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holding complaint stated claim that board improperly delegated task of negotiating merger agreement to CEO, chairman, and owner of more than 25% of the stock
Summary of this case from W. Palm Beach Firefighters' Pension Fund v. Moelis & Co.Opinion
CONSOLIDATED C.A. No. 15779-NC
Dated Submitted: December 28, 2000
Date Decided: June 26, 2001
Joseph A. Rosenthal, Esquire, of Rosenthal, Monhait, Gross Goddess, P.A., Wilmington, Delaware; of counsel: Judith L. Spanier, Esquire, of Abbey, Gardy Squitieri, LLP, New York, New York, and Stull, Stull Brody, New York, New York, Attorneys for Plaintiffs.
A. Gilchrist Sparks, III, Esquire, Alan J. Stone, Esquire and Stephanie L. Nagel, Esquire, of Morris, Nichols, Arsht Tunnell, Wilmington, Delaware; of counsel: Mitchell A. Lowenthal, Esquire, and Dylan D. Smith, Esquire, of Cleary, Gottlieb, Steen Hamilton, New York, New York, Attorneys for Defendants Herbert P. Dooskin, Joseph M. Goldenberg, Albert Hersh, William Lilley III, Elihu H. Modlin, Dana R. Snyder, and Jeffrey S. Silverman.
Kevin G. Abrams, Esquire, of Richards, Layton Finger, Wilmington, Delaware; of counsel: John D. Donovan, Jr., Esquire, Michael P. Allen, Esquire, and Christopher G. Green, Esquire, of Ropes Gray, Boston, Massachusetts, Attorneys for Defendant Ply Gem Industries, Inc.
MEMORANDUM OPINION
Plaintiffs, former shareholders of Ply Gem Industries, Inc. ("Ply Gem" or the "Company"), bring their Consolidated Amended Class Action Complaint (the "Complaint") asserting, on behalf of themselves and their fellow former shareholders, that the merger of Ply Gem into a subsidiary of Nortek, Inc. ("Nortek"), pursuant to an agreement entered on July 24, 1997, was the product of breaches by the then-directors of Ply Gem of their fiduciary duties of loyalty and due care. Defendants have moved to dismiss. They contend that (1) Plaintiffs lack standing to pursue their claims, which can be asserted, if at all, only in a derivative action and not through an individual action and (2) in any event, the allegations of the Complaint do not, under Court of Chancery Rule 12(b)(6), state a claim upon which relief can be granted.
I conclude that the claims which Plaintiffs seek to assert are individual in nature and that Plaintiffs have alleged sufficiently that the merger was not approved by a disinterested and independent majority of the directors. I also find that one director defendant is entitled to dismissal of all claims against him because Plaintiffs' allegations do not raise sufficient doubt as to his loyalty and because Plaintiffs' duty of care claims against him are barred by the exculpatory provision in Ply Gem's certificate of incorporation. Accordingly, I grant in part and deny in part Defendants' motion to dismiss.
I. PARTIES
Plaintiffs, Herman Smilow, Adele Brody and Andrew Klotz, allege that they were shareholders of Ply Gem at all times relevant to this action.
The individual defendants were directors of Ply Gem:
1. Defendant Jeffrey S. Silverman ("Silverman"), who owned more than one-quarter of the outstanding Ply Gem stock, was the Chief Executive Officer and Chairman of the Board, positions that he had held for more than a decade.
2. Defendant Dana R. Snyder ("Snyder") was the President and Chief Operating Officer of Ply Gem. He held approximately 6% of the Ply Gem stock. Snyder's 1996 compensation included a salary of $440,000, a bonus of $890,000, and a long-term compensation award of options. With the Nortek merger, Snyder received more than $3.6 million for all of his options.
3. Defendant Herbert P. Dooskin ("Dooskin") was Ply Gem's Executive Vice President and owned more than 3% of its stock.
4. Defendant Elihu H. Modlin ("Modlin") had been General Counsel of Ply Gem for more than three decades. He was a partner in a law firm with his son, Charles M. Modlin, who was the Secretary of Ply Gem. During 1996, Ply Gem paid Modlin's law firm almost one million dollars for professional services.
5. Defendant Joseph M. Goldenberg ("Goldenberg") was a co-founder of a wholly-owned subsidiary of the Company and served as a consultant to the Company, for which he was paid approximately $287,000 in 1996.
6. Defendant Albert Hersh ("Hersh") was a co-founder of the Company and provided consulting services to the Company. In 1996, he was paid approximately $90,000 for those consulting services.
7. Defendant William Lilley III ("Lilley") was the President of Policy Communications, Inc., a business consulting firm, that received $25,000 from Ply Gem in 1996 for its consulting services.
Ply Gem was a manufacturer and distributor of building materials.
II. BACKGROUND
The factual background is taken from the Complaint, the well-pleaded allegations of which, for present purposes, must be taken as true. Vanderbilt Income and Growth Assocs., L.L.C. v. Arvida/JMB Managers. Inc., Del. Supr., 691 A.2d 609, 612-13 (1996).
