Corwin Cleaning Denied In Motion For Put up-Closing Injunctive Aid Underneath Unocal

On Could 1, 2023, the Delaware Courtroom of Chancery addressed an unsettled query beneath Delaware legislation—whether or not a totally knowledgeable, uncoerced vote of disinterested stockholders (so-called “Corwin cleaning”[1]) will be utilized to defeat claims to enjoin defensive measures beneath Unocal Corp. v. Mesa Petroleum Co.

In an opinion by Vice Chancellor Zurn, the Courtroom held that Corwin cleaning doesn’t apply to claims for post-closing injunctive aid beneath Unocal. The case, In re Edgio, Inc. Stockholders Litigation, has probably important implications for companies and their boards within the negotiation of funding agreements with important stockholders.

In reaching its resolution, the Courtroom discovered that sure voting commitments and switch restrictions in a stockholders’ settlement between Limelight Networks, Inc. (n/ok/a Edgio, Inc.) (“Limelight” or the “Firm”) and its 35% stockholder have been defensive measures that, not less than for functions of ruling on a movement to dismiss, it was affordable to deduce have been carried out so as entrench Limelight’s administrators towards a perceived menace of shareholder activism. Because of this, the Courtroom reviewed the challenged provisions with enhanced scrutiny beneath Unocal. The Courtroom discovered it fairly conceivable on the pleadings stage that Limelight’s administrators breached their fiduciary duties in acquiring these defensive provisions, and thus denied defendants’ movement to dismiss plaintiff’s claims to enjoin these provisions (plaintiff shouldn’t be in search of damages). Whereas the ruling stays topic to appellate evaluation by the Delaware Supreme Courtroom, and the Courtroom might in the end decline to enjoin the provisions on a extra developed report, within the meantime it gives vital steerage for boards negotiating the phrases of an funding by a serious stockholder.

Background

Limelight gives community service for supply of digital media content material and software program. The case arose out of a 2022 stock-for-stock transaction through which the Firm acquired a portfolio firm of Apollo International Administration, Inc. (“Apollo”) in alternate for newly issued Firm frequent inventory representing 35% of its professional forma shares excellent.

On the time of transaction, Limelight’s inventory worth had been in regular decline since its July 2020 all-time excessive, affected by Limelight’s earnings misses and underperformance relative to analysts’ consensus estimates.[2] By early 2021, Limelight had pursued quite a few turnaround initiatives (together with hiring a brand new CEO, implementing a turnaround plan and retaining a guide), however these measures have been unsuccessful. Market commentators started speculating that the Firm could also be a goal for activist buyers.[3]

Round this time, Limelight was approached by Apollo to debate the potential mixture of Limelight with Edgecast, Inc. (“Edgecast”).[4] Edgecast’s dad or mum firm, Faculty Father or mother, L.P. (“Faculty Father or mother”), was owned roughly 90% by Apollo funds and 10% by Verizon Communications, Inc. Following a interval of negotiation and due diligence, in March 2022, the events executed a purchase order settlement pursuant to which Limelight would purchase Edgecast in alternate for newly issued Limelight frequent inventory, which might end in Faculty Father or mother proudly owning 35% of Limelight’s excellent frequent inventory after the closing of the transaction (the “Acquisition”).[5] In reference to the Acquisition, the events agreed on a type of stockholders’ settlement (the “Stockholders’ Settlement”) that might govern the phrases of Faculty Father or mother’s funding following the closing. Nasdaq itemizing guidelines required Limelight to acquire stockholder approval for the issuance of the inventory consideration within the Acquisition.[6] Prematurely of the vote, the Firm issued a proxy assertion that summarized the Acquisition and Stockholders’ Settlement (which was additionally publicly filed), together with the provisions that might turn into the topic of the litigation.[7] On June 9, 2022, the Firm’s stockholders voted overwhelmingly in favor of the inventory issuance. At closing of the Acquisition one week later, the events entered into the Stockholders’ Settlement.[8]

After the closing, two Firm stockholders filed swimsuit in Chancery Courtroom towards the Firm and its Board of Administrators (the “Board”), claiming the Stockholders’ Settlement included defensive measures that created a big and enduring stockholder block designed to entrench the Board and protect it from stockholder activism.

