted with scienter concerning either the Change of Control Bonuses or the Merger Notice. With respect to the
262 RBC Capital Markets, LLC v. Jervis, 129 A.3d 816, 861 (Del. 2015).
263 See, e.g. In re Crimson Expl. Inc. S’holder Litig., 2014 WL 5449419, at *27 (Del. Ch. Oct. 24, 2014) (“Because the underlying breaches of fiduciary duty are being dismissed, Plaintiffs’ aiding and abetting claim must be dismissed as well.”). 264 Malpiede v. Townson, 780 A.2d 1075, 1097 (Del. 2001).
265 RBC, 129 A.3d at 862 (internal quotations and citations omitted).
Change of Control Bonuses, plaintiffs have not presented any evidence suggesting that anyone at Herman Miller knew that its conduct was “legally improper.” It is unsurprising that such evidence does not exist, given that having the Company—as the counterparty to the employees’ option agreements—pay the Change of Control Bonuses was an objectively reasonable solution. With respect to the Merger Notice, plaintiffs have not identified any evidence suggesting that Herman Miller actually knew that the Merger Notice contained any of the alleged false or misleading statements or omissions.
D. Rescissory Damages Finally, plaintiffs contend in Count I that they are entitled to rescissory damages on the theory that the Merger was tainted by defendants’ breaches of fiduciary duty with respect to the Change of Control Bonuses and the Merger Notice, and Herman Miller’s aiding and abetting of the same.266 Rescissory damages are “the monetary equivalent of rescission”267 and are “an exception to the normal out-of-pocket measure” of compensatory damages.268 “An
266 Plaintiffs also argue they are entitled to rescissory damages because the Merger was not lawfully effected as a short-form merger under 8 Del. C. § 253, on the theory that Herman Miller held fewer than 90% of DWR’s shares at the time of the Merger due to the defective corporate acts identified in the Ratification Resolutions. This argument fails given the court’s validation of those acts under Section 205. 267 Lynch v. Vickers Energy Corp., 429 A.2d 497, 501 (Del.1981), overruled in part on other grounds, Weinberger v. UOP, Inc., 457 A.2d 701, 714 (Del. 1983). 268 Strassburger v. Earley, 752 A.2d 557, 579 (Del. Ch. 2000), as revised (Jan. 27, 2000).
award of rescissory damages is one form of relief that could be imposed if [a] merger is found not to be entirely fair and if one or more of the defendants are found to have violated their fiduciary duty of loyalty.”269 “Any award of rescissory damages only would be imposed on those fiduciaries who committed a loyalty breach.”270 Given that plaintiffs do not challenge the fairness of the Merger and have not proven a breach of the fiduciary duty of loyalty, no basis exists to entertain plaintiffs’ request for rescissory damages. VI. CONCLUSION For the reasons explained above, judgment is entered in defendants’ favor and against plaintiffs on all claims in this case, i.e., Counts I-XII of the Complaint and the counterclaim. The parties are directed to confer and submit an implementing order within ten business days. If plaintiffs intend to seek an award of attorneys’ fees with respect to the court’s granting of relief under Section 205, the form of order should include a schedule for briefing that issue.
269 In re Orchard Enter., Inc. S’holder Litig., 88 A.3d 1, 41 (Del. Ch. 2014).
270 Id. See also Strassburger, 752 A.2d at 578 (“Rescissory damages must approximate as closely as possible the financial equivalent of rescission, and may be recovered only for a breach of the duty of loyalty.”); Transkaryotic Therapies, 954 A.2d at 360 (“[W]here a breach of the disclosure duty does not implicate bad faith or self-interest, both legal and equitable monetary remedies (such as rescissory damages) are barred on account of the exculpatory provision authorized by 8 Del. C. § 102(b)(7).”); Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1144 (Del. Ch. 1994), aff’d, 663 A.2d 1156 (Del. 1995) (“R]escissory damages should never be awarded against a corporate director as a remedy for breach of his duty of care alone; that remedy may be appropriate where a breach of the directors duty of loyalty has been found.”).
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