In August 1995, Ply Gem announced that it had hired an investment banking firm to explore various strategic alternatives, one of which was the sale of Ply Gem. During the next several months, Ply Gem discussed a potential acquisition with several parties. Some of these parties entered into confidentiality and standstill agreements; some also received non-public information about the Company. Nortek was one of those parties that received confidential information and entered into a standstill agreement with Ply Gem.
In February 1996, Ply Gem received an indication of interest in purchasing the Company at a price of $17 per share from an unidentified third party. Nortek at that time also raised the possibility of a merger with Ply Gem. Although Silverman and Snyder discussed a stock-for-stock merger with Nortek for several months, nothing came of the discussions; and, in July 1996, the Ply Gem board announced that it had decided not to sell the Company but, instead, to move forward with the development of Ply Gem's business.
Silverman and Snyder, however, had not given up on finding a buyer. They even considered a recapitalization of Ply Gem that would result in the termination of Silverman's employment relationship and in the appointment of Snyder as Ply Gem's new chief executive officer.
In March 1997, Silverman, without informing the board, retained another investment banking firm to explore the possibility of a leveraged buyout of Ply Gem and to identify potential partners for Silverman if he elected to participate in such an effort. The investment banker approached six leveraged buyout firms. All six committed to a two-year standstill provision which required, at Silverman's insistence, that they would not propose to acquire Ply Gem except with Silverman's, or the Ply Gem board's, prior approval.
Silverman's employment with Ply Gem was governed by an employment contract extending to 2007. Silverman informed the potential buyout firms that he did not want to continue in his position after any buyout and that they should assume that he would receive termination compensation of $25 million, $2 million per year for a non-compete covenant spanning five years, and cancellation of his indebtedness ($17.4 million plus accrued interest) to Ply Gem. Unless these demands were met, there would be no transaction. Silverman's existing agreement with Ply Gem contained a non-compete covenant that would not survive both a change in corporate control and Silverman's termination as a result thereof.
Silverman and Snyder (who wanted to become the chief executive officer of the surviving entity) selected Hicks, Muse, Tate Furst ("Hicks, Muse") for negotiations from among the many potential buyout firms. Hicks, Muse was discussing a price range of $17 — 19 per share in May 1997. One of the possibilities was that Silverman would retain an equity position in the venture. While discussions were ongoing with Hicks, Muse, Silverman and Snyder continued to discuss the possibility of a combination with Nortek, which was floating a price of $17 per share. Hicks, Muse, however, was prepared to offer to Silverman $10 million more than was Nortek to resolve the issues posed by Silverman's employment agreement and non-competition agreement.
On or about June 10, 1997, the Ply Gem board was told about the Hicks, Muse and the Nortek expressions of interest in acquiring the Company. The board designated Silverman and Lilley to meet with and select an investment banking firm to advise the board. Silverman identified the firms to be considered, and Lilley and he chose Furman Selz Co. ("Furman Selz").
The board, notwithstanding Silverman's extensive personal financial interest in any transaction, did not appoint a special committee. Instead, it allowed Silverman to continue as Ply Gem's negotiator with both Hicks, Muse and Nortek.
On June 16, 1997, Nortek advised Silverman that it was willing to pay $20 per share, but was not prepared to enhance its proposal to Silverman for his personal contractual requirements.
On June 20, 1997, Furman Selz met with the Ply Gem board and indicated that it would provide a favorable fairness opinion at that time on the Hicks, Muse offer of $18 per share, which, unlike the Nortek offer, also satisfied Silverman's demands. Two days later, Hicks, Muse increased its offer to $18.75 per share while Nortek remained interested at $20 per share or perhaps slightly more.
On June 24, 1997, Silverman provided Nortek with copies of the proposed agreements with Hicks, Muse, including those dealing with his personal employment arrangements. Silverman, in essence, was attempting to induce Nortek to meet his personal demands while also securing a better price for the Ply Gem shares. Silverman informed the Ply Gem board that he anticipated a proposal from Nortek at up to $21 per share in definitive form by June 25, 1997. The board, however, on June 24, 1997, chose to accept the Hicks, Muse offer (through an affiliate, Atrium Acquisition Holdings Inc.) of $18.75 per share. Later the same day, Nortek submitted an offer to purchase Ply Gem at $20.25 per share, but it withdrew that offer the next day when the Hicks, Muse agreement was announced.
On July 14, 1997, Nortek offered $19.50 per share to acquire Ply Gem. Its offer also satisfied Silverman's personal demands concerning the termination of his employment agreement, his non-competition agreement, and the forgiveness of his debt to the Company. Nortek's offer, accordingly, was $0.75 per share less than its offer of two weeks earlier, allegedly reflecting the cost to Ply Gem's shareholders of Nortek's meeting Silverman's specific demands.
Complaint, ¶ 42.
Later in July 1997, the Ply Gem board approved a merger agreement with Nortek and terminated the Hicks, Muse agreement, paying Hicks, Muse (or its affiliate) $12 million as a termination fee and for reimbursement of its expenses. The board also received a fairness opinion from Furman Selz. Plaintiffs allege that the fairness opinion was inadequate because it failed to consider the consequences of Silverman's "side" deal.
Nortek, Ply Gem, and Silverman executed, concurrently with the merger agreement, an agreement providing for the termination of Silverman's employment, a non-competition covenant, payment to Silverman of more than $22 million (reduced by amounts paid to Silverman before his termination as a bonus for 1997) and forgiveness of Silverman's over $17 million debt to the Company, plus any accrued interest on the debt.