Stockholders’ Settlement – The Challenged Provisions

Plaintiffs targeted on three provisions within the Stockholders’ Settlement (the “Challenged Provisions”) that allegedly warranted enhanced scrutiny beneath Unocal. First, the settlement requires Faculty Father or mother to vote in favor of the Board’s suggestions on director nominations (and towards any nominees not really useful by the Board) and different routine issues, equivalent to “say on pay” and auditor ratification.[9] Second, for different non-routine issues submitted for a stockholder vote, Faculty Father or mother was required to vote both in favor of the Board’s advice or professional rata with all different Firm stockholders.[10] Every of those voting agreements stay in place till 90 days after the sooner of (i) Faculty Father or mother ceasing to personal not less than 35% of the inventory issued to it at closing and (ii) Faculty Father or mother ceasing to have the proper to designate nominees to the Board.[11] Third, Faculty Father or mother is restricted from transferring its shares for 2 years from closing of the transaction, topic to customary exceptions, and for an extra yr thereafter is prohibited from transferring its shares to any transferee recognized to be a Firm competitor or listed on essentially the most lately printed “SharkWatch 50” record of activist buyers.[12]

The Events’ Arguments

Plaintiffs claimed that the Firm’s administrators breached their fiduciary duties by “prioritizing their very own private, monetary, and/or reputational pursuits” in approving the Acquisition and the Stockholders’ Settlement, “which they used to entrench themselves.”[13] In sum, they argued that these provisions established a 35% voting bloc contractually dedicated to defending the Board and deterring and defeating any activist threats. Plaintiffs requested the Courtroom to enjoin the Challenged Provisions, however didn’t search damages.[14] The Firm moved to dismiss the Grievance on the grounds that the Board’s selections in regards to the Challenged Provisions are protected by the enterprise judgment rule.[15] Moreover, the defendants argued that even when enhanced scrutiny does apply, the Courtroom should dismiss the Grievance beneath Corwin as a result of a totally knowledgeable, uncoerced majority of the Firm’s stockholders permitted the inventory issuance for the Acquisition, of which the Stockholder’s Settlement was an integral half, cleaning any alleged breaches of fiduciary obligation and restoring enterprise judgment evaluation.[16]

The Resolution

The Courtroom denied the movement to dismiss. The Courtroom started its evaluation with a dialogue of Corwin, noting that Delaware courts haven’t clearly resolved the query of whether or not Corwin can apply to a declare that’s in search of injunctive aid. V.C. Zurn discovered that “a cautious studying of Corwin’s textual content and different authorities compels the conclusion that Corwin was not supposed to cleanse a declare to enjoin a defensive measure beneath Unocal enhanced scrutiny.”[17] The Courtroom pointed to language in Corwin itself, limiting its holding to post-closing damages claims, as reiterated by the Delaware Supreme Courtroom in Morrison v. Berry.[18] V.C. Zurn additionally famous that Corwin left untouched earlier Delaware Supreme Courtroom precedent, In re Santa Fe, that seems to counsel a stockholder vote can’t cleanse claims for injunctive aid introduced beneath Unocal.[19] Lastly, the Courtroom asserted that making use of Corwin to claims for injunctive aid wouldn’t serve Corwin’s underlying public coverage rationale of permitting stockholders to make free and knowledgeable decisions based mostly on the financial deserves of a transaction.[20]

In so holding, the Courtroom was confronted with two prior Delaware Supreme Courtroom selections, Stroud v. Grace[21] and Williams v. Geier[22], that are inconsistent with the Courtroom’s studying of Corwin. Each held (earlier than Corwin was determined) {that a} stockholder vote can decrease the usual of evaluation for enjoining defensive measures from enhanced scrutiny to the enterprise judgment rule.[23] Whereas acknowledging this inconsistency, V.C. Zurn reasoned that, in contrast to Santa Fe, neither Stroud nor Williams was acknowledged in related half within the Corwin resolution.[24] She decided that she was certain by Corwin and Morrison, which she interpreted as implicitly overruling Stroud and Williams whereas preserving Santa Fe.

The Courtroom then turned as to if the claims as pled prompted enhanced scrutiny beneath Unocal. Outdoors of the poison tablet context (the place such a motivation is inferred), triggering Unocal enhanced scrutiny requires pleading the board acted with a subjective motivation of defending towards a perceived menace. A courtroom might think about all related circumstances to discern the administrators’ motivations.[25] On this case, the Plaintiffs requested the Courtroom to deduce a subjective entrenchment motivation from the Firm’s underperformance, market commentary that the Firm was a possible goal for activists, the timing of the transaction in relation to those developments and the phrases of the Challenged Provisions themselves.[26] The Courtroom discovered that the Challenged Provisions had a defensive impact and, making use of plaintiff-friendly inferences on the pleading stage, decided it was affordable to deduce that the Board had such a defensive motivation.[27] The Courtroom famous that it reached these conclusions cautiously as a result of “[i]nferring subjective defensive intent from the target traits of a defensive measure shouldn’t be very completely different than the per se set off of Unocal that thus far has been reserved for rights plans.”[28]

