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In Chester County Employees’ Retirement Fund v. KCG Holdings, Inc. et al the Delaware Court of Chancery considered the interplay between the Corwin and Revlon doctrines. In July 2017, Virtu Financial, Inc. (“Virtu”) acquired KCG Holdings, Inc. (“KCG”) for $20 per share. A former KCG stockholder alleged KCG’s directors failed to maximize value for the KCG stockholders in negotiating the merger.

In April 2017, Virtu made its best and final bid of $20 per share. Every director except for KCG’s chief executive officer, Daniel Coleman, approved a $20.21 per share counteroffer. Coleman told the board that a $20.21 counteroffer was “too low” and that a contemplated restructuring plan would create 25% more value than KCG’s offer. Still, Coleman promised that he would support the merger if he could negotiate a satisfactory compensation and retention pool for himself and his management team.  According to the Court, Coleman’s desire to obtain compensation for his management team conflicted with the KCG board’s obligation to maximize consideration paid to the KCG stockholders. Despite this conflict, the board authorized Coleman to negotiate simultaneously the compensation pool and deal price. In the end, KCG rejected the $20.21 counteroffer and Coleman negotiated a compensation pool to his satisfaction. Then, the KCG board—including Coleman—approved a $20 per share price.

The plaintiff commenced litigation claiming, among other things, that the director defendants breached their fiduciary duties in negotiating and approving the merger. The Court examined the allegations in the complaint on a motion to dismiss.  The defendants argued that the merger was subject to the deferential business judgment standard of review under Corwin because it was approved by a majority of KCG’s stockholders in a fully informed, uncoerced vote.

The Court rejected the defendants’ arguments that the stockholder vote was fully informed.  Corwin was therefore inapplicable and plaintiff’s claims were subject to the Revlon standard of review.  The Court explained under Revlon:

  • directors are generally free to select the path to value maximization, so long as they choose a reasonable route to get there;
  • directors must maintain ‘an active and direct role in the context of a sale of a company from beginning to end:
  • part of providing active and direct oversight is becoming reasonably informed about the alternatives available to the company;
  • another part of providing active and direct oversight is acting reasonably to learn about actual and potential conflicts faced by directors, management, and their advisors.

The Court noted KCG’s charter contained a provision exculpating the director defendants from liability for monetary damages for breaching their duty of care.   Therefore the plaintiff must plead a violation of the duty of loyalty or good faith to avoid dismissal of its claims against the director defendants.  To meet this standard, the plaintiff argued that the majority of the director defendants acted in bad faith by failing to cabin Coleman’s conflict.

The Court found the complaint adequately alleged that Coleman’s interest in negotiating the compensation pool gave rise to conflicts during Coleman’s negotiations of the deal price. The director defendants knew of these conflicts and also knew that Coleman was willing to make them paramount to negotiating a higher deal price. In fact, plaintiff alleged that Coleman told the Board that “if Virtu were to be agreeable with providing comfort on the closing risks, particularly personnel risks and the retention pool, he would work diligently in support of the Board’s decision to see the transaction successfully through closing.”

Rather than cabining Coleman, or limiting his authority to negotiations over the compensation pool, the full Board authorized Coleman to negotiate both the compensation pool and the deal price. KCG’s Board Chairman Charles E. Haldeman, Jr. expressly instructed Coleman to “get the comp issue resolved and then you can resolve the price issue.” This suggested an understanding that success on the compensation issue might position KCG to give on the price issue. Once Coleman secured the compensation pool that benefitted the officers and directors, the Board agreed to the $20 per share price. Although Virtu had rejected the Board’s counteroffer of $20.21, once the negotiations for the compensation pool were finalized, Haldeman was happy.  Upon learning from Coleman that he had resolved the compensation pool issue with Virtu, he responded: “[G]reat news. Thank you for your understanding on this. The Board is very appreciative on this.”

According to the Court, the Board then permitted Coleman to revise the KCG projections downward, which made the $20 per share merger price look more attractive. The plaintiff alleged that the Board approved the revised projections at Coleman’s request, without any deliberation, over email, and the night before receiving a financial advisor’s fairness opinion.

The court stated the plaintiff’s allegations make it reasonably conceivable the KCG board placed the interests of members of management, who benefited from the compensation pool, above the interests of the stockholders. Citing precedent, the Court stated “A failure to act in good faith may be shown . . . where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation[.]”  The Court found the complaint supported an inference of bad faith, and stated a non-exculpated claim because it was reasonably conceivable that the director defendants placed management’s interests ahead of their obligation to maximize stockholder value.

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