The merger of Ply Gem with a Nortek subsidiary was consummated thereafter.
III. THE CONTENTIONS
Plaintiffs allege that Silverman used his status as chief executive officer and director and as the principal, if not sole, negotiator to enrich himself at the expense of the other Ply Gem shareholders. They contend that Silverman's conduct tainted the merger process and denied Ply Gem's shareholders a fair price for their stock. Plaintiffs further allege that by acquiescing in Silverman's conduct, the directors breached their duties of loyalty and due care to the Company and its shareholders. At oral argument and in correspondence following oral argument, Plaintiffs also invoked McMullin v. Beran to advance the contention that the board improperly delegated responsibility for the negotiation process to Silverman.
McMullin v. Beran, Del Supr., 765 A.2d 910 (2000).
In response, Defendants first argue that the claims asserted by Plaintiffs are derivative in nature. They contend that if the claims are derivative, then Plaintiffs lost standing to assert those claims when their status as shareholders of Ply Gem was terminated as a result of the merger. Second, Defendants maintain that the merger was approved by an informed and independent board and that as a result the directors' actions are to be evaluated under the business judgment rule. The Defendants also seek to invoke an exculpatory charter provision that protects the directors from monetary liability for breaches of their duty of care. Finally, they contest Plaintiffs' characterization of McMullin v. Beran as establishing a prohibition against merger negotiations conducted by an interested corporate officer who has a substantial personal financial interest, independent of his interest as a shareholder, in the merger agreement.
See Lewis v. Anderson, Del. Supr., 477 A.2d 1040, 1049 (1984).
Defendants, at p. 16, n. 6 of Defendant's Joint Brief in Support of their Motion to Dismiss Plaintiffs' Consolidated Amended Complaint, invite the Court to dismiss the Complaint because Plaintiffs lost standing when they tendered their shares or accepted the benefit of the cash out merger. See Bershad v. Curtiss-Wright Corp., Del. Supr., 535 A.2d 840, 848 (1987). In addition to relying upon facts not alleged in the Complaint, Defendants have failed to demonstrate that those who accepted the merger benefits (under either format) did so knowingly. See Norberg v. Security Storage Co. of Washington, Del. Ch., C.A. No. 12885, Steele, J. (Sept. 19, 2000).
IV. ANALYSIS
A. Applicable Standard.A motion to dismiss under Court of Chancery Rule 12(b)(6) requires the Court "to take the facts alleged as true and view all inferences from those facts in the light most favorable to plaintiff" and "to determine with reasonable certainty, under any set of facts that could be proved" that the Plaintiffs would not be entitled to relief. If Defendants do not meet this rigorous standard, then the Court must deny their motion to dismiss.
McMullin v. Beran, 765 A.2d at 916; Wagner v. Selinger, Del. Ch., C.A. No. 16740, Steele. V.C. (Jan. 18, 2000).
B. Individual or Derivative Claims.
The line that separates an individual action from a derivative action is sometimes difficult to discern. When the challenged conduct is part of the merger process, characterization of the claim as derivative is fatal to the prosecution of the claim. Here, Plaintiffs allege that Silverman manipulated the merger process to favor his own personal purposes. They assert that Silverman used his position to assure himself an extravagant personal compensation package to the detriment of the shareholders' best interests. Examples cited by Plaintiffs as evidence of Silverman's self-dealing and the unfairness of the merger process include his exercising full control over all negotiations, pursuing negotiations despite the board's decision that Ply Gem was not for sale, failing to advise the board of his efforts to negotiate a sale, and insisting that his unjustified personal demands be met as a condition to any agreement.
Parnes v. Bally Entertainment Corp., Del. Supr., 722 A.2d 1243 (1999); Behrens v. Aerial Communications, Inc., Del. Ch., C.A. No. 17436, mem. op. at 8, Jacobs, V.C. (May 18, 2001); Turner v. Bernstein, Del. Ch., C.A. No. 16190, mem. op. at 28, Jacobs, V.C. (Feb. 9, 1999); Donald J. Wolfe, Jr. Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery, ¶ 9-2(a) at 9-4-5 (2000).
See n. 4, supra, and accompanying text.
Although Plaintiffs allege in conclusory fashion that the price paid to them for their shares was "unfair," the specific factual allegation in the Complaint is that Nortek reduced its offer by $0.75 per share in order to satisfy Silverman's unjustified personal demands. Parnes v. Bally Entertainment Corp. teaches that, in the merger context, the presentation of a direct claim requires that the "stockholder must challenge the validity of the merger itself, usually by charging the directors with breaches of fiduciary duty resulting in unfair dealing and/or unfair price." The attack on Silverman's conduct during the course of the merger negotiations, and the board's acquiescence in it, is a challenge by Plaintiffs to the fairness of the merger process. Accordingly, Parnes dictates that Plaintiffs' claims must be treated as individual claims and not as derivative claims.
Complaint, ¶ 47. See Parnes v. Bally Entertainment Corp., 722 A.2d at 1246-47, for its discussion of "unfair" price in a similar context.