Evaluation of the Resolution

It’s unclear why Delaware courts ought to apply Unocal scrutiny to an alleged defensive system when it has been permitted by a totally knowledgeable, uncoerced vote of the disinterested stockholders. In spite of everything, in such a state of affairs, the priority of Unocal and its progeny that the board took “unilateral motion” is absent. The Courtroom additionally emphasised Corwin’s purported coverage rationale of permitting stockholders to have “the free and knowledgeable probability to resolve on the financial deserves of a transaction for themselves” (Courtroom’s emphasis), contrasting the “financial” resolution to approve a merger with a vote on entrenching measures, which the Courtroom characterised as unsuitable for financial valuation due to the potential for irreparable hurt. However it’s unclear why stockholders have been much less able to approving this inventory issuance and associated phrases than any variety of different transactions which can be able to ratification by stockholder vote. Delaware legislation has lengthy held that, exterior of the controlling stockholder context, approval of an transaction by an knowledgeable, non-coerced majority of the disinterested stockholders will invoke the enterprise judgement rule. The choice additionally didn’t tackle the methods through which the Challenged Provisions might have benefitted the general public stockholders.

It is usually unclear whether or not the choice would have been completely different if the defensive measures have been put to a separate vote, the place approval of these measures was not a situation to approval of the inventory issuance. In every of Stroud and Williams, the alleged defensive measures have been included in constitution amendments that have been put to a standalone vote, whereas in Santa Fe the challenged deal protections have been a part of a sale settlement the place stockholders have been solely requested to approve the transaction as an entire. It’s doable the Courtroom considered the bundling of the defensive measures with the approval of the inventory issuance as coercive, on the premise shareholders would have needed to settle for the previous with a view to get hold of the advantages of the latter. However any M&A transaction is a product of quite a few bargains, and it’s tough—and never all the time doable or advisable—to topic the element components of a negotiated entire to unbiased approvals. In specializing in how the Stockholders’ Settlement might have defended the Board towards an activist, the choice doesn’t tackle the methods through which that settlement might have protected the company and the remainder of the stockholders from a brand new main investor, whose pursuits might not totally align with public stockholders as an entire. Even for a worth enhancing transaction and even when it anticipated stockholders to approve the voting and switch restrictions, a board could also be reluctant to conform to a transaction that might end in such a big focus of possession if the board didn’t have certainty of some safety towards such a big stockholder exerting outsized affect on company governance and coverage, or creeping towards management with out fee of a management premium, or enabling another person to do the identical. And as commentators have famous, Corwin itself entails a sure bundling—the place shareholders who vote to approve a transaction are additionally successfully required to absolve fiduciaries of breaches they dedicated in the midst of its execution.

Lastly, one might query whether or not the Courtroom overestimated the insulating impact of the restriction on transfers to recognized activists. As a way to amass their place, usually activists should accumulate shares on the open market, which may take time. An accumulation of higher than 5% of the excellent shares have to be disclosed inside 10 days beneath present SEC guidelines. Any activist was free to amass public shares that weren’t topic to the Stockholders’ Settlement, simply as they have been previous to closing of the Acquisition. However the Acquisition created a newly issued, concentrated block that, following expiration of the lockup, might have made it a lot simpler for an activist to amass a really important stake with out superior disclosure. Such a switch restriction is perhaps extra precisely characterised as partially neutralizing what would possibly in any other case have given activists a big benefit, fairly than placing activists at a drawback. Whereas Unocal and its progeny limit boards from entrenching themselves towards activist stockholders, it’s not clear it ought to require boards to put down the purple carpet. Moreover, as is customary, the supply solely restricted a commerce to an investor who was recognized to be on the SharkWatch record. This might not have restricted Faculty Father or mother from gross sales on the open market after the lockup expired, by way of which any activist might have acquired shares, straight or not directly. The strongest activist deterrent was not the switch restriction however fairly the presence of such a big investor within the inventory within the first place, which was not at difficulty within the case.