Complaint, ¶ 42. A fundamental difficulty with Plaintiffs' case is that it is likely that some substantial payment could properly have been made to Silverman and they have not articulated clearly their split on how much was appropriate and how much was not appropriate. They rely upon the $0.75 reduction in the Nortek offer to accommodate Silverman's side deal, but it is conceivable, on further proof, that the side arrangement was reasonable and fair to the shareholders. That, however, is a question for another day because, based on the allegations of the Complaint, the Court must draw the inference in favor of Plaintiffs that Silverman was not entitled to insist upon a termination of his employment agreement on his own initiative and, further, to receive substantial payments for the termination. The record before the Court does not support any contention that Nortek (or Hicks, Muse for that matter) insisted that Silverman leave the business. If Silverman was going to exit because he wanted to exit, the basis for his right to demand termination compensation cannot be gleaned from the Complaint, and Plaintiffs have alleged that he was not entitled to such payments.
Parnes v. Bally Entertainment Corp., 722 A.2d at 1245.
See also Crescent/Mach I Partners, L.P. v. Turner, Del. Ch., C.A. No. 17455, Steele, J. (Sept. 29, 2000); Chaffin v. GNI Group, Inc., Del. Ch., C.A. No. 16211, Jacobs, V.C. (Sept. 3, 1999).
Defendants rely extensively upon Golaine v. Edwards, but that case does not dictate a different result. In Golaine, this Court commented on Parnes' analysis of what a plaintiff must allege about the merger process in order to plead an individual claim, as follows:
Golaine v. Edwards, Del. Ch., C.A. No. 15404, Strine, V.C. (Dec. 21, 1999).
"It is not quite clear whether the door is open for a plaintiff to state an individual claim by alleging that the negotiation of side transactions tainted the merger negotiations by unfairly diverting merger consideration that would have otherwise gone to the target stockholders into the pockets of target company fiduciaries."
Id., mem op. at 15.
The Golaine Court then posited the following circumstances, remarkably similar to those alleged here:
1. The CEO of the target company learned that the acquirer would pay $10,000,000 more.
2. The CEO agreed to this proposal but on the condition that $2,000,000 of the additional payment would be diverted to him.
3. The final consideration was fair, but the shareholders would have received an additional $2,000,000 if the CEO had not negotiated for his own account.
The Golaine Court's conclusion was that, in these hypothetical circumstances, it was probable that under Parnes the $2 million payment could be attacked individually as the product of unfair dealing that tainted the final merger terms. The issue became whether an individual claim could exist only if the process were so unfair as to have resulted in an unfair price, or whether an individual claim could exist where the unfair process resulted in a less than the best reasonably available, but not unfair, price. Parnes makes clear that the test is whether the alleged breaches of fiduciary duties resulted in unfair price and/or unfair process. Thus, given the disjunctive nature of the standard, it is difficult to imprint an unfair price concept on the process side of the Parnes evaluation. As Golaine frames it, "the real question underlying the teaching of Parnes [is] whether the Complaint states a claim that the side transactions caused legally compensable harm to the target's stockholders by improperly diverting consideration from them to their fiduciaries."
Id.
Parnes v. Bally Entertainment Corp., 722 A.2d at 1245 (emphasis added).
Fairness considerations of price and process are not necessarily considered separately. See Weinberger v. UOP. Inc., Del. Supr., 457 A.2d 701, 711 (1983).
Golaine v. Edwards, mem. op. at 16-17. In Golaine, the payment to KKR of $20 million was deemed immaterial when measured against the $8.3 billion transaction. Here, the benefits flowing to Silverman, to some of which he may well have been entitled, constituted in excess of 10% of the total transactional value (i.e., approximately $37 million out of a transaction valued at roughly $275 million).
In short, the Complaint can be read fairly to allege that, as the result of the unfair process orchestrated by Silverman, Nortek reduced the per share price that it was willing to pay to the Ply Gem shareholders in order to increase the amount that it was willing to pay Silverman on his side transaction. Parnes teaches that such conduct will serve as the basis for individual or direct claims.
Complaint, ¶ 42.
Although the Complaint may directly challenge the merger, "it does not necessarily follow that the Complaint adequately states a claim for relief' under Court of Chancery Rule 12(b)(6). Thus, by putting fairly before the Court the contention that they are challenging the fairness of the merger price or the merger process, Plaintiffs can survive the derivative-individual obstacle yet still fail to assert a claim that would allow them to move beyond a Rule 12(b)(6) confrontation. With this in mind, I now turn to the issue of whether Plaintiffs' claims are legally sufficient.
Parnes v. Bally Entertainment Corp., 722 A.2d at 1246.
C. The Duty of Loyalty Claims.
The Ply Gem directors, became obligated to seek "the best value reasonably available for all stockholders when they joined the process for a complete sale of the Company."
McMullin v. Beran, 765 A.2d at 918; Paramount Communications. Inc. v. QVC Network, Inc., Del. Supr., 632 A.2d 34, 44 (1993).
Plaintiffs assert that the Ply Gem board breached its duty of loyalty to the shareholders and that, as a consequence of that breach, Silverman received the benefits of an "exorbitant" and improper "side" deal at the expense of the Ply Gem shareholders. Because Ply Gem's directors are presumed to have exercised disinterested and independent business judgment in approving the Nortek merger, the Plaintiffs must allege facts sufficient to overcome that presumption. As this Court has held:
Complaint, ¶ 44.