Key Takeaways for Companies and their Boards

• At the very least for now, boards can’t depend on a totally knowledgeable, uncoerced stockholder vote to keep away from enhanced scrutiny of defensive measures beneath Unocal. As described above, it’s unclear why Delaware courts ought to apply Unocal scrutiny to an alleged defensive system when it has been permitted by a totally knowledgeable, uncoerced vote of the disinterested stockholders. However not less than for now, boards can’t depend on the impact of such a vote to “cleanse” (or ratify) any provision that may very well be topic to problem beneath Unocal. Thus, boards contemplating adopting such provisions needs to be ready to defend them beneath Unocal.
• However that doesn’t imply Unocal will all the time apply. Notably, the phrases of the Stockholders’ Settlement that have been most at difficulty on this case are typically customary for important fairness investments and are seen in lots of PIPE transactions. However this resolution doesn’t imply that each case will likely be vulnerable to a Unocal problem. Certainly, in a footnote, V.C. Zurn famous that “it’s unlikely that the character of the Challenged Provisions alone could be enough to set off Unocal.”
  • A number of details of this case appear to have pushed the end result, together with that the Firm was by all accounts susceptible to activist assault on the time it agreed to the Challenged Provisions, resulting in an inference that the Board was subjectively motivated to hunt to fend off potential activists. It’s value noting, nonetheless, that the Courtroom inferred this largely from the Firm’s efficiency and market commentary—there was no proof that an activist had really emerged or that the Board had particular motive (e.g., from statement of surprising buying and selling exercise) that an activist engagement was imminent. Whereas on this case the Stockholders’ Settlement arose from an acquisition, such agreements are frequent in giant fairness investments and it’s incessantly the case that issuers in these transactions have confronted some operational or monetary headwinds (which is commonly accompanied by the kind of activism vulnerability commentary seen right here).
  • Measurement of the funding in all probability additionally mattered to this resolution. Whereas it is not uncommon for issuers to acquire voting commitments and buying and selling lockups from important buyers, the entrenching impact of such provisions possible seems completely different with a 35% stockholder than it might with, e.g., a ten% or maybe even 20% stockholder. The size of the lockup interval may even possible be reviewed with this in thoughts.
  • As well as, you will need to be aware that this resolution was on a movement to dismiss, and the Courtroom’s ruling was restricted to discovering it “fairly conceivable” that the stockholder plaintiffs might show their declare and so they need to be permitted to proceed to discovery. After discovery, together with into the Board’s subjective motivations, the Courtroom might attain the alternative end result.
• Highlight on Activist Switch Restrictions.  It’s value noting the outsized position the supply proscribing switch to the “Sharkwatch 50” performed within the Courtroom’s resolution. The Courtroom intimated that it was affordable to deduce from that provision that the Board’s subjective motivation was to defend towards an activist menace. As described above, we consider this provision possible obtained undue focus. In our expertise such provisions often are motivated by extra benign concerns (e.g., avoiding giving an activist a simple solution to purchase a big bloc with out advance discover). And the supply at difficulty right here wouldn’t have restricted Faculty Father or mother from promoting on the open market (the place any activist might have been a direct or oblique purchaser). Finally, the strongest activist deterrent was the presence of such a big investor within the inventory within the first place. However, it’s value contemplating whether or not the advantages of such a provision outweigh the prices in mild of this resolution.
• Significance of Constructing the Document. You will need to set up a transparent and thorough report of the board’s deliberations concerning, and rationale for in search of, protections of the sort at difficulty right here. Outdoors of the poison tablet context, software of Unocal requires a exhibiting that the board acted with a subjective motivation of defending towards a perceived menace. Whereas board minutes and different inside paperwork straight reflecting the subjective motivation of the administrators have been absent from the report on the movement to dismiss stage (as a result of the plaintiff declined to hunt books and information beneath DGCL § 220 previous to submitting swimsuit), such information will presumably be produced in discovery and will likely be a part of the report for abstract judgment or trial. Along with shedding mild on the Board’s motivation for coming into into the transaction and agreeing to the phrases of the Stockholders’ Settlement, such information might focus on the methods through which the Challenged Provisions benefitted the general public stockholders, together with by stopping creeping management by the investor with out fee of a management premium, or dumping the inventory within the close to time period following the transaction. It can be crucial for boards to doc such rationales, in the event that they exist, along with establishing different non-defensive motivations.

[1] Named for the Delaware Supreme Courtroom’s resolution in Corwin v. KKR Monetary Holdings LLC, 125 A.3d 304 (Del. 2015). In Corwin, the Delaware Supreme Courtroom dominated that approval of a transaction by a totally knowledgeable, uncoerced vote of disinterested stockholders might cleanse a post-closing declare for damages. The place the Corwin doctrine applies, such a vote will end in Delaware courts reviewing the transaction beneath the extremely deferential enterprise judgement rule, which can typically result in dismissal of the declare.

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

[3] Id. at 6.

[4] Id. at 7.

[5] Id. at 8-9.

[6] Nasdaq Rule 5635(d)

[7] In re Edgio, Inc. at 12.

[8] Id. at 13.

[9] Id. at 10.

[10] Id. at 10-11.

[11] Id. at 11.

[12] Id. at 11.

[13] Id. at 14.

[14] Id. at 14.

[15] Id. at 15.

[16] Id. at 15.

[17] Id. at 18.

[18] Id. at 27.

[19] See In re Santa Fe Pacific Corp. Shareholder Litigation, 669 A.second 59 (Del. 1995).

[20] In re Edgio, Inc. at 27.

[21] Stroud v. Grace, 606 A.second 75 (Del. 1992).

[22] Williams v. Geier, 671 A.second 1368 (Del. 1996).

[23] In re Edgio, Inc. at 33-34.

[24] Id. at 36.

[25] Id. at 39.

[26] Id. at 41.

[27] Id. at 42-43.

[28] Id. at 45.