Chaffin v. GNI Group, mem. op. at 13.
"The Delaware Supreme Court broadly set forth the inquiry for questions regarding director disinterest and independence in Aronson v. Lewis. There, the Court held that a director is considered interested when he will receive a personal financial benefit from a transaction that is not equally shared by the stockholders or when a corporate decision will have a materially detrimental impact on a director, but not the corporation or its stockholders. Independence, the Aronson Court held, means that a director's decision is based on the corporate merits of the subject matter before the board rather than extraneous considerations or influences. To establish lack of independence, a plaintiff meets his burden by showing that the directors are either beholden to the controlling shareholder or so under its influence that their discretion is sterilized."
In re Western National Corp. Shareholders Litig., Del. Ch., C.A. No. 15927, mem. op. at 28, Chandler, C. (May 22, 2000) (footnotes omitted).
Thus, unless the Nortek merger was approved by a majority of disinterested and independent directors, the Defendants must bear the burden of proving that the transaction was entirely fair to Ply Gem's shareholders.
Cinerama. Inc. v. Technicolor, Inc., Del. Ch., 663 A.2d 1134 (1994), affd, Del. Supr., 663 A.2d 1156 (1995).
1. Interested in the Transaction.
A director is considered interested in a transaction if he receives "a personal benefit from a transaction that is not equally shared by the shareholders." Here, Plaintiffs allege, Silverman received payment for the termination of his employment contract and his non-competition agreement and the forgiveness of his debt to Ply Gem. All of these benefits were unique to him and were not shared with the other stockholders. Thus, for purposes of this motion, Silverman must be considered "interested."
Rales v. Blasband, Del. Supr., 634 A.2d 927, 936 (1993); Aronson v. Lewis, Del. Supr., 473 A.2d 805, 812 (1984).
There is no allegation that any of the remaining directors obtained any improper benefit whatsoever from the merger other than from their entitlement, as shareholders, to receive the merger consideration. They received the merger consideration on the same terms as any other shareholder. Thus, the Complaint does not allege that any of the other six directors were "interested" in the Nortek merger transaction.
Although Snyder received significant compensation for his options, I do not read the Complaint to allege any impropriety with respect to such payment.
2. Independence from Silverman's Alleged Domination.
Plaintiffs' challenge to the independence of the other directors from Silverman's domination presents a more difficult question.
"In assessing director independence, Delaware courts apply a subjective `actual person' standard to determine whether a `given' director was likely to be affected in the same or similar circumstances." McMullin v. Beran, 765 A.2d at 923.
The focus of Plaintiffs' attack on the loyalty of the directors is directed to Silverman's status both as the holder of 25% of the Ply Gem stock and as Ply Gem's Chairman and Chief Executive Officer. The inference, which Plaintiffs seek the Court to draw in their favor under the pleading standards of Court of Chancery Rule 12(b)(6), is that Silverman, by virtue of his position, was able to induce the directors to place Silverman's personal interests ahead of the stockholders' interests in approving the Nortek merger and the related Silverman agreement.
In Friedman v. Beningson, the chairman, chief executive officer and president held 36% of the outstanding stock. The Court observed that "[f]rom a practical perspective, this confluence of voting control with directorial and official decision making authority, while not itself sufficient under the cases to support a conclusion of reasonable doubt [citing Aronson], is nevertheless itself quite consistent with control of the board." That Silverman's status is consistent with an ability to override fellow director independence may well be an accurate assessment, but, as noted in Friedman, Silverman's status alone is not sufficient to overcome the presumption that the other directors, in fact, performed their duties loyally. Indeed, in Aronson, the Supreme Court acknowledged that a 47% shareholder would not be presumed to dominate the corporation's board of directors.
Friedman v. Beningson, Del. Ch., C.A. No. 12232, mem. op. at 10, Allen, C. (Dec. 4, 1995), appeal refused, Del. Supr., 676 A.2d 900 (1996)(TABLE).
Aronson v. Lewis, 473 A.2d at 815.
Plaintiffs are confronted with the challenge of pleading facts that create, at a minimum, a reasonable doubt that the board members could not honestly and objectively evaluate the Nortek merger, with its related Silverman agreement, because of their relationship with Silverman. "Speculation on the motives for undertaking corporate action" will not satisfy Plaintiffs' burden. Similarly, the mere assertion of personal or business relationships will not defeat the presumption of independence.
Grobow v. Perot, Del. Supr., 539 A.2d 180, 188 (1988).
In re Walt Disney Co. Derivative Litig., Del. Ch., 731 A.2d 342, 355 (1998), aff'd in part and rev'd in part sub nom. Brehm v. Eisner, Del. Supr., 746 A.2d 244 (2000); In re Grace Energy Corp. Shareholders Litig., Del. Ch., C.A. No. 12464, Hartnett, V.C. (June 26, 1992).
Although Plaintiffs' allegations of lack of independence may be far from compelling, the facts alleged in the Complaint supply the Court with a basis for a reasonable doubt as to whether five of the other six directors were independent. Although discovery and development of the factual record may well prove that the directors discharged their duties with absolute propriety and free of any control by Silverman, at this stage, "the existence of [the other directors' interests and relationships with Silverman] is enough to defeat a motion to dismiss and warrant further inquiry.
The Complaint does not allege how many directors voted for the merger. Plaintiffs must allege sufficiently that the merger would not have been approved without the vote of the directors who were interested or disqualified. See Beneville v. York, Del. Ch., C.A. No. 17638, Strine, V.C. (July 10, 2000); Aronson v. Lewis, 473 A.2d at 815.
In re New Valley Corp. Derivative Litig., Del. Ch., C.A. No. 17649, mem. op. at 19-20, Chandler, C. (Jan. 11, 2001).
A review of the status of each of the other directors follows.
a. The Employee Directors.
(i) Dooskin. In addition to having been a director of Ply Gem since 1986, Dooskin was also its Executive Vice President. However, his status as an officer does not necessarily support the inference that he was under the control of Silverman, and his ownership of more than 3% of the then-outstanding Ply Gem stock would suggest a high level of personal self-interest in maximizing the merger value of Ply Gem. On the other hand, not only was Silverman Dooskin's supervisor, but also he was the largest stockholder in Ply Gem. As such, Silverman was "in a position to exercise considerable influence" over Dooskin, and, therefore, Plaintiffs, under the pleading standards of Chancery Rule 12(b)(6), have created a reasonable doubt as to Dooskin's capacity to consider impartially the Nortek merger agreement and the related Silverman agreement.
See Mizel v. Connelly, Del. Ch., C.A. No. 16638, mem. op. at 7, Strine, V.C. (July 22, 1999).
See Rales v. Blasband, 634 A.2d at 937. I acknowledge that Dooskin had an employment contract extending into 2000 and that Plaintiffs do not allege that Dooskin received "substantial remuneration" for his position. See In re Walt Disney Co. Derivative Litig., 731 A.2d at 357 ("reasonable possibility that they are more beholden to").
(ii) Snyder. Snyder was also both President and Chief Operating Officer of Ply Gem. He had joined the Company in 1995 and had acquired approximately 6% of its common stock. In addition to a long-term compensation award consisting of options, Snyder, in 1996, received a salary of $440,000 and a bonus of $890,000. Plaintiffs allege that Snyder received substantial compensation for his services to Ply Gem, and, thus, Silverman, as with Dooskin, was "in a position to exercise considerable influence" over Snyder. Accordingly, the Complaint has raised a reasonable doubt as to Snyder's capacity to consider impartially the Nortek transaction with its benefits for Silverman.
But see text accompanying n. 46, infra. (Defendants assert that Snyder abstained from voting on the Nortek transaction.)
Although three of these directors were not employees of Ply Gem, they were intimately connected to the Company. Modlin had been the Company's lawyer for years and Goldenberg and Hersh had been Company executives.
(i) Modlin. Modlin had been general counsel for Ply Gem for almost four decades, apparently predating Silverman's arrival. In 1996, his law firm received almost $1 million in fees from Ply Gem. That a director's law firm receives fees from the corporation does not, by itself, demonstrate a lack of independence. However, the Complaint alleges that Modlin "was a partner in the firm of Messrs. Elihu H. Modlin and Charles M. Modlin," from which it can be inferred that his was a small law firm. The Chancellor's analysis of a case involving comparable facts is instructive:
See McMillan v. Intercargo Corp., Del. Ch., 768 A.2d 492, 503 (2000) (as to interestedness).
Complaint, ¶ 6.
Director Goodman is an attorney employed by a law firm, not Telxon itself. Defendants characterize him as an outside independent director, beyond the influence of Telxon's CEO. According to the complaint, Goodman's law firm, however, received nearly $1 million in 1993 for services provided to Telxon. Goodman's firm is a small one. Realism of the kind signaled by Rales requires one to acknowledge the possibility that a partner at a small law firm bringing in close to $1 million in revenues from a single client in one year may be sufficiently beholden to, or at least significantly influenced by, that client as to affect the independence of his judgment. . . . As Myerson is Telxon's chief executive officer, he undoubtedly possesses the authority to hire and fire the corporation's legal counsel. For this reason, the pleadings raise a reasonable doubt concerning Goodman's independence in assessing the merits of a demand letter attacking the [subject] agreements.
Steiner v. Myerson, Del. Ch., C.A. No. 13139, mem. op. at 24-25, Allen, C. (July 18, 1995).
Thus, Modlin's firm's receipt of substantial fees over a period of years for professional services raises a reasonable doubt as to the independence of his judgment.
See In re Walt Disney Co. Derivative Litig., 731 A.2d at 357-58 (architectural services); but see Tabas v. Mullane, D.N.J., 608 F. Supp. 759, 768 (1985) (legal services). Although lawyers are subject to unique and demanding professional standards, see e.g., The Delaware Lawyers' Rules of Professional Conduct, I am not persuaded that, for present purposes, the nature of professional fees ( e.g., architectural, medical, or legal) supports a differential analysis based on the specific profession.
I also note that Modlin's son was Ply Gem's corporate secretary. Whether the position of corporate secretary carried any material benefit or whether it was simply an accommodation provided as part of his firm's legal services to Ply Gem is not clear from the Complaint. Thus, I infer nothing from the son's status. See Chaffin v. GNI Group. Inc., supra; Mizel v. Connelly, supra.
(ii) Goldenberg. Goldenberg served as a consultant to Ply Gem from 1994, after he ceased serving as its chairman. In 1996, he received consulting fees of almost of $300,000. The receipt of substantial consulting fees, in the context where Silverman was the largest shareholder and the chief executive officer provides a sufficient factual basis to create a reasonable doubt as to whether Goldenberg was independent of Silverman.
See In re Walt Disney Co. Derivative Litig., 731 A.2d at 357-58; See Kahn v. Dairy Mart Convenience Stores, Inc., Del. Ch., C.A. No. 12489, mem. op. at 14, Jacobs, V.C. (Mar. 29, 1996).
(iii) Hersh. Hersh, a co-founder of the corporation and a director since 1954, is alleged to have received $91,000 in consulting fees during 1996 from Ply Gem. Although the allegations against Hersh may fairly be characterized as skimpy, given my disposition as to other directors against whom the allegations are not compelling and the Chancellor's conclusion in Friedman v. Beningson that consulting fees of $48,000 in one year could provide the basis for the finding of impairment of ability to exercise non-conflicted business judgment, I conclude that the Complaint does state a reasonable basis to question Hersh's independence.
See Friedman v. Beningson, supra. Although the Chancellor in In re Walt Disney Co. Derivative Litig., 731 A.2d at 360, concluded that allegations of payment of a consulting fee of $50,000 in one year to Senator Mitchell did not justify a reasonable doubt as to his independence, the Court, in so ruling, focused on his status as "a nationally known legal and political figure," which seemingly reduced the potential that such a payment might affect his judgment.
(iv) Lilley. The only allegation regarding Lilley, who had been a director for less than three years, was that his firm was paid $25,000 for consulting services. In the absence of some allegation that this was material to Lilley, I am satisfied that the Plaintiffs have not stated any basis to doubt Lilley's independence.
Because, Plaintiffs have been successful in alleging the necessary factual basis for a reasonable doubt as to the disinterestedness or independence of six of the seven directors, Defendants' Motion to Dismiss the Complaint, except as to Lilley, as to the duty of loyalty claims must be denied. This result does not reflect any judgment on the ultimate merits of these claims. It is the product solely of their status and their relationships with both the Company and Silverman. At this stage of the proceedings, the Court is required to afford Plaintiffs every reasonable inference from their well-pled factual allegations. The Court's scope of inquiry is also limited because, subject to certain exceptions not relevant here, it may not look beyond the Complaint. For example, I cannot consider Defendants' assertions that Snyder abstained from voting on the Nortek transaction and that the outside directors all lost their legal or consulting fees as a result of the Nortek merger. These issues, and others, can all be addressed on a more complete factual record and must wait for another day.
In re Sante Fe Pac. Corp. Litig., Del. Supr., 669 A.2d 59, 68 (1995).
Affidavit of Mitchell A. Lowenthal in Support of Defendants' Motion to Dismiss Plaintiffs' Consolidated Amended Complaint ("Lowenthal Aff."), Ex. A, Schedule 14D-9 at 19. 25-26.
See Defendants' Joint Reply Brief in Support of their Motion to Dismiss Plaintiffs' Consolidated Amended Complaint, at 2 (also chastising Plaintiffs for their "apparent decision to avoid reference to publicly disclosed (but inconvenient) facts."). In addition, Defendants have apprised the Court that one of the Plaintiffs in this action filed an action in New York against Furman Selz in which he alleged that an independent Ply Gem board relied upon, a fairness opinion negligently prepared by Furman Selz in approving the Nortek merger. The plaintiff in the New York proceedings suggested that the five directors (other than Silverman and Snyder) operated independently as an ad hoc special committee:
"Lilley and the rest of the Ply Gem board (other than Silverman and Snyder who had conflicting interests) occupied a role substantially equivalent to that of a special committee."
Letter from A. Gilchrist Sparks, III, Esquire, dated Dec. 5, 2000, quoting at 2, Plaintiffs' Memorandum of Law in Opposition to Defendant Furman Selz LLC'C (sic) Motion to Dismiss or, in the Alternative, to Stay this Action. Exhibit at p 19, as filed in the New York proceedings.
See McMullin v. Beran, 765 A.2d at 924-25; In re Western National Corp. Shareholders Litig., supra.; In re New Valley Corp. Derivative Litig., supra; Parnes v. Bally Entertainment Corp., Del. Ch., C.A. No. 15192, Chandler, C. (Feb. 20, 2001).
D. The Duty of Care Claims.
The breach of duty of care claims, alleged by Plaintiffs without preciseness or enthusiasm, seem to be a combination of two considerations: (i) that the directors agreed to a payment to Silverman that was substantially more than any amount to which he was entitled, and (ii) that the directors were not appropriately involved in the negotiations and failed to acquire adequate information regarding the merger agreement, including the side benefits to Silverman.
Article VIII of Ply Gem's Certificate of Incorporation provides in part:
A director of this corporation shall not be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the General Corporation Law of the State of Delaware, or (iv) for any transaction from which the director derived an improper personal benefit.
Lowenthal Aff., Ex. D.
This provision, authorized by 8 Del. C. § 102(b)(7), generally shields directors from monetary liability for a breach of their duty of due care.
Section 102(b)(7), of course, does not shield directors from personal liability for breach of their duty of loyalty. See, e.g., McMullin v. Beran, 765 A.2d at 926.
Because the Section 102(b)(7) provision cannot be found in the Complaint, there may be doubt as to whether the Court may consider the exculpatory provision in the Certificate of Incorporation in the context of a motion to dismiss. The established Chancery practice, which I will follow until instructed otherwise, is to address the Section 102(b)(7) defense in resolving motions to dismiss through the taking of judicial notice of the applicable provision in the certificate of incorporation. I do so because it promotes the efficient allocation of the Court's and the parties "resources.
Id., at 926; Emerald Partners v. Berlin, Del. Supr., 726 A.2d 1215, 1223-24 (1999)(§ 102(b)(7) provision "is in the nature of an affirmative defense.").
In Re Frederick's of Hollywood, Inc. Shareholders Litigation, Del. Ch., C.A. No. 15944, Jacobs, V.C. (Jan. 31, 2000), appeal pending sub nom. Malpiede v. Townson, Del. Supr., No. 80, 2000; McMillan v. Intercargo Corp., 768 A.2d at 501 n. 40; In Re Lukens, Inc. Shareholders Litig., Del. Ch., 757 A.2d 720, 724 n. 1 732-34 (1999); see In re BHC Communications, Inc. Shareholders Litig., Del. Ch., Consol. 18209, mem. op. at 15 n. 4, Lamb, V.C. (June 4, 2001).
Accordingly, because Lilley is entitled to the shield of Section 102(b)(7) and because the Complaint fails to state a claim as to any breach of his duty of loyalty, he is entitled to dismissal of the action against him.
Plaintiffs' allegations of disloyalty as to the other directors, however, have survived the motion to dismiss. "[I]f a complaint adequately alleges . . . disloyalty . . . or if the nature of the alleged breach of duty is unclear, the complaint will not be dismissed on a motion made under Rule 12(b)(6) on the basis of an exculpatory charter provision." Thus, I need not determine if the imprecise allegations of breaches of the duty of care would, if they stood alone, be dismissed under Section 102(b)(7).
In re Lukens, Inc. Shareholders Litig., 757 A.2d at 734. "Because the nature of the defendants' breach of fiduciary duty remains unclear at this time, I may not now properly consider exculpatory provisions. The defendants will have the opportunity to present their affirmative defenses as the case progresses. At this stage of the proceedings, I can not conclude as a matter of law that the Board acted in good faith and that their actions constituted no more than mere carelessness." Sanders v. Wang, Del. Ch., C.A. No. 16640, mem. op. at 28, Steele, V.C. (Nov. 8, 1999).
E. Delegation of Authority to Negotiate.
At oral argument, and in correspondence following oral argument, Plaintiffs attempted to make the claim that the directors improperly delegated to Silverman the responsibility for negotiating the merger transaction. There is nothing inherently wrong with an interested chief executive officer negotiating a merger transaction. In most instances, the chief executive officer is the person most knowledgeable about the company, its value, and the industry in which it operates. Moreover, because Silverman was Ply Gem's largest shareholder, he also had a significant personal incentive to maximize the value of his shares. As noted in McMullin, the Ply Gem board "could properly rely on the majority shareholder to conduct preliminary negotiations." Plaintiffs, however, contend that Silverman did more than "conduct preliminary negotiations." Even if that is true, the issue becomes whether the Ply Gem board satisfied its "ultimate statutory duty and fiduciary responsibility to make an informed and independent decision" on whether to enter into the Nortek merger transaction.
This contention is addressed separately, not because it is not to be analyzed under the triad of the duty of care, the duty of loyalty, and the duty of good faith, but because the parties have addressed it separately.
McMillan v. Intercargo Corp., 768 A.2d at 503.
McMullin v. Beran, 765 A.2d at 924.
Id.
If an informed and disinterested majority of the board had duly approved the Nortek merger and the related Silverman agreement, Silverman's interest in the transaction and his involvement in the negotiations would not have provided the basis for a challenge. Here, however, the Plaintiffs' Complaint sufficiently alleges that a majority of the board approving the merger was not independent of Silverman's domination. Thus, Plaintiffs' loyalty claims survive, not so much because negotiation authority was delegated to a conflicted officer and director, but because it is sufficiently alleged that the directors who ultimately reviewed and approved the transaction were not independent of that interested officer and director.
IV. CONCLUSION
For the foregoing reasons, Defendants' Motion to Dismiss is granted as to Lilley, but it is denied in all other respects.
An Order will be entered in accordance with this Memorandum Opinion.
ORDER
NOW, this 26th day of June, 2001, for the reasons set fofth in the Court's Memorandum Opinion of this date,
IT IS HEREBY ORDERED:
1. Defendants' Motion to Dismiss Plaintiffs' Consolidated Amended Complaint is granted, without prejudice, as to Defendant William Lilley III.
2. Defendants' Motion to Dismiss Plaintiffs' Consolidated Amended Complaint is otherwise